ECON 1102 Midterm 2

saving

income that is not spent on consumption goods

investment

the purchase of new capital goods

lifecycle theory of savings

by borrowing, saving, and dissaving, workers can smooth their consumption over their lifetime

demand to borrow

the lower the interest rate, the greater the quantity of funds demanded

markets for loanable funds

occurs when suppliers of loanable funds (savers) trade with demanders of loanable funds (borrowers)

equilibrium in the market for loanable funds

the quantity of funds supplied equals the quantity of funds demanded

financial intermediaries

they reduce the costs of moving savings from savers to borrowers and investors

• entities such as banks, bond markets, and stock markets

bond

a sophisticated “I owe you” that documents who owes how much and when payment must be made

maturity date

date at which the face value is received

face value (V)

cash amount received at the maturity date

coupon payment

amount that bond pays until the maturity date

T-bonds

30-years bonds; they pay interest every 6 months

T-notes

maturities range from 2 to 10 years; they pay interest every 6 months

T-bills

maturities range from a few days to 26 weeks; they pay only at maturity

zero-coupon bonds

“discount bonds”; they pay only at maturity

present value

the discounted value of a stream of payments

collateral

something of value that, by agreement, becomes the property of the lender if the borrower defaults

arbitrage

the buying and selling of equally risky assets

• ensures that equally risky assets earn equal returns

crowding out

the decrease in private consumption and investment that occurs when government borrows more

stock

a certificate of ownership in a corporation

• also called a share

initial public offering (IPO)

the first time a corporation sells stock to the public in an effort to raise capital

usury laws

impose a maximum ceiling on the interest rate that can be charged on a loan

owner equity

the value of the asset minus the debt

E = V - D

leverage ratio

the ratio of debt to equity

D/E

insolvent

when a firm has liabilities that exceed its assets

fire sale

the forced sale of a financial asset drives down the price of related assets, forcing more sales, further driving down the price

stock exchanges

people trade stocks in organized markets

interest rate

the cost of borrowing money and the reward for saving

• essentially the number of dollars per dollar (%)

commercial banks

funded themselves largely through deposits that are insured by the Federal Deposit Insurance Corporation (FDIC)

• always has some source of legally guaranteed funding

shadow banking system

financial institutions that act like banks but are traditionally less heavily regulated and monitored than banks; funded largely by investors and are not insured through the Federal Deposit Insurance Corporation (FDIC)

• includes investment banks, hedge funds, money market funds, etc.

• unlike deposits, their short-term sources of funds are not government-guarenteed

securitization

bundling individual loans into a single asset to be sold to investors

active funds

run by managers who try to pick stocks

passive funds

attempt to mimic a broad stock market index

buy and hold

the practice of buying stocks and holding them for the long run, regardless of what prices do in the short run

risk-return trade off

higher returns come at the price of higher risk

technical analysis

an approach that looks for patterns and trends in stock and asset prices

efficient markets hypothesis

the prices of traded assets reflect all publicly available information

speculative bubbles

arise when stock prices rise far higher, and more rapidly, than the fundamental prospects of the company

• e.g., price of a stock continuously rises because people expect it to, not because the company is actually making more money

herd

investors buy when others are buying and sell when others are selling

• can result in increased stock prices, followed by big decreases

unemployed

adults who do not have a job, but who are looking for work

unemployment rate

the percentage of labor force without a job

labor force participation rate

the percentage of adults in the labor force

discouraged workers

workers who have given up looking for but who would still like a job

underemployment rate

A Bureau of Labor Statistics measure that includes part-time workers who would rather have a full-time position and people who would like to work but have given up looking for a job

frictional unemployment

short-term unemployment caused by the ordinary difficulties of matching employee to employer

structural unemployment

persistent, long-term unemployment caused by long-lasting shocks or permanent features of an economy that make it more difficult for some workers to find jobs

unions

an association of workers that bargains collectively with employers over wages, benefits, and working conditions

employment at-will doctrine

an employee may quit or an employer may fire an employee at any time and for any reason

• most basic U.S. employment law

active labor market policies

policies such as work tests, job search assistance, and job restraining programs that focus on getting unemployed workers back to work

cyclical unemployment

unemployment correlated with the business cycle

natural employment rate

the rate of structural plus frictional unemployment

inflation

an increase in the average level of prices

disinflation

a reduction in the inflation rate

inflation rate

percentage change in a price index from one year to the next

consumer price index (CPI)

measure the average price for a basket of goods and services bought by a typical American consumer

• covers 80,000 goods and services, and is weighted so that major items count more

GDP deflator

the ratio of nominal to real GDP multiplied by 100

• covers finished goods and services

producer price index (PPI)

measure the average price received by producers

• includes intermediate and finished goods and services

real price

a price that has been corrected for inflation; used to compare the prices of goods over time

quantity theory of money

• sets out the general relationship between money, velocity, real output, and prices

• helps to explain the critical role of the money supply in determining the inflation rate

• SAYS the growth rate of the money supply will be approximately equal to the inflation rate

velocity of money

the average number of times a dollar is spent on finished goods and services in a year

• essentially, how fast money passes from one holder to another

deflation

a decrease in the average level of prices

money illusion

when people mistake changes in nominal prices for changes in real prices

real rate of return

the nominal rate of return minus the inflation rate

nominal rate of return

the rate of return that does not account for inflation

Fisher effect

the tendency of nominal interest rates to rise with expected inflation rates

monetizing the debt

when the government pays off its debts by printing money

business fluctuations

fluctuations in the growth rate of real GDP around its trend growth rate

recession

a significant, widespread decline in real income and employment

aggregate demand curve

shows all the combinations of inflation and real growth that are consistent with a specified rate of spending growth

Solow growth rate

an economy’s potential growth rate; the rate of economic growth that would occur given flexible prices and the existing real factors of production

long-run aggregate supply curve (LRAS)

a vertical line at the Solow growth rate

real shocks

rapid changes in economic conditions increase or decrease the potential growth rate

• e.g., wars, weather, major new regulations, tax rate changes, mass strikes, terrorist attacks, and new technologies

negative real shocks

LRAS curve moves left

• bad weather

• higher price of oil or another input

• productivity/technology slump

• higher taxes

• disruption of production by war, earthquake, or pandemic

positive real shocks

LRAS curve moves right

• good weather

• lower price of oil or another input

• productivity/technology boom

• lower taxes

• smooth production without disruption

short-run aggregate supply curve (SRAS)

shows the positive relationship between the inflation rate and real growth during the period when prices are and wages are sticky

aggregate demand shock

a rapid and unexpected shift in the AD curve (spending)

positive aggregate demand shocks

increases aggregate demand (shifts upward + right); higher growth rate of spending

• A faster money growth rate

• Confidence

• Increased wealth

• Lower taxes

• Greater growth of government spending

• Increased export growth

• Decreased import growth

negative aggregate demand shocks

decreases aggregate demand (shifts downward + left); lower growth rate of spending

• A slower money growth rate

• Fear

• Reduced wealth

• Higher taxes

• Lower growth of government spending

• Decreased export growth

• Increased import growth