macro unit 3
Ch 13:
The labor force (LF) is the number of people employed plus unemployed people
LF = E + U
Unemployment rate: number of people unemployed as a percentage
unemployment rate = U/LF
When person stops looking for work is consider out of labor force & no longer counted as unemployed
Know:
frictional unemployment:
Short term skill matching problems:
Ex: anytime between jobs for any reason → job too far, don’t like boss, etc
structural unemployment
Skill matching problems: labors firm demanding are not matching skills labor force has
Ex: huge demand for engineers but not enough ppl with these skills (short labor supply)
Cyclical unemployment:
Unemployment caused by downton in economy
Inventory levels rising, production outpacing sales → firms cut production so cut laborers that make production
Cyclical unemployment can hit 0% (only one that can be 0)
Natural rate of unemployment = only consists of structural and frictional unemployment
Cyclical rate is 0
Classical labor
Household supplies labor + firms demand labor (in classical labor market)
Prices increase, purchasing power decreases so ppl demand higher wages
Classical view of labor: wages adjust to clear labor market consistent with the view that wages respond quickly to changes
According to this view no unemployment problem
Long run AS curve is vertical
keynesian: wages not flexible
AS curve is not vertical (horizontal than changes to vertical) → add pic
Figure 13.1
What causes labor demand to shift:
Province of worker
Value of the output firm produces
Value of the worker = VMPL = mp x p = wage → profit maximizing
Mp = change in total product/change in labor
P = price of product
What causes labor supply curve to shift
Value people place on their leisure time
Don’t value leisure = supply curve shift to the right
Marginal tax rate
Increase tax rate = ppl work less
Dec tax rate = ppl work more
Explaining resistance of unepment
Theres 3 common arguments for the resistance of frictional or structural unemployment
Efficiency wage theory
Imperfect information
Min wage laws
Efficiency wage theory
Efficiency wage theory
Are wages that that are high than market equilibrium
Affirms productivity of workers increase with wage rate
If this so firms pay hv incentive to pay wages above market-clearing rate
Potential benefits firms receive include:
Lower turnover:
Turnover means need to hire more workers so more training cost
Improved morale
And reduced shirking of work
Efficiency wage theory
Internally offer income/wages above the market
So they get more skilled workers
Propensity to shirk during the job decreases bc job pays well
Highly motivated workers → more productive
.
Imperfect information:
Firms may ot have enough info that their disposal to know what market clearing wage is
This case means imperfect info
If firms hv imperfect or incomplete info they may simply set wages that don’t clear labor market
Win wage laws
Laws that set a flor on wage rates → min hourly rate for any kind of labor
In 2015, fed min wage was abt $7.25 per hr
If some teens can produce only $6 no one wants to hire
Price floor: only effective above equilibrium
Sticky wages: ??
Sticky wage
Social or implicit contracts: unspoken agreements between workers and firms that will not cut wages
Implicit = unspoken
If choice between cut wages or cut employers → will choose to cut employees
If lower wages ppl will lose productivity or quit
Explicit contracts:
Signed & agreed upon by firm
Cost of living adjustments:
Contract stipulates wages will rise based on inflation
Add figure 13,2
Unemployment & aggregate output negatively related
When Y rises, U falls,
When Y falls → U rises
Relationship between aggregate output and overall price level is positive
When Y increases, P increases
When Y dec, P dec
So when p increases, U falls
P decreases = U rises
Inverse relationship
Inflation rate : ???
Phillips curve
Shows relationship between inflation & unemployment
When stagflation curve doesn’t work
Figure 13.3
Figure 13.4
Shows negative relationship (inverse) between price level (P) & unemployment rate (U)
Figure 13.8
1st graph: When aggregate demand shifts out (right) reconfirms phillips curve
When AD shifts left → stagflation (2nd graph refutes phillips curve)
In short run phillips curve is neg slope
Long run phillips curve:
Vertical curve → shows no relationship at all between
Add pic + bullets
Phillips curve will shift to the right
Higher inflation at every level of employment
Phillips curve Shift left:
Lower inflation at every level of employment
Natural rate of unemployment:
Occurs as normal part of a functioning economy
??
Figure 13.10
If AS curve vertical in long run → so is phillips curve
U = natural rate of unemployment
NAIRU
Non-accelerating inflation rate of unemployment
Rate of unemployment that will not affect unemployment
If Actual unemployment rate below NAIRU
= inflation high = upward pressure on price
If actual unemployment Above NAIRU
= less spending = downward pressure on price → inflation go down
.
Figure 13,11 slide on exam
If NAIRU is at 1% then graph = zero change in inflation
0 is not inflation rate
1% means change in inflation every period
If greater than 1% means less spending = downard level of price = at this level inflation will dresses by 1% at every period
Leisure & working are substitutes
*Effects when income changes:
Substitution effect
When wages rise, opportunity cost of working has gone up (giving up more wages if don’t work) → so ppl will work more
When wages go down, opportunity cost of working decreases → ppl work less
Income effect
If wages go up, leisure increases → so work less
Leisure is a normal good
If wages go down, leisure decreases → so work more
Substitution effect and income effect clash (hv opposite effects)
4/11
Example: (slide 32)
Qd = 100 -5w (demand) Qs = 10w-20 (supply)
Put in terms of w so easier to graph
From Qd →
From Qs →
$11 is min wage
Find unemployment rate:
Set equations equal to each other
Quantity supplied = plug in wage at 11
Min wage is effective bc is binding price/wage floor
Qs = 90
Find Number of unemployed:
Qd = 100 - 5(11) = 45
# unemployed = Qs - Qd
= 90 - 45 = 45 unemployed
Find Unemployment rate = unemployed/labor force
Labor force = unemployed + employed
Unemployment rate = 45/90 = 0.5 → 50%
Ch 18 & 19 lectures on exam → pay attention in class
Ch 14: financial crisis, stabilization & deficits
Stocks and bonds (on exam)
When a firm goes public has right issue stocks
Downside of stock going public is losing ownership
Shareholders earn money: through asset appreciation & dividends
Stock: A certificate that certifies ownership of a certain portion of a firm.
A share of a common stock is a certificate that reps the ownership of a share of the business, almost always a cooperation
Shareholders entitled to a share of company’s profit
When profit paid directly to shareholder →payment called dividend
Instead of putting money in saving, ppl buy stock bc higher rate of return (but also riskier)
asset appreciation is how stock grows/ppl earn money → as company does better, value of stock rises
Stock price determined by:
IPO market (primary market)
Investment banks (underwriting)
Present value
Comparable companies
Damnd
Secondary market
demand (Secondary Market)
Growth Rate
Risk analysis
The expected future dividends
Interest rates
Present Value
Investment banks determine IPOs: underwrites values of shares
IPO 1st only go to high net investors, banks, etc
Normal ppl buy from secondary market
Only in IPO company acquires cash/raise capital
One period valuation model: (on exam)
.
P0 = current price of stock
Div1 = dividend paid at end of year 1
Ke = required rate of return on investment in equity
P1 = sale price of stock at end of period
Example: slide 8
Div 1 = 0.50
P1 (Expected price) = $30
Ke = 20%
Current price of stock (P0) = $25.42
If fed contractionary monetary policy:
increase rates then Ke goes up → price of stock goes down
Consumption slows down
Stock market goes down → evolutions go down
Expansionary monetary
Decrease rates: Ke goes down → price increases
Generalized dividend valuation model: (not on exam)
Difficult to determine dividends/price of stock with high level of accuracy
Capital gain: increase in value of an asset
Realized gain:
Ex: bought for $10 & sell for $15 tmr
Unrealized gain:
Ex: bought for $10 and didn’t sell when it raised to $15
Total return of owning stock is sum of dividends + capital gain/loss
Expected rate of return:
Where:
P1 = probability 1
P2 = probability 2
All probabilities must add up to 100%
Stock markets
DOW:
30 largest firms in usa
Is proxy for usa economy
If dow jones going up → economy doing well
NASDAQ
Composited index
Approx 5000 firms
Includes us companies & foreign firms
Bigger market cap = more weight firm holds in calculating index
Market cap = # of shares x price
Large cap: 300 million - 2 billion
Small cap
Mid cap
Standard & Poor’s 500 (S&P 500):
An index on the 500 largest firms in US
Leading economic indicator
Price weighted average
Market capitalization: price times the number of outstanding shares
Shares being traded in the secondary market
Market capitalization = current stock price x shares outstanding
Mutual funds mostly small cap → more risky (higher chance going bankrupt)
Bonds:
3 things stimulated when first issued a bond: face value, duration, and coupon rate
These factors never change
Bond can be issued by:
government (risk free rate)
corporate (risk free rate + risk free premium)
Corporate:
High yield bonds: very risky bonds, triple B or lower rating
Invest grade: bonds that are triple A or BAA or higher
Coupon Bond:
P = price of coupon bond
C = yearly coupon payment
F = face value of the bond
n = years to maturity date
Easier to calculate: coupon payments are certain (guaranteed)
Add pic
Example:
Face value: 1000
YTM: 3%
Coupon rate: 3%
Coupon payment: coupon rate times face value
0.03 times 1000 = 30
Duration: 2 year
P0 = 30/(1 + 0.03 )^1 + 30/(1+0.03)^2 + 1000/(1+0.03)^2 = 1000
29.13 + 28.28 + 942.60 = 1000
Bond Pricing:
Coupon Rate:
The percentage of the face value that is paid Semi-annually
Coupon rate never changes
Current yield: post settlement: (Secondary Market): is the required rate of return based on market rates
Current yield = coupon payment / current market price
Yield to maturity
The percentage rate of return for a bond assuming that the investor holds the asset until its maturity date
YTM: is a true rate of return (measures holding period not the duration)
Yield to maturity
Bond (current yield) vs coupon rate
Coupon payment = coupon rate x face value
Coupon rate = coupon payment / face value
Coupon yield = coupon payment / current price
Yield to maturity: most accurate measure of rate of return
Example: slide 18
When price above par value:
Current yield < Coupon rate: bond selling above par (face value)
bond selling above par (face value)
When price equal to par value
Current yield = Coupon rate: price equals par
When price below par value
Current yield > Coupon rate: price selling below par
Add chart slide 19
Slide #20:
Face value: 1000
YTM: 3%
Coupon rate: 5%
Coupon payment: 0.05 times 1000 = $50
Duration: 2 year
P0 = 50/(1 + 0.03 )^1 + 50/(1+0.03)^2 + 1000/(1+0.03)^2 = $1038.26
Bond can’t be 100 cuz coupon rate and YTM don’t equal
The bond has to be above face value
Set = annual / term n = 2
RDV = 1000 CPN:50 PRC = “solve”
YTM: 3
Future Value (Slide #21) add/finish
FV = ???
n is usually 1
Compound interest
???
???
FV = 100 times (1 + 0.8)^1 = 108
FV = 100 times (1 + 0.8)^2 = 116.64
FV = 100 times (1 + 0.8)^3 = 125.97
Example: Slide #22
Part 1:
(1220 - 1000) / 1000 = 0.22
FV = 150000 times (1 + 0.22)^6 = $49459.56
Part 2:
4/15
Final exam will hv min 100 questions - 105 (max)
Profit margin vs markup (on exam)
Profit margin = profit/revenue = total revenue - total cost/revenue
Mark up = profit/cost
Financial crises and 2008 bailout
3 large investment banks collapsed so market collapsed → $7 trillion lost in wealth
Middle class and wealthy ppl affected the most
Dried up investments bc sometimes mature in terms of shares
Many ppl consider fall in housing prices that began in 2006 to hv led to financial crisis of 2008-2009
Cost of investment project in terms of shares of stock is smaller than higher the price of the stock
Cost of investment in terms of shares = cost of investment/share price
As a result of fallout will passed in oct 2008:
Fed gov baliled out most of the large financial institutions experiencing financial trouble in the mortgage market
Federal reserve also participated in bailout by buying huge amts of mortgage-backed-securities (MBS)
MBS = over the counter products
TARP: $700 billion to purchase mortgage backed securities
Wall street reform and consumer protection act
Financial stability oversight
CFPB
Contains whistleblowing provision → encourage ratting ppl out
Glass steagall act of 1933
Investment banks not allowed to conduct same activity as commercial banks
Time lags regarding monetary and fiscal policies
Stabilization policy
Describes both monetary & fiscal policy the goals of which are to smooth out fluctuations in output and employment and keep prices as stable as possible
Time lags
Delays in economy due to response to stabilization policies
Don’t know if your in recession until 2 quarters after (same with bubbles)
Figure 14.4
Graph should look like this
Figure 14.5
No impact until point D, (implemented at B) → policy designed to stabilize doesn't
Recognition lag:
Time it takes for policymakers to recognize the existence of a boom or a slump
Implementation lag
Time it takes to put designed policy into effect once economists & policy makes recognize that economy is in slump or boom
Monetary Policy implemented quicker
Response lag
Time takes for economy to adjust to the new conditions after a new policy implemented
Lag occurs bc of operation of economy itself
response quicker with fiscal policy
Feel tax effect of increase immediately → if more taxes cut from paycheck
Know which is quicker for each: response lag quicker for fiscal policy and longer for monetary policy??
The response lag is generally shorter for fiscal policy than it is for monetary policy
Response lags fiscal policy
Response lag shorter
Bc takes time for the gov spending multiplier ??
??
Gov deficit
Gov trying to stimulate economy through tax cuts or spending will increase gov deficit
Cyclical deficits are temporary & don't impose long run problems
Structural deficits can have negative long run effects
Large deficits beginning in 2008 led to large rises ???
??
Figure 14.7
Increase tax and cut spending during recession (doesn’t work)
But impossible to deficit target during recession
Deficit targeting in recession doesn’t work
Deficit targeting:
Has undesirable macroeconomic consequences
It requires cuts in spending or increases in taxes at times when the economy is already experiencing problems.
Locking in spending cuts or tax increases during periods of negative demand shocks is not a good way to manage the economy.
Moving forward, policy makers around the globe will have to devise other methods to control growing structural deficits
Ch 15
Life cycle theory of consumption
Life cycle theory of consumption
Theory of household consumption
Households make lifetime consumption decisions based on their expectations of lifetime income
Permanent income
Average level of persons expected future income stream
Figure 15.1
Permanent income higher for college grads than high school grads
In early years consume more than income bc can take more risks and hv time to pay it off
Middle ages (35-60 - peak earning yrs): income > consumption bc use it to pay off earlier years
At end consumption stays same but income decreases bc retirement
APC = consumption/income ??
Labor supply decisions
Amt of income required to consume is dependent on the wage Rate, which helps determine the level of working hours.
When a household is choosing a level of
consumption, the household also sets the amount of leisure they wish to have and leisure is a substitute for working.
A consumption path requires a certain amount of lifetime income to pay for it and lifetime income is determined by working hours.
Average propensity to consume -
APC = consumption/income
APS: fraction or % income saved
APS = saving/income
APS + APC = 1
Labor and leisure are substitutes
Size of labor force determined by
Demographics:
Legal and illegal immigration
Behavior also plays a role
Households make decisions about labor supply in order to earn income to pay for their consumption.
Wage rate
Substitution effect
If wages go up, opportunity costs of working has gone up
→ giving up more wages → so will work more
Lower Wages lead to lower quantity of labor supplied
Lower wages → work less
Income effect
Leisure is a normal good → ppl buy more as income increases
Higher income Consume more leisure = work less
Lower income = less leisure → wok more
Income effect of wage rate increase:
Because leisure is a normal good, people with higher income will spend some of it on leisure by working less.
Higher incomes lowers labor supply
Lower incomes raises labor supply
Substitution effect and income effect oppose each other
Nominal wage: wage rate in current dollars
Real wage rate:
amt of goods you can purchase with that wage
Real income = nominal income/price index
Example: slide 11
2014 base: 10/7 = 1.4 index
Real wage rate in 2016, using 2014 as base year
Nominal income 2016/index in 2016 = 13/1.9 = $6.84
Purchasing power dec over years bc in 2014 could buy $7 now $6.84
Nonlabor or nonwage income.
Any income received from sources other than working
Ex inheritance, interest dividends, ??
???
??
Increase in wealth (non-labor income) → leisure increases → work less
Interest rate
Sub effect
Rise in interest rate → opportunity cost of not saving gone up → consume less
Opposite true
Income effect
Interest also income
If increase in interest income → will consume more → increase consumption
Table 15.1
Unconstrained labor supply
Amt a household would like to work within a given period at the current wage rate if ??
???
???
Factors that affect household consumption & labor supply decisions: (know for exam)
Current and expected future real wage rates
Initial value of wealth
Current and expected future non-labor income
Interest rates
Current and expected future tax rates and transfer payments
Durable goods last over 3 yrs
Figure 15.3
Animal spirits of entrepreneurs
Term describe investors feelings (by keynes)
Accelerator effect
Investment increases when aggregate output increases → GDP increases
Tendency for investment to increase when aggregate output inc and dec when aggregate output decreases, accelerating decline or ??
Firms don’t wanna operate at full capacity bc if demand increases than need to be able to rise to meet demand
Excess labor, excess capital
Labor & capital that aren’t needed to produce the firm's current level of output
Adjustment costs:
Cost that a firm incurs when it changes its production level
For ex: admin costs of laying employees off or training costs of hiring new workers
Constant training reduces productivity
Inventory investment:
Inventory investment: change in stock of inventories
Stock of inventories (end of period) = stock of inventory (beginning period) + production - sales
Desire or optimal level of inventories
Difficult to get desired level of inventory
???
Example: slide 24
Period 3: 100k + 40,000 - 30,000 = ??
Period 4: 12.3K
Figure 15.8
Output fluctuates more than employment bc adjustment costs
?????
Average product = quantity/units of labor
Example:
(1 million + 750)/ 200,250 hrs worked = 5
Okun’s law
Unemployment decreases abt 1% for every 3% increase in GDP
???
Effects that dec size of multiplier:
Automatic stabilizers
The interest rate
The response of the price level
Excess capital and excess labor
Inventories
People’s expectations about the future
Size of multiplier practice:
C = 300 + 0.5Y, when income rises what’s APC?
Y = 1000 (income?)
APC = 800/1000 = 0.8
C = 0.5Y, when income rises what's APC?
Y = 500
APC = 500/1000 = 0.5
No autonomous spending
Ch 16
Output growth: growth rate of output of entire economy
Per capita output growth: growth rate of output per person in economy
gdp/population
Used a barometer between standards of living per country
Higher Capita per output growth = higher standard of living
Labor productivity growth: growth rate of output per worker
Increase productivity of workers through incentives
Ex: physical capital
Growth process: agriculture to industry
Tech changes & capital accumulation
New inventions & machinery
New products, more output wider choice
A rural agrarian society was quickly transformed into a urban industrial society
Growth comes from bigger workforce & more productive workers
Large service sector indication of wealthier economy (USA ⅔)
Growth process:
Catch up:
Theory stating growth rate of less developed countries will exceed growth rates of developed countries
Allowing less developed to catch up
Convergence theory
Idea that gaps in national incomes tend to close overtime
Less developed countries can catch up by replicating technology of developed countries
Advantages of backwardness
Phenomena of less developed countries leaping ahead by borrowing tech of from more developed countries
In order for living standards to increase output (growth) needs to outpace population growth.
Basically an increase in GDP per Capita
GDP/population = average income per person
Per capita GDP is a measure of the total output of a country that takes gross domestic product (GDP) and divides it by the number of people in the country
Figure 16.1:
The production possibility frontier shows all the combinations of output that can be produced if all society’s scarce resources are fully and efficiently employed.
Economic growth expands society’s production possibilities, shifting the Ppf up and to the right.
Sources of economic growth:
aggregate production function:
mathematical relationship stating total GDP (output) depends on total amt of labor & total amount of capital used
Both capital & labor needed for production ??
Example:
Y = 5K???
Y = 5 x 7 x 4 = 140 (output)
Are markets fair?
2 broad & generally conflicting views of fairness:
It’s not fair if the result isn’t fair
It's not fair if the rules aren’t fair
Table 16.2 on exam
Labor productivity = Y/L = output/ quantity of labor
Marginal return to labor: delta Y/delta L
Algebraic measures of productivity:
Use derivatives to go from equations
Q/L = average product of capital
Example:
Capital 1st, labor 2nd → given as Q = F(10,5)
TP = 150 = Q
Add pic from slide 18
Example 2
Q = F(1, L) = 11/4 L3/4
Fixed input = K
Marginal product of labor wen 16 units of labor hired
MPL = 11/4 x ¾ x 16-¼ = 1/x x ¾ = 3/8 = 0.375
Table 16.3 (on exam)
1960: 69.6/117.3 = 59.3
Percentage of population = Civilian non-institutional population/civilian labor force
Determine non-instuatinaled population = labor force/percentage of population
Increase in physical capital:
Advanced economies
Adding physical capital to units of labor
Developing economies
Foreign direct investment (FDI)
Greenfield investment
building entire factory from ground up
Brownfield investment
Acquiring business assets of an existing firm in another country
Usually invest shares in company
Horizontal integration
Replicating entire production process abroad → bc of transportation cost (also shipping cost)
Can be either brownfield or greenfield
Vertical integration
Dicing up production process into stages → 1 stage abroad & rest is in original country
Due to production costs
Ex: apple has apple build monitors and then ship to USA
Table 16.4
Table 16.5 In all economies experiencing ??/
Increase in quality of labor supply (human capital)
Level of educational attainment in US has risen significantly since 1940
As quality of labor increases through more education labor productivity increases
Increase
Embodied technical change
Technical change that results in an improvement in quality of capital
Increase in quality of labor ???
???
Disembodied technical change
?????
Not testing on invention vs innovation
4/22
Abt (102-103) or 105 questions on final, each question worth 1 pt
Ch 18: international trade & protectionism
Technology has made it easier to import and export goods (international trade)
Trade surplus & deficits
Trade surplus
the situation when a country exports more than it imports
= dollar value of Exports - imports dollar value → positive = surplus
Neg number = deficit
Trade deficit
the situation when a country imports more than it exports
Economic basis for trade:
Nations have different resource endowments:
Labor abundant → labor-incentive goods
Ex: mexico is labor abundant vs USA is not
Land abundant → land-incentive goods
Capital abundant → capital-incentive goods
If abundant in a factor, should focus on that
→ ex: mexico should focus on labor intensive goods
comparative advantage (not personal bio tested)
David ricardo
Theory of comparative advantage
Labor is only factor of production
Specialization and free trade will benefit all trading partners
Focuses on specialization causes real wages to rise
Natural vs acquired advantage on exam:
Natural comparative advantage:
exists within a country that has natural resources that are required to produce a product
Ex: saudi arabia with oil, central america with coffee
Acquired comparative advantage:
is the Advantage gained by an individual or a country by spending a lot of time or resources producing a product.
Learning curve is complete
Ex: germany producing beer for centuries
Absolute advantage:
The ability of a party (an individual, or firm, or country) to produce an Equal level of output of a specific good or service as another individual, firm, or country using fewer resources.
Or The ability of a party (an individual, or firm, or country) to produce a greater level Of output, of a specific good or service ,using the same amount of resources
Who can produce more using fewer resources
or produce greater output using same level of resources
Table 8.1:
Table 8.2
Figure 18.1: PPF for australia & new zealand before trade
New zealand:
6 wheat = 2 cotton
1 wheat = 0.33 cotton
1 cotton = 3 wheat
Comparative advantage in wheat → specialize
Australia
2 wheat = 6 cotton
1 wheat = 3 cotton
1 cotton = 0.33 wheat
Comparative advantage in cotton
Mutually beneficial terms: Trade agreement: 1 wheat = (0.34 - 2.99) cotton
Ex: 1 wheat for 1 cotton
Figure 18.2: expanded possibilities after trade
Why does Ricardo's plan work?
Figure 18.3: comparative advantage means lower opportunity cost
Terms of trade = 1 wheat for 2 cotton
Example: slide 19:
thailand:
- 20 tractors = 300 motorcycles
- 1 tractor = 15 motorcycles
1 motorcycle = 0.67 tractor
Comparative advantage Motorcycles
China
30 tractors = 300 motorcycles
1 tractor = 10 motorcycles
1 motorcycle = 0.1 tractor
Comparative advantage in tractors
Terms of trade
The ratio at which a country can trade domestic products for imported products.
The terms of trade determine how the gains from trade are distributed among trading partners.
Trade in international markets happens with money instead of barter
Exchange rate
The ratio at which two currencies are traded
Price of one currency in terms of another
exchange rate:
Appreciation of the dollar
At t1: $1 = 1 real
At t2: $1 = 1.2 real
$1/1.2 = 1.2R/1.2
= 0.83 = 1 R → means dollar has appreciated
Depreciation of the dollar
At t1: $1 = 1 real
At t2: $1 = 0.9 real
$1/0.9 = 0.9 R/0.9
= $1.11 = 1 real → dollar has deprecated (need more reals for $1)
Table 18.7:
Table 18.8 (based on 18.7) → exact table on the exam (read well)
Trade flows in both directions as long as the exchange rate settles between $1 = 2.1 R and $1 = 3 R.
Stated the other way around, trade will flow in both directions if the price of a real is between $0.33 and $0.48.
Exchange rates & comparative advantage
If exchange rates end up in the right ranges
The free market will drive each country to shift resources into those sectors in which it enjoys a comparative advantage.
Only in a country with a comparative advantage will those products be competitive in world markets.
Whoever’s exporting has comparative advantage
Heckscher-ohlin theory:
A theory that explains the existence of a country’s comparative advantage by its factor endowments:
A country has a comparative advantage in the production of a product if that country is relatively well endowed with inputs used intensively in the production of that product.
Aka Exporting what your good at
Principal US exports include:
Chemicals agricultural products
Consumer durables:
common products we export and import
Natural response to consumer preferences of those diversity of goods
Semiconductors
Aircraft
Princ US imports include:
Petroleum
Metals
Consumer Durables
Product differentiation is a natural response to diverse preferences across economies.
Protection: The practice of shielding a sector of the economy from foreign competition
Direct effects:
Higher Prices
Decline in consumption
Increase in domestic production
Decline in imports
Indirect effects
Increased output for less efficient industries
Tariffs subsize inefficient production
Less revenue to exporting country
Less US exporting (Efficient Industries)
4/24
Final exam 80 questions unit 3 (are 1st) & rest uni 1-2 (105 total questions)
Trade warriors & export subsidies
Tariffs → tax on imported goods: dollar amount per unit
Revenue tariff
Sole purpose is to provide revenue for gov (on imports coming in)
Protective tariff
To protect industries in US
Benefits import competitive community
Non-tariff barrier
Import quota
Max limit on number of items that can be imported into the country
Same result as tarfits → raise price of product
Export subsidy
Subsidy that gov applies to exporting firm to lower cost of production so price of product is lower in international market ( to compete more competitively in international market)
Dumping
Exporting firm sells its product in foreign market and price in foreign market is less than price it sells in its domestic market
Purpose is to drive out domestic market competition to hv monopoly
Is illegal to do
Smoot hawley tariff
Passed in 1930’s which set highest tariffs in US history (60%)
Set off international trade war & caused the decline in trade that's considered one of the causes of worldwide pression of 1930s
Made recession into depression
General agreement on tariffs and trade
International agreement signed by US & 23 countries in 1947 to
Goal to eliminate/lower tariffs → make trade more free
World trade organization (WTO)
Is an organization → not agreement
Wanted to further liberalize trade → carried on GATT objectives
Negotiating forum dealing with rules of trade across nations
Rules of trade established by uruguay round of GATT
159 member nations in 2013
Oversees trade agreements and rules on disputes
Economic integration:
Economic integration:
Agreement among among countries in a geographic region to reduce and ultimately remove, tariff and non tariff barriers to the free flow of goods or services and factors of production among each others
Occurs when two or more nations join to form a free-trade zone.
Lower trade restrictions
European union (EU)
Objective was to use common currency → euro
Bc exchange rates act as natural trade barriers
Initiated in 1958 as Common Market
Officially created in 1993 by the Maastricht Treaty
Abolished tariffs and import quotas between member nations
Established common tariff with nations outside the EU
Created Euro Zone with one currency
Not all Nations that are in the Union are part of the Euro currency (zone)
The European trading bloc composed of 28 countries (of the 28 countries in the EU, 17 have the same currency—the euro)
Free trade among countries included (trade internationally must be agreed on by all countries)
US –Canadian free trade agreement
Agreement with US & canada agreed to eliminate all barriers to trade between 2 countries by 1998
Elements:
Elimination of tariffs
Reduction of non tariff barriers
Increased trade in services
Created dispute settlement mechanism
North American Free Trade Agreement (NAFTA):
An agreement signed by the United States, Mexico, and Canada in which the three countries agreed to establish all North America as a free-trade zone.
Succeeded by the USMCA
Bc canada placed quota on US dairy products so agreement needed to change
Key Elements
Free Trade Zone (Economic Integration)
Eliminated tariffs (Agricultural: Dairy Products)
New Protection for US intellectual Property
Additional stipulations
Case for free trade
Tree trade benefits all counties
In one sense, the theory of comparative advantage is the case for free trade.
Citizens in both countries involved in trade end up paying less and consuming more.
Effects of a tariff & import quota (on exam)
Consumer loss = a + b + c + d = = (a+ b + c) + d = (½ x 1.4 million) + (??) = 45 million loss
Producer surplus = area a = (30 x 600,000) +( ½ x 30 x 200,000) = 21 million gain
Government revenue = area C = base x height = $30 x 600,000 = 18 million gain
Net loss = 6 million
Area A + D = deadweight loss → equals 6 million
Area a = ½ x 30 x 200,000 = 3 million loss
Area d = ½ x 30 x 200,000 = 3 million loss
Area C categorized as quota rent??
Don’t need to look at right illustration
Figure 18.4 gains from trade & losses from imposition of a tariff
Know how to calculate how much is imported for exam
Case for protection:
Protection Saves Jobs
Jobs lost in import competing industries
Some Countries Engage in Unfair Trade Practices
Ex: canada violated nafta & us threatened to levy tariffs
Cheap Foreign Labor Makes Competition Unfair
Firms are able to outsource labor → cheap labor abroad
Protection Safeguards National Security
Protection Discourages Dependency
Ex: should depend on other countries for food
Environmental Concerns
Protection Safeguards Infant Industries
Average total cost declines as you produce more levels of output
When firm tries to enter industry its difficult to compete with existing firms
Ex: when european firm enters, USA agrees to customize the firm so it can lower its price & sell its products in the market and compete in the industry
Add pic
Ch 19
No world monetary system & brett
Exchange rates
The price of one country’s currency in terms of another country’s currency; the ratio at which two
currencies are traded for each other
Ratio of 2 currencies that exchange
Foreign exchange
Largest market in the world
is the trading of one currency for another
Foreign exchange transactions can take place on the foreign exchange market (FOREX market)
The forex market is the largest, most liquid market in the world, with trillions of dollars changing hands every day
Balance of payments
The record of a country’s transactions in goods, services, and assets with the rest of the world; also the record of a country’s sources (supply) and uses (demand) of foreign exchange.
The Current Account
The Capital Account
Current account
Dollar value of exports and imports
Balance of trade (dominant account) = exports - imports → largest component
Countries exports of goods and services minus its imports of goods & services
Trade deficit occurs when exports of goods & services ares less than import of goods and services
Surplus is opposite
Investment income
Dividends
Interest
Rent
Capital gains
Transfer payments
Pension payments
Ex: US citizen retire in monaco (neg entry)
Remittances
Income paid (negative)
Ex: immigrate to US and send money to home country (neg entry)
Income received (positive)
Know categories of current account
Know direction of cash flow (pos vs neg entry)
When buying foreign securities →US lending them money
When we sell US securities → US borrowing money
Capital account and current account must balance
Capital account
Record offsetting entry for current account
For each transaction recorded in the Current Account there is an offsetting transaction recorded in the Capital Account
Current account deficit → exports - imports = negative balance
Imports must exceed exports
Will result in positive offsetting entry in capital account
Selling US securities (offsetting entry)
Current account surplus: $ exports - $ imports = positive balance
Exporting more than importing →US income rising & world has deficit
Will result in negative offsetting entry in capital account
Purchase foreign securities (offsetting entry)
US net liabilities
selling/buying US securities or financial derivatives
Liquidating foreign assets.
????
AE = C + G + EX - IM
When AE includes exports & imports = open economy
When exports & imports not included → closed economy
Determining levels of imports
When income rises, imports tend to go up, algebraically
IM = mY
Y is income and m is some positive number (multiplier?).
Marginal propensity to import (MPM)
Change in imports caused by $1 change in income
Solving for equilibrium:
Figure 19.1: determining equilibrium output in open economy
AE = C + I + G + exports = 100 + 0.75Y = 100 + 300/400Y
2nd line = c + I + G + net exports = 100 + 0.5Y = 100 + 100/200Y
Combine equations: to solve for MPM → 1st equation - 2nd equation
100 + 0.75Y - (100 + 0.5Y)
= 100 + 0.75Y -100 - 0.5Y
-0.25Y → MPM
Open economy multiplier
Open economy multiplier = 1/(1 - (MPC - MPM)
Multiplier is smaller in open economy
gov/investment multiplier: Closed economy multiplier = 1/(1-MPC)
Example: slide 14
Is open economy bc given exports and imports
Y = 100 +0.8(Y-40) + 30 + 75 + (25 - (0.05Y - 40) )
Y = 100 + 0.8Y -32 + 30 + 75 + 25 - 0.05Y + 2
Y = 200 + 0.75Y
Y = 800
Account balance = exports - imports
25 - (0.05 x (800-40) ) = -13
Gov deficit = G - T
75 - 40 = 35
Change in gov spending = 5
5 x 1/(1- (MPC - MPM)
= 5 x 1/(1 - (0.8 - 0.05))
= 5 x 4 = 20 → change in income (increases by $20)
Imports increase by:
Mpm = 0.05 , delta Y = 20
0.05 x 20 = 1 → imports increase by $1
Imports = 0.05Y
0.05 x 800 = 40
Open economy multiplier → based on quota of 40
= 1/(1 - (0.8 - 0) ) =1/0.2 = 5
Change in gov spending(delta 5) = 5 x 5 = 25 → change in Y
How to get Current account equal to 0?
Exports must equal imports
25 = 0.05 (Y - T)
25 = 0.05Y - 2
27 = 0.05Y
Y = 540
How Get from 800 to 540?
Open multiplier = 4
800 - 540 = 260
260/4 = 65 —> change in gov spending → decrease by $65
Determinants of imports:
relative prices of domestically produced & foreign produced goods also determine spending on imports
Determinants of exports
Demand for US exports depends on economic activity in rest of the world as well as on the prices of US goods relative to price of rest of the world goods
Trade feedback effect
Increase in economic activity in 1 country leads to increase in other countries
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Price feedback effect
Refers to intermediate goods: goods that need further processing
If import prices rise, then US has to spend more money on imports (ex: parts of car) so they’ll raise price of final product so when selling final product above price is raised
Ex: apple uses SOuth korea to build screens, if south korea has inflation, then apple has to pay more to import price of screens → price of producing macbook pro grows so when selling macbook in korea price increases
Floating or market determined exchange rate:
Market functioning on its own without gov interference
Supply & demand
those who Demand pounds are holders of dollars seeking to exchange them for pounds.
Ex: us consumers
Those who Supply pounds are holders of pounds seeking to exchange them for dollars.
Ex: british citizens who want to buy us goods
Table 19.2
Figure 19.2 demand
If you need less dollars to buy a pound → dollar appreciated
If you need more dollars to buy a pound → dollar depreciated
Figure 19.3: supply
Is dollar deprecated → pound appreciates
dollar appreciated →pound depreciates → supply less pounds
The Equilibrium Exchange Rate
The equilibrium exchange rate occurs at the point at which the quantity demanded of a foreign currency equals the quantity of that currency supplied.
Appreciation of a currency
The rise in value of one currency relative to another.
Depreciation of a currency
The fall in value of one currency relative to another.
Figure 19.4
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purchasing power
Law of 1 price:
Ex: Price (US) = E ($/euro) x P euro
In $20 = 1.10 x 16 euros
In europe pizza cost = $17.60
$20 = 1.25 x 16 → price of euro will rise until reaches equilibrium
Purchasing power of parity
Refers to basket of goods
Add slide 26 pic & 27
Figure 19.5
19.6
Constrict money supply, higher interest rates, US assets more lucrative than british assets → Makes dollar appreciate
Buy more US bonds → british offer more pounds to buy US securities
Depreciation
Ex: Dollar depreciates → makes US goods less expensive than british goods
1: $1 = 1 pound
2: $1.20 = 1 pound → dollar depreciate, US exports rise,
british goods more expensive → british exports decline
Any time country’s currency depreciates→ it Helps exports & hurts imports
Figure 19.7: J curve (on exam)
0 is trade balance → exports = imports
Depreciation causes deficit initially and then adjusts and causes trade surplus
Monetary policy & flexible
Rescission:
????
Open market operations → buy securities, bank reserves rise & lower interest rates
M1 increases
Lower interest rates
Stimulate c
Lower demand
Increase in
Value of dollar depreciates
Stimulating
Inflation
Contractionary Monetary Policy
M1 decreases
Raises Interest Rates
Lowers demand for Consumption and Gross Private Domestic Investment
Higher Demand for US Securities
Decrease in demand for Foreign Securities
The value of the dollar appreciates → US goods more expensive
Stimulating imports and lowering exports
Flexible Exchange Rates help the Fed in its goal to slowing inflation
Monetary policy helps economy with flexible rates
Fiscal policy is detrimental to economy with flexible rates
Fiscal policy
Recession
Expansionary Fiscal Policy
Increasing Government spending and or a cut in taxes
Upward pressure on price
FED raises rates
Dollar denominated assets are more attractive
Demand for dollar increases and the dollar appreciates
Making exports more expensive and imports less expensive
Which has a negative effect on output → makes GDP decrease
Inflation
Contractionary Fiscal Policy
Decreasing Government spending and or increasing in taxes
Downward pressure on price
FED lowers rates
Dollar denominated assets are less attractive
Demand for dollar decreases and the dollar depreciates–
Making exports less expensive and imports more expensive
Which as a positive effect on output
Monetary Policy with Fixed Exchange Rates
Countries that peg their currency give up their ability to exercise Monetary Policy
The exception
The one case in which a country can change its interest rate and keep its exchange rate fixed is if it imposes capital controls.
Imposing capital controls means that the country limits or prevents people from buying or selling its currency in the foreign exchange markets.
No benefit of fixed exchange rate
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Final exam review:
Know efficiency wage theory
Firms intentionally paying above market range
Why classical is flexible vs keynesian wages are rigid
Explicit contracts, etc
Slide 15 from ch 13
Ch 16 slide 20: labor numbers table, know how to calculate
Phillips curve: what it looks like & relationship presented
Distinction between short run and long run curve
Slides 23 & 24 ch 13
Non-accelerating inflation rate of unemployment (slide 31 ch 13)
Definition of stock
How you can make money off stock: asset appreciation & dividends
1 period appreciation (slide 7 ch 14)
No slide 9 from ch 14
Bonds defintionatin
Pay interest, coupon payments
Can appreciate & depericate
Know how to price a bond
Formula: Ch14 slide 15
Know capital gain (asset appreciation): buy at low price & sell at high price
Know bonds pay fixed interest, face value set, stocks pay dividends (based on firms discretion),
Stock indexes → slide 12 ch 14
Calculate expected return → slide 11 ch 14
Know all the lags: response, implementation, etc
Know which are longer for fiscal policy & monetary policy slide 33-34 ch 14
Deficit targeting (slide 38 ch 14)
Corporate bonds & gov bonds
Gov sell securities to borrow money
Ch 15
Life cycle theory of consumption
Assumption of what household previous they'll make in the future
Difference between leisure & working
Are subs
Nominal vs real wage
Slides 10-11 ch 15
Income effect and substitution effect of a change in income (or wages)
sub effect: when income rises, opportunity cost of working has gone up → so you'll work more
Income effect: if wages go up → leisure is a normal good → so you’ll consume leisure & work less
Interest rates: Slide 13-14 ch 15
Calculate inventory levels: slide 24
Calculate APC
APC = consumption/income = C/Y
Know if it falls, remain constant,
APS not on exam
Ch 16
Slide 7
Production function: Slide 9 - 10
Calculate average product of labor & capital Slide 18
Ex: Q = F(K, L)
Slide 16
Diminishing returns to labor → if increase labor units and keep capital contant = average productivity decrease & marginal returns finishing
Slide 21: will be given examples & will hv to determine what FDI it is
Greenfield investment: build entire factory in foreign country from ground up
Brownfield: licensing on firm or buying majority ownership and then incorporating own managers
Ex: ford uses current (existing) mexican factory to build an engine (buy 20% of mexican factory so they can hv majority) → brownfield & vertical
Horizontal: replicating entire stages of production in foreign market due to transportation costs
Often is greenfield investment as well → ex: ford builds entire truck from ground up in mexico
vertical integration: taking 1 stages of production and outsourcing it bc of production costs
Ch 18
International trade: main focus
How to calculate trade surplus and deficit
Dollar value exports - dollar value imports
Know ricardian model:
Absolute advantage
How to calculate opportunity costs
How to interpret comparative advantage
If hv advantage specialize in that product, only produce that product & export it
Import product you don’t have comparative advantage in
No mutually beneficial terms of trade on exam
Slide 19 ch 18
Could give table, word problem or graph
Use intercepts for graph from axises
Know difference between other ways to get comparative advantage
Hecklin oiler model based on factor endowments (slide 25-26)
Labor endowed = labor intensive
Acquired comparative advantage vs natural comparative average
acquired: been doing so long
Natural: hv natural resources
Consequences of trade restrictions
Ex: tariffs: objective to reduce imports (is import tax)
Americans pay tariff on imported goods
Slide 29 - 30
Dumping, export subsidy, quota etc
Slide 38
Calculator gain or loss of consumer surplus (also deadweight loss)
And surplus or loss before/after tariff
Area c in graph b is now quota rent for the firm
Know exchange rates & how to calculate them
Slide 23
question Similar to tabl2 18.8 on exam
Ch 19
Know balance of payment accounts: current & capital (Know categories of each)
if us has current account deficit → are importing more than exporting → US would hv to borrow money → so they'll sell US securities
Then capital account: will have offsetting positive entry
Ex: selling US securities will have inflow of cash
current account surplus: $ of exports greater than imports → foreign needs to borrow money → so US will buy foreign securities
Then in capital account: will have offsetting negative entry
Bc outflow of cash from giving cash for buying foreign securities
Slide 8
Categories of capital & current
Marginal propensity to import slide 11
Slide 13: open economy multiplier
Slide 12
How to read slide → how to get MPC from graphs and ten from there get MPS and then get MPM
Slide 14
Exchange rates fluctuate → how do they affect trade
Ex: dollar depreciates, makes US goods less expensive
Ex: at T1: $1 = 1 euro & T2: $1.20 = 1 euro
Makes european goods more expensive
US exports rise & european exports decline
Dollar appreciates:
Ex: T1 = $1 = 1 euro T2: $1 = 1.30 euro
Makes European goods less expensive → europe exports rise
US goods more expensive → US exports decrease
Fixed & floating exchange rate
Floating = let market determine exchange rate
Purchasing power parity formula (Slide 27)
Law of one price (slide 26)
Given ⅔ parts
Ex: us pizza price $20, price in canada $20
How monetary policy effects appreciation or depreciation of dollar
Expansionary: depreciates dollar
Contrantionary: decrease money supply → appreciate the dollar
Summarizing slides 32-33
Monetary policy pretty effective with floating exchange rates
Slides 34-35
Fiscal policy with floating exchange rate is ineffective
Know how to read j-curve
Know axises
90 questions from unit 3
Unit 1-2: 15 questions
Purely definition: normal good and inferior goods
Know substitutes & compliments
Know price ceiling and floors definitions
Know how to locate equilibrium price & quantity from graph or table
Know consumer surplus and producer surplus definition
Definition of GDP
Calculate disposable income (income -taxes)
Calculate unemployment rate
unemployed/labor force
Difference between nominal & real interest rate
Real is nominal - inflation
Tools of fiscal & monetary policy
Calculate equilibrium income
Set Y = aggregate expenditures
Aka Y = AE
Closed economy: AE = C + I + G
Open economy: AE = C + I + G + (Ex - Im)
Table with AE with missing numbers
Ex: given investment, gov spending, etc → calculate missing numbers so it equals AE
Know categories of M1 & M2
Read bank balance sheet
required reserves, excess reserves, calculated required reserves ratio
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