AP Macroeconomics Unit 4

Mutual Funds: Pool money from many investors to purchase securities.
Life Insurance Companies: Provide financial protection in exchange for premiums.
Pension Funds: Investment pools for retirement plans.
Banks: Provide services to reduce transaction costs, mitigate risk, and ensure liquidity.

Inflation Rate Calculation:
$ext{Inflation Rate} = \frac{ ext{PL in Year 2} - ext{PL in Year 1}}{ ext{PL in Year 1}} imes 100$
Nominal Interest Rate: Unadjusted for inflation.
Real Interest Rate: $ext{Real Interest Rate} = ext{Nominal Interest Rate} - ext{Inflation Rate}$
Inflation Effects:
- Higher than Expected:
- Winners: Borrowers (repay with less valuable currency)
- Losers: Lenders
- Lower than Expected:
- Winners: Lenders
- Losers: Borrowers

National Savings Formula: National Savings = Private Savings + Budget Balance
Capital Inflow: Net inflow of funds into the country.
Liquidity: Ability to convert an asset into cash without significant loss of value.
Illiquid: Assets that lose value quickly upon conversion to cash.

Strategy where an investor spreads investments across several assets to mitigate risk.

Money serves three primary roles:
- Medium of Exchange: Used in trade for goods and services.
- Unit of Account: Standardizing value for savings and pricing.
- Store of Value: Assets can retain value over time.
Types of Money:
- Commodity Money: Intrinsic value (precious metals).
- Commodity-Backed Money: Value from convertibility into goods.
- Fiat Money: Government-ordered currency with no intrinsic value.

A dollar today is worth more than a dollar in the future due to inflation.
Net Present Value Calculation:
ext{NPV} = ext{PV of current & future benefits} - ext{PV of current & future costs}

Banks manage deposits and keep part as reserves, lending the rest.
Bank Runs: Occurs when multiple depositors withdraw at once, often due to panic.
Regulations to prevent bank runs include:
- Deposit Insurance: Secures first $250,000 in accounts.
- Reserve Requirements: Mandated proportion of deposits banks must hold.
- Discount Window: Facility for banks to borrow from the FED.
- Capital Requirements: Assets must exceed liabilities.

Can affect money supply by adjusting reserves:
- Reserve Ratio: $ext{Money Multiplier} = \frac{1}{ ext{reserve ratio}}$
Money Multiplier Effect: Total increase in deposits from each dollar increase in the monetary base.

Interest Rates Influence: Short-term interest rates affect the money supply.
Demand for Money Drivers:
- Opportunity cost of holding money vs. other assets.
- Aggregate price levels and GDP swings influence demand.

Suppliers: Savers and lenders; Demanders: Borrowers.
Demand Curve Shifters: Optimism on business opportunities, increased government borrowing increase demand for loans.
Supply Curve Shifters: Increased savings or foreign investments lead to higher supply.

Relationship between expected inflation and interest rates:
- Increase in expected inflation leads to a rise in interest rates.
- Decrease in expected inflation leads to a fall in interest rates.

Provides financial services and supervises banking institutions.
Ensures financial system stability and conducts monetary policy:
- Expansionary Policy: Reduce required ratios, lower discount rates, or buy T-bills.
- Contractionary Policy: Increase required ratios or discount rates, or sell T-bills.