Absolute Advantage v. Comparative Advantage

•Absolute Advantage 

-Individual: exists when a person can produce more of a certain good/service than someone else in the same amount of time. 

-National: exists when a country can produce more of a good/service than another country can in the same time period. 

•Comparative Advantage 

-Individual/National: Exists when an individual or nation can produce a good/service at a lower opportunity cost than can another individual or nation. 

•Absolute Advantage 

   -Faster, more, more efficient 

•Comparative Advantage 

    -lower opportunity cost 

Dollar Appreciation

Dollar Appreciation: 

•Each dollar gets you more of the other currency.

• this means is that US exports gets more expensive for foreigners. 

•US imports gets cheaper for us

•Results: Exports decrease while imports increased 

• $ is leaving the US 

   -Xn and GDP decrease

   - Demand for the dollar increases

   - Supply of the dollar decreases 

Dollar Depreciation:

• Each dollar gets you less of the other currency. 

• Less of the foreign currency is needed. 

•Exports are going to increase and imports are going to decrease. 

•money is entering the US 

   - Xn increases

   - GDP increases 

•Demand for the dollar decreases 

•Supply of the dollar increase 

*if it comes to supply of the dollar, we're making transfered payments to foreigners 

*If it comes from supply of the dollar, foreigners are making transfer payments to us. 

* Supply of the dollar: comes from US Citizens, banks and industries, wanting to purchase our goods, investments and assets. 

     

Foreign Exchange Market

•Foreign Exchange: the buying or selling of currency

    -Ex: in order to purchase souvenirs in France, it is first necessary for Americans to sell (supply) their dollars and buy (demand) Euros. 

•The Exchange adage is determined in the foreign currency markets. 

      -Ex: The current exchange rate is approximately 77 Japanese Yen to 1 US dollar. 

•Simply put the exchange rate is the price of a currency 

•Do not try to calculate the exact exchange rate.

TIPS

•Always change the D line on one currency graph, the S like on the other currency's graph

•Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer. 

•If D on one graph increases, S on the other will also increase. 

•If D moves to the left, S will move got the left on the other graph. 

-Changes in Exchange Rates

•Exchange rates (e) are a function of the supply and demand for currency. 

   -An increase in the supply of a currency will make it cheaper to buy one unit of that currency. 

   - A decrease in supply of a currency will make a more expensive to buy one unit of that currency.

   -An increase in demand for a currency will make it more expensive to buy one unit of that currency 

    - A decrease in demand for a currency will make it cheaper to buy one unit of that currency 

-Appreciation 

•Appreciation of a currency occurs when the exchange rate of that currency increases (e^)

     -Hypothetical: 100 Yen used to buy $1. 

                             Now 200 Yen buy 1US$.

     - The dollar is "stronger" because one   buys more Yen than it used to. 

-Depreciation of a currency occurs when the exchange rate of that currency decreases 

       -100 Yen used to buy one dollar. Now 50 

         Yen buys one dollar. 

      - The dollar is weaker because it takes 

         Fewer Yen to buy one dollar. 

The Balance of Payments

•Measuring money of inflows and outflows between the United States and the Rest of the World (ROW)

•Inflows are referred as CREDITS 

•Outflows are referred to as DEBITS

• The balance of Payments is divided into 3 accounts 

-Current Account 

-Capital/Financial Account

-Official Reserves Account 

***Double Entry Bookkeeping***

•Every transaction in the balance of payments is recorded twice in accordance with standard accounting prices. 

   -Ex: US Manufacturer John Deere exports $50 million worth of farm equipment to Ireland. 

     • A credit of 50 million to the current account 

      *(- 50 million worth of farm equipment or physical assets) 

-Current Account 

• Balance of trade or Net Exports 

  *   Exports of goods and services-imports of goods and services 

 *Exports create a credit to the balance of payments 

 * Imports create a debit to the balance of payments 

    -Net Foreign Income 

       • Income earned by US owned foreign assets- income foreign held US Assets 

    Ex: Interest payments on US owned Brazilian bonds - interest payments on German owned US treasury bonds 

    -Net Transfers (tend to be unilateral) 

        • Foreign Aid: a debit to the current account 

     Ex: Mexican migrant workers send money to family in Mexico 

-Capital/Financial Account 

•The balance of capital ownership 

•Includes the purchase of both real and financial assets 

•Direct investment in the US is a credit tot he capital account 

    *Ex: the Toyota Factory in San Antonio 

• Direct investment by US firms/individuals in foreign country are debits to the capital account 

    *Ex: The Intel Factory in San Jose, Costa Rica 

•Purchase of foreign financial assets represents a debit to the capital account. 

   *Ex: a Warren Buffet buys stock in Petrochina. 

•Purchase of domestic financial assets by foreigners reprints a credit to the capital account.  

   *Ex: The United Arab Emirates sovereign wealth fund purchases a late stake in the NASDAQ. 

-Relationship between Current and Capital Account 

•Remember double entry bookkeeping? 

• The current account and the capital account should zero each other out. 

-Official Reserves 

•The foreign currency holdings of the United Staes Federal Reserve System

•When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments 

•When there is a balance of payments deficit the Fev depletes its reserves of foreign currency and credits the balance of payments. 

-Active v. Passive Official Reserves 

•The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate. 

•The people's republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States. 

Supply Side Economics

-Supply Side Economics (Reaganomics)

• Supply side economists tend to believe the ASA curve will determine levels of inflation, unemployment, and economic growth.
• To increase the economy, you take actions to shift the AS curve to the right. 
• Always benefitting the company first. 
• They focus on marginal tax rates, which is the amount paid on the last dollar earned or on each additional dollar.
• Lowered taxes are an incentive for businesses to invest in our economy. 
• Lowered taxes are incentives for people to increase savings and therefore create lower interest rates for increases and business investment. 
• They only believe in AS. 

• The laffer curve is a trade off between tax rates and government revenue 
• It is used to support the supply side argument 
• As tax rates increase from zero, tax revenues increase from zero to some maximum level and then decline. 

-Criticisms of the Laffer Curve: 

-Research suggest that the impact of tax rates of incentives to work save and invest are small.

-Tax cuts also create demand. Which will cause demand to exceed supply. 

-Where the economy is actually located on the curve is difficult to determine. 

-Reaganomics:

-lowered the marginal tax rates to get the US out of a recession led to a deficit. 

Long Run Phillips Curve

-The Long Run Phillips Curve (LRPC) 

•because the long run Phillips curve exists at the natural rate of unemployment, structural changes in the economy that affect unemployment will also cause the LRPC to shift.

•increases in unemployment will shift LRPC>

•decreases in unemployment will shift LRPC< 

•Changes in the AS/AD model can also be seen in the Phillips curves 

•an easy way to understand how changes in the AS/AD model affect the Phillips curve is to think of the two sets of graphs as mirror images 

•NOTE: the 2 models are not equivalent. The AS/AD model is static, but the Phillips curve includes change over time. Whereas AS/AD shows one time changes in the price level as inflation or deflation, the Phillips curve illustrates continuous change in the price level as either increased inflation or disinflation. 

Periods of Stagflation:

•civil rights movement 

•women's movement 

•baby boom error

•Vietnam ended 

• all embargo (1973 and 1979)

•Disinflation: reduction in the inflation rate from year to year. 

•This also occurs when aggregate demand declines.

•In the short run, profits fall and the unemployment rate increases.

•Deflation: an actual drop in the price level. 

Phillips Curve

Phillips Curve: Relationship between unemployment and inflation.

The trade off between unemployment and inflation is on the short run. 

SHORT RUN PHILLIPS CURVE:

•It has relevance to Okun's law. For every 1% percent of unemployment, there is a 2% 

•There is an inverse relationship between unemployment rates and inflation rates. 

• Since wages are sticky, inflation changes. Move the points on the SRPC. 

•If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward. Which creates a situation called "stagflation".

•STAGFLATION: You have high unemployment plus high inflation simultaneously. 

•If inflation expectations stop due to new technology, then the SRPC will move downward. 

LONG RUN PHILLIPS CURVE: 

•It occurs at the natural rate of unemployment.

• It is represented by a vertical line. 

•There is no trade off between unemployment and inflation in the long run. •It only shifts if the LRAS curve shifts. 

• The major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefit create lower natural rates. 

•If LRAS is stable, so is LRPC.

Natural Rate of Unemployment: Seasonal, structural, and Frictional. Cyclical does not count because 

•Aggregate supply shocks can cause the rate of inflation and the rate of unemployment to increase. 

-What are Supply Shocks? 

•They are rapid and significant increases in resource cost which will cause the SRAS curve to shift. 

-The Misery Index: 

•A combination of inflation and unemployment in a given year.

• Single digit misery is good. 

Unit 4 video

Loanable Funds Market

The Loanable Funds Market

•The market where savers and borrowers exchange funds (QLF) at the real rate of interest. 

•The demand for Loanable funds, or borrowing comes from households, firms, government, and the foreign sector. The demand for Loanable funds is in fact the supply of bonds. 

•The supply Loanable funds, or savings comes from households, firms, government, and the foreign sector. The supply of Loanable funds is also the demand for bonds. 

-Changes in the demand for Loanable funds

•Remember that demand for Loanable funds= to borrowing or supplying of bonds 

•More borrowing= more demand Loanable funds 

•Less borrowing= less demand for Loanable funds 

•Examples

- Government deficit spending= more borrowing = more demand for Loanable funds 

DLF-> r%

-Less investment demand= less borrowing= less demand for Loanable funds 

Changes in the supply of Loanable funds

•remember that supply of Loanable funds= saving (demand for bonds)

•More saving= more supply of Loanable funds 

•Less saving= less supply of Loanable funds

EXAMPLES 

-Government budget surplus= more saving = more supply of Loanable funds 

-Decrease in consumers MPS= less saving= less supply of Loanable funds 

*When the government does fiscal policy it will affect the Loanable funds market*

*Changes in the real interest rate will affect Gross Private Investment* 

Federal Fund Rate

Federal Fund Rate

• it is the interest rate that commercial banks charge other commercial banks for over night loans.

PRIME rate 

• it is the interest rate that is given to a banks most credit worthy customers 

Anywhere from 0 to 4 % 

AP Macroeconomics Unit 4 Video Series Notes

Part 1:
There are three types of money. The types of money she brings up are commodity money, which has been around and has been used the longest. Then there is representative money which means whatever you are using as currency is representing a specific quantity of metal. And lastly, the type of money we use today, Fiat money. This money is not back by precious metal and must be accepted for transactions. The functions of money consist of is that money is a medium of exchange, money as a store of value, and lastly, money being a unit of account.

Part 3:
Money Market graphs are graphs that we have to become very familiar with and have to be able to master them when it comes to drawing them properly. The Y Axis will always be labeled as the interest rate, and the x axis will be labeled as the quantity of money. The demand for money will slope in a downward direction because when the price is high, demand is low and vise versa. What is different from the supply and demand graphs is that the supply of money is vertical in this case. Demand for money is set by the Fed.

Part 4:
Expansionary policies are also called easy money, and contractionary policies are called tight money. Required reserves is a portion of money that is of the total deposits that they have to hold on to. Money that has been RR will become the excess reserves that the bank can begin to loan out. The discount rate is the rate that banks can borrow money from the fed. This is the interest rate that the fed charges.

Part 7:
Another graph we have to learn to  master is the loanable funds graph. We have to tie it to the money market and show the results in AD/AS graphs. Loanable funds is money that is available for the public to borrow. Demand for loanable funds is downward sloping, while the supply slopes in an upward direction. Supply of loanable funds is dependent on people's savings.

Part 8:
Another concept we have to become familiar with is the money creation process. Banks create money by creating loans, which is a key point in the process of creation. One of the Feds tools is being able to adjust and control the Reserve Requirement. The formula for the money multiplier is 1/RR.

Part 9:
We have to learn how to show the connection of what is actually happening in the economy. Keep everything labeled to show your work. To be consistent, show the same interest rate and the demand will slope downward. Increase in government spending is going to increase aggregate demand. Do not try to change 5 or 6 factors at once because it will get very complicated.

•Demand for money has an inverse relationship between nominal interest rates and he quantity of money demanded. 

1. What happens to the quantity demanded of money when interest rates increase? QD decreases. 

2. What happens when to the quantity demanded when interest rates decrease? QD increases. 

Seven Functions of the FED

*Multiple Deposit Expansion and the Federal Reserve*

•Seven Functions of the FED

1) issue paper currency: paper currency produced everyday

2) sets reserve requirements and holds reserves of banks

3) it lends money to banks and charges them interest

4) they are a check clearing service for banks

5) it acts as personal bank for the government 

6) supervises member banks

7) controls the money supply in the economy 

 

•Investment: redirecting resources that you would consume now for the future. 

•Financial Assets: Claims on property and income of the borrower 

•Financial Intermediaries: An institution that channels funds from savers to borrowers.

•Three purposes for Financial Intermediaries 

-Share risk (diversification is the number one way risk is shared) which means spreading out your investment to reduce risk. 

-Providing information

- Liquidity: easily converted to cash 

      -(Returns: it is the money an investor receives above and beyond the sum of money that was initially invested)

     -*Higher the risk, higher the investment* 

•Bonds: are loans or IOUs that represent death that 

-generally low risk investments

•3 components

    1) coupon rate: it is the interest rate that a bond issuer will pay to a bond holder. 

    2) Maturity: time at which payment to a bond holder is due. 

    3) Par Value: the amount that an investor pays to purchase a bond and that will be repaid to an investor at maturity. 

•Yield: the annual rate of return on a bond if the bond were held to maturity. 

•The difference between bonds and stocks are bonds you loan and stocks you own. 

•Time value of money 

•Is a dollar today worth more than a dollar tomorrow? 

    -YES 

•Why? 

     -Opportunity cost and inflation 

     -this is the reason for charging and paying interest.

Let V= future value of money 

      P= present value of money 

      R= real interest rate( nominal rate- inflation rate)  expressed as a decimal 

      N= years

       K= number of times interest is credited per year 

• The simple interest formula 

   - v= (1+r)^n •p 

•The compound interest formula

    - v = (1+ r/k)^nk•p

•Monetary Equation of Exchange 

•MV= PQ

-M= money supply (m1 or m2) 

-V= moneys velocity (m1 or m2) 

-P= price level (PL on the AS/AD diagram) 

-Q= real GDP (sometimes labeled y on the AS/AD diagram) 

Money Notes

•Money is any asset that can be easily used to purchase goods and services. 

•Three uses of money: 

- Medium of Exchange: it is used to determine value 

-Unit of Account: need something where you can compare the costs of items. 

-Store of Value: when you hide money

•Three types of money:

-Commoditie money: salt, olive oil, and gold

-representative money: represents something of value (IOU) 

-Fiat money: money because the government says so (paper currency and coins) 

•Six characteristics of money:

1) Durability: how long it lasts 

2) Portability: take it  and store wherever you go and want 

3) Divisibility: being able to be broken down 

4) Uniformity: all money looks the same 

5) Limited supply

6)Acceptability 

•Money Supply: all of the available money in the US economy 

•M1 Money: 

-Consists of liquid assets (liquid means easily converted to cash) 

    -Currency 

    - Coins

    - Checkable deposits (checks) 

    - Travelers checks 

•M2 Money: 

 - Consists of M1 money plus savings accounts plus money market accounts. 

•Three purposes for financial institutions:

-store money

-save money

-loan money 

•Two reasons to LOAN money: 

-Credit cards

-mortgage 

•Four ways to save money 

-through savings account

-through checking account 

-through money market account 

-through certificate of deposit (CD) 

•Loans: Banks operate on a fractional reserve banking system, which means they keep a fraction of the funds and loan out the rest.

•Two components of interest rate 

•Principal: the amount of money borrowed

Interest: price paid for the use money 

•Two types of interest: 

-Simple: 

-Compound: paid on the principle plus the accumulated interest 

•Formula for simple interest 

I= p•r•t / 100 (principal•rate of interest•time) 

T= i•100/ p•r 

P= i•100/ r•t

R= I•100/ p•t

•Types of Financial Institutions 

-commercial banks

-savings and loans institutions 

-mutual savings banks 

- credit unions 

-finance companies 

Fiscal Policy Notes

Fiscal policy (2/25)

Changes In expenditures or tax revenues of the federal government.

2 tools of fiscal policy 

•taxes- government can increase or decrease taxes

•spending- government can increase or decrease spending.

Deficits, surpluses, and debt

•balanced budget

-revenues=expenditures 

•budget deficit

-revenues < expenditures

•budget surplus

-revenues > expenditures 

•government debt

-sum of all deficits - sum of all surpluses

Government must borrow money when it runs a budget deficit

•individuals

•corporations

•financial institutions

•foreign entities or foreign governments 

Two options

•discretionary fiscal policy (action) 

-expansionary fiscal policy -think deficit

-contractionary fiscal policy -thing surplus 

•nondiscretionary fiscal policy (no action)

Discretionary 

•increasing or decreasing government spending and or taxes in order to return economy to full employment. Involves policy makers doing fiscal policy in response to an economic problem. 

Automatic

Unemployment compensation & marginal tax rates are examples that help mitigate the effects of recession and inflation. Takes place without policy makers having to respond to current economic problems.

Contractionary v. Expansionary fiscal policy

Contractionary- policy designed to decrease aggregate demand.

-strategy for controlling inflation

Expansionary- policy is designed to increase aggregate demand.

-strategy for increasing GDP, combatting a recession and reducing unemployment 

•increases government spending

•decreases taxes

Contractionary fiscal policy

•Decreases government spending 

•Increases taxes

Automatic or built in stabilizers

•anything that increases the government spending budget deficit during a recession and increases its budget and surplus without requiring explicit action by policy makers. 

•welfare checks

•food stamps

•unemployment checks

•corporate dividends 

•social security

•veteran's benefits 

Progressive tax system

•average tax rate (tax revenue/GDP) rises with GDP

Proportional tax system 

•average tax rates remains constant as GDP changes

Regressive tax systems

•average tax rate falls with GDP

Disposable Income Notes

Disposable income (DI)

Income after taxes or net income

DI= Gross Income - taxes

2 choices

With disposable income, households can either 

-Consume (spend money on goods and services)

-Save (not spend money on goods and services)

Consumption 

Household spending

The ability to consume is constrained by

-the amount of disposable income

-the propensity to save

Do households consume if DI=0?

-Autonomous consumption 

-Dissaving

APC=C/DI=% DI that is spent 

SAVING

Household NOT spending

The ability to save is constrained by 

-the amount of disposable income

The propensity to consume

Do households save if DI=0?

-NO

APS= S/ DI= % DI that is not spent 

APC& APS

APC+APS=1

1-APC= APS

1-APS= APC

APC> 1.: Dissaving 

-APS.: Dissaving 

Marginal propensity to Consume

-CHANGE IN C/CHANGE IN DI

-% of every extra dollar earned that is spent 

Marginal propensity to Save 

-CHANGE IN s/CHANGE IN DI

-% of every extra dollar earned that is saved

Mpc+mps=1

1-mpc=mps

The spending multiplier effect 

An initial change in spending causes a larger change in aggregate spending or aggregate demand

Multiplier= Change in AD/ Change in spending

Multiplier = change in AD: change in c,i, g, Xn

Why does this happen?

Expenditures and income flow continuously which sets odds spending increase in the economy. 

The spending multiplier cans be calculated from the mpc of the mps 

Multiplier = 1/1-MPC or 1/MPS

Multipliers are positive when there is an increase in spending and negative when there is a decrease 

Small changes in expenditure are examined by the multiplier effect.

When the government taxes the multiplier works in reverse 

Why?

Because now money is leaving the circular flow

Tax multiplier (it's negative)

•=-MPC/1-MPC or -MPC/ MPS 

If there is a tax cut, then the multiplier is positive because there is now more money in the circular flow