UNIT 7

UNIT 7 PRACTICE

AP Macroeconomics Unit 7 - Part 1

Unit 7

• Absolute Advantage

-Individual- exists when a person can produce more of a certain good/ service than someone else in the same amount of time (or can produce a good using the least amount of resources.)
-National-exists when a country can produce more o a good/ service than another county can in the same time period.

• Comparative Advantage

-A person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner.

• Examples of output problem:

-word per minute

-miles per gallon

-tons per acre

-apple per tree

-television produced per hour

• Examples of Input problems:

-number of hours to do a job

-number of acres to feed a horse

-number of gallon of paint to paint a house

• Specialization and trade

-Gains from trade are based on comparative advantage, not absolute advantage

(who can d what in a certain amount of time)

IMPORTANT (Smallest number is who has opportunity cost)

Unit 7

Exchanges

• Foreign Exchange (FOREX)

- the buying and selling of currency

      Example: in order to purchase souvenirs in France, it is first necessary for Americans to sell their dollars and buy Euros

- any transactions that occurs in the balance of payments necessitates foreign exchange

-Exchange Rate (e) is determined in foreign currency markets

• Changes in Exchange Rates

-exchange rates (e) are a function of supply and demand for currency

•        an increase in the supply of a currency

•        a decrease in supply of a currency will increase the exchange  rate of currency

•        increase in demand for currency will increase the exchange rate of currency

•        decrease in demand for a currency will decrease the exchange rate of currency

• Appreciation and Depreciation

-appreciation of currency occurs when exchange rate of that currency increases (e^)

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

• Exchange Rate Determinants

-consumer tastes

-relative income

-relative price level

-speculation

• Exports and Imports

-exchange rate is a determinant of both exports and imports

-appreciation of the dollar causes american goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports

-depreciation of the dollar causes american goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

Unit 7

Balance of payments

• measure of money inflows and outflows between the US and the Rest of the World (ROW)

     *Inflows are referred to as CREDITS

     *out flows are referred to as DEBITS

• the balance of payments is divided by 3 accounts

      - current account
      - capital/ financial accounts
      - official reserves accounts

Current Accounts

- balance of trade or net exports

-net foreign income

-net transfers (tend to be unilateral)

Capital/ Financial Accounts

- the balance of capital ownership

-includes the purchase of both real and financial assets

-direct investment in the US is a credit to the capital account

-direct investment by US Firms/ individuals in foreign country are debits to capital accounts

-purchase of foreign financial assets represents a debit to a capital account

-purchase of domestic financial assets by foreigners represents a credit to the capital accounts

          Important Info:the current account and the capital account should zero each other out***

Official Reserves 

-foreign currency holdings of US Federal Reserve System

-when there is a balance of payments surplus the FED accumulates foreign currency and debits balance of payments

-when there is a balance of payments deficit FED depletes its reserves of foreign currency and credits balance of payments

Active US passive official reserves

-the US is passive in its use of official reserves

unit 6

Economic Growth Defined

•Sustained increase in Real GDP over time.

•Sustained increase in Real GDP per Capital over time.

Why Grow?

•Growth leads to greater prosperity for society.

•Lessens the burden of scarcity.

•Increases the general level of well-being.

Conditions for Growth

•Rule of Law

•Sound Legal and Economic Institutions

•Economic Freedom

•Respect for Private Property

•Political & Economic Stability

–Low Inflationary Expectations

•Willingness to sacrifice current consumption in order to grow

•Saving

•Trade

Physical Capital

•Tools, machinery, factories, infrastructure

•Physical Capital is the product of Investment.

•Investment is sensitive to interest rates and expected rates of return.

•It takes capital to make capital.

•Capital must be maintained.

Technology & Productivity

•Research and development, innovation and invention yield increases in available technology.

•More technology in the hands of workers increases productivity.

•Productivity is output per worker.

•More Productivity = Economic Growth.

Human Capital

•People are a country’s most important resource. Therefore human capital must be developed.

•Education

•Economic Freedom

•The right to acquire private property

•Incentives

•Clean Water

•Stable Food Supply

•Access to technology

Hindrances to Growth

•Economic and Political Instability

–High inflationary expectations

•Absence of the rule of law

•Diminished Private Property Rights

•Negative Incentives

–The welfare state

•Lack of Savings

•Excess current consumption

•Failure to maintain existing capital

•Crowding Out of Investment

–Government deficits & debt increasing long term interest rates!

•Increased income inequality à Populist policies

•Restrictions on Free International Trade

Unit 5

Unit 5
• Short Run aggregate Supply
- The period in which wages (+ other $’s) remain fixed as price level increases or decreases
• Long Run As
- Period of time in which wages have become fully responsive to changes in Pl.
• Effects over short run
- In SR , price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant .
- In LR , wages will adjust to the price level and previous output levels will adjust accordingly.
• Equilibrium in the extended model
- The extended model means the inclusion of both the short run and LRAS curves
- The LRAS curve is represented with a vertical line and full employment level of real GDP.
• Demand pull inflation in the AS. Model
- Demand Pull prices increase based on increase in AD
- In the SR , demand pull drive up prices , and increase production
- In the LR , increases in the aggregate demand will eventually return to previous levels.
• Cost push and the extended model
- CP arises from factors that will increase per unit costs such as increase in the price of a key source
- Short run shifts left. What is important is that this case, it is the cause of the PL increase, not the effect.
• Dilemma for the government
- in an effect to Fight cost push, the government can react in 2 ways
- Action such as spending by the government could begin an inflationary spiral
- No action however could lead to a recession by keeping production and employment levels declining


4/8/16

• THE PHILLIPS CURVE
- the long run Phillips curve
*note – The Natural rate of unemployment is held constant





- Because the LRPC exists at the natural rate of unemployment
(Un) , structural changes in the economy that effect un, will also cause the LRPC to shift.
- Increase in un, will shift LRPC >
- Decrease in un, will shift LRPC <


Assume that the US economy is in long run equilibrium with an expected inflation rate of 6 percent and an unemployment rate of 5 percent. The nominal interest rate is 8 percent


B) i% = n% - Ti %
          = 8% - 6%
          = 2%
C) buy bonds


4/11/16

• INFLATION- a general rise in the price level
• DEFLATION- a general decline in the price level
• DISINFLATION- a decrease inflation rate over time.
• STAGFLATION- unemployment and inflation increasing at the same time.


4/13/16

SUPPLY SIDE ECONOMICS- change AS not AD. Determines the level of inflation, unemployment rates, and economic growth
SUPPLY SIDE ECONOMIC – support policies that promote GDP growth by arguing that high marginal  tax rates along with the current system of transfer payments such as unemployment compensation or warfare programs , provide disincentive to work , save , innovate , and undertake enterperal ventures.

Lower Marginal tax rates – induce more work , this causes as to increase. Al6 makes leisure more expensive, and work more attractive.

INCENTIVE TO SAVE AND INVEST
1. High marginal tax rates reduce the rewards for saving and investment.
2. Consumption might increase , but investment depends upon savings
3. Lower marginal tax rates encourage savings and investment

LAFFER CURVE
- Theoretical relationship between tax rates and government revenue.
- As tax rates increase from 0 , government revenues increase increase from 0 to
- Criticisms :
1. Research suggests that the impact of tax rates on incentives to work , save , and invest are small.
2. Tax units also increase demand, which can fuel inflation, and demand may exceed supply
3. Where the economy is actually located on the curve , is difficult to determine


4/26/16

• BALANCE OF PAYMENTS – measure of money inflows and outflows between then US and the post of the world (grow)
- Inflows = credits
- Outflows = debits
• The balance of payments is divided into 3 accounts

1. Current account
2. Capital / financial account
3. Official reserves account

• Double entry bookkeeping
• Current account
- Balance of trade or net exports
- Exports of goods / services-import of goods /services
- Exports create a credit to the balance of payments
- Imports create a debit to the balance of payments

• Net foreign
- Income earned by US owed foreign assets – income paid to foreign held US assets
- Ex: interest payments on US own Brazilian bonds – interests payments on German owed US  treaty bonds
• Net transfer (tend to be unilateral)
- foreign aid > a debit  to the current account
- Ex : Mex . Migrant workers send $ to farm 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 to the capital account
- Toyota factory in San Antonio (EX)
• Direct investment in the US firms (individual in a foreign country are debits to the capital account
- the Intel factory in San Jose , Costa Rica
• Purchase of domestics financial assets by foreigners represents a credit to the capital account
- The United Arab Emirates Sovereign wealth funds purchases a large stake in the NASDAQ
        RELATIONSHIP BETWEEN CURRENT AND CAPITAL ACCOUNT
- double entry bookkeeping
- The current account and capital account should sew each other out
- That is…. If the current account has a negative balance (DefIcit)
Then the capital account should

OFFICIAL RESERVES
- The current foreign currency holdings of the US federal reserve system
- When there is a balance of payments supply the federal accumulate foreign currency and debits the balance of payments
- When there is reserves of foreign currency and credits the balance of payments
- The official reserves sew out the balance of payments

ACTIVE VS. PASSIVE OFFICIAL RESERVES
• The US is passive in its use of official reserves. It dives not seek to manipulate the dollar exchange rate
• The people 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 US

4/27/16
         BALANCE OF TRADE
            Goods             +             Goods
            Exports                           Imports

BALANCE ON GOODS AND SERVICES
             Goods           +                Service         +            Goods
              Exports                           Exports                      Imports

Here is a great video over monetary policy
https://youtu.be/1dq7mMort9o

unit 4

Video that might help you in monetary policy

https://youtu.be/1dq7mMort9o

UNIT 4 Day 3

Banks

• Fin. Intermediary - use liquid assets to fund investments of borrowers -- Fractional Reserve Banking

• Liquid assets include currency in bank vaults and bank reserves

• Banks create money by lending out deposits that are used multiple times

• When a customer deposits cash or withdraws cash from their demand deposit account, it has NO EFFECT ON THE MONEY SUPPLY

                                           It only changes...

• The composition of money

• Excess Reserves

• Required Reserves

Changes in Money Supply for 

• Single Bank

                      -Loan money from ER

• Banking System

                     -ER x Money multiplier (1/RR) -> Total Money Supply

• When the FED buys or sells bonds, ER is created

Basic Accounting Review

• T-Account (Balance Sheet) - Lists assets and liabilities

• Assets (Amounts owned) - Items claimed legally by bank; use of funds by fin. intermediary

• Included in assets

Required Reserves - % of DD in vaultExcess Reserves - Remaining % of DD used for loansProperty - Statement of a bank's property valuesSecurities or Bonds - Previously purchased bonds held by the banks as investmentsLoans - Previously loaned funds now owed back to the bankLiabilities (Amounts owed) - Legal claims against a bank; sources of funds.
Included in liabilities

• Demand Deposits (Cash deposits from the public to the bank)

• Part of MS if from person's cash holdings

• Becomes new $ if from a bond -> MS up

• Owner's equity or stock shares (Values of the bank stocks as held by the public)

• DD = RR + ER

Federal Reserve Banks

• Functions

• Uses paper

• Set reserve requirement and holds bank reserves

• Lends $ to banks and charges interest

• Check-clear service for banks

• Personal bank for government

• Supervises member banks

• Controls money supply in the  economy

• Reserve Requirement - Fed needs banks to always have $ to meet demand

• Amount = Reserve Ratio - % of DD locked to bank

Scenario 1
A private citizen takes cash that they possess and put it into a bank account

• The cash placed into the bank is already part of the money supply

• The deposit is counted as a bank liability

• A % must be placed into required reserve

• The remainder is placed into excess reserve

• The bank will want to lend all of the ER, if possible

• The amount in ER is multiplied by the monetary multiplier

• This will be assumed to become new loans in the banking system

• This will be counted as the change in money supply

Scenario 2

• The Fed buys bonds back from the public

• The public now has new cash

• This new cash is new loans

• Assume that the public puts the cash into demand deposits

• A set percentage is placed into required reserve

• The remainder becomes excess reserve

• Excess reserve is multiplied by the money multiplier (1/RR)

• This amount becomes new loans and is new money supply

• The total change in money supply is the amount of demand deposits plus the new loan amounts

Scenario 3

• The Fed buys bonds back from the member banks

• The banks now have new ER

• No money is needed to be placed in RR, since this is not owed to the public

• All of these ER are multiplied by the monetary multiplier

• This amount becomes new loans

• This amount is the change in the money supply

Unit 4 day 4

Three Tools of Monetary Policy

Reserve requirement-

• Only small % of bank deposit is safe. Rest is loaned out. “Fractional Reserve Banking”

• FED sets amount that banks must hold

• The reserve ratio is % of the deposits banks must hold

• When FED increases money supply, it increases money held in bank deposits 

If there is a recession, what should FED do to the reserve requirement?

• Decrease reserve ratio

•  Banks hold less $, more ER

•  Banks create money by loaning out ER

• Money supply increases, interest fall, AD ^

If there is inflation, what should FED do to RR?
   -Increase RR
    -Banks hold $, less ER
  -  Banks create less money
   - MS decreases, Interest up, AD down
The Discount Rate

•    Interest rate that the FED charges commercial banks

****Ex. If bank needs 10 mil, the borrow from US treasury(FED controls) but they must pay back with interest
-To increase MS, FED decreases Discount rate(Easy money policy)
-To Decrease MS, FED increases discount rate(Tight money policy)
Open Market Operations(OMO)

•    FED buys/sells govt bonds(securities)

•    Most important and widely used monetary policy

•    To increase MS, FED buys Govt securities

•    To decrease MS, FED sells govt securities

Federal Funds Rate
   FDIC member banks loan each other overnight funds instead of FED.
Prime Rate

• Interest rates banks give to their most creditworthy customers

Unit 4

3/9/16

Time Value of Money

        I.            Is a dollar today worth more than a dollar tomorrow? Yes

      II.            Why? Opportunity Cost and inflation. This is the reason for charging and paying interest

Let v= future value of $

      p= present value of $

                     r= real interest rate (nominal rate minus inflation rate) (express as decimal)          

                     n= years

                     k= number of times interest is credited per year

• Simple interest rate~ v=(1+r)^n * p

• Compound interest rate~ v=(1+ r/k)^nk *p

Demand for money has an inverse relationship between the nominal interest rate the quantity of money demanded

        I.            What happens to the quantity of money of moneyed when the interest increases? Quantity demanded falls

      II.            What happens to the quantity demand when interest rates decrease? Quantity demanded increases.

Demand Always Downward

Money Demand Shifters

I.                    Changes in the price level

II.                  Changes in income

III.               Changes in taxation that affects investment

Increase money supply, decreases interest rates, investment increases, AD increases and shifts right

Decreasing money supply, increases interest rates, investment decreases, AD decreases and shift left

·         Financial Sector

-Financial assets are what you own

-Financial Liabilities is what you owe

·          Interest Rate

-the cost of borrowing money

·          Stocks

-simply conveying ownership in a company

·          Bonds

-loaning money to the government

Bonds are safe; stocks are not.

What Banks Do

A bank is a financial intermediary

                                 *           Uses liquid assets (i.e. bank deposits) to finance the investment of borrowers

                               **           Process is known as Fractional Reserve Banking, a system in which deposits institution hold liquid assets less than the amount of deposits

                             ***            Can take the form

A.)       Currency in bank vaults

B.)     Bank reserve deposits held at the Federal reserve

• T- Account (balance sheet)
• Assets- Items to which a bank hold legal claim
• Uses of funds by financial intermediates liabilities (amount owned)

• Legal claims against sources of fund financial intermediaries