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 of a good/service than another country in a given time.

COMPARATIVE ADVANTAGE

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

EXAMPLES OF OUTPUT

Tons/acres
Miles/gallon
Apples/tree
Televisions produced per hour

EXAMPLES OF INPUT

Number of hours to do a job.
Number of acres to feed a horse
Number of gallons of paint to paint a house

SPECIALIZATION AND TRADE

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

Mechanisms of foreign exchange 

Foreign exchange 

-The buying and selling of currency 

-Any transaction that occurs in the balance of payment necessitates foreign exchange.

-The exchange rate is determined in the foreign currency market.

Changes in exchange rate

Exchange rates are a function of the supply and demand for currency.

-An increase in the supply of a currency will decrease the exchange rate of a currency.

-A decrease in supply of a currency will increase the exchange rate.

-An increase in demand of a currency will increase the exchange rate of a currency.

-A decrease in demand of a currency will decrease the exchange rate of a currency.

Appreciation and Depreciation 

-Appreciation of a currency occurs when the exchange rate of that currency increases.

-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 

-The exchange rate is a determinant of both exports and imports.

-Appreciation of the dollar causes American 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 more expensive thus increasing exports and reducing imports.

BALANCE OF PAYMENTS

-Measure of money inflows and outflows between the U.S. and the rest of the world.

 *Inflows are referred to 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.

CURRENT ACCOUNT

Balance of trade or net exports

-Exports of goods and services – import of goods and services.

-Exports create a debit to the balance of payments.

Net foreign income

-Income earned by U.S. owned by foreign assets – income paid to foreign held U.S. assets.

Net transfers

-Foreign aid -> a debit to the current account.

CAPITAL/FINANCIAL ACCOUNT

-The balance of capital ownership.

-Includes the purchase of both real and financial assets.

-Direct investment in the U.S. is a credit to the capital account.

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

-Purchase of domestic financial assets by foreigners represents a credit to the capital account.

RELATIONSHIP BETWEEN CURRENT AND CAPITAL ACCOUNT

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

-That is if the current account has a negative balance (deficit), then the capital account should have a positive balance (surplus).

OFFICIAL RESERVES

-The foreign currency holding of the U.S. Federal Reserve System.

-When there is a balance of payments surplus, the FED accumulates foreign currency and debits the balance of payment.

-When there is a balance of payment deficit, the FED depletes its reserves of foreign currency and credits the balance of payments.

-The official reserves zeros out the balance of payment.

ACTIVE VS PASSIVE OFFICIAL RESERVES

-The U.S. is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

THE PHILLIPS CURVE

Original SR Phillips Curve
Inflation and unemployment	Inverse relationship.
Inflation	It increases as the economy expands.
Recession	Unemployment increases as the economy slows down.
Along the curve	Cyclical change in the GDP.
Stagflation
Late 1970s to 1981	Increasing inflation and unemployment at the same time.
Data?
A New Philips Approach
New range?	The SRPC can move inward and outward.
Cost push inflation	More stress on resources, wages and input costs.
Supply shocks	Rapid loss of resources or rapid increase in resource cost.
SRPC curves moves	Outward during shocks.
SRPC moves back	Inward as the society increases productivity or regains resource.
Long Run Philips Curve
Inflation	Society adjusts for cost/wage increases with new prices.
LRPC is?	The efficient PPF.
Natural rate of unemployment	Becomes the equivalent of full employment rate.
Phillips and AD/AS curves
Change points on SRPC	If AD changes, you move the points on the curve.
Move the SRPC	You shift the curve of the SRPC.

THE LONG RUN PHILLIPS CURVE

-Because the long run Phillips curve exists at a natural rate of unemployment (Un), structural changes in the economy that affects Un will cause the LRPC to shift.

-Increases in Un will shift LRPC ->.

-Decreases in Un will shift LRPC <- (Low inflation -> high unemployment).

Relating Phillips curve to AS/AD

-Changes in the AS/AD model can also be seen in the Philips curve.

Misery index

-a combination of inflation and unemployment in any given year. Single digit misery is good.

Supply shocks

-this is the rapid and significant increase in resource cost.

Disinflation

-this is reduction in inflation from year to year or over time. It is found in the LRPC.

Deflation

-general decline in price.

SUPPLY SIDE ECONOMY

-changes in AS and not AD are the main active force in determining the level of inflation, unemployment rates and economy growth.

Supply side economists

-supports policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payment such as unemployment compensation or welfare programs provide disincentive to work , invest, innovate and undertake entrepreneurial ventures.

INCENTIVES TO SAVE AND INVEST

1)      High marginal taxes reduce the revenues for savings and investments.

2)      Consumption might increase but investments depend upon savings.

3)      Lower marginal tax rates encourage savings and investments.

LAFFER CURVE

-theoretical relationship between tax rates and tax revenues. As tax rates increase from zero, tax revenues increase from zero to some maximum level and then decline.

CRITICISM TO THE LAFFER CURVE

1)      Evidence suggests that the impact of tax rates on incentives to work, save and invest is small.

2)      Tax cuts increase demand which can fuel inflation and demand may exceed supply.

CROWDING OUT

What is it? 

-A critique and flaw of Keynesian policies that are applied to fight a recession (expansionary policy).

Why does it happen?

-The policy of cutting taxes and raising spending will create a budget deficit.

So?

-The budget deficit must be funded and to do this congress orders the sale of US bonds.

This money comes from?

-Money comes from US citizens and companies and investment firms.

Therefore?

-Money that could be spent on consumption or used for private savings is now being used to buy bonds.

On the money market?

-This will cause the  money demand curve to shift outward.

On the loan-able funds?

-This will cause the supply curve to shift inward because the are not saving money privately anymore.

On both graphs?

-The nominal and real interest rate will increase.

Therefore, on the investment D graph?

-The increase in nominal and real interest rates will cause Ig to decrease.

Isn't this counterproductive?

-Yes.

Why do it?

-Fiscal policy supporters insist that gains in C and G will outweigh any loss in future Ig.

Why?

-C and G are greater than Ig and they are short run improvements. Ig is longer run and Keynesian don't worry about that. In the long run we are all dead.

Anymore?

-Yes, this is summarized on the aggregate model. The AD will move outward due to the increases in C and G and then "maybe" move inward due to the loss of Ig, but not as much as the increase. Therefore the economy improves.

COUNTER-CYCLICAL POLICIES: KEYNESIAN FISCAL POLICY VS. MONETARY POLICY

MONETARY TOOLS

1) Reserve requirement

    -Only a small percent of your bank deposit is in the safe. The rest of the money has been loaned out. This      is called "Fractional Reserve Banking". The FED sets the amount that the banks must hold. The                   RR(reserve ratio) is the % of deposits that banks must hold and not loan out.
  -When the FED increases money supply(MS), it increases the amount of money held in bank deposits.

If there is a recession, the FED should decrease the RR:

1) Banks hold less money and have more excess reserves.
2) Banks create more money by loaning out excess reserves.
3) MS increases, interest rates fall, AD goes up.

If there is inflation, FED should increase the RR:

1) Banks should hold more money and have less ER.
2) Banks create less money.
3) MS decreases, interest rates up, D down.

2) Discount rate

    -This is the interest rates that FED charges commercial banks.
    -To increase the MS, the FED should decrease the discount rate (easy money policy).
    -To decrease MS, the FED should increase the discount rate (tight money supply).
    -Only member banks are entitled to the discount rate.

3) Open market operations

    -The FED buys/sells government bonds(securities),
    -This is the most important and widely used monetary policy.
    -To increase the MS, the FED buy government securities.
    -To decrease the MS, the FED sell government securities.
    -Buying bonds = bigger MS, selling bonds = smaller MS.

Federal funds rate

-This is where FDIC member banks loan each other overnight funds.

Prime rate

-This is the interest rate that banks charge their most credit worthy customer.

When a customer deposits or withdraws cash from their demand deposit account, it has no effect on money supply. It only changes:

1) The composition of money
2) Excess reserves.
3) Required reserves.

Single bank

-Loan from your excess reserves (ER).

Banking system

-ER * multiplier (total money supply).

Anytime the FED buys or sells bonds, ER is created. 

BANKS AND THE CREATION OF MONEY

How do banks create money?

*By lending out deposits(money).

Where do loans come from?

*Loans come from depositors who take cash and place it in accounts at the banks.

How are the amounts of potential loans calculated?

*They are calculated by using a T-Account that consists of assets and liabilities.

Banks liabilities(the right side of the T-Account sheet):

*Demand deposits: these are cash deposits from the public, they are a liability because they belong to             depositors and can be withdrawn by depositors.
*Owner's Equity: values of stocks held by the public ownership of bank shares.

Key Concept for AP concerning liabilities:

1) If the DD comes in from someone's cash holdings then that DD is already part of the money supply.
2) If the DD comes in from the purchase of bonds(by the FED) then it creates new cash and therefore               creates new money supply.

Bank assets(the left side of the T-Account sheet):

1) Required reserves(RR): These are the percentages of DD that must be held in the vault so that some            depositors have access to their money. it is usually 5%, 10%, 20% but in reality is 10% or below.
2) Excess reserves(ER): They are source for new loans.
3) Property.
4) Securities(bonds): Securities are bonds purchased by the bank. These could be bonds purchased by the       FED.
5) Loans: These can be amounts held by banks from previous transactions owed to the bank by prior               customers.

Money creation (using excess reserves)

*Banks want to create profits.

The money multiplier (also known as):

*The loan multiplier.
*Reserve multiplier.
*Check-able deposit multiplier.

The formula is:

*1 divided by the reserve requirement ratio (1/RR).
Excess reserves are multiplied by the multiplier to create new loans for the entire banking system and this creates new money supply.

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 $.
       P= present value of $.
       r= real interest rate (nominal rate - inflation rate).
       n= years.
       k= number of times interest credited per year.

-The simple interest formula:

 *V= (1+r)^n *P

-The compound interest formula:

 *V= (1+ r/k)^nk *P
Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded.
1) What happens to the quantity demanded of money when interest rates increase?
    *Quantity demanded falls because individuals would prefer to have interest earning assets instead of                 borrowing liabilities.
2) What happens to the quantity demanded when interest rates decrease?
     *Quantity demanded increases. There is incentive to convert cash into interest earning assets.
3) What happens if price level increase?
     Money demand shifters
     *Changes in price level.
     *Changes in income.
     *Changes in taxation that affects investment.
   If the FED increases the money supply, a temporary surplus of money will occur at 5% interest. The              surplus will cause the interest rate to fall to 2%.
4) How does this affect AD?
    a)Increase in money supply > decreases interest rates > increases investment > increases AD.
   If the FED decreases the money supply, a temporary shortage of money will occur at 5% interest. The          shortage will cause the interest rate to rise to 10%.
5) How does this affect AD?
    Decrease money supply > increase interest rate > decrease investment > decrease AD.

FINANCIAL SECTORS

Financial assets

-It is stocks and bonds whose benefit to the owner depends upon the issuer of the asset meeting certain          obligation.

Financial liabilities

-It is liabilities incurred by the issuer of a financial assets to stand behind the issued assets.

Interest rates

-Price payed for the use of a financial asset.

Stocks

-Financial asset that convey ownership in a corporation.

Bonds

-A promise to pay a certain amount of money plus interest in the future.

WHAT BANKS DO

A bank is a financial intermediary
-Uses liquid assets (i.e bank deposits) to finance the investments of borrowers.
-Process is known as fractional reserve banking.
 *A system in which depository institutions hold liquid assets less than the amount of deposits can take the        form of :
   1) Currency in banks vaults.
   2) Bank reserves: deposits held at the federal reserve.

BASIC ACCOUNTING REVIEW

T-Account (balance sheet)

-statements of assets and liabilities.

Assets (amounts owned)

-Items to which a bank holds a legal claim.
-The uses of funds by financial intermediaries.

Liabilities (amounts owed)

-The legal claim against a bank.
-The sources of funds for financial intermediaries.

FUNCTIONS OF THE FEDERAL RESERVE (FED)

1) It issues paper currency.
2) It sets reserve requirements and holds reserves of the bank.
3) It lends money to the banks and charges them interest.
4) They are a check clearing service for banks.
5) They act as a personal bank for the government.
6) They supervise member banks.
7) They control the money supply in the economy.

UNIT 4:MONEY

USES OF MONEY

-As a medium of exchange.

 *To barter (trade).

-Unit of account

 *This establishes worth in the exchange process.

-Storage values

 *Money holds value over a period of time.

TYPES OF MONEY

-Commodity money

 *It gets value from the type of material from which it is made.

-Representative money

 *Paper money backed by something tangible that gives it value.

-Fiat money

 *This is the type of money used in the U.S. It is money because the government says so.

CHARACTERISTICS OF MONEY

-Portable
-Durable
-Divisible
-Limited supply
-Acceptable
-Uniform

MONEY SUPPLY

-M1 Money (75%)

 *It consists of currency in circulation.
 *Check-able deposits(checking account).
 *Traveler's check.
 *It is held as a medium of exchange.
 *It is the most liquid.

-M2 Money

 *It consists of M1 money along with savings account, money market accountand deposits held by banks        outside the U.S.

-M3 Money

 *It encompasses M2 money and certificates of deposits (CD's).

FISCAL POLICY

-Changes in expenditures or tax revenues of the federal government.

TOOLS OF FISCAL POLICY

-Taxes: government can increase or decrease taxes.

-Spending: government can increase or decrease spending.

DEFICITS, SURPLUSES AND DEBT

Balanced Budgets

-Revenues = Expenditures.

Budget Deficit

-Revenues < Expenditures.

Budget Surplus

-Revenues > Expenditures.

Government Debt

-Sum of all deficit - sum of all surpluses.

Government must borrow money and its run a budget deficit.

Government borrows money from:

-Individuals.

-Corporations.

-Financial Institutions.

-Foreign entities or government.

FISCAL POLICY TWO OPTIONS

Discretionary Fiscal Policy(action)

-Expansionary Fiscal Policy- think deficit.

-Contractionary Fiscal Policy- think surplus.

Non-Discretionary Fiscal Policy(no action)

DISCRETIONARY FISCAL POLICY

-Increasing or decreasing government spending and/or taxes in order to return the economy to full        employment.

-Discretionary policy involves policy makers doing fiscal policy in response to an economic problem.

AUTOMATIC FISCAL POLICY

-Unemployment compensation and marginal tax rates are examples of automatic policies that help    mitigate the effects of recession and inflation.

-Automatic fiscal policy takes place without policy makers having to respond to current economic  problems.

EXPANSIONARY FISCAL POLICY

-Combat a recession.

-Government spending increases.

-Taxes decreases.

CONTRACTIONAL FISCAL POLICY

-Combat inflation.

-Government spending decreases.

-Taxes increases.

TYPES OF TAXES

PROGRESSIVE TAX SYSTEM

-Average tax rate(tax revenue/ GDP) rises with GDP.

PROPORTIONAL TAX SYSTEM

-Average tax rate remains constant as GDP changes.

REGRESSIVE TAX SYSTEM

-Average tax rate falls with GDP.

AUTOMATIC OR BUILT-IN STABILIZERS

-Anything that increases the government's budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers.

CONSUMPTION & SAVINGS

DISPOSABLE INCOME(DI)

-Income after taxes or net income.
-DI = gross income -taxes.
-With disposable income, households can either:
 *Consume(spend money on goods & services)
 *Save(spend money on goods &services).

CONSUMPTION

-Household spending
-The ability to consume is constrained by:
 *The amount of disposable income.
 *The propensity to save.
-Do household consume if DI=0.
 *Autonomic consumption
 *Dis saving.

SAVING

-Households not spending.
-The ability to save is constrained by:
 *The amount of disposable income.
 *The propensity of disposable income.
-Do households save if DI=0.
 *No.

APC &APS(AVERAGE TO CONSUME/SAVE)

-APC+APS = 1.
-1- APC = APS.
-1- APS = APC.
-APC >1: Dis saving.
-(-APS): Dis saving.

MPC(MARGINAL PROPENSITY TO CONSUME)

-The fraction of any change in-disposable income that is consumed.
-MPC = change in consumption/ change in disposable income.

MPS(MARGINAL PROPENSITY TO SAVE)

-The fraction of any change in disposable income that is saved.
-MPS = change in savings/ change in disposable income.

MARGINAL PROPENSITIES

-MPC +MPC =1.
 *MPC = 1- MPS.
 *MPS = 1- MPC.
-Remember, people do two things with their disposable income, consume or save it.

SPENDING MULTIPLIER EFFECTS

-An initial change in spending(C, Ig, G, Xn) causes a larger change in aggregate spending or aggregate  demand.
-Multiplier = change in AD/ change in spending.

CALCULATING SPENDING MULTIPLIER

-The spending multiplier can be calculated from the MPC or MPS.
-Multiplier = 1/1- MPC or 1/MPS.
-Multipliers are (+) when there is an increase in spending and (-) when there is a decrease.

CALCULATING TAX MULTIPLIER

-When the government taxes, the multiplier works in reverse.
-Why?
 *Because now money is leaving the circular flow.
-Tax multiplier(note: it's negative)
 *-MPC/1- MPS or -MPC/MPS.
-If there is a tax cut, then the multiplier is (+), because there is now more money in the circular flow.

REAL(r%0) VS. NOMINAL(i%)

What is the difference?

-Nominal is the observable rate of interest rate of interest. Real subtracts out inflation and is only known ex post facto.

How do you compute the real interest rate(r%)?

-r% = i% - inflation.

What then, determines the cost of an investment decision?

-The real interest rate(r%).

INVESTMENT DEMAND CURVE

What is the shape of the investment demand curve?

-Downward sloping.

Why?

-When interest rates are high, fewer investments are profitable; when interest rate are low, more investments are profitable.

SHIFTS IN INVESTMENT DEMAND(ID)

-Cost of production.

 *Lower costs shift(ID ->).
 *Higher costs shift(ID <-).

-Business taxes

 *Lower business taxes shift(ID ->).
 *Higher business taxes shift(id <-).

- Technological Change

 *New technological shifts(ID ->).
 *Lack of technological change shifts(ID <-).

-Stock of capital

 *If an economy is low on capital, then(ID ->).
 *If an economy is low on capital, then(ID <-).

-Expectations

 *Positive expectations shift(ID ->).
 *Negative expectations shift(ID ->).

LONG RUN VS SHORT RUN AGGREGATE SUPPLY

LONG RUN AGGREGATE SUPPLY (LRAS)

-Period of time where input prices are completely flexible and adjust to changes in the price level.
-In the long run, the level of real GDP supplied is independent of the price level.
-The long run aggregate supply marks the level of full employment in the economy.
-Because input prices are completely flexible in the long run, change in price level do not change firms' real  profits and therefore do not change firms' level of output. this means that the LRAS is vertical at the  economy's level of full employment.

SHORT RUN AGGREGATE SUPPLY (SRAS)

-Period of time where input prices are sticky and do not adjust to changes in the price level.
-In the short run, the level of real GDP is directly related to the price level.

CHANGES IN SRAS

-An increase in SRAS is seen as a shift to the right(SRAS ->).
-A decrease in SRAS is seen as a shift to the left(SRAS <-).
-The key to understanding shift in SRAS is per unit cost of production.
-Per unit production cost = total input cost/ total output cost.

DETERMINANTS OF SRAS

-Input prices
-Productivity
-Legal-institutional environment

INPUT PRICES

-Domestic resource prices

 *Wages(75% of all business costs).
 *Cost of capital.
 *Raw materials(commodity prices).

-Foreign resource prices

 *Market power.
 *Increase in resource price(SRAS <-).
 *Decrease in resource prices(SRAS ->).

PRODUCTIVITY

-Productivity = total output/ total input.
-More productivity = lower unit production cost(SRAS ->).
-Lower productivity = higher unit production cost(SRAS <-).

LEGAL-INSTITUTIONAL ENVIRONMENT

-Taxes and subsidies

 *Taxes($ to government) on business increase per unit production cost(SRAS <-).
 *Subsidies($ from government) to business reduce per unit production cost(SRAS ->).

-Government regulation

 *Government regulation compliance cost(SRAS <-).
 *Deregulation reduces compliance cost(SRAS ->).

FULL EMPLOYMENT

-Full employment equilibrium exists where AD intersects LRAS X SRAS at the same point.

INFLATIONARY GAP

-An inflationary gap exists when equilibrium occurs beyond full employment prices.

RECESSIONARY GAP

-A recessionary gap exists when equilibrium occurs below full employment.

AGGREGATE DEMAND

WHY IS AD DOWNWARD SLOPING?

1) Real Balance Effect: 

    -Higher price levels reduce the purchasing power of money.
    -This decreases the quantity of expenditures.
    -Lower price levels increase purchasing power and increase expenditures.

2) Interest Rate Effect:

    -When the price level increases, lenders need to charge higher interest rates to get a REAL return on their       loans.
    -Higher interest rates discourage consumer spending and business investments.

3) Foreign Trade Effect:

    -When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign       goods.
    -Exports fall and imports rise causing real GDP demanded to fall. (Xn decreases).

SHIFTERS OF AGGREGATE DEMAND

GDP= C+I+G+Xn

 There are two parts to a shift in AD:
  -A change in C, I, G AND Xn.
  -A multiplier effect that produces a greater change than the original change in the four components.
    *Increase in AD = AD ->
    *Decrease in AD = AD <-

CONSUMPTION 

Household spending is affected by;

-Consumer wealth

  *More wealth = more spending(AD shifts ->)
  *Less wealth = less spending(AD shifts <-)

-Consumer expectations

  *Positive expectations = more spending(AD shifts ->)
  *Negative expectations = less spending(AD shifts <-)

-Taxes

  *Less taxes = more spending(AD shifts ->)
   *More taxes = less spending(ad shifts <-)

GROSS PRIVATE INVESTMENT

Investment spending is sensitive to:

-The real Interest Rate

  *Lower real interest rates = more investment(AD ->)
  *Higher real interest rate = less investment(AD <-)

-Expected Returns

 *Higher expected returns = more investment(AD ->)
 *Lower expected returns = less investment(AD <-)
 *Expected returns are influenced by
   +Expectations of future profitability
   +Technology
   +Degree of excess capacity(existing stock of capital)
   +Business taxes

GOVERNMENT SPENDING

-More government spending(AD->)
-Less government spending (AD<-)

NET EXPORTS 

Net exports are sensitive to:

-Exchange rates(international value of $)

 *Strong$ = more imports and fewer exports = (AD <-)
 *Weak$ = fewer imports and more exports =(AD ->)

-Relative income

 *Strong foreign economies = more exports =(AD ->)
 *Weak foreign economies = less exports =(AD <-)

GDP GAP

- It is the amount by which actual GDP falls short of potential GDP.

Okun's Law

- It states for every 1% that actual employment rate exceeds the natural rate of unemployment (NRU), a GDP gap of 2% occurs.
- Example: In mexico, the unemployment rate is 7.4%, the natural of employment is 6%. 2(7.4 - 6) =     2.8%.

Rule of 70

- It is used to determine how many years it take for a value to double given a particular annual growth   rate.
- Example: If you put $20,000 in the bank and it earns a yearly interest rate of 7%, then how many years will it take for your income to double.
- Formula: (70/ # of years).

UNEMPLOYMENT

- Failure to use available resources particularly labor to produce desired goods and services.

Unemployment Rate

- Ideal unemployment rate is (4-5%) which means full employment or natural rate of unemployment   (NRU).

Labor Force

- Above 16 years old.
- Able and willing to work.

Not in the Labor Force

- Military.
- Jail/ Prison.
- Mental institutions.
- Retired People.
- Students.
- Homemakers.
- People who are not looking for a job.

How to Calculate Unemployment

- (# of unemployed people/ # of employed people + # of unemployed people) 100.

Types Of Unemployment

Frictional

- Temporarily unemployed or in between jobs.
- Recent high school graduate.
- Better position.

Structural

- Workers do not have transferable skills and these jobs will never come back.

Seasonal

- Unemployment due to the time of the year and nature of the job.
- Bus drivers, Santa Claus impersonator.

Cyclical

- Results from economic downturns.
- As demand for goods and services fall, demand for labor also fall.
- Full employment means no cyclical employment.

INFLATION

- It taxes those who receive relatively fixed income.

Unanticipated Inflation

Hurt by Inflation

- Lenders (lend money at a fixed rate).
- People with a fixed income (elderly and welfare consumers).
- Savers (those who save money at a certain rate).

Helped by Inflation

- Debtors.
- A business where the price of the product increases faster than the price of resources.

REAL VS NOMINAL GDP

Real GDP

- The value of output produces in constant base year prices. 

- It can increase if quantity increase. 

- We use real GDP to measure economic growth.

Nominal GDP

- The value of output produced in current prices. 

- It can increase from year to year if price and quantity increase. 

- It is used to measure inflation.

GDP Deflator

- It is a price index used to adjust from nominal to real GDP.

- Formula: (Nominal GDP/Real GDP) 100.

Consumer Price Index (CPI)

- It is the most commonly used measurement of inflation for consumers.

- Formula; (Current year/ Base year) 100.

Calculation For Inflation

- Formula: (GDP Deflator of current year - GDP Deflator/ GDP Deflator) 100.

Real Interest Rate

- Adjusted for inflation.

- Formula = Nominal interest rate - Inflation.

Nominal Interest Rate

- Not adjusted for inflation. 

WAYS OF CALCULATING GDP

Expenditure Approach

- We add up all of the spending on final goods and services produced in a given year.

- Formula: GDP= C+IG+G+XN.

Income Approach 

- We add up all of the income that resulted from selling all final goods and services produced in a          given year.

- Formula: GDP= N+R+I+P+Statistical adjustments.

* Compensation of Employees: It includes wages, salaries, franking benefits, social security contribution, health and pension plans.

* Rents: income of property owners.

* Interests: income that comes from money.

* Corporate Profits: income of company stockholders.

* Proprietor's Income: income from sole proprietorship and partnerships.

* Statistical Adjustments:

   - Indirect Business Taxes.

   - Depreciation.

   - Net Foreign Factored Payment.

- Rarely used because people lie about their age.

NET DOMESTIC PRODUCT (NDP)

GDP - depreciation (consumption of fixed capital).

NET NATIONAL PRODUCT (NNP)

GNP= GDP + net foreign factored payment.

Budget Surplus/ Deficit

- Formula: government purchase of goods and services + government transfer payment - government   tax and fee collection.
- Surplus (-) and Deficit (+).

Trade Surplus/ Deficit

- Formula: export - import.

National Income

- Formula: compensation of employees + rental income + interest income + corporate profits + proprietor's income.

                                                   OR

- Formula: GDP - indirect business tax - depreciation - net factored payment.

Disposable Personal Income

- Formula: national income - personal household taxes + government transfer payment.

GDP/GNP

GDP

- This is the market value of all final goods and services within a country's border within a given year.

GNP

- It is the total value of all final goods and services by citizens of that country on its land or a foreign and.

INCLUDED IN GDP:

C- Personal consumption expenditures (65%).
IG- Gross private domestic investment (17%).
      * Factory equipment, factory equipment maintenance, construction of housing, unsold inventory of                    products built in a year.
G- Government spending (20%).
XN- Net exports (-2%).
        * (Exports - Imports).
Formula: C+IG+G+XN.

WHAT'S NOT INCLUDED IN GDP.

1) Intermediate Goods: goods that require further processing before they are ready for final use
    * Parts of a car.
2) Used/ Secondhand Goods.
    * To avoid double counting.
3) Purely Financial Transactions(stocks and bonds).
4) Illegal Activities(drugs).
5) Unreported Business Activity(unreported tips).
6) Transferred Payments.
     * Public(social security, welfare, VA).
     * Private (scholarship, trust funds).
7) Non-Market Activity.
     * Volunteer work, babysitting, any work performed for self.

CIRCULAR FLOW DIAGRAM

- It represents the transactions in an economy.

Resource (Product) Market

- This is the place where households sell resources and businesses buy resources(goods and services).

Factor Market

- This holds the factors of production(land, labor, capital and entrepreneurship).

Firms

- It is an organization that produces goods and services for sale.

- Firms sell finished products to households.

Household

- It is a person or a group of people that share their income. Households sell their factors of production to businesses.

BUSINESS CYCLE

Peak

- It is the highest point of real GDP. This is where we have the greatest spending and lowest unemployment. In this phase, inflation is a problem.

Expansion

- This is where real GDP is increasing, spending increases and unemployment decreases.

Contraction/Recession

- This is where real GDP declines for 6 months. This is also where we have increased unemployment and decline in spending.

Trough

- This is the lowest point of real GDP. It has the highest unemployment and the least spending.

DEMAND, SUPPLY AND MARKET EQUILIBRIUM.

Demand.

- The quantities people are willing and able to buy at various quantities.

The Law of Demand.

- This states that there is an inverse relationship between price and quantity demanded.

What Causes a "Change in Quantity Demanded"?

- Change in price.

What Causes a "Change in Demand"?.

1) Change in buyer's taste (advertisement).

2) Change in the number of buyers (population).

3) Change in the price of related goods.

    - Complimentary Goods (go together).

    - Substitute Goods.

4) Change in income.

    - Normal Goods (increase in income that causes an increase in demand). 

    - Inferior Goods (increase in income that causes a fall in demand).

5) Change in expectations (looking at the future). 

Supply

- The quantities that producers or sellers are willing and able to produce at various prices.

The Law of Supply

- This states that there is a direct relationship between price and quantity supplied.

What Causes a "Change in Quantity Supplied"?

- Change in price.

What Causes a "Change in Supply".

1) Change in expectations.

2) Change in the number of suppliers.

3) Change in weather.

4) Change in the cost of production.

5) Change in taxes or subsidies.

6) Change in technology.

Supply Shifts to the Left

1) Cost of production increases.

2) Technology decreases.

3) Taxes increase.

4) Subsidies reduce.

5) Number of sellers decrease.

6) Weather decreases.

Supply Shifts to the Right

1) Cost of production reduces.

2) Technology increases.

3) Taxes are lowered.

4) Subsidies increase.

5) Number of sellers increase.

6) Good weather.

A price ceiling is placed on corn:

A price floor is placed on steak:

ELASTICITY OF DEMAND

- It is a measure of how consumers react to a change in price.

Elastic Demand

- Demand that is very sensitive to a change in price. E>1

- The product is not a necessity and there are available substitute.

- Ex; soda, T-bone and steaks.

Inelastic Demand

- Demand that is not very sensitive to a change in price. E<1.

- The product is a necessity and there are few substitute, therefore people will always buy.

- Ex; gas and medicine

Unit/ Unitary Demand.

- E=1.

Price Elasticity of Demand (PED)

Step 1: Quantity.

          New quantity - Old quantity/ Old quantity.

Step 2: Price

          New price- Old price/ Old price.

Step 3: PED

          % change in quantity demanded/ % change in price.

Costs of Production

Total Revenue

- The total amount of money a firm receives from selling goods and services.
- P.Q

Fixed Cost

- A cost that does not change no matter how much of a good is produced.
- Ex; mortgage, insurance, rent and salary.

Variable Cost

- A cost that rises or falls depending on how is produced.
- Ex; electricity bill.

Marginal Cost

- The cost of producing one more unit of a good.
- New TC - Old TC.

Formulas

TFC + TVC = TC.
AFC + AVC =ATC.
TFC / Q = AFC.
TVC / Q = AVC.
TC / Q = ATC.
TFC = AFC (Q).
TVC= AVC (Q).

PRODUCTION POSSIBILITIES CURVE

Production possibilities curve (PPC)

- It shows alternative ways on how to use a country's resources.

4 Assumptions of a PPC

- Two Goods (resources are used to produce one or both of only two goods).

- Fixed Resources (quantities of land, labor, capital and entrepreneurship do not change).

- Fixed Technology (information and knowledge, society has about the production of goods and services is fixed).

- Technical Efficiency.

 

1) Efficiency.

   - using resources in such a way to maximize the production of goods and services.

2) Allocative Efficiency.

   - products being produced are the ones that are most desired by the society.

3) Productive Efficiency. 

   - products are being produced in the least costly way and this is any point on the PPC.

4) Under-utilization.

   - using fewer resources than the economy is capable of using.

What Causes PPC/PPF To Shift

1) Technological Change.

2) Change in Resources.

3) Economic Growth.

4) Change in Labor Force.

5) Natural Disasters/ War/ Famine.

6) More Education.

AP MACROECONOMICS UNIT 1

BASIC ECONOMIC CONCEPTS

Macroeconomics vs Microeconomics

Macroeconomics: study of the economy as a whole.

- minimum wage.

- international trade.

- supply &demand.

Microeconomics: study of individual of specific unit of the economy.

-market structures.

Positive economics vs Normative economics

Positive economics: claims the attempt to describe the world as it is.

- collects and present facts.

Normative economics: claims the attempt to prescribe how the world should be (opinion).

- "ought to be"

- "should be"

Needs vs Wants

Needs: basic requirements for survival.

- food, water, shelter and clothing.

Wants: desire of citizens.

Goods vs Services

Goods: tangible commodities always (bought, sold or produced).

- capital goods (items used in the creation of other goods such as factory machines and trucks).

- consumer goods (goods that are for final use by the consumer).

Services: work performed for someone.

- can be touched or felt.

Scarcity vs Shortage

Scarcity: trying to satisfy unlimited wants with limited resources. 

- the most fundamental economic problem that all societies face. 

Shortage: where quantity demanded is greater than quantity supplied.

Factors of Production

Resources required to produce goods and services.

1) Land (natural resources).

2) Labor (workforce).

3) Capital.

- physical capital ( tools, machinery, factories).

- human capital (skills, knowledge or talents).

4) Entrepreneurship.

- innovative.

- risk taker.

Trade-offs

Trade-offs: alternatives that we give up whenever we choose one course of action over another.
-Opportunity Costs: next best alternative.