Absolute and 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 (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.

               

Specialization and Trade:

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

Examples of Output Problem:

- per acre 

-miles per gallon

-word per minute

-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

Foreign Exchange

Foreign Exchange:

-  Buying and selling of currency-Any transactions that occurs in the balance of payments necessitates foreign exchange-Exchange Rate (ex): is determined in the 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

Floating/ Flexible Rates:

Depends upon supply and demand of that currency vs. other currenciesVery sensitive to business cycle / provide options for investments
Fixed Rates:Based on a country's willingness to distribute currency and to control the amount
As two currencies trade:

1.    One supply line will ∆, the other demand line will ∆.
2.    They will move in the same direction
3.    One currency will appreciate, the other will depreciate

Unit IV - Creation of money

• How do banks "create" money?
• By lending out deposits.
• 
• Where do the loans come from? 
• Depositors who take cash and place it in their banks.
• How are the amounts of potential loans calculated?
• By using the balance sheet or T account which consists of liabilities and assets.
• Bank Liabilities (right side of T Account)
1. Demand Deposits (DD) or Checkable Deposits (CD)
• Cash deposits from the public.
• They are a liability because they belong to the depositors and can be withdrawn by the depositors.
2. Owner's Equity
• Values of stock held by the public ownership of bank shares.
• Bank Assets (left side of T Account)
1. The required reserves (RR): A % of DD that must be held in the vault so that some depositors may have access to their money.
2. ER (Excess Reserves): Source of new loans
• DD = RR + ER
3. Property: Bank's holdings
4. Securities (Bonds): Purchased by the bank or new bonds sold to the bank by the Federal Reserve. 
• These bonds can be purchased from the bank turned into cash that immediately becomes available as excess reserves. 
5. Loans: Money creation using excess reserves.
• Key Concept for AP concerning Liabilities
• If the DD comes in from someone's cash holdings, then that DD is already part of the money supply. 
• If the DD comes in from the purchase of bonds (by the FED), then this creates new cash and therefore creates new money supply. 
• Monetary Multiplier: 1 / RR 
• The Monetary Multiplier is multiplied by Excess Reserves to get the change in money supply.

Unit IV - Monetary Policy

1. Reserve Requirement
• Only small % of your bank is safe.
• ER is loaned out - "Fractional Reserve Banking"
• FED sets the ER. 
• When FED increases MS, it increases the amount of money held in bank deposits. 
• Decrease RR
• Banks have less money and more ER.
• Banks create more money by loaning out excess reserves.
• Money supply increases, interest rate decreases, and AD increases.
• Increase RR
• Banks hold more money and less ER.
• Banks create less money.
• Money supply decreases, interest rate increases, and AD decreases. 
2. Discount Rate
• Interest rate that the FED charges commercial banks.
• To increase money supply, FED should lower discount rate (Easy Money policy)
• To decrease money supply, FED should increase discount rate (Tight Money policy)
• 
3. Open Market Operations
• The FED buys/sells government bonds (securities).
• To increase MS, FED should buy government securities.
• To decrease MS, FED should decrease government securities.

• Expansionary (Easy Money)
• OMO: Buy bonds
• Discount Rate: Decrease
• Reserve Requirement: Decrease
• Loans decrease, AD increases, GDP increases, MS increases, and interest rate decreases.
• Contractionary (Tight Money)
• OMO: Sell bonds
• Discount Rate: Increase
• Reserve Requirement: Increase
• Loans decrease, AD decreases, GDP decreases, MS decreases, and interest rate increases.
• Federal Fund Rate: Where FDIC member banks loan each other overnight funds.
• Prime Rate: Interest rate that banks give to their most credit-worthy customers. 

Unit IV - Time Value

• 
• 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.
• Simple Interest Formula
• V = ((1 + r) ^ n) * p 
• V = future value of $
• P = present value of $
• r = real interest rate (nominal - inflation) expressed as a decimal
• n = year
• k = # of times interest is credited per year.
• Compound Interest Formula: V = (1 + r/k)^ nk
• When interest rates increase, the quantity demanded of money decrease.
• Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded. 

• Money Demand Shifters
1. Change in price level
2. Change in income
3. Changes in taxation that affect investment
• Increase money > decreases interest rate > increases investment > increases AD 

• Financial Assets vs. Financial Liabilities
• Asset: Something you own.
• Liability: Something you owe.

• Stocks vs. Bonds
• Stocks: A share of a company you buy.
• Bonds: Lend money to government so they pay you back with interest. 

• Bank: A financial intermediary
• Uses liquid assets (i.e. bank deposits)
• 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:
• Currency in bank vaults
• Bank Reserves: deposits held at the federal reserve. 
• T-Account (Balance Sheet)
• Statement of assets and liabilities. 

• Reserve Requirement: FED requires bank to always have some money readily available to met consumers' demand for cash.
• Ratio: Amount set by the FED.
• % of DD that must not be loaned out.
• Typically is 10%.
• 3 Types of Multiple Deposit Expansion
• Type 1: Calculate initial change in excess reserves.
• Type 2: Calculate change in loans in banking.
• Type 3: Calculate change in the money supply.
• Sometimes type 2 and type 3 will have the same result. 

Unit IV - Money

• Uses of Money
• Medium of Exchange: barter and trade
• Unit of Account
• Establishes economic value
• Store of Value: Money holds its value over a period of time
• Types of Money
•  Commodity money: gets value from type of material from which it is made
• Gold and Silver Coin
• Representative money: paper money backed by something tangible, giving it value
• Fiat money: money because the government says so.

• Characteristics of money
• Divisible
• Can be broken down
• Portable
• Uniform
• Scarce
• Durable

• Money Supply
• M1 Money - 75% of all money and most liquid (easy to convert)
• Currency (cash and coins) 
• Checkable Deposists (Demand deposits) - not as liquid as TC
• Travelers Check - worth 20$ - very liquid
•  M2 Money - not as liquid as M1 Money
• M1 money
• Savings Account
• Deposits held by banks outside of US
• M3 Money
• M2 money
• Certificate of Deposits (CD's)

Video

Unit 4 - Video summaries

Video 1

Commodity money is a good that functions as money through exchanges. Representative money is when money is backed up by a metal such as silver or gold. Fiat money is not backed by metal and backed up by the government's word. Money has many functions as well such as being a medium of exchange, store of value, and a unit of account.

Video 2

In mm graphs, Demand slopes downward as it did in the S and D graphs because price and demand have an inverse relationship. Certain factors that can shift the Demand is if there was an incentive to want more money via loans and etc. If people borrowing and spending more money, then the Demand will shift right. In effect it would put upward pressure on the interest rate. If the Fed wants to lower the interest rates in certain times such as an recession, they would increase the money supply.

Video 3

The FED has expansionary and contractionary policies. In expansionary, the reserve requirement (RR) decreases, the discount rate decreases, and the FED buys bonds to expand the money supply. A way to remember this is "buy bonds = big bucks!" In contractionary, the reserve requirement increases, the discount rate increases, and the FED sells bonds to lower the money supply.

Video 4

On the loanable funds graph has the same axes as the Money Market graphs. Demand for loadable funds is downward sloping because when interest rates are lower, people demand more money and vice versa. Supply is upward sloping and it also dependent on savings.Savings is a positive factor in this market because the more people save, the more banks will have available. In order to shift the Supply curve left or right there must be an incentive or an lack of a incentive for people to save.  The money market and loanable funds are connected, loanable funds is the source of money for the money market.

Video 5

Banks create money by making loans. The formula for the money multiplier is 1 / reserve requirement. The money multiplier is then multiplied by the amount of money loaned to get the potential total amount of money created in the banking system. This can only be done by assuming that the banks have no excess reserves. If there are excess reserves, then the potential total amount of money is lower.

Video 6

The money market, loanable funds market, and AD/AS market have affects on each other, The money market is where the government gets the money, the demand for loans increase for another source of money(government spending), and the AD increases because government spending is a determinant for the AS/AD market. The equation of exchange is MV=PQ can be used to explain the relationship, as price levels increase the interest rates increase. This can be explained by the "fisher effect." It ultimately means that there is a 1:1 ratio.

Unit 3- Fiscal Policy

Fiscal Policy: Changes in the expenditures or tax revenues of the federal government.

• 2 tools:
• Taxes: The government can increase or decrease taxes.
• Spending: The 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 (Fiscal Policy)
• Discretionary Fiscal Policy (action)
• Expansionary (deficit)
• Foreign entities or foreign governments
• Discretionary: Increasing or decreasing government spending in order to return the economy to full employment.
• Automatic: Unemployment compensation and marginal tax rates.
• Takes place without policy makers having to respond to current economic problems.
• Expansionary ("Easy") Fiscal Policy
• Combats a recession
• Increased government spending
• Decreased taxes
• Contractionary ("Tight") Fiscal Policy: 
• Combats inflation
• Decreased government spending
• Increased taxes

Automatic 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.
• Transfer payments (Social Security, medicaid/medicare, unemployment, veterans benefits)
• Progressive Tax System
• Average tax rate rises with GDP.
• Proportional
• Average tax rate remains constant as GDP changes.
•   Regressive Tax System
• Average tax rate falls with GDP. 

Unit 3- DI & Multipliers

Disposable Income (DI)

• Income after taxes or net income.
• DI = Gross Income - taxes
• 2 choices for households: consume or save
• Consumption: Household spending
• Amount of DI
• propensity to save
• Do households consume if DI = 0?
• Autonomous consumption
• Dissaving
• Saving: Household NOT spending
• Ability to save constrained by:
• Amount of disposable income
• Propensity to consume
• Do households save if DI = 0?
• NO

APC and APS

• Average Propensity to Consume and Average Propensity to Save
• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1: Dissaving
• - APS: Dissaving

MPC and MPS

• Marginal Propensity to Consume (MPC): Fraction of any change in disposable income that is consumed.
• Formula: Change in Consumption / Change in DI
• Marginal Propensity to Save (MPS): Fraction of any change in DI that's saved.
• Formula: Change in savings / Change in DI
• MPC + MPS = 1
• MPC = 1 - MPS
• MPS = 1 - MPC

Spending Multiplier Effect

• An initial change in spending causes a large change in aggregate spending or aggregate demand.
• Multiplier = Change in AD / Change in spending ( C, I, G, or X)
• Calculating Multiplier:
• 1 / 1-MPC or 1 / MPS
• + = increase in spending
• - = decrease in spending
• When the government taxes, the multiplier works in reverse.
• Because money is leaving circular flow.
• Tax multiplier
• -MPC / 1 - MPC
• -MPC / MPS
• If there's a tax cut, multiplier is positive.

Unit 3- Wages

Nominal Wages vs. Real Wages

• Nominal Wages: Amount of money received by a worker per unit of time.
• Real Wages: Amount of goods/services a worker can purchase with their nominal wage. 
• Sticky Wages: Nominal wage level that is set according to an initial price level and does not vary due to labor contracts or other restrictions.

• Recession(Keynesian Range): Fixed price and wages and flexible employment level.
• Output depends upon changes in employment level.
• Intermediate Range; Flexible price and employment level and fixed wages.
• Output depends upon changes in price and employment level.
• Inflationary Range: Flexible price and wages and fixed employment level.
• Output is independent of changes in the price level.
• 

Investment

• Money spent or expenditures on new plants (factories), capital equipment (machinery), technology (hardware and software), new homes, and inventories (goods sold by producers).
• 

Expected Rates of Return

• How does business make investment decisions?
• Cost/Benefit Analysis
• How does business determine benefits?
• Expected rate of return
• How does business count the cost?
• Interest costs
• How does business determine the amount of investment they undertake?
• If expected return > interest cost, then invest.
• If expected return < interest cost, do not invest.

Real (r%) vs. Nominal (i%)

• Nominal is the observable rate of interest.
• Real subtracts out inflation (pi%) and is only know ex post facto.
• How do you compare the real interest rate (r%)/
• r% = i% - pi%
• What then, determines the cost of investment decision? 
• Real interest rate (r%)

Investment Demand Curve (ID)

• What is the shape of the Investment Demand Curve?
• Downward sloping
• Why?
• When interest rates are high, fewer investments are profitable. 
• When interest rates are low, more investments are profitable.
• 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 technology shifts ID >
• Lack of technological change shifts ID < 
• Stock of capital
• If an economy is low, then ID >
• If capital increases, then ID < 
• Expectations
• Positive = ID >
• Negative = ID < 

Unit 3 - Aggregate Demand (AD) & Aggregate Supply (AS)

Aggregate Demand Curve

AD = C + I + G + Xn

Shows the demand by consumers, businesses, government, and foreign countries.

Changes in the price level cause a move along the curve.

Why is the 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 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 investment.
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 + Ig + G + Xn
• Two parts to a shift in AD:
• A change in C, Ig, G, and/or Xn.
• A multiplier effect that produces a greater change than the original change in the 4 components.
• Increase in AD = AD > 
• Decrease in AD = AD < 
• Consumption
• 
• Household spending is affected by:
• Consumer wealth ( ^ wealth, ^ spending)
• Consumer expectations ( ^ expectations, ^ spending)
• Household indebtedness ( if debt decreases, spending ^) 
• Taxes (if taxes decrease, spending ^)

• Gross Private Investment
• Investment spending is sensitive to:
• Real Interest Rate (if interest rate decreases, investment ^)\
• Expected returns ( ^ expected returns = ^ Investment)
• Influenced by: 
• Expectations of future profitability
• Technology
• Degree of excess capacity
• Business taxes
• Government Spending
• ^ government spending = AD > 
• Decrease in government spending = AD < 
• Net Exports
• Sensitive to:
• Exchange rates (International value of $)
• Strong $ = more imports/fewer exports (AD < )
• Weak $ = fewer imports/more exports (AD > )
• Relative Income
• Strong foreign economy = ^ exports (AD >)
• Weak foreign economy = less exports ( AD < )

Aggregate Supply

• Long Run
• Input prices are completely flexible and adjust to changes in the price-level.
• Real GDP is independent of price-level.
• Short Run
• Input prices are sticky and don't adjust to a change in price-level.
• Level of Real GDP is directly related to price level.
• Long Run Aggregate Supply (LRAS)
• Marks the level of full employment in the economy.
• Because input prices are completely flexible in the long-run, changes in price-level do not change firms' real profits.
• LRAS = Vertical
• Changes in SRAS
• Increase in SRAS = >
• Decrease in SRAS = < 
• Per-Unit cost of production =  total input cost / total output

Determinants of SRAS

• Input prices, productivity, and legal institutional environment affect unit cost per production.
• 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 prices = SRAS < 
• Decrease in Resource prices = SRAS >
• Productivity = Total output / total input
• More productivity = lower unit of production = SRAS >
• Less productivity = higher unit of prodution = SRAS <
• Legal Institutional Environment
• Taxes and subsidies
• Government regulation
• Cost of compliance = SRAS <
• Re-regulation = SRAS > 

Full Employment

• FE Equilibrium exists where AD intersects SRAS and LRAS at the same time.
• Recessionary Gap: When equilibrium point occurs below full employment output.
• Inflationary Gap: When equilibrium point occurs beyond full employment output.
• 
• Classical(Vertical) Range: Inflationary 
• Keynesian(Horizontal) Range: Recession