4 Fundamentals Fundamental problem in economics is scarcity Opportunity cost-next best alternative.Adam Smith-Invisible hand, self-interest, justifies a marketMacro-Whole economyMicro-Part of the economy (firms and households)
5 3 Economies Market Traditional Command MIXED-Mix of market and government, its what we have
6 Growth, or AS/LRAS Sources of Growth Quantity and quality of human and natural resources increaseAmount of capital goods or stock increaseTechnology increases productivity
7 Unit Two: Supply and Demand Graphs: Supply and DemandBig Concepts: Price Ceilings and Floors
8 FundamentalsLaw of Demand-As price rises, quantity demanded falls (D is downward sloping)Law of Supply-As price rises quantity supplied rises (S is upward sloping)Quantity Demanded-Points on a demand line.Quantity Supplied-Points on a supply line.
9 Ceilings and FloorsPrice Ceiling-Below equilibrium, causes more quantity to be demanded than is willing to be supplied (shortage).Price Floor-Occurs above equilibrium, causes more to be supplied than is demanded (surplus).
11 Unit Three: GDP, Unemployment and Inflation Graphs: AD/AS, Phillips CurveBig Concepts:CPI, GDP Deflator and Inflation CalculationsTypes of UnemploymentGPD CalculationWho is hurt and helped by inflation?
12 Business CycleRecession-Decreased GrowthExpansion-Increased Growth
13 GDP 1 Nominal GDP has not been adjusted for inflation Real GDP is output that HAS been adjusted for inflationGDP-Gross (Total) Domestic (In America) Product (Stuff Produced). GDP is the total amount of stuff produced in America in a given year.
14 GDP2 Things that count in GDP: Things that don’t count in GDP: Additions to business inventoriesRent and other services like a financial consultant.Final output at final pricesThings that don’t count in GDP:Household workIntermediate GoodsIllegal activityStuff from last year’s inventoriesSecondhand goodsStocks and Bonds
15 GDP (and AD) Components Consumption-consumer purchasesI-Investment by businesses, strongly influenced by interest rates.G-Government spending, fiscal policyNX-Net exports, exports-imports.Depreciation increases NX as exports increase and imports decrease.Appreciation decreases NX as exports decrease and imports increase.
16 Unemployment 1 Four Types Frictional-I’m between jobs (or dates) Structural-My skills don’t match the existing jobs (or girls)Cyclical-Caused by a recession, this is all unemployment below full-employment. Expansionary policy targets this.Seasonal-Freebie.
17 Unemployment 2Labor force-people over 16, not in the army, who are able and willing to work.Part time workers count as EMPLOYED.NRU-Natural Rate of Unemployment=LRPCStructuralFrictional-Can be changed via changes in unemployment compensation.
18 Inflation 1 Inflation-a rise in the price level over time Consumer Price Index (CPI)-measures price level over time using a market basket of goods.GDP Deflator-uses output of economy as market basket.Another way to find inflation: solve for it given nominal interest rates-real interest rates=inflation.Demand-pull Inflation-Demand for goods causes prices to rise.Cost-push-Decreases in Supply causes prices to rise.
19 Inflation 2 Calculate rate of inflation: Quantities in Market Basket Price in Base YearPrice in Current YearShoes3$15$20Foot-Long Subs5$5$6Guns1$30$40
20 Inflation Rate=30% from base year to current GDP Deflator=100 in base and 130 in currentReal GDP=Nominal GDP/Inflator
21 Inflation: Who is hurt and helped? People with fixed rate loansHurt:People on a fixed incomeLenders of fixed-rate loansSavers in fixed-rate accounts
22 AD/AS 1Potential Output-Output when an economy is at its full employment (LRAS) point.If the price level changes it DOES NOT CHANGE AD or AS!LRAS is vertical because price level changes will not effect available resources or productivity in the long-run.Inflationary Gap-Equilibrium occurs AFTER full- employment (overheating)Recessionary Gap-Equilibrium occurs BEFORE full-employment (recession)
24 AD is downward sloping because… 1. Wealth Effect- as price level goes down people feel richer and buy more.2. Interest Rate Effect-Lower price levels (inflation) means there is a lower interest rate, so output would go up.3. International Effect-A decrease in the price level causes our stuff to feel cheaper, which causes exports and output to rise.
25 Unit Four: Fiscal Policy Graphs: Loanable FundsBig Concepts: Balanced Budget Multiplier and MPC Math, Fiscal Policy
26 MOST IMPORTANT SLIDE EVER Fiscal PolicyTaxesGovernment SpendingExpansionaryCut TaxesIncrease Government SpendingContractionaryRaise TaxesCut Government Spending
27 When do you use fiscal policy? Expansionary Policy -> When you have cyclical unemployment and are in a recessionContractionary Policy -> When you have inflation and want price stability
28 Criticisms of Fiscal Policy Lag Time-Government is slow (IE, everything we learned in AP Gov)Crowding Out-Increased deficit spending can raise interest rates and crowd out private investment, offsetting the goal of increased AD
29 StabilizersThe federal government is set up with automatic stabilizers that use expansionary policy in a recession, and contractionary in inflationary phases.Discretionary Spending-Congress has to approve spending.In a recession:Tax receipts go down so taxes are in effect, CUT.More people are unemployed so unemployment compensation would go UPThe opposite of this would happen in an inflationary phase.This process avoids a lot of the difficulties in using fiscal policy as it is automatic.
30 Terms Deficit-When expenditures (spending) exceeds revenue (taxes). Deficits are funded through the selling of bonds in open-market operations.Surplus-Revenues exceed expenditures.Debt-Total amount of accumulated deficits.
31 Classical EconomistsGiven flexible prices and wage, a classical economist would deal with a recession by doing nothing.They believe this would cause wages to drop ( as employers cut costs) and thus increasing AS back to full-employment.
32 Keynesian EconomistsArgue that wages and prices aren’t flexible, and that decreased wages would cause AD to decrease even more.He argues that the government must take action and increase AD through government spending and tax cuts (fiscal policy).
33 MPC and Balanced Budget MPC is Marginal Propensity to ConsumeMPS is Marginal Propensity to SaveMPC + MPS = 1Government Spending or Expenditure Multiplier is 1/MPS.Tax Multiplier is 1/MPS x MPC.Balanced Budget Concept-Government Spending has a greater effect on AD than tax cuts.
34 Unit Five: Monetary Policy Graphs: Money MarketBig Concepts: Reserve Requirement and Money Expansion Math,
35 Fundamentals Investment-purchase of real assets (factories, machines). INVESTMENT IS THE BEST. Increase I increases AD in the short run and increases LRAS!Monetary policy influences AD/AS by effecting interest rates.Higher interest rates decrease AD.Lower interest rates increase AD.Theory of rational expectations-Increasing the MS on its own doesn’t increase AD because if the inflation is expected, then buying habits won’t change.
36 SECOND MOST IMPORTANT SLIDE EVER Monetary PolicyExpansionaryContractionaryOpen Market OperationsBuy BondsSell BondsDiscount RateLowerRaiseReserve Requirement
37 Terms Federal Reserve-central bank, conducts Monetary Policy Discount Rate-Short-term interest rate on loans from the Federal Reserve to Banks.Federal Funds Rate-Short-term interest rate on loans from one bank to another.Prime Rate-Prime lending rate a bank will give to people with the best credit.Fractional Reserve Banking-When you deposit money, banks only keep a fraction and lend out the rest, allowing the money supply to be expanded.
38 Money Fiat Money-money only backed by government say so. 3 Functions of MoneyStore of Value-Can last for extended periods of time.Unit of Account-can vary in prices.Medium of Exchange-can be traded for real goods.
39 The Money Supply M1- M2 Checkable Deposits (Checking Accounts) Cash and Coins IN CIRCULATIONM2M1Savings AccountsShort Term CD’s (Money Market Accounts)
40 Quantity Theory of Inflation MV=PQM is Money SupplyV is velocity of moneyP=Price LevelQ=Quantity of Real Goods SoldPQ=Nominal GDPAssume V is constant, thus MS changes will change Nominal GDP.Q is also unrelated to changes in MS, so price level is most directly effected by changes in MS.
41 Unit Six: International Trade Graphs: Foreign Exchange MarketBig Concepts: Balance of Payments, Comparative and Absolute Advantage
42 Terms Balance of Trade: Exports-Imports Balance of Payments: Current Account – Capital/Financial AccountCurrent: All real goods and services traded between countries.Capital/Financial: All loans (inflows/outflows) that will have to be paid back at some point.
43 Complex DetailsInflationary Expections-If a questions says this phrase, its referring to producers changing supply based on inflation.Lower than expected inflation-cut input costs thus increasing AS