2. Unemployment Rate = (Number of Unemployed / Labor Force) x 100
Where:
Labor Force = Adult Population – Those Not Actively Seeking Employment
For example if:
Adult Population = 300 million;
Those not Actively Seeking Employment = 100 million, and
Unemployed = 10 million, then
5% = ( 10 million / 200 million ) x 100

6. Natural rate of unemployment: the normal rate of unemployment around which the unemployment rate fluctuates.
Cyclical unemployment: the deviation of unemployment from its natural rate.

9. Frictional unemployment: unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills.
Structural unemployment: unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one.
Unemployment Insurance: A government program that partially protects workers’ incomes when they become unemployed.

11. Money: the set of assets in an economy that people regularly use to buy goods and services from other people.
Money serves three functions in our economy:
As a medium of exchange: an item that buyers give to sellers when they want to purchase goods and services.
b. As a unit of account: the yardstick people use to post prices and record debts.
c. As a store of value: an item that people can use to transfer purchasing power from the present to the future.

12. Liquidity: the ease with which an asset can be converted into the economy’s medium of exchange.
a. Money is the most liquid asset available.
b. Other assets (such as stocks, bonds, and real estate) vary in their liquidity.
c. When people decide in what forms to hold their wealth, they must balance the liquidity of each possible asset against the asset’s usefulness as a store of value.

13. Commodity money: money that takes the form of a commodity with intrinsic value.
Fiat money: money without intrinsic value that is used as money because of government decree.

14. Currency: paper bills and coins in the hands of the public.
Demand Deposits: balances in banks accounts that depositors can access on demand by writing a check or using a debit card.
Money Market Mutual Fund: comprised of short-term, or less than one year, securities representing high-quality, liquid debt and monetary instruments.

16. The Federal Reserve System (Fed) – the Central Bank of the United States
1. Board of Governors – seven Governors and Chairman based in Washington D.C.
2. 12 Regional Banks – located in major cities around the United States.
3. Open Market Committee (FOMC) – power to increase or decrease the supply of money in the domestic economy.

17. Major Responsibilities of the Federal Reserve System (Fed)
1. Regulate banks and ensure the health of the banking system. Audit financial conditions of banks, ensure security of the payments system, and act as “lender of last resort”.
2. Control the Quantity of Money or the “Money Supply” - power to increase or decrease the supply of money in the domestic economy.

18. Three ways the Federal Reserve Controls the Money Supply
1. Open-Market Operations – the purchase and sale of bonds or securities by the Fed. Fed selling bonds reduces the money supply, Fed buying bonds increases the money supply.
2. Fed Lending to Banks – by changing the Discount Rate banks will borrow more or less.
3. Reserve Requirements – regulations on the minimum amount of reserves that banks must hold against deposits. Raising Reserve Requirements decreases the amount banks can lend, lowering Reserve Requirements increases

19. Bank Reserves
In a fractional reserve banking system, banks keep a fraction of deposits as reserves and use the rest to make loans.
The Fed establishes reserve requirements, regulations on the minimum amount of reserves that banks must hold against deposits.
Banks may hold more than this minimum amount if they choose.
The reserve ratio, R
= fraction of deposits that banks hold as reserves
= total reserves as a percentage of total deposits
Segue from last slide:
The Fed controls the money supply and regulates banks. Banks clearly play an important role in the money supply because bank deposits are part of the money supply (recall that M1 includes checking account deposits, and M2 also includes savings account deposits).
In the interests of parsimony, I have combined the definitions of “fractional reserve banking system” and “reserves,” as shown in the first bullet point. I believe it is sufficient to convey the meaning of both terms. 19

20. Bank T-Account
T-account: a simplified accounting statement that shows a bank’s assets & liabilities.
Example:
FIRST NATIONAL BANK
Assets
Liabilities
Reserves $ 10
Loans $ 90
Deposits $100
Deposits are liabilities to the bank because they represent the depositors’ claims on the bank.
Loans are an asset for the bank because they represent the banks’ claims on its borrowers.
Reserves are an asset because they are funds available to the bank.
Banks’ liabilities include deposits, assets include loans & reserves.
In this example, notice that R = $10/$100 = 10%. 20

21. Banks and the Money Supply: An Example
Suppose $100 of currency is in circulation.
To determine banks’ impact on money supply, we calculate the money supply in 3 different cases:
1. No banking system
2. 100% reserve banking system: banks hold 100% of deposits as reserves, make no loans
3. Fractional reserve banking system 21

22. Banks and the Money Supply: An Example
CASE 1: No banking system
Public holds the $100 as currency.
Money supply = $100. 22

23. Banks and the Money Supply: An Example
CASE 2: 100% reserve banking system Public deposits the $100 at First National Bank (FNB).
FNB holds 100% of deposit as reserves:
FIRST NATIONAL BANK
Assets
Liabilities
Reserves $100
Loans $ 0
Deposits $100
Money supply = currency + deposits = $0 + $100 = $100
In a 100% reserve banking system, banks do not affect size of money supply. 23

24. Banks and the Money Supply: An Example
CASE 3: Fractional reserve banking system
Suppose R = 10%. FNB loans all but 10% of the deposit:
FIRST NATIONAL BANK
Assets
Liabilities
Reserves $100
Loans $ 0
Deposits $100 10 90
The notion that banks create money by making loans is a new and perhaps awkward idea for students. The following slide may help.
Depositors have $100 in deposits,
borrowers have $90 in currency.
Money supply = $90 + $100 = $190 24

25. Banks and the Money Supply: An Example
CASE 3: Fractional reserve banking system
Borrower deposits the $90 at Second National Bank.
SECOND NATIONAL BANK
Assets
Liabilities
Reserves $ 90
Loans $ 0
Deposits $ 90
Initially, SNB’s T-account looks like this: 9 81
If R = 10% for SNB, it will loan all but 10% of the deposit. 25

26. Banks and the Money Supply: An Example
CASE 3: Fractional reserve banking system
SNB’s borrower deposits the $81 at Third National Bank.
THIRD NATIONAL BANK
Assets
Liabilities
Reserves $ 81
Loans $ 0
Deposits $ 81
Initially, TNB’s T-account looks like this:
$ 8.10
$72.90
If R = 10% for TNB, it will loan all but 10% of the deposit. 26

27. Banks and the Money Supply: An Example
CASE 3: Fractional reserve banking system
The process continues, and money is created with each new loan.
In this example, $100 of reserves generates $1000 of money.
Original deposit =
FNB lending =
SNB lending =
TNB lending =
. . . $
$ 90.00
$ 81.00
$ 72.90
Total money supply = $ 27

28. The Money Multiplier
Money multiplier: the amount of money the banking system generates with each dollar of reserves
The money multiplier equals 1/R.
In our example,
R = 10%
money multiplier = 1/R = 10
$100 of reserves creates $1000 of money 28