Unit 4- Topic 1- Money

Three Uses of Money

1. Median of Exchange (barter)
2. Unit of Account (economic value)
3. Store of Value (money's value over time)

Types Of Money

1. Commodity Money (Gold Silver)
2. Representative Money (IOU's) ( ex. chicken could be representative money, but has no value.)
3. Fiat Money (money because the government says so)

Characteristics of Money

1. Durability (withstand physical wear and tear)
2. Portability (carry/transfer)
3. Divisibility (divided into small increments)
4. Uniformity (same/identical)
5. Acceptability (cash is accepted)

Money Supply

• M1 Money
• cash
• currency
• coins
• checkable/demand deposits (checking account)
• M2 Money
• encompasses M1 money + saving account
• M3 Money
• M2 + money market account + CD
• liquidity (easy to convert to cash)

⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤘⤗⤗⤗

Balance Sheet- # summarizes the financial position of a bank at a certain time.

Liabilities VS. Assets 

Liabilities

• OWE
• 1. RR- Required Reserve- the % of demand deposits that must be held in the vault.
• 2. ER- Excess Reserve- source of new loans
• 3. Property (building/fixtures)- value of bank's property
• 4. Security and Bonds- bonds that are previously purchased by the banks new bonds sold to the bank by the federal reserve these bonds can be purchased from the bank and into cash and immediately becomes available as excess reserve.
• 5. Loans

Assets

• OWN
• Net Worth of Owner's Equality
• DD- Demand Deposit- cash deposit from the public

Liabilities =Assets 

RR+ER=DD

Liabilities                             Assets

RR (Required reserves)          DD (Demand/ Chekable Deposits) 

ER (Excess Reserves)

In order for money supply to increase, federal government must buy bonds, loans. To decrease money supply, they sell bonds or loans

• Federal Revenue Banking System: Federal government holds a fraction of the deposits back as a reserve in the bank. 

Fractional Reserve Banking System

• Banks hold fraction of deposit back as a reserve in a bank.
• Vote Cash- money that is kept back

↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠↠

Money Market- It is the market where the fed and the user's of money interact thus determining the nominal interest rate.

• Money Demand (MD)- comes from households, firms, government, and the foreign sector 
• Money Supply (MS)- is determined by the federal reserve. 
• Transaction Demand: demand for money as a medium or exchange 
• Asset Demand: demand for money as a store of value.
• Depended upon interest rate

Total Money Demand

• MD Is downward sloping because at high interest rates, people are less inclined to hold money and more inclined to hold stocks and bonds. 
• Money supply is determined by the Fed because they have control over the supply of money 
• Money supply is vertical because it is independent of the interest rate 

Contractionary Monetary Policy: 

• interest rate increases 
• Money Supply (MS) shifts to the left
• Reserve ratio↑
• Discount rate↑
• SELL BONDS (less money) (MS ↓)

Expansionary Monetary Policy: 

• interest rate decreases
• MS shifts to the right
• Reserve ratio↓
• Discount rate ↓
• BUY BONDS (more money) (MS ↑

Open Market Operations: The government will either sell or buy bonds based on the situation.

Federal Funds Rate: Proportion of the money required to save as reserve. (bank to bank loan)

Discount Rate: money banks borrow from the FEDS

Monetary Multiplier: 1/RR 

⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝⇝

Loanable Funds 

the market where buyers and savers meet to exchange funds at the real interest rate both the demand supply for loan-able funds comes from households, firms, the government, and the foreign sector.

⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨⇨

Unit 3- Topic 6: Fiscal Policy

What is Fiscal Policy? Changes in the expenditures or tax revenues of the federal government.

2 Tools of Fiscal Policy

• Taxes: Government can increase or decrease taxes
• Spending: Government can increase or decrease spending
• TAX ↑ SPEND ↓
• TAX ↓ SPEND ↓

Fiscal Policy is enacted to promote our nations economic goals: full employment, price stability, and economic growth.
Deficit, Surplus, Debt

• Balanced Budget- Revenues = Expenditures
• Budget Deflict- Revenues < Expenditures
• Budget Surplus- Revenues > Expenditures
• Government Debt-  (Sum of all deficits- sum of all surplus)

Government must borrow money when it runs into budget deflict
Government borrows from;

• Individuals
• Corporations
• Financial Institution (Banks)
• Foreign cities/ governments

Fiscal Policy; Two Option

Discretionary Fiscal Policy (action)

• Expansionary Fiscal Policy- think deflict
• Contractionary Fiscal Policy- think surplus
• Non Discretionary Policy- no action 

Discretionary (Governmental action)
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 (No government action)
Unemployment compensation and marginal tax rates are examples of automatic policies that helps mitigate the effects recession and inflation. Automatic Fiscal Policy takes place without policy makers having respond to current economic problems.

Contractionary Fiscal Policy- policy designed to decrease aggregate demand; strategy for controlling inflation

• Inflation is countered with contractionary policy
• Decrease government spending (G↓)
• Increase Taxes (T↑)

Expansionary Fiscal Policy- policy designed to increase aggregated demand; strategy for increasing GDP, combating a recession and reducing unemployment.

• Recession is countered with expansionary policy. 
• Increase government spending (G↑)
• Decrease taxes (T↓)

Automatic or Built- in stabilizer

• Anything that increase the government's budget deficit during a recession and increases its budget surplus during inflation WITHOUT REQUIRING EXPLICIT ACTION BY POLICY MAKERS

What Counts As a Transfer Payments?

1. Welfare Checks
2. Food Stamps
3. Unemployment Checks
4. Corporate Dividends
5. Social Security
6. Veteran's Benefits

• Progressive Tax System- Average tax rate RISES with GDP
• Proportional Tax System- Average tax rate remains CONSTANT with GDP
• Regressive Tax System- Average tax rate FALLS with GDP

Average tax rate (tax revenue/ GDP) 

Unit 3: Topic 5- Consumption and Savings

Disposable Income (DI)

• Money (Income) after taxes or net income
• Can actually spend
• DI = Gross Income- - Taxes
• Gross means TOTAL

2 Choices When It Comes To DI

With disposable income, households can either

1. Consume (spend money on goods and services)
2. Save (not spend money on goods and 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?

• Autonomous Consumption
• Dissaving

Saving

• Household NOT spending

The ability to save is constrained by

• The amount of disposable income
• The propensity to consume

Do households save if DI = 0?

• NO

APC AND APS

Average Propensity to Consume (APC)

Average Propensity to Save (APS)

• APC + APS = 1
• 1 - APC = APS 
• 1 - APS = APC 
• APC > 1 = DISSAVING
• -APC = DISSAVING

Marginal Propensity to Consume AND Marginal Propensity to Consume

Marginal Propensity to Consume (MPC)
🔺C/🔺DI
(C- Consumption)
% of every extrar dollar earned that is spent
Marginal Propensity to Save (MPS)
🔺S/🔺DI
(S- Saving)
% of every extra dollar earned that is saved
MPC + MPS = 1
1 - MPC = MPS
1 - MPS = MPC

The Spending Multiplier Effect 

• An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending or Aggregate Demand (AD)
• Multiplier = 🔺 in AD/ 🔺 in spending
• Multiplier = 🔺 in AD / 🔺 (C, Ig, G, Xn)

Why does this happen? 

• Expenditures and income flow continuously which sets off a spending increase in the economy.

Calculating the Spending Multiplier 

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

Calculating the Tax Multiplier 

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

Unit 3- Topic 4: Interest Rates and Investment Demand

What is Investment? 

Money spent or expenditures on:

• New plants (factories)
• Capital Equipment (machinery)
• Technology (hardware and software)
• New Homes (homes built that year)
• Inventories (goods sold by producers)

Expected Rates of Return

How does business make investment decision?

• Cost/ Benefit Analysis

How does business determine the benefits?

• Expected rate of return

How does business count the cost?

• Interest costs

How does business determine the amount of investment they undertake?

• Compare expected rate of return to interest cost
• If expected return > interest cost, then invest
• If expected return < interest cost, then do not invest

What then, determines the cost of an investment decision?

• The 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.
• Conversely, there are few investments that yield high rates of return and many yield low rates.  

Unit 3- Topic 3: The AS/AD Model

The AS/AD Model- The equilibrium of AS & AD determines current output (GDPR) and the price level (PL)

Full Employment- Full Employment equilibrium exists where AD intersects SRAS & LRAS at the same point.
Recessionary Gap- A recessionary gap exists when equilibrium occurs below full employment output.
Inflationary Gap- an inflationary gap exists when equilibrium occurs beyond full employment output.

(Lower case (u))- stands for employment
(Pie (𝞹))- stands for inflation

3 Ranges of Aggregate Supply

Horizontal or Keynesian Range- A lot of unemployed resources which creates a recession or depression. It includes only levels of only real GDP that are less than the full employment output.

Intermediate Goods- Resources are getting closer to the full employment level which creates pressure on wages and prices.

Classical or Vertical Range- This is where real GDP at a level with unemployment at the full employment level and where any increase in demand will result in only increase in prices. The economy is unable to produce any more goods and services for a sustainable period of time.

Unit 3- Topic 2: Aggregate Supply

Aggregate Supply- The level of Real GDP that firms will produce at each price-level.

Long-Run v. Short-Run

Long-Run 

• Period of time where input prices are completely flexible and adjust to change in the price-level.
• In the long-run, the level of Real GDP supplied is independent of the price-level
• Vertical

Short-Run

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

Long-Run Aggregate Supply (LRAS)

• Always located with full employment 
• The Long-Run Aggregate Supply marks the level of full employment in the economy. 
• Analogous to PPC

Short-Run Aggregate Supply (SRAS)

• Because input prices are sticky in the short-run, the SRAS is upward sloping.

Changes in SRAS

• Increase: SRAS →
• Decrease: SRAS ←
• The key to understanding shifts in SRAS is per unit cost of production.
• Per Unit Production Cost Formula: (Total Input Cost/Total Output Cost)

Determinants of SRAS

1. Input Prices
2. Productivity
3. Legal- Institutional Environment

1) Input Prices

Domestic Resource Prices

• Wages (75% of all business costs)
• Cost of captial
• Raw materials (commodity prices)

Foreign Resources Prices

• Strong $= lower foreign resource prices
• Weak $= higher foreign resource prices

Market Power

• Monopolies and cartel that control resources control the price of those resources

Increase in resource prices= SRAS ←

Decrease in resource prices= SRAS →

2) Productivity

Productivity= (Total Output/ Total Input)

• Most productivity= lower unit production cost= SRAS →
• Lower productivity= higher unit production cost= SRAS ←

3) Legal- Institutional Environment 

Taxes and Subsidies

• Taxes ($ to gov't) on business increase per unit production cost = SRAS ←
• Subsidies ($ from gov't) to business reduce per unit production cost= SRAS→

Government Regulation

• Government Regulation creates a cost of compliance = SRAS ←
• Deregulation (lift up rules and regulation, set your own price) - Reduces compliance costs= SRAS →