Unit 4 Video Responses

1^st Video-    Commodity money are things that have value and can be used as pay in replacement of coin. A cow is an example because it has values and can be used for other purposes. Representative money is the currency you are using to represent the quantity of a precious metal such as gold or silver. Fiat money is that which the government says that something specific has value based on their promise. The functions of money are unit of account, store of value and medium of exchange.

2^nd Video- Demand for money is downwards sloping because when the price is high, the quantity demanded is low. The supply of money is vertical because it does not vary based on the interest rate. The supply of money is fixed by the FED. If the FED does not want high interest rates during a recession, they can increase the money supply to stabilize the interest rates.

3^rd Video- The Fed's tools of monetary policy are discount rates, required reserves, and buy/sell government bonds and securities. In certain cases the Fed will increase or decrease the tools. If the Fed wants to expand the money supply they would decrease RR, buy bonds, and decrease discount rates. While, in an effort to contract the money supply the FED would increase the RR, increase, discount rates, and sell bonds. Reducing "interest rates" basically means buying or selling bonds to put downward or upward pressure on the Federal Fund Rate.

4^th Video- Loanable funds is money available in the banking system for people to borrow. Interest rate is going to be on the x axis and quantity on the y axis Q (F). Demand for loanable funds is downward sloping because when the interest rate is lower people demand more money, and when the interest rate is higher people have a disinvite to borrow. Supply of loanable funds comes from money that people have in banks that means it is dependent on savings.

5^th Video- 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.

6^th  Video-  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- Chapters 28 & 29

Aggregate Demand


Aggregate Demand Curve

AD = C + I + G + Xn

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

Changes in price level cause a move along the curve. 

Why does AD downward slope?

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.

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.

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

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 profit

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 production = SRAS <

Legal Institutional Environment

Taxes and subsidies

Government regulation

Cost of compliance = SRAS <

Reregulation = 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.

SRAS and Nominal Real Wages

SRAS

Classical(Vertical) Range: Inflationary
Keynesian(Horizontal) Range: Recession












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 < 

Disposable Income (DI) and 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.

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.