Unit 7 - Comparative and Absolute Advantage

Absolute advantage -  one country would have an absolute advantage over the other if it can produce same amount of goods with fewer resources.

• This is then the ability of country to produce more goods than its competitors using same or less resources.

Comparative advantage  - the production of a product  can produce the product at a lower domestic opportunity cost than can a trading partner.

• It is also the basis for all trade.
• If the two nations specialize according to comparative. advantage, then to get the other product, they must trade.

Terms of Trade - the rate of exchange of two products is be determined through negotiation

• Terms of trade - the outcome .
• Gains from trade are based on comparative advantage, not absolute advantage

Specialization and Trade

• Specialization based on comparative advantage improves global resource allocation.
• Specialization and trade - increase productivity and the standard of living within a nation.
• Because of specialization and trade, there will be a larger global output of goods and services.

Input and Output Approach

• Output problem - based on the most of an item producer can make if it specializes using a set amount of resources.
• Take B/A for comparative advantage and pick the highest amount for absolute advantage.
• Input problem approach -  based on the least resources producer needs to make a set amount of an item .
• Take A/B for comparative and pick lowest amount for absolute.

Unit 7 - Foreign Exchange Market

Foreign Exchange Market

• A market in which various national currencies are exchanged for one another. (this is the definition)
• The buying and selling of currency
• Ex: If you travel and want to buy souvenirs from Japan, you have to sell your Dollars to buy Yen.

Exchange rate - the equilibrium prices of currency in these markets, determined in foreign currency exchange.

• Ex: If you sell $1.00, then you can buy ¥102.185.

2 Points

1.  A competitive market - real-world foreign exchange markets characterized by large numbers of buyers and sellers dealing in standardized products such as American’s dollars, European’s Euro, British’s Pound and Japanese Yen.
2.  Linkages to all domestic and foreign prices - the market price or exchange rate of a nation’s currency is an unusual price; it links all domestic prices with all foreign prices. Enable consumers to translate prices of foreign goods into units of their own currency.

 Dollar-Yen Market

• U.S exports goods to Japan demand payment in dollar not Yen and vice-versa to Japan and they will exchange their currency in the foreign exchange market.
• Some U.S. importers need to pay the Japanese in exporters in Yen, so these people will demand for Yen.
• Because of the demand between two currency, we have “price” is in Dollars and the “product” is in Yen.
• If we show it on a graph of Supply and Demand the intersection of Demand Curve and Supply Curve establishes the equilibrium Dollar price of Yen.

Changing Rates : Depreciation and Appreciation

• Appreciation occurs when the exchange rate of a certain currency decreases.
• Depreciation occurs when the exchange rate of a certain currency increases.
• Ex: If the Japan products sell out more, then Yen will increases while the Dollars will decreases.

Unit 7 - Balance of Payments

Balance of Payments - the sum of all the transaction that takes place between its residents and the residents of all foreign nations.

Current Account - the US trade in currently produced goods and services.

• Export - credit (+)
• Import - debt (-)

A country's balance of trade on goods and services is the difference between the export and import of goods.

• Trade surplus = export > import.
• Trade deficit = export < import.

Official Reserves - the central banks of nations hold quantities of foreign currencies.

Balance of Payment Deficit and Surpluses - imbalance between current and capital accounts that causes a drawing down or building up of foreign currencies. 

Graph 16 - Other Market

Graph 15 - 15 Dollar Market Graph (International Supply & Demand)

Unit 6 - Economic Growth & Productivity (From Ms. McCartney's Powerpoint)

Economic Growth

• Sustained increase in Real GDP over time.
• Sustained increase in Real GDP per Capita over time. 

Grow - leads to greater prosperity for society. It lessens the burden of scarcity and increases the level of well-being.

• Conditions
• Rule of law.
• Sound Legal & Economic Institutions.
• Economic freedom.
• Respect for private property.
• Political & Economic stability -Low inflation expectancy.
• Willingness to sacrifice current consumption.
• Saving.
• Trade.

Physical Capital - product of investment (sensitive to interest rates and expected rates of return).

• Tools, machinery, and factories.
• Takes capital to make capital.
• Capital must be maintained.

Technology & Productivity

• More technology = Increases productivity.
• Productivity - output per unit of input.
• Labor productivity - output per worker.
• More Productivity = Economic Growth.
• Research + development and innovation + invention = Increases in technology.

Human Capital - people are the most important resources, so they must be developed.

• Education.
• Economic Freedom.
• The right to acquire private property.
• Incentives.
• Clean water and stable food supply.
• Access to technology.

How to show Economic Growth Graphically

1. LRAS shifts to the right.
2. PPC shifts outward. 

Obstacles to Growth

• Economic and Political Instability – such as high inflation expectancy.
• No of the rule of law.
• Diminished private property rights.
• Negative incentives.
• Lack of savings.
• Excess current consumption.
• Failure to maintain existing capital.
• Crowding out of investment – government deficits & debts increasing long term interest rates.
• Restrictions on free international trade.

Unit 5 - April 3

Supply Side Economics / Reaganomics - tends to believe that the AS curve will determine level of inflation, unemployment, and economic growth.

• To increase economy - AS shifts right.
• Companies benefit - AS.
• Consumers benefit - AD.
• Focus on the marginal tax rate - amount of tax paid on additional dollar of income.
• By reducing the marginal tax rate, it will encourage more people to work longer.
• High marginal tax rate reduces saving because saving money taxed at a higher rate on profit/interest.

Laffer Curve 

• Tax Rates and Government Revenue have an inverse or a trade off relationship.
• High tax rate = Low government revenue.
• There is a U-shaped, because it always tries to maximizes government revenue.
• As tax rate increase from 0, tax revenue increases from 0 to some maximum number then they decline.

3 Criticisms of the Laffer Curve

1. Where the economy is located on the curve is difficult to determine.
2. Tax cuts also increase demand, which can fuel inflation and demand may exceed supply.
3. Research state that tax rate impact people's incentive to work, invest, and save.

Graph 14 - Laffer Curve

Unit 5 - April 2

Supply Shock - rapid and significant increase in resource prices, which cause the SRAS to shift which results in producing a shift in the SRPC curve.

• Examples
• Oil embargo.
• Increase in input prices.
• Wages heights
• Could be positive or negative, depending on what it is.
• Could lead to stagflation - simultaneous increase in inflation and unemployment.

Disinflation - reduction in inflation rate from year to year, which can be seen in the LRPC.

Graph 13 - Phillips Curve

Unit 5 - April 1 (Phillip Curve)

The Phillips Curve - deals with inflation and unemployment. 

3 Generalizations of Inflation and Unemployment.

1. Inverse relationship.
2. AS Shocks can cause both higher rates of inflation and rates of unemployment.
3. There is no significant trade off between the two in the long run

If inflation persists and the expected rate of inflation rises, then the entire SRPC move upward (Stagflation possibility or probable).

If inflation expectation drops due to new technology, then new SRPC moves downward. 

Movements of Short Run Phillips Curve (SRPC)

• Increase in AD (C, Ig, G, Xn) - Up/Left along the SRPC. 
• Decrease in AD - Down/Right along the SRPC. 
• Increase in AS - SRPC moves Left (<---). 
• Decrease in AS - SRPC moves Right (--->). 

Long Run Phillips Curve (LRPC) - vertical at full employment (Natural Rate of Unemployment - seasonal, frictional, and structural).

• Major Assumption : More workers benefit creates higher natural rate of unemployment. Fewer workers benefit creates lower natural rate of unemployment.
• Example - Jobs that pays less = More stable people.
• Shifts - same as LRAS (technological advances).

Misery Index - combination of inflation and unemployment in any given year.

• Single digit misery - Good.
• Example - Unemployment rate = 4% ~ 5% 

Unit 5 - Mar 31

Short Run AS - time too short for wages to adjust to the price level. Reason being workers may not be aware of the changes in their real wages due to inflation. Therefore they adjust their labor decisions accordingly as well as wage demand.

Nominal Wages - the amount of money received per hour, per day, per week.
 *People brings home real wages, which is adjusted with inflation, not nominal wages.

Long Run AS - time long enough for wages to adjust to the price level.

• Key Assumptions
• Wages in price - Flexible.
• Changes in wage and price - Offset each other.
• LRAS is represented by a vertical line.
• Shifts in LRAS - Same as PPG (left = technological advances).

Graph 12 - Crowding Out

Graph 11- Loanable Funds or Bond Market

Graph 10 - Money Market

Important Formulas

• Required Reserves = Amount of Deposit x Required Reserve Ratio.
• Excess Reserves = Total Reserves - Required Reserves.
• Maximum amount a single bank can loan = the change in excess reserves caused by a deposit.
• The money multiplier = 1 / required reserve ration.
• Total Change in Loans = Amount single bank can lend x Money Multiplier.
• Total Change in the money supply = Total change in loans + $ Amount of Fed action.
• Total change in demand deposits = Total change in loans + Any cash deposited.

Unit 4 - Video Notes

Part 1: Types and Functions of Money.

Three Types of Money 
1. Commodity - goods that has other purposes. Not as durable as coins, primitive type of money. (ex: Native Americans uses cows)
2. Representative - whatever you are using as currency represents a specific quantity; (ex: Gold/silver)

3. Fiat - money not backed by metal. Money that must be accepted by transactions; backed by government. 

Functions of Money
1. Medium of Exchange - through money that exchanges happen. (Buying things)
2. Store of Value - when you store money, you expect it to be stable and still have value.
3. Unit of Account - price implies worth (something expensive, it is said to have a higher quality).

Part 2: Money Market Graphs.

Negative slope because demand for money slows down (rate is high, quantity is low and vice versa).

Supply for money is vertical because it does not various based on the interest rate.

To stabilize interest rates, increase the money supply.

If the interest rate is unstable, it is not possible to predict the level of investment, manipulate AD, and predict the level of spending. 

Part 3: Fed’s Tools of Monetary Policy.

1. Expansionary (Easy $)

• RR : lowered.
• Discount Rate (rate that banks can borrow from the FED): lowered. Used to give banks incentive, doesn't mean it will work.
• Buy/sell government bonds/securities: FED buys bonds (public gets money, which causes the money supply to go up).

2. Contractionary (Tight $)

• RR : raised.
• Discount Rate : raised.
• Buy/sell government bonds/securities: sell bonds (federal open market committee makes open market decisions).

• RR - the percentage of banks total deposits that they must hang on to.
• Federal Funds Rate - rate that banks can borrow money from each other. A downward pressure is put on to the rate, when the FED buys bonds.

Part 4: The Loanable Funds Market.

The graphs shows the effect of government deficit.

•  SLF - comes from the amount of money in banks. (Dependent on savings).
•  Government deficit in loanable funds market can shown two ways: increase in demand or decrease in supply.

Part 5: Money Creation and Multiple Deposit Expansion.

• Banks create money by making loans.
• One of the Feds tool is adjust and control RR.
• Ex.)The RR is 20% and the bank makes a loan of $500. How much money will be created?
• 1 / .20 = 5(500) = $2500. We got from $500 to $2500 due to multiple deposit expansion 
• Example of how multiple deposit expansion works - Bob gets $500 to bank. The bank loans $400 to Joe and then Joe puts that money in his bank. The bank then makes a loan of $320 to Susie and so on. This process can go on until nothing is left. If all of these loans are added, it would total $2500 (RR is 20% and no excess reserves). 
• If banks hold excess reserves (banks keeping more than the 20%), the total of $2500 is reduced.

Part 6: Relating Money Market, Loanable Funds Market, and AS & AD Model.

• Change in supply of money is equivalent to change in price.
• Fisher Effect - interest and price level are connected. As interest goes up, price level also goes up. 
• Ex.) 1% increase in interest = 1% increase in price level.

Graphs show the impact of deficit spending

Unit 4 - Mar 19

	Expansionary	Contractionary
OMO	Buys Bonds	Sell Bonds
Discount Rate	Decrease	Increase
Federal Fund Rate	Decrease	Increase
Required Reserves Ratio	Decrease	Increase

• Single Bank - amount of money single bank can create (loan out) = ER
• AR - RR = ER 
• $1000 - $100 = $900

• Banking System - can create money by a multiple of its initial ER 
• Deposit Multiplier = 1 / RR = 1 /.1 = 10

• System New Money = Deposit Multiplier X Initial ER
•   10 X 900 = $9000 

• Total change in Money Supply as a result of the deposit 
• Initial deposit (if new) + Banking system created money
• $1000 + $9000 = $10,000 

Unit 4 - Mar 17 (Monetary Money)

Monetary Policy - controlled by the Fed (Federal Reserve Bank)

• Influencing the economy through changing and reserve which influence the money supply and available credit.
• Banker's bank.

4 Options of  Monetary Policy

1. Reserve Requirement - % that set by the Fed of the minimum reserve a bank must have.
2. Discount Rate - banks borrow money from the Federal Reserve (last resort).
3. Federal Fund Rate - bank loan each other overnight funds.
4. OMO (Open Market Operation) - security/bonds. Fed doings (sells/buys) 
• Reserve Requirement, Discount Rate, Federal Fund Rate - Decrease : Expansionary Monetary Policy.             Increase : Contractionary Monetary Policy. 

Unit 4 - Mar 7 (Multiple Deposit Expansion)

Reserve Requirement

• The Fed requires banks to always have some money readily available to meet consumers demand for cash
• The amount set by the Fed is the Required Reserve Ratio
• The Required Reserve Ratio - the percentage of demand deposit (checking account balances) that must not be loaned out
• Typically the Required Reserve Ratio is 10%.

The Money Multiplier

• Shows the impact of a change in demand deposits on loans and eventually the money supply
• Money multiplier = 1/ Required Reserve Ratio
• Example: If the reserve ratio is 25% then the multiplier is 4

The 3 types of Multiple Deposit Expansion

1. Type 1: calculate the initial change in excess reserves (the amount a single bank can loan from the initial deposit).
2. Type 2: calculate the change in loans in the banking system.
3. Type 3: calculate the change in money supply.

• Sometimes type 2 and type 3 will have the same results (I.e. No Fed involvement)

Example 1
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the amount that a single bank can lend from this Federal Reserve purchase of bonds. 
     Amount of new demand deposit - required reserve = the initial change in excess reserve
     $100 million - (20%)($100 million)
     $100 million - $20 million = $80 million in ER

Example 2
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in loans in the banking system from this Federal Reserve purchase of bonds.
     The initial change in excess reserves (the money multiplier)= max change in loans
     $80 million (1/20%)
     $80 million(5) = $400 million max in new loans

Example 3
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in the money supply from this Federal Reserve purchase of bonds. 
     The maximum change in loans + $ amount of federal reserve action
     $400 million + $100 million = $500 million max change in money supply

A Formula For All Seasons
<{[deposit - (rr% x deposit)] X 1 / rr%} + $ of OMO >
<Maximum change in money supply>
{ max change in loans in banking system}
[initial change in excess reserves]
(Required reserve)

• RR + ER = DD 

Unit 4 - Mar 6 (Money)

I. Uses of Money

• Mediums of Exchange -  can be used to trade/barter.
• Unit of Account - establishes economic worth.
• Store of Value - money holds its value over period of time.

II. Type of Money

• Commodity - gets value from the materials it is made from (gold/silver).
• Representative - backed by something tangible (paper $).
• Fiat - money because the government said so.

III. Characteristic of Money 

• Durability - last through many transaction (Can be used after washed).
• Portability - able to transport money in many ways (Wallet, purse, etc).
• Uniformity - even (All $5 looks the same).
• Divisibility - can divide bills into smaller units ($10 = two $5 bills)
• Scarcity - might not have money at that time (No change for a cashier).
• Acceptability - acceptable anywhere. 

M1 Money - 75% of $ circulation.

• Liquid - easier to convert to cash.
• Consists of :
• Currency - cash/coins.
• Checkable/Demand Deposit - checking account.
• Traveler's Check

M2 Money - 25% of $ circulation.

• Consists of :
• Savings Accounts
• Market Money Accounts
• CD - Certificate of Deposit.
• Deposits held by banks outside the U.S. + M1 Money.

How Banks and Thrifts (Savings & Loans institution) create money

•  Assets (own) = Liabilities (owed) + Net Worth.
•  Bank deposits are subject to a reserve requirement.
•  Reserve Ratio = reserve requirement / checkable deposit liabilities.
• Excess Reserve = Actual Reserve - Required Reserve.
• Assume 20% reserve requirement.
• Banks creates $ by 
• Lending excess reserves and destroy it by loan payments. 
• Purchasing bonds from the public also creates $. 

Unit 3 - Feb 27 (Fiscal Policy)

Fiscal Policy - changes in the expenditure or tax revenue of the federal government.

• 2 Tools
• Taxes - government can increase/decrease taxes.
• Spending - government can increase/decrease spending.
• Fiscal Policy is enacted to promote our nation's economic goals: 
• Full employment
• Price stability
• Economic growth

Deficit, Surpluses, and Debt

• Balance budget
• Revenue = expenditure
• Budget deficit
• Revenue < expenditure
• Budget surplus
• Revenue > expenditure
• Budget debt
• Deficit - surplus
• Government must borrow money, when it runs a budget deficit.
• Government can borrow from 
1. Individuals (taxing)
2. Corporation
3. Financial institutions
4. Foreign entities / foreign government

Fiscal Policy has 2 options

• Discretionary Fiscal Policy (action)
• Expansionary Fiscal Policy - think deficit.
• Contractionary Fiscal Policy - think surplus.
• Non-discretionary Fiscal Policy - no action.

Discretionary vs. Automatic Fiscal Policy

• Discretionary - increasing/decreasing government spending and or taxes in order to full employment.
• Automatic - unemployment compensation and margin tax rates are examples of automatic policies that help mitigate the effects of recession and inflation.

Contractionary vs. Expansionary 

• Contractionary - policy designed to decrease AD.
• Strategy used to control inflation
• Expansionary - policy designed to increase AD.

Recession is countered with expansionary policy.

• Increase government spending.
• Decrease taxes.

Contractionary - inflation countered.

• Increase government spending.
• Decrease taxes.
• Unemployment increases.

Automatic/Built-in Stabilized - anything that increase the government budget deficit during a recession and increase it's budget surplus during inflation without regulating explicit action by policy makers (Transfer payment).

Progressive tax system - average tax rate (tax revenue / GDP), rises with GDP.

Proportional tax system - average tax rate remains constant as GDP changes.

Regressive tax system - average tax rate that falls with GDP.