AD may be referred to consumption expenditures GDP = Total market value of all final goods and services produced annually within the boundaries of the United States. What would cause the PPC to shift inward or outward? Govt. spending causes a greater impact on AD then taxes of the same amount. Difference between nominal gdp and real gdp Nominal includes inflation and has not been adjusted for inflation Real does not include inflation, it is adjusted for inflation (Inflation) Money is valued by what it can purchase The more money people have the more they will consume given no inflation.
Trade & Specialization
How do tariffs effect domestic production and exports? Tariffs/import quotas increase domestic production, but raise the price above the world price because of the limiting of specialization and trade. Why do countries that have a comparative advantage in production of a certain good trade? Because there opportunity cost of production of a specific good is less than there trading partner. In order for a comparative advantage to exist 2 countries must have different opportunity costs of producing the same 2 goods. 1 country cannot have a comparative advantage in the production of both goods. 1 country can have an absolute advantage in the production of both goods. How do increases/decreases in imports/exports effect the dollar appreciation/depreciation? Look at the determinants of foreign exchange page 384 in the soft back book. For further analysis of how the appreciation/depreciation of the dollar affects the U.S. imports/exports, look at the fiscal policy net export effect on page 226. Why is free international trade beneficial? In the long run, gains to consumers and some producers exceed the losses to other producers. Balance of Payments If a countries currency appreciates in value, more capital will flow into it. If a countries currency appreciates in value, it will have a decrease in exports/net exports.
UNEMPLOYMENT Examples of the 4 types of unemployment - structural – skills don’t match what the economy needs - frictional – between jobs - cyclical - not enough spending in economy - seasonal – example: Snow ski instructor in N.C. in July The labor force DOES include part-time workers. The natural rate of unemployment 4% - 5%
Any thing over the natural rate of unemployment is cyclical unemployment.
AD / AS
What shifts the AD (Fiscal, Monetary Policies, govt. spending, gross investment, net exports, consumption spending) or AS (resource costs, business taxes, number of resources, technology) lines and how does this effect output (employment) and price level (inflation) The vertical portions of the AS line means all resources are being used; this is like being on the curve of the PPC. The horizontal portion of the AS line means some resources are being underemployed; this is like being inside the curve of the PPC. Know how Fiscal policy (Govt. spending & taxes) will change AD. How will the increase or decrease of AD affect output (unemployment) and price level? Increase in AD will raise prices and raise output which in turn will lower unemployment. What Fiscal or Monetary polices will help get us out of a recession? Expansionary Fiscal (lower taxes, increase govt. spending), Loose Monetary (lower discount rate, lower reserve ratio, buy govt. securities/bonds) What Fiscal or Monetary polices will help get us out of inflation? Contractionary Fiscal, tight monetary.
Crowding
Crowding out – higher interest rates cause less private investment spending. (Business’s purchase less equipment because it cost more to borrow money) Crowding out occurs when the govt. runs an expansionary fiscal policy causing a budget deficit which increases the Md (money demand) on the money market. Because the govt. is spending more (expenditures increase) and taking in less (taxes decrease) they need to borrow more money. Where do they get this money? From the money market. The graph below shows the crowding out effect. The end result is that after the AD line shifts right due to the expansionary fiscal policy, there will be a slight shift left of the AD line due to the decrease in investment. Money Market Graph (Monetary Policy) Money Supply
Nominal interest rate
I2
I1
Crowding in – lower interest rates cause more private investment spending. (Business’s begin purchasing more equipment)
Short Run Phillips Curve
What relationship does the Phillips curve show? (The inverse relationship between the unemployment rate & inflation rate) How do you get a movement upward/leftward along the curve? (By having an increase in AD) A decrease in AS (cost push), causes the entire SRPC to shift rightward (stagflation), typically due to an increase in resource costs
BANKING
Banks create money by lending out their excess reserves. Amount of new money created = Excess Reserves X 1/Reserve Ratio If people are holding onto money as currency and not depositing back into banks, then the banks cannot expand credit as far. When the Govt. engages in expansionary loose money/monetary policy to increase AD, it’s typically financed by issuing new bonds, not by changing the reserve ratio or discount rate. What are Monetary policy tools - Discount Rate (the interest rate the Fed. charges member banks to borrow money.) (The Federal Funds rate is how much normal banks charge each other for short term loans – the loaning money comes from the banks excess reserves. Prime rate – interest rate that banks charge their best customers) - Open Market Operations (buying or selling govt. securities by the Federal Reserve) - Reserve Ratio (the percentage of demand deposits a bank must hold on reserve)
Bank vs. Banking System
Bank new money creation: A bank can loan out whatever it has in excess reserves Example: A bank with no excess reserves has a 20% reserve requirement. What is the value of new loans this single bank can issue if a customer deposits $1,000. (Answer) $800 $1,000 x .2 = $800 in excess reserves
Banking SYSTEM: The new money an entire banking system can create is found by taking the excess reserves and multiplying it by one over the reserve ratio in decimal format. Example: The current reserve requirement is 20%. What is the value of new money created in the banking system if a single customer deposits $1,000. (Answer) $4,000 $1,000 x .2 = $800 excess reserves multiplier = 1/.2 = 5 $800 x 5 = $4,000 What to produce and how to produce it? Who answers these questions in the following economy? Command Economy – Strong Central Govt. Mixed Economy – Markets and Govt. Pure Market Economy – Market / The people
Keynesian vs. Classical
Classical economics Vs Keynesian theory economics (chapter 19 page 339 figure 19.1) Classical view – prices are flexible up & down - As is a vertical line AP example question: The classical economist argued that involuntary unemployment would be eliminated by (Answer) self-correcting market forces stemming from flexible prices and wages This was the only option that had flexible wages. Keynesian view – prices are inflexible down - As is horizontal till full potential is reached, then AS become vertical
LRAS & PPC
Long Run Aggregate Supply is a vertical AS line. An increase in the vertical LRAS or AS line indicates long run economic growth. An increase in the LRAS is the same as an outward shift of the PPC curve.