April 2017 - May 2017

Loanable Funds Market Notes 

Is an interest rate of 50% good or bad?

• It is bad for borrowers but good for lenders 

The loanable funds market is the private sector supply & demand of loans 

• This market brings together those who want to lend money (savers) & those who want to borrow (firms with investment spending projects)
• This market shows the effect on REAL INTEREST RATE 
• Demand- Inverse relationship between real interest rate & quantity loans demanded.
• Supply- Direct relationship between real interest rate & quantity loans supplied 
• NOT the same as money market (SUPPLY is not vertical) 

Prime Rate 

• Interest rate that banks charge their most credit worthy costumers

	Expansionary Policy	Contractionary Policy
Open Market Operation	Buy Bond	Sell Bond
Reserve Requirement	↓	↑
Discount Rate	↓	↑
Bank Reserve	↑	↓
Money Supply	↑	↓
Federal Fund Rate	↓	↑

Philip's Curve

What is Philip's Curve?

• An inverse relationship between unemployment and inflation.
• As one increases, the other decreases
• An increase in AD will cost price level and real output to increase, which increases inflation and reduces unemployment
• Each point on the Philip's curve corresponds to a different level of output 
• Since wages are sticky, inflation changes move the points on the SRPC
• If inflation persists, and the expected rate of inflation rises, then the entire SRPC moves upward.

What is Stagflation?

• When inflation and unemployment rise simultaneously, which results in an increase in input cost
• Philip's curve shifts outward.

What is Supply Shocks?

• Sudden large increase in resource costs.

• If inflation expectations drop, due to new technology or efficiency, then the SPRC will move downward.

• LRPC occurs at the natural rate of unemployment

• Represented by a vertical line

• No trade-off between unemployment and inflation because the economy produces at the full employment output level.

• Will only shift if LRAS shifts.

• Increases in unemployment shifts LRPC to the right.

• Decreases in unemployment shifts LRPC to the left.

• Natural rate of unemployment is equal to frictional, structural and seasonal.

• Major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefits create lower natural rates.

What is Misery Index?

• A combination of unemployment and inflation in any given year.

• Single- digit misery = good.

What happens in the Long-Run?

Inflation

What is Inflation?

• It is a rise in the general level of prices

What is Deflation?

• It is a general decline in the economy's price level.

What is Disinflation?

• It is a reduction in the inflation rate from year to year.

What is Hyperinflation?

• A rapid rise in the price level
• An extremely high rate of inflation

Laffer Curve

What is Supply- Side economics/ Reaganomics?

• trying to stimulate production of supply to spur output

1) Cut taxes & government regulations to increase incentives for business and individuals
2) Business invest and expand creating jobs
3) People work, save, and spend more.
What is the Laffer Curve?

• Depicts a theoretical relationship between tax rates and tax revenues

What are some Criticisms of the Laffer Curve?

1) Empirical evidence suggests that the impact of the tax rates on incentives to work, save and invest are small.
2) Tax cuts also increase demand, which can feel inflation and demand impacts may exceed supply impacts.
3) Where the economy is actually located on the Laffer curve is difficult to determine.

Balance of Payments

What is the Balance of Payments?

• Measure of money inflows and outflows between the U.S and the rest of the world.
• Inflows are referred to as CREDITS
• Outflows are referred to as DEBITS

It is Divided into 3 Accounts:

1. Current Account
2. Capital/ Financial Account
3. Official Reserves Account

What is the Current Account?

• Balance of Trade or Net Exports
• Exports (-) Imports
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments

Net foreign income is earned by U.S. owned foreign assets (-) income paid to the foreign held U.S. assets.
Net Transfers are foreign Aids or a debit to the current account
What is the Capital/ Financial Account?

• The balance of Capital ownership
• Includes the purchase of both real and financial assets.
• Direct investment in the U.S. is a credit to the capital account
• Direct invest by U.S firms/ individuals in a foreign country are debits to the capital account.
• Purchase of foreign financial assets represents a debit to the capital account.
• Purchase of domestic financial assets by foreigners represent a credit to the capital account.

What is the Relationship between a Capital and Current Account:

• They should zero each other out
• That is... if the current account has a negative balance (deficit), then the capital account should then have a positive balance (surplus)

What are Official Reserves?

• The foreign currency holdings of the U.S.  Federal Reserve System
• -When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments.
• When there is a balance of payments deficit, the Fed depletes its reserves of foriegn currency and credits BOP
• The Official Reserves zero out the BOP

FORMULAS

1.     Balance of Trade:
Good Exports + Goods Imports

2.     Balance of Goods/Services:
(Goods exports +  Service exports)
-Goods import +Service import)

3.     Currency Account: 
Balance of goods and services + Net investments + Net transfers

4.     Balance on Capital Account:
Investments or stocks or bonds

5.     Official Reserves:
Current account
(+) or (-)
+Capital account ≠ 0 (theoretically) 

Foreign Exchange 

• Foreign Exchange:
  - The buying and selling of currency
  - In order to purchase souvenirs in France, it is first necessary for Americans to sell their dollars and buy euros
  -Any transactions that occurs in the Balance of Payments necessities foreign exchange.
  -The exchange rate is determined in the  foreign currency markets.
• Changes in Exchange Rates:
  -Exchange rates are a function of the supply and demand for currency.
• Exchange Rates Determinants:
  1) Consumer tastes
  2) Relative income
  3) Relative price level
  4) Speculation
• Exports and Imports:
  -The exchange rate is a determinant of both exports and imports
  -Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports
  -Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively cheaper and foreign goods to be relatively more expensive; thus, increasing exports and reducing imports. 

Comparative and Absolute Advantage

• Specialization: 
  -Individuals and countries can be made better off if they will produce in what they have a comparative advantage and then trade with others for whatever else they want or need
• Absolute and Comparative Advantage:
  
  Absolute:
  -The producer that can produce the most output or requires the least amount of inputs
  Comparative:
  -The producer with the lowest opportunity cost
  - Countries should trade if they have a relatively lower opportunity cost
  - They should specialize in the good that is cheaper for them to produce
• Distinguishing Input from Output:
  - An output problem presents the data as products produced given a set of resources.
  - An input problem presents the data as amount of resources needed  to produce a  fixed amount of output.
  -When identifying absolute advantage, input problems change the scenario from who can produce the most to who can produce a given product in a least amount of time and resources.