Unit 7 - Comparative & Absolute Advantage

Absolute Advantage

• looks at who can produce more with the same resources or who can produce the same output with less resources
• ex: Papa John's producing 20 pizzas while McDonald's produces 4

Comparative Advantage

• who can produce with the least opportunity cost

Input vs. Output

• Input
• Examples:
• # of hours to do a job
• # of gallons of paint to paint a house
• # of acres to feed a horse
• Output
• Examples:
• miles per gallon
• tons per acre
• words per minute
• apples per tree
• computers produced per hour

Unit 7 - Foreign Exchange Market

• buying and selling of currency
• Appreciation - value of currency is strong, the dollar buys more of another currency which results in less expensive imports and more expensive exports
• imports increase because they are cheaper and creates a trade deficit
• Depreciation - weak dollar, the dollar buys less of another currency and results in more expensive imports and less expensive exports

Unit 7 - Balance of Payments

Balance of Payments

• it is a measure of money inflations and outflows between the U.S. and the rest of the world
• inflations are referred to as credits
• outflows are referred to as debits
• the balance of payments is divided into 3 accounts:
1. current account
2. capital/financial account
3. official reserves
• Current Account
1. balance of trade/net exports
• export = credit or asset
• import = debit or liability
2. net foreign income/net investment
• income earned by U.S. owned foreign assets
• encompasses income paid to foreign held U.S. assets
3. net transfers
• foreign aid (ex: U.S. gives money to other country for disaster)
• tends to be unilatteral
• Capital/Financial Account
• balance of capital ownership
• includes purchase of both real and financial assets
• real assets = real estates
• financial assets = stocks and bonds
• direct investment in U.S. is a credit to the capital account (ex: Toyota factory in U.S.)
• direct investment by U.S. firms/individuals in a foreign country are debits to the capital account (ex: Dell computer factory in Costa Rica)
• the purchase of foreign financial assets represents a debit to the capital account (ex: Bill Gates buys stock in Petrol China)
• purchase of domestic financial assets by foreigners represents a credit to the capital account (ex: Venezuela buys stock in McDonalds)
• Official Reserves
• the foreign currency holdings of the U.S> Federal Reserve System
• the official reserves should zero out the balance of payments
• the capital and current account must zero each other out

Formulas

• Balance of Traders = goods exports + goods imports
• Balance on Goods & Services = (goods exports + service exports) - (goods imports + service imports)
• Balance on Current Account = balance of traders + net investment + net transfers
• Balance on Capital Accounts = foreign purchase of assets + U.S. purchase of assets abroad

Unit 5

Phillips Curve

• represents the relationship between unemployment and inflation
• there is a trade-off between inflation and unemployment in the short term
• in the short run, inflation increases as the economy expands
• during a recession, unemployment increases because the economy slows down
• Long Run  Phillips Curve (LRPC)
• occurs at the natural rate of unemployment
• represented by a vertical line
• there is no trade-off between unemployment and inflation in the long run
• the economy produces at full employment output level
• LRPC will only shift if LRAS shofts
• Supply Shocks
• a rapid and significant increase in resource cost
• Stagflation
• where inflation and unemployment increase at the same time
• shifts of the Phillips Curve
• if AD changes, we will move points on the SRPC
• if SRAS changes, we will move the SRPC
• LRPC is equivalent to the natural rate of unemployment
• natural rate of unemployment = frictional, seasonal, and structural unemployment
• Misery Index
• a combination of inflation and unemployment in a given year
• single-digit misery is good
• Disinflation
• a reduction in the inflation rate from year to year, which can be seen in the long-run Phillips Curve
• this also occurs when aggregate demand declines
• Deflation - a general decline in the price level
• Hyperinflation - when an economy experiences a high and unusual rates of inflation, which can decrease the value of the local currency

Supply-Side Economics

• changes in AS, not AD
• to determine the level of inflation, unemployment rate, and economic growth
• a.k.a. Reaganomics
• supply-side economists support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments (unemployment compensations and welfare programs) provide disincentives to work, invest, and underline entrepreneurial ventures

Laffer Curve

• depicts a fear radical relationship between tax rates and government revenue
• as tax rates increase from zero, tax revenues increase from zero to some maximum level and then declines
• 3 criticisms of Laffer Curve
1. empirical evidence suggests that the impact of tax rates on incentives to work, save, and invest are small
2. tax cuts also increase demand which can fuel inflation
3. where the economy is actually located on the Laffer Curve is difficult to determine 

Unit 4 - Money

Money

• Uses of Money
1. Medium of exchange
2. Unit of account
3. Store of value
• Types of Money
1. Commodity money
• products
• Ex: gold, silver
2. Representative money
• Ex: IOU's
3. Fiat money
• has value because the government says so
• Characteristics of Money
1. Durability
2. Portability
3. Visibility
4. Uniformity
5. Scarcity
6. Acceptability
• Money Supply
• M1 Money
• cash, coins, currency, travelers checks, demand or checkable deposits
• 75%
• largest component is checkable or demandable deposits - checking accounts
• M2 Money
• M1 money + savings account
• M3 Money
• M2 money + the money market account + CD's (certificate of deposit)
• Liquidity
• easy to convert to cash

Banking System

• Balance Sheet
• summarizes the financial position of the bank at a certain time

Assets (own)	Liabilities (owe)
1.      RR (required reserves)            2.      ER (excess reserves)            3.      Bank property            4.      Securities or bonds            5.      Loans	DD (checking) CD (checking) Net worth or owner’s equity

• RR + ER = DD
• Fractional reserve banking system
• the banks have to keep a fraction of the total money supply that is held in reserve as currency (the bank cannot loan out everything)

Money Market

• it is the market where the Fed and the user of money interact, thus determining the nominal interest rates
• money demand comes from households, firms, the government, and the foreign sector
• the money supply (MS) is determined only by the Federal Reserve Bank
• Types of Money Demand:
1. Transaction Demand - demand for money as a medium of exchange
2. Asset Demand - demand for money as a store of value; it is dependent upon the interest rate
• Money Demand
• downward sloping because at high interest rates, people are less inclined to hold money and more inclined to hold stocks and bonds
• Money Supply
• it is determined by the Fed because the Fed has a monopoly over money supply
• this is why money supply has a vertical curve
• it is also vertical because it is independent of the interest rate

Expansionary Monetary Policy	Contractionary Monetary Policy
·         MS will shift to right          ·         i (↓)          ·         discount rate (↓)          ·         reserve ratio (↓)          ·         buy bonds (more $)          ·         MS increases	·         MS will shift to left          ·         i (↑)          ·         discount rate (↑)          ·         reserve ratio (↑)          ·         sell bonds (less $)          ·         MS decreases

Loanable Funds

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

Unit 3 - Fiscal Policy

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
• fiscal policy is enacted to promote our nation's economic goals; full employment, price stability, economic growth

Deficit, 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 deficit
• government borrows from
• individuals
• corporations
• financial institutions
• foreign entities or foreign governments

Fiscal Policy Two Options

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

Discretionary v. Automatic Fiscal Policies

• Discretionary
• 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
• Unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation. Automatic fiscal policy takes place without policy makers having respond to current economic problems.

Contractionary vs. Expansionary Fiscal Policy

• Contractionary Fiscal Policy - policy designed to decrease aggregate demand
• strategy for controlling inflation
• Expansionary Fiscal Policy - policy designed to increase aggregate demand
• strategy for increasing GDP, combating a recession, and reducing unemployment

Expansionary Fiscal Policy

• recession is countered with expansionary policy
• increase government spending (G↑)
• decrease taxes (G↓)

Contractionary Fiscal Policy

• inflation is countered with contradictory policy
• decrease government spending (G↓)
• increase taxes (G↑)

Automatic or Built-In 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:
• Welfare checks
• Food stamps
• Unemployment checks
• Corporate dividends
• Social security
• Veteran's benefits

Tax Systems

• 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 falls with GDP

Unit 3 - Multipliers

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 = change in AD / change in spending
• Multiplier = (Δ AD) / (Δ C, Ig, G, or 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

Calculating the Tax Multiplier

• when the government taxes, the multiplier works in reverse
• Why?
• because now money is leaving the circular flow
• Tax Multiplier (note: it's negative) = (-MPC) / (1 - MPC) or (-MPC) / (MPS)
• if there is a tax-cut, then multiplier is (+), because there is now more money in the circular flow