Scarcity, Choice, Opportunity Cost Resources- land, labor, capital, and entrepreneurship. All resources are limited factors of production. We are forces to make choices about how the resources are to be used due to scarcity which leads to opportunity costs. A trade-off is simply the act of giving up one thing for another, but an opportunity cost is the value of what you give up when you make your decision. What to produce, what method and for who are the essential questions.
Production Possibilities CurveA graphical way to represent the fact that we must give upsome of one good to get more of another.Shows us what combinations of goods we produce whenwe are using our resources efficiently.It is usually between two products and it reflects the law ofincreasing opportunity costs.The law of increasing opportunity costs give the PPC itsconvex shape.This may shift right due to resources and technology.If points are inside it is inefficient.
ComparativeAdvantage, Specialization, TradeSpecialization allow a person, business, or nation tospecialize in production of what it does best, instead ofstriving for self-sufficiency.It allows for a greater variety of goods and servicesavailable and at lower cost.Relates to the principle of the division of labor, it increasesoutput because it gives people an opportunity to becomebetter at one specific job.Trade helps economic growth when one can producesomething at a lower opportunity cost than another, theyhave the comparative advantage.
Example of how tofind out who had the comparative advantage.
Demand Curve Determinants Shifters1. Change in income (normal/inferior)2. Change in preferences3. Change in price of other goods(complements/substitutes)4. Expectations5. Change in consumer information
Supply Curve Determinants Shifters1. Change in costs of production2. Change in technology3. Change in number of producers4. Change ins prices of alternative items5. Expectations6. Change in time period to produce goods
National Income AccountsNational income accounts GDP FORMULA:keep track of a country’s Consumption +diverse goods andservices. Investment +GDP is the market value Government Spending +of all the final goods and Net Exportsservices produced by acountry’s economy in a (Expenditure Approach)specific time period.
Inflation Measurement and AdjustmentPrice Index measures the combined price of aparticular collection of goods and services called amarket basket relative to that of similar items inanother period.Consumer Price Index tells us about average changesover time in prices of a fixed group of goods andservices that are bought by consumers.Adjusts nominal GDP to real GDP in order to accountfor inflation.
Formulas Price Index: GDP (consumer) Price Price level in given year= Index:Price of market basket in GDP Price Index=specific year / price of the Price of GDP market basketsame market basket in the in a specific year / prices ofbase year x 100 GDP market basket in base year x 100
UnemploymentFrictional – includes workers who are searching for jobs orwaiting to take jobs in the near future. This unemploymentis inevitable, since many workers switch to better jobs.Structural – changes over time in consumer demand andtechnology change the “structure” of total demand forlabor. Some skills will not be needed as much or becomeobsolete, and new skills will appear. This is a mismatchbetween job seekers’ skills and the skills needed for thejob. This is also inevitable because the demand for laborwill always change over time as new technologies arise.Cyclical – this type of unemployment is caused byrecession. People who are laid off because of decreasedoverall spending in the economy.
Natural Rate of Unemployment This is NOT zero unemployment, as frictional and structural unemployment are regarded as unavoidable in an economy. Therefore, full employment means no cyclical unemployment, and the full-employment rate is equal to the frictional plus structural rates. It is also called the natural rate of unemployment. 3%-5% Calculation: Unemployment means unemployment in the labor force, not the whole population. The labor force is total population – under 16 and/or institutionalized – people not in the labor force. The unemployment rate = Unemployed people in the labor force divided by Total number of people in the labor force x 100
Aggregate DemandAggregate demand is a measure the ability tospend or a level of expenditure used to commandvarying quantities of goods and services at differentprice levels. This concept is a measure of purchasingpower such that when prices increase with a givenlevel of nominal income, fewer goods or services canbe purchase.Caused by Wealth Effect, Interest Rate Effect, andExchange Rate Effect.
For a given level of nominalexpenditure, an inverserelationship existsbetween the price level Pand Real Income YR.Aggregate demandrepresents this inverserelationship between theprice level and a given levelof purchasing power in aneconomy.
Aggregate Demand Determinants 1. C (consumer wealth, consumer expectations, household indebtedness, taxes) 2. I (interest rates, expected returns on investment, business taxes, technology, degree of excess capacity) 3. G 4. Xn (National income abroad, exchange rates)
MultipliersExpress the ratio of a change in aggregate output to a change intax or spending policy.Money Multiplier = 1/R where R = reserve ratio. Application: aninitial injection of $1000 of new money into an economy with areserve ratio of 10% (.1) will generate $1000*(10) = $10,000 intotal money.MPC + MPS = 1Expenditures Multiplier = 1/(1 – MPC) OR 1/MPS. It tells you howmuch total spending an initial injection of spending in theeconomy will generate. For example, if the MPC = .8 and thegovernment spends $100 million, then the total increase inspending in the economy = $100 * 5 = 500 million.
Aggregate SupplyThe total amount spent for final goods and services inthe economy.The aggregate supply curve shows the relationshipbetween the price level and output. While the longrun aggregate supply curve is vertical, the short runaggregate supply curve is upward sloping.
Aggregate Supply Determinants Supply shocks Production Costs Technology
EquilibriumIf the economy is in long run equilibrium:1. Real GDP produced is the full employment or potential orsustainable level.2. Actual unemployment will be equal to the naturalrate (since the economy is at full employment). If you don’tremember what the natural rate of unemployment is, youmay wish to review the unemployment concepts.3. Cyclical unemployment is zero (this is because theeconomy is at full employment).4. The price level anticipated by decision makers is equal tothe actual price level.
MoneyTo act as a medium of exchange to facilitate the payment of incomeand purchase of goods and services.To act as a unit of account--a measure by which all prices areestablished, andTo act as a store of value -- that is to alter the timing of spendingdecisions relative to earning income.M1: the narrowly defined money supply; currency and checkabledeposits.M2: a more broadly defined money supply; equal to M1 plus noncheckable savings deposits, money market deposits, mutual funds,and small time deposits.M3: very broadly defined money supply: includes M2 plus large timedeposits.
BankingFederal Reserve Banks - Branches of the Fed that serve asbanks for non-government controlled banks by acceptingdeposits, giving withdrawals, and making loans as needed.Monetary Policy - Policy used to affect the money supplyemployed by the Fed. In particular, this describes the openmarket operations of buying and selling governmentbonds.Reserve Requirement - The percent of total depositsrequired to be held back for repaying depositors. This iscontrolled by the Fed as a form of monetary policy.
Financial MarketsOpen Market Operations - The purchase and sale ofgovernment bonds by the Fed in order to affect themoney supply.Money Multiplier = 1/R where R = reserveratio. Application: an initial injection of $1000 of newmoney into an economy with a reserve ratio of 10%(.1) will generate $1000*(10) = $10,000 in total money.
Central Bank and Control of Money Supply Three basic ways that the Fed can affect the money supply. The first is through open market operations. The second is by changing the reserve requirement. The third is through changing the federal funds interest rate. Each of these actions in some way affects the total amount of currency or deposits available to the public.
Inflation, Unemployment and Stabilization Policies
Fiscal and Monetary PoliciesFiscal policy is changes in the taxing and spending of the federalgovernment for purposes of expanding or contracting the levelof aggregate demand. In a recession, an expansionary fiscalpolicy involves lowering taxes and increasing governmentspending. In an overheated expansion, a contractionary fiscalpolicy requires higher taxes and reduced spending.Monetary policy is under the control of the Federal ReserveSystem (our central bank) and is completely discretionary. It isthe changes in interest rates and money supply to expand orcontract aggregate demand. In a recession, the Fed will lowerinterest rates and increase the money supply. In an overheatedexpansion, the Fed will raise interest rates and decrease themoney supply.
Contractionary PolicyA. If the flow of currency is increasing (too much money ortoo much velocity of circulation), and if at the same timethere is the same flow of goods and services, then theaverage price of goods and services will rise: its inflation.To curb inflation, the possibilities are:1. to decrease the monetary mass: by monetarydestruction or by higher rates2. to decrease the velocity of circulation of money: byimmobilizing large amounts of money
Expansionary PolicyB. If the flow of currency is decreasing (lack of money or lack ofvelocity of circulation), and if at the same time there is the sameflow of goods and services, then the average price of goods andservices will decrease: its deflation.To curb deflation, the possibilities are:1. to increase the monetary mass: by monetary creation or bydebt and ordinary bounds emission.2. to increase the velocity of circulation of money: byexceptional fiscal measures, each during 2 or 3 months, toinduce people into spending their money3. to decrease the production sold: in taxing unnecessary goodsor services, taxing unnecessary importations, regulating lending
FormulaMoney Multiplier = 1/R where R = reserveratio. Application: an initial injection of $1000 of newmoney into an economy with a reserve ratio of 10%(.1) will generate $1000*(10) = $10,000 in total money.
Types of InflationDemand-pull inflation occurs when spending ongoods and services drives up prices. Demand-pullinflation is fueled by income, so efforts to stop itinvolve reducing consumers income or givingconsumers more incentive to save than to spend.Cost-push inflation occurs when the price of inputsincreases. Businesses must acquire raw materials,labor, energy, and capital to operate.
Human Capital vs. Physical Capital Physical Capital (equipment, buildings and machines used to produce other goods), belongs to the company or firm that purchases it. Human capital (the education and experience we bring to our employer) does not stay with the company if the employees who have it leave. Investment in human capital is necessary for a company to grow, but it also benefits the individual. Workers can stay with a company or take their knowledge and experience with them to another firm that might pay more. From a business standpoint, human capital is an investment worth making.
Economic GrowthA healthy economy leads to higher living standards andgreater prosperity for individuals. It also helps businessesto be profitable, which generates employment andincome.Greater business confidence: Growth has a positive impacton company profits & business confidence – good news forthe stock market and for the growth of small and largebusinesses.Potential environmental benefits – richer countries havemore resources available to invest in cleaner technologies
EconomicGrowth can be shown on a production possibilitiescurve but on anational level.
Balance of Payments Accounts The balance-of-payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries. Although the totals of payments and receipts are necessarily equal, there will be inequalities excesses of payments or receipts, called deficits or surpluses in particular kinds of transactions.
Foreign Exchange MarketAll trades that take place in the foreign exchange market involvethe buying of one currency and the selling of another currencysimultaneously.This is because the value of one currency is determined by itscomparison to another currency. The first currency of a currencypair is called the “base currency,” while the second currency iscalled the counter currency.The currency pair shows how much of the counter currency isneeded to purchase one unit of the base currency. Currency pairscan be thought of as a single unit that can be bought or sold.When purchasing a currency pair, the base currency is beingbought, while the counter currency is being sold. The opposite istrue, when the sale of a currency pair takes place
The Market for ImportsThe supply of imports is the total amount of exports of foreignnations; the demand for imports is the amount of imports of theU.S.If U.S. income increases, then the demand for imports willincrease, shifting the demand curve to the right and increasingthe equilibrium price and quantity of imports. With both theequilibrium price and quantity increasing, the value of importswill increase. If foreign incomes increase, then foreignconsumption will absorb some of the goods previouslyexported.The supply of goods to the U.S. will decrease, shifting the supplycurve to the left and causing a higher equilibrium price andlower equilibrium quantity. In this case, the value of imports isindeterminate and depends upon the proportionate size of theprice increase relative to the quantity decrease.
Net Exports and Capital FlowsWhen a country’s imports exceed its exports, it has acurrent account deficit.Its foreign trading partners who hold net monetary claimscan continue to hold their claims as monetary deposits orcurrency, or they can use the money to buy other financialassets, real property, or equities (stocks) in the trade-deficit country.Net capital flows comprise the sum of these monetary,financial, real property, and equity claims. Capital flowsmove in the opposite direction to the goods and servicestrade claims that give rise to them. Thus, a country with acurrent account deficit necessarily has a capital accountsurplus.
Financial and Good MarketsThe price of a companies stock is determined by four primaryfactors:earnings growth,interest rates,the magnitude of dividends, andmarket forces.When an investor buys stock in a company he or she becomes apartial owner of that company. In the most basic sense, shareprices reflect the business conditions of the corporation. If thecompany is doing well, it is likely that the prices of its shares willrise, and they will certainly fall when the company faces aprolonged period (perhaps six months, usually less) of weakbusiness conditions.