NOTES (3/20/15) - Policy Summary: Countercyclical Options

Expansionary Policy (Recession)

• "full employment" economy will have:
• 1. annual unemployment rate of 4-5%
• 2. annual inflation rate of 2-3%
• if economy goes into recession:
• 3. real GDP will decrease for at least six months
• 4. unemployment rate will go to at least 6% or more
• 5. inflation rate will go to 2% or less
• if Congress enacts Keynesian Fiscal Policies to slow/stop recession:
• 6. policy will try to improve C or G (parts of AD)
• 7. Congress will cut federal taxes
• 8. Congress will increase job and spending programs
• 9. federal budget will probably create a deficit
• 10. due to changes in Money Demand, interest rate will increase
• if Federal Reserve employs Monetary Fiscal Policy to slow/stop recession:
• 11. policy will target improvement in Ig (part of AD)
• 12. Fed will target a lower federal fund rate
• 13. Fed can lower the discount rate
• 14. Fed can buy bonds (OMO) 
• 15.Fed can (theoretically) lower reserve requirement
• 16.Fed policies will lower the interest rates through changes in the Money Supply
• 17. these options increase Ig

Contractionary Policy (Inflation)

• if economy suffers from too much demand-pull inflation, then:
• 18. unemployment rate will go to 4% or less
• 19. inflation rate will go to 4% or more
• if Congress enacts Keynesian Fiscal Policies to slow/stop recession:
• 20. policy will try to decrease C or G (parts of AD)
• 21. Congress will raise federal raise taxes
• 22. Congress will decrease job and spending programs
• 23. federal budget will probably create a surplus
• 24. due to changes in Money Demand, interest rates will decrease
• if Federal Reserve employs Monetary Fiscal Policy to slow/stop recession:
• 25. policy will target decreases in Ig (part of AD)
• 26. Fed will target a increase federal fund rate
• 27. Fed can increase the discount rate
• 28. Fed can sell bonds (OMO) 
• 29.Fed can (theoretically) raise reserve requirement
• 30.Fed policies will increase the interest rates through changes in the Money Supply
• 31. these options decrease Ig

Notes (2/12/15) - AGGREGATE SUPPLY

• The level of real GDP (GDPR) that firms will produce at each price level (PL)
• Long Run v. Short Run
  • Long Run: time where input prices are flexible and adjust to change in price level
  • level GDP supplied is independent of the price level
  • Short Run: time where input prices are sticky and don't adjust to change in price level
  • level of GDP supplied is directly related to price level

Long Run Aggregate Supple (LRAS)

• marks level of full employment in the economy (analogous to PPC)
• because input is completely flexible in the long run, changes in price level do not change firms real profits and therefore do not change firms' level of of output
• LRAS is vertical at the economy's level of full employment

Short Run Aggregate Supply (SRAS)

• because input prices are sticky in the short-run, the SRAS is upward sloping

• changes in SRAS
• increases in SRAS is seen as shift to right
• decreases in SRAS is seen as shift to left
• key to understanding shifts is per unit cost of production
• per-unit cost of production = total input cost / total output

Determinants of SRAS

• input prices
• productivity
• legal institution environment

Input Prices

• domestic resource prices
• wages (75% of all business prices)
• cost of capital
• raw materials (commodity prices)
• foreign resource power
• Strong money = low foreign resource prices
• Weak money = high foreign resource prices
• market power
• monopolies and cartel that control resources and control prices of those resources
• increase in resource price = SRAS shift left
• decrease in resource prices = SRAS shift right

Productivity

• total output/total inputs
• more productivity = low unit production cost (AS shift right)
• less productivity = high unit production cost (AS shift left)

Legal Institution Environment

• Taxes and subsidies
• taxes ($ to the govt.) on business increase per-unit production cost (AS shift left)
• subsidies ($ from the govt.) to business reduce per-unit production cost (AS shift right)
• Government regulation
• government regulation creates a cost of compliance (AS shift left)
• deregulation reduces compliance cost (AS shift right)

Notes (2/11/15) - AGGREGATE DEMAND

• shows the amount of real GDP that the private, public, and foreign sectors collectively desire to purchase at each possible price level
• the relationship between the price level and the level of real GDP is inverse

• Three reasons AD is downward sloping:
• (1) Real-balance effects
• when price-level is high households and businesses cannot afford to purchase as much output
• when price-level is low households and businesses can afford to purchase more output
• (2) Interest-rate effects
• higher price-level increases the interest rate which tends to discourage investment
• lower price-level decreases the interest rate which tends to encourage investment
• (3) Foreign-purchase effect
• higher price-level increases the demand for relatively cheaper imports
• lower price-level increases the foreign demand for relatively cheaper U.S. exports

Shifts In AD

• two parts to a shift in AD:
• (1) change in C, Ig, G, and/or Xn
• (2) multiplier effect that produces a greater change than the original change in the four components
• Increases in AD = AD shifts right
• Decreases in AD = AD shifts left
• Increase:

• Decrease: 

Consumption

• Household spending affected by:
• consumer wealth
• more wealth = more spending (AD shifts right)
• less wealth = less spending (AD shifts left)
• consumer expectation
• positive expectation = more spending (AD shifts right)
• negative expectation = less spending (AD shifts left)
• household indebtedness
• less debt = more spending (AD shifts right)
• more debt = less spending (AD shifts left)
• taxes
• less taxes = more spending (AD shifts right)
• more taxes = less spending (AD shifts left)

Gross Private Domestic Investment

• Investment spending is sensitive to:
• Real-interest rate
• lower real interest rate = more investment (AD shifts right)
• higher real interest rate = less investment (AD shifts left)
• Expected returns
• higher expected return = more investment (AD shift right)
• lower expected return = less investment (AD shifts left)
• influenced by
• (1) expectations of future probability
• (2) technology
• (3) degree of excess capacity (existing stock of capital)
• (4) business taxes

Government Spending

• More government spending (AD shift right)
• Less government spending (AD shift left)

Net Exports

• sensitive to:
• Exchange rate (international value of %)
• strong $ = more imports & fewer exports (AD shift left)
• weak $ = less imports &more exports (AD shift right)
• Relative income
• strong foreign economies = more exports (AD shift right)
• weal foreign economies = less exports (AD shift left)

Notes (2/3/15)- Unemployment

Unemployment: percentage of people who do not have jobs but are in the labor force

• Labor Force
• number of people in a country that are classified as either employed or unemployed
• Unemployment rate: # of unemployed / # of unemployed + # employed * 100
• Not In Labor Force
1. Kids
2. Retired people
3. Military personal
4. Mentally insane
5. Incarcerated
6. Stay at home parents
7. Full time students
8. Discouraged workers
• Full Employment
• occurs when there is no cyclical unemployment present in the economy
• natural rate of unemployment (NRU): another name for full employment
• 4% to 5%
• Why is unemployment good?
1. because there is less pressure to raise wages
2. more workers are available for future expansions
• Why is unemployment bad?
1. not enough consumption
2. too much poverty
3. too much government assistance needed
• Okun's Law
• for every 1% of unemployment above the NRU causes a 2% decline in real GDP 

Notes (2/2/15)- Inflation

• I. Inflation: rise in general level of prices
• standard rate is 2%-3%
• II. Measuring Inflation
• a. Inflation rate: measures the % increase in the price level over time; key indicator of the economy's health
• i. deflation: decline in general price level
• ii. disinflation: when the inflation rate itself declines
• b. Consumer Price Index (CPI): measures inflation buy tracking the yearly price of a fixed basket of consumer goods & services; in addition, indicates changes in cost of living and price level
• III. Solving Inflation Problems
• a. Finding inflation rate using market basket data
• current year market basket value - base year market basket value / base year market basket value * 100
• b. Finding inflation rate using price indexes
• current year price index - base year price index / base year price index * 100
• c. Estimating inflation using the Rule of 70
• used to calculate # of years it will take the price level to double at any given rate of inflation
• years needed to double inflation = 70 / annual inflation rate
• d. Determining real wages
• real wages = nominal wages / price level * 100
• e. Finding real interest rates
• real interest rate = nominal interest - inflation premium 
• i. Real interest rate: cost of borrowing and lending adjusted for expected in inflation rate
• Nominal interest rate: unadjusted cost of borrowing or lending money
• IV. Cause of Inflation
• a.Demand-pull inflation: cause by an excess of demand over output that pulls prices upward
• Cost-pull inflation: caused by a rise in per unit production cost due to increasing resource cost
• V. Effects of Inflation
• Anticipated: anticipated inflation
• Unanticipated inflation: not expecting inflation

Notes (1/27/15)- GDP/GNP

• GDP- total dollar value of all goods & services produced within a country's borders within a given year
• GNP- total value of all final goods and services produced by Americans in a year

• Included in GDP:
• C+Ig+G+Xn
• C:consumption
• 67% of economy
• has to be final good or service
• Ig: gross private domestic investment
• factory equipment maintenance
• new factory equipment
• construction of housing
• unsold inventories of products built in a year
• G: government spending
• military spending
• education
• Xn: net exports
• exports-imports
• Excluded from GDP:
• (1) Non-market activities
• volunteering
• family work
• illegal drugs
• (2) Intermediate goods
• goods/services that are purchased for resale or for further processing
• trying to avoid double or multiple counting
• things that go into making something
• (3) Used or second-hand goods
• not counted because it was counted the first time purchased
• (4) Financial transactions
• stocks, bonds, and real estate
• (5) Gifts or transferred payment
• private transfer payments produce no output
• public transfer payments recipients contribute nothing to the current production

Calculating Cost of GDP:

• Expenditure approach
• C+Ig+G+Xn=GDp
• Income approach- add up all the income earned by households and firms in a single year
• Wages+Rent+Interest+Profit+Statistical Adjustments

Budget Formula: government purchases of goods & services + government transfer payments - government tax and fee collections

                   -if # is positive = deficit

                   -if # is negative = surplus

Trade Formula: exports - imports

GNP Formula: GDP + net foreign factor payment

NNP Formula: GNP - depreciation

NDP Formula: GNP - depreciation  

National Income Formula: (1) GDP - indirect business taxes - depreciation - net foreign factor payments (2) compensation of employees + rental income + interest income + proprietors income + corporate profits

Disposable Personal Income Formula: national income - personal household taxes + government transfer payments

Nominal GDP: the value of output produced in current prices

          -price * quantity

          -an increase from year to year if either output or price increases

Real GDP: the value of output produced in constant or base year prices

          -price * quantity 

          -can increase from year to year only if output increases (output measured by quantity)

          -real GDP only reflects base year prices because of inflation

Price Index

• measures inflation by tracking changes in the price of a market basket of goods compared to the base year
• price of market basket of goods in current year / price of market basket of goods in base year * 100

GDP Deflator

• price index used to adjust from nominal to real GDP
• in base year, GDP deflator will equal 100                                                                        
• for years after base year, GDP deflator is greater than 100
• for years before base year, GDP deflator is less than 100
• Nominal GDP / Real GDP * 100

Calculating Inflation

• new GDP deflator-old GDP delfator / old GDP deflator * 100 

Circular Flow Model Notes (1/23/15)- Market Economy 

• Resource (Factor) Market- land, labor, entrepreneurship
• firms buy
• households sell
• Product Market- product, service
• firms sell
• households buy
• Government 
• both a consumer & producer in both markets

Example of a market economy: