ECON 2030- “Hey, Charles”

Chapter 1: Economics and Economic Reasoning

08/22/16

Exam1:

Exam2:

Exam3:

Final:

A. Syllabus
1. Overview
2. Note on text: Chapter and page numbering
3. Important information about labs

B. The basic basics

1. Definitions
a. Economics- the study of how societies provision themselves
with the material means of existence (goods and services)
b. Economies- people doing stuff- provisioning ourselves with the
material means of existence, interacting with one another
c. Markets- one specific type of economy we are focusing on-
where or how people exchange goods and services for
MONEY (buyers and sellers) insert MARKET figure
2. What? How? For whom? what product (schools, coffee, clothing), who
works for it (prisoners, child labor), who’s gonna get the stuff
(whoever buys)
a. Microeconomics- behaviors of individual people, businesses,
industries, markets (world oil market),
3. Consequences?
a. Macroeconomics- the big picture- the society as a whole
(economic growth, employment/unemployment, inflation,
income)

C. Economic reasoning: the basics

1. Benefit: What you get $10- (do not subtract cost)- not always monetary
2. Opportunity cost: What you give up $100 (do not subtract benefit)- not
all of the other options only the BEST ALTERNATIVE

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 THE BENEFIT OF DOING ONE IS EXACTLY THE SAME AS THE COST
OF DOING THE OTHER
3. Rationality
a. Do something if benefit ≥ opportunity cost- at the time you make
the decision with the information that was available, aka bad
movie can be rational
4. Margin- “small increments”
a. Either/Or decisions- left vs right hand $$$
b. How much/How many decisions-decisions made on the margin/
small increments, the change in the total from doing one
more of something, do i take that 6th class?

D. Economic Reasoning: Examples

1. A question-would it ever be rational to stop doing something that is
profitable?
2. Either/or Choices
a. Which book to purchase? if choices are equal= indifference
i. Relevant costs which book to purchase? 1 is $16, 2 is $10
benefits of #1: expected pleasure of reading; costs: expected
pleasure of book 2, $6
benefits of #2: expected pleasure, $6 saved; costs: expected
pleasure of book 1
ONLY BOOK 2 IS RATIONAL YA DIGG
ii. Sunk costs- in this case, $10; cost you bear no matter
what (only going to be monetary in this class)
3. How Much/How Many Choices- not the total benefit/ total cost
a. All-you-can-eat buffet- benefit- expected pleasure
i. Relevant costs- monetarily (before you enter)
ii. Sunk costs- money after you enter, already paid
looking at the margin, the extra, each additional bite; rationally, you
eat until you’re full
4. The answer
a. Delta and the Mayor- Delta airlines announced that after a
certain date, they will be cutting one daily flight from a certain city.
The Mayor of that city unhappy- hurts the business community.
Mayor says it doesn’t make sense bc it’s a profitable flight. For
Delta, it freed up crew and equipment for a more profitable flight on
another route. The flight given up was 65% full, but getting rid of it
frees up equipment. They choose better routes instead, switching
things up.
i. Relevant costs^^^

B. Note on graphing: Appendix to Chapter 2

Charles’ happiness vs. # of cars on the highway per mile

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 C. Opportunity Cost Application: International Trade
1. Questions to Answer
a. If “workers in the United States are the most productive in the
world,” why do we consume so many imported goods?- 1.
answer from experience (where your clothes are made)— we
buy products from other countries because they’re cheap
2. it isn’t productivity that matters, it’s something else
b. If “trade can make everyone better off,” why is there so much
opposition to it?- “consume more goods and services”— if a country
which produces goods and trades with other countries, all countries

can consume more goods than they could have before

~~as a whole, the benefits of trade are good on a macro scale; on a
micro scale, individual results may vary (winners and losers)
2. Tool: Production Possibilities Frontier (PPF)-
“making stuff””what you are able to
do- what is possible””international border, edge,
limit”
-the
limit of our
ability to
make stuff at
a point in
time
clothing vs.
food

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 red- outside the limits, do not have the resources
blue-attainable, can produce more food if producing less clothing
green- attainable, but inefficient
yellow- attainable, efficient

efficiency- if in order to get more of one thing, we have to give up some of

another, (blue and yellow, every point on the PPF graph)
trade can costs the individual more than the entire country

D. How Trade Can Benefit All: An example

1. Assumptions
a. Two Countries: England, Portugal
b. Two Homogeneous Goods: Wine, Cloth- if the goods are
exactly the same, then all we care about is the price
c. All workers in a country are equally productive- (makes the
numbers more simple)
d. Resources: 100 worker/hours in each country
2. Relevant Concepts
a. Productivity = output per worker per hour
b. Absolute Advantage = highest productivity
c. Comparative Advantage = lowest opportunity cost
3. Autarky: production = consumption- not trading with anyone else, you
can only consume what you produce
4. Specialization and trade accordizng to Comparative Advantage
5. With Trade: consumption > production
6. Conclusions
a. Gains from trade- both sides do work with least opportunity cost
but get both products
b. Winners and losers

A. How Trade Can Benefit All: Conclusions

1. Meaning of “mutually beneficial”- for BUYERS and SELLERS
buyers get it at lower price
sellers get a profit
2. Winners and Losers buy or sell if benefit > cost
WINNERS-
sellers -more production, more jobs, profit
consumers that consume products because they’re cheaper (goods
being imported)

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 LOSERS-
sellers that went out of business due to outsourcing/
importing
consumers that see the price of the goods go up; if countries sell to
other countries for more of a profit, they will charge their own
citizens a higher price

B. Buyers’ side of market: Demand (D)

1. Definition- want and willingness to buy a product at various prices
2. Not to be confused with Quantity Demanded (QD)- how much the
consumer is willing to buy at a specific price
3. Determinant of Quantity Demanded
a. Price (P) of good (-)- price change = demand change
i. Link with Reservation Price- what the consumer thinks a
product is worth- max price the consumer is willing to
pay

(-) inverse relationship

(+) direct relationship

4. Determinants of Demand
a. Income how much you earn, ability to buy something; more
income= buy more and better things
i. Normal good (+) name brands
ii. Inferior good (-) generic brand, ramen noodles
b. Price of related goods
i. Substitutes: Increase price (+) gas stations next to each
other, price of hamburgers goes up, price of hot dogs
goes up
ii. Complements: Increase price (-) frames and lenses,
price PB goes down, demand for both PB and J go up
c. Tastes and preferences (+)
d. Expectations
i. Future price (+)
ii. Future income: normal good (+); inferior good (-)
e. Number of buyers (+)

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 5. Graphically
a. Change in Quantity Demanded: movement along curve
b. Change in Demand: shift of entire curve

price

(increase in demand)

market (quantity demanded)

B. Sellers’ side of market: Supply (S) working

1. Definition giving up something of value to get paid
2. Not to be confused with Quantity Supplied (Qs)
3. Determinant of Quantity Supplied
a. Price of good (+) higher price, higher quantity supplied
i. Link with Reservation Price conceived value of good or
service by buyer or seller
4. Determinants of Supply
a. Cost of labor (i.e., wages, benefits) (-) everything else held
constant, if the wage of workers goes up, business sells
less; change in supply
b. Other input costs (-) materials, utilities, transportation; fuel goes
up, sell less; change in supply
c. Productivity (+) change in supply
d. Expectations
i. Future price (-) if stock is expected to sell for more next
week, sell less today; change in supply
e. Number of sellers (+) more sellers, more supply; change in
supply

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 5. Graphically
a. Change in Quantity Supplied: movement along curve
b. Change in Supply: Shift of entire curve

Qs

C. Market Equilibrium and Disequilibrium

1. Equilibrium: quantity supplied = quantity demanded
2. Disequilibrium
a. Excess supply: Surplus
b. Excess demand: Shortage
c. Return to equilibrium

B. The Method exam strategy

1. Who is DIRECTLY affected?
a. i.e., Who would notice the change and alter their behavior?
2. How does behavior change?
3. What is the result?

WHO Buyers Buyers Sellers Sellers

HOW More (D up) Less (D More (S up) Less (S

down) down)

PRICE UP DOWN DOWN UP

QUANTITY UP DOWN UP DOWN

TRANSACTE
D

more less more less

desirable desirable available available

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 C. Price controls
1. Price ceiling highest price at which a product can be sold
a. Binding (i.e., effective) changes outcome— only if it’s BELOW
the current market price
b. Non-binding (i.e., ineffective) has no effect - if price ceiling is
placed at $8/ gal— does not change price, at current price—
does not change price
c. Examples anti- price gouging laws; in a state of emergency gas
can’t go to $20/gal

binding ceiling- price goes down, quantity supplied decreases

because not as much profit, quantity demanded increases
because product is cheaper, quantity transacted goes down
because there is less product—> PERSISTENT SHORTAGE

2. Price floor minimum price

a. Binding (i.e., effective) must be placed above equilibrium
b. Non-binding (i.e., ineffective)
c. Examples guaranteed min price for farmers for things like milk
and sugar

binding floor- price of good goes up, quantity supplied goes up,
quantity demanded goes down, quantity transacted goes down,
PERSISTENT SURPLUS

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 EXAM 2——————————————————

A. Elasticity sensitivity, responsiveness

1. Motivation
2. Price elasticity of demand for a given percent change in price, elasticity
is the percent by which people react by buying more or less
a. Definition sensitivity of consumer to change in price
b. Measure

% ∆ P —> % ∆ Qd
i. Elastic responsive, sensitive- Qd greater than P
ii. Inelastic unresponsive, insensitive- Qd less than P

Ed= | (% ∆ Qd/s) |
| (% ∆ P) |
E_d > 1 elastic
E_d < 1 inelastic
E_d = unit elastic

iii. Unit elastic ^^ =1

c. Determinants
i. Number and availability of substitutes (other options)
ii. Necessity or luxury necessity= inelastic; luxury= elastic
iii. Proportion of budget spent on good
iv. Time more time= more elastic
d. Key: relationship with total revenue %P * %Qd = TR
i. Price discrimination charging two different customers
different prices for the same good
ii. Examples - store discount cards (old people and
pharmacies)

elastic, raise price, Qd drops more, TR down

lower price, Qd rises more TR up
inelastic, raise price, Qd drops less, TR up
lower price, Qd rises less, TR down
e. Graphically

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 3. Price elasticity of supply
a. Definition percent by which suppliers change amount of good
supplied
b. Measure
i. Elastic >1
ii. Inelastic <1
iii. Unit elastic =1
c. Determinant
i. Time more time, more supply, more elastic
d. Graphically

B. Incidence of taxation
1. Motivation when business people are taxed for goods and they pass it
on to customers
2. Tools
a. Elasticity who bears the tax depends upon the customer
sensitivity to the price
taxes are on the purchase total, not individual item; excise taxes
are per item (alcohol, cigarettes)
b. Economic surplus = benefit - cost
ES = CS + PS
ES ≥ 0
i. Consumer surplus = benefit - cost (buyers)
“reservation price - actual price” (integral of demand curve)
Rational: buy if CS ≥ 0
ii. Producer surplus = benefit - cost (sellers)
“actual price - reservation price”
Rational: sell if PS ≥ 0

supply down buyers ∆ CS sellers ∆ PS all

price up BAD GOOD bad + good

+ + NO EFFECT

quantity BAD BAD bad + bad

transacted BAD
down = =

TOTAL BAD GUOUS bad +

ambiguous
BAD

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 Pbuyer - Pseller = amount of tax

iii. Government revenue = amt of tax * quantity sold

iv. Deadweight loss
v. Examples
2. Examples
a. Who bears the burden of a tax?
b. How is economic surplus affected?

example:
Ed = 1.8
Es = 1.2 $10 excise tax imposed:

What percent of burden falls on buyers? = Es ÷ (Ed +Es) • 100

= 1.2 ÷ (1.8 +1.2) • 100 = 40%

Sellers? = Ed ÷ (Ed + Es) • 100

What is ∆ price for buyers? = percent • tax = 0.4 • 10 = $4

∆ price for sellers? 0.6 • 10 = $6

A. Theory of the Firm: The Basics

1. Assumption businesses make decisions that maximize their profit
2. Profit = benefit - cost
a. Definitions
i. Total Revenue (TR) = price x quantity sold
ii. Marginal Revenue (MR) how much/ how many; change
in total revenue from selling one more unit of the
good or service = ∆TR ÷ ∆Q = TR’(Q)
iii. Total Cost (TC)
α. Explicit dollars flowing out, labor, materials,
utilities, accounting
β. Implicit day job and associated salary given up,
“dollars NOT in”(money from doing best
alternative)

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 iv. Marginal Cost (MC) change in total cost from producing
one more unit = ∆TC ÷ ∆Q = TC’(Q)
b. Accounting the profit which would be calculated by an
accountant = total revenue - explicit cost
c. Economic profit that would be calculated by an economist =
total revenue - (explicit + implicit cost)
= accounting profit - implicit cost
= accounting profit from present - acct profit from best alternative

d. Maximizing rule
i. Produce quantity Q* where MR = MC
e. Normal economic profit = 0 ; when current acct profit = best alt.;
equilibrium
f. Examples
3. Costs
a. Total (TC) = FC + VC
b. Fixed (FC) costs that do not change, independent of quantity
(rent)
c. Variable (VC) costs that vary; function of quantity
d. Marginal (MC)
e. Average
i. Total (ATC) FC +VC
ii. Fixed (AFC) FC ÷ Q
iii. Variable (AVC) VC ÷ Q
f. Average/Marginal cost relationship
g. Examples
4. Time
a. Short run
i. Definition FC > 0; TC = FC + VC
b. Long run
i. Definition FC = 0; TC = VC, when a contact runs out, you
run into a long run decision

B. Perfect competition
1. Market structure
a. Many small buyers and sellers no one individual sellers can
control the price of a good
b. Homogeneous good every firm is selling exactly the same thing
c. Perfect information buyers know the price at which each seller is
selling the good
d. No barriers to entry/exit
2. Firm behavior in the short run: How much to produce?
profit = (P - ATC) * Q
a. Case 1: P > ATC doing they best they can be
i. Equilibrium quantity Q* > 0
ii. Profit > 0 (economic; accounting is + and higher)

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 b. Case 2: P = ATC doing ok
i. Equilibrium quantity Q* > 0
ii. Profit = 0 (accounting profit positive, econ prof=0)
c. Case 3: ATC > P ≥ AVC short run only
i. Equilibrium quantity Q* > 0
ii. Profit econ prof = < 0
more case 3: in the short run, the firm must choose whether
to stay open or shut down
SHUT DOWN:
profit = TR - FC - VC
= 0 - FC - 0
= -FC
STAY OPEN:
profit = ( P - AFC - AVC) * Q
= (P - AVC) * Q - AFC * Q
≥0
= ≥ - FC
staying open is at least as good as shutting down

d. Case 4: P < AVC should close down

i. Equilibrium quantity Q* = 0
ii. Profit econ prof < 0
e. Conclusions

1) “price takers”
2) demand at any firm is perfectly elastic
3) demand and price are the same, (P=MR)

1) profit = (P - ATC) * Q
2) profit-maximizing rule: produce Q* where MR = MC
[Q* is the quantity transacted at equilibrium]
a) perfect competition: P = MR = MC
b) in monopoly P > MR = MC

3. Firm behavior: short run fixed moment in time now to long run fixed
moment in the future
a. Case 1: P > ATC doing the best you can be
i. Entry firms will enter market
ii. Change in output/profit entry = more sellers= more
supply= down price, up Qt in market (but down in firm)
[lower price= lower profits] entry continues driving down
profits until profit = 0 (long run result)
market output up, firm output down
profit will decrease
b. Case 2: P = ATC no profit—long run result

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 i. Entry/Exit neither
ii. Change in output/profit neither change
c. Case 3: ATC > P ≥ AVC opposite of case 1, shut down
Profit = (P - ATC) * Q, Profit < 0
i. Entry/Exit sellers are leaving, supply decreases, price up,
quantity transacted down
ii. Change in output/profit— price increases causes profits
to increase (but still losses), exit continues until profit
= 0 in long run
d. Conclusions if profits at a time are positive or negative, firms
will enter or exit the market which will always push the profits
to 0 in the long run— case 2 is the only one that can persist for the
long run because it is already there

B. Monopoly
1. Market structure
a. One seller
i. Implications that seller IS the market
b. Good with no close substitutes
i. Implications demand is going to be more price- inelastic,
customers can say no- no profit; if they want to sell
more units, they have to lower the price = increase in total
revenue (more) + decrease (lower price) = MR is ambiguous
would need to know price elasticity of demand
c. High barriers to entry
i. Causes extremely high fixed costs (patents, resources)
ii. Implications positive economic profit attracts entry but
monopolist can keep out competition (if they have a
patent)
IF a monopolist is earning a positive economic profit in the
short run, the barriers of entry will continue this trend
into the long run; but there is no guarantee that the
monopolist will be profitable
2. Monopolist in the short run: How much to produce? What price to
charge? produce the amount such that MR = MC
price should be the highest that the customers are willing to pay

PROFIT = (P - ATC) *Q- (economic profit)

a. Case 1: P > ATC stays in business, positive profit

b. Case 2: P = ATC economic profit = 0, act profit high as best
alternative
c. Case 3: ATC > P ≥ AVC stay open to minimize losses due the
fixed costs

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 d. Case 4: P < AVC shut down, not enough demand
e. Conclusions

3. Monopolist in the long run: How much to produce? What price to

charge?two possibilities:

a. Case 1: P ≥ ATC stay open, econ profit ≥ 0 (case 1 and 2 ^^^)

b. Case 2: P < ATC exit of market, shut down, econ profit < 0
4. vs. Perfect Competition (not on exam) good for consumers, bad for
sellers. As a policy would we want to encourage monopoly or
competition? Both. Competition causes reduce of incentive to innovate.
Monopoly makes prices higher.

EXAM 3 ———————————————————

A. Introduction to macroeconomics- large scale, unemployment, inflation

B. Economic Growth
1. Definition producing more stuff than previously
2. Measure the % change in gross national/ domestic product (GDP)—
the measure of all goods and services produced in a country
3. Major Issue: Fluctuations over time economy has grown 2.5-3%
annually (average)
a. Short Run: Business Cycle short run fluctuations in econ growth
i. Recession econ growing more slowly, unemployment up
ii. Expansion growing quickly

unemployment peaked at 10.8% in 1982

largest expansion ’91-’01 (10 years)
probably a recession before 2020

b. Relation with Business Cycle

i. Procyclical the relationship w/ short run rates of growth—
pro = with, when economy expands, corporate profits
up
ii. Countercyclical when economy is in recession, corporate
profits move up; expansion: down (ex: grad school)
c. Long Run: Changes in Productivity output per worker per hour,
with more resources, worker productivity much higher that
100 years ago

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 GROWTH IS EXPONENTIAL (% like rate of interest)
small changes in growth over long periods of time have huge
impacts on wealth
amt ( 1 + percent ) ^ (years) = amt after time

C. Unemployment: The Basics MOST IMPORTANT TOPIC (currently 5.0%)

1. Definitions and measures
a. Unemployment Rate
b. Weekly jobless claims a measure of the number of people who
have made an INITIAL file for unemployment insurance in
the week that is being studied (number of people who lost their jobs in
a given week)
2. BLS Household survey to reflect entire civilian noninstitutional
population
a. Employed = a
b. Unemployed = b
c. Not in Labor Force = c
d. Civilian Labor Force = a + b
e. Civilian noninstitutional population = a + b + c
over age of 16, not active duty military, not
institutionalized (elderly homes, prison [2.2 mil people])
3. “True” problem of unemployment
a. Underemployment
b. Discouraged workers
c. Alternative measures of labor underutilization
spending resources to give people skills

B. Unemployment: Four Types

1. Frictional
a. Definition individual people, individual business
b. Short-term; desirable
c. Examples
unemployed person has required skills and location to do a job
it takes time for the person to find a job/ business to find employee
“search” unemployment
helped by online job sites

2. Structural specific industry, region

a. Definition
b. Long-term; undesirable; policies
c. Examples
no skills match or significant geological separation

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 growing industries- new skills, but skills come from experiences
engineers move to CA or TX for jobs

BOTH BELOW MEAN SURPLUS IN LABOR MARKET

3. Cyclical all industries, entire country; macro economic

a. Definition
b. Short or long-term; very undesirable; policies
c. Examples
unemployment related to the business cycle (recession)

4. Seasonal
a. Definition
b. Short-term; inevitable; adjustments
c. Examples
cultural seasons (holidays, summer)

B. Policy Goal: Full Employment

1. Definition the lowest sustainable rate of unemployment; zero
unemployment is not achievable; no cyclical unemployment; labor
market in equilibrium

A. Inflation and Inflation Rates

1. Measurement: Fixed basket of goods and services fixed: only variable
that will change is price
a. Consumer Price Index (CPI) monthly release; measure of the
total aggregate price level at the retail level; how prices are
changing that affects average consumers; gives
inflation rate at the retail level
b. Producer Price Index (PPI) monthly release; buyer level;
wholesale level; rate of inflation that affects sellers; gives
inflation rate at the wholesale level
c. Total and Core inflation rates exclude food and energy (they are
extremely volatile, or change on a daily basis; makes it hard
to see economic trends)— %∆CPI

B. Uses for the inflation rate

1. KEY RELATIONSHIP: Nominal and Real values
a. Real = Nominal – Rate of inflation ***
nominal- #, how many dollars
real- how much something is worth
b. Example: Interest rates
when is it most advantageous to borrow? at the lowest interest rate

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 real or nominal? —always real
when is it best to lend? highest real rate of interest
need to know finance rate and rate of inflation
when is it most advantageous to be saving?
lending and saving can be seen as the same thing
2. Deflating
a. Convert nominal values into real ones
b. Application: Gasoline prices—higher in 1970 or 2016?
in 1970, $0.36 = $2.24 today. real value of gas has decreased
3. Indexing
a. Adjust nominal values to hold real values constant if prices go
up 10% (rate of inflation) then if indexed, wage should go up 10%
(nominal)
b. Application: Social Security benefits fixed in nominal terms

some states (WA) min wage is indexed: fixed in real terms

C. True Costs of Inflation: NOT loss of purchasing power, rather…

inflation does not cause money to be worth less
“a dollar spent is a dollar earned”
with inflation, you have to spend more money to get the same thing,
but the seller receives more money for the same thing, so over all,
prices and income go up together
1. Interference with long-run planning
a. Increased fluctuation in inflation rates = increased risk in
borrowing and lending reduces economic growth rates and
living standards; (1% or more per month) rates become more
volatile
if nominal interest rate is fixed but the interest rate increases,
the real rate of interest goes down: this is good for borrowers
because the price of debt goes down
if the rate of interest goes down: good for lenders
if the rate is very variable, it is hard for people to predict
whether or not it is a good decision to borrow or lend: there is a risk
of loss
if we can keep the rate of inflation around 2% every year, the
economy is more predictable
less risk means more activity
b. Fisher Effect: nominal interest rates and inflation rates nominal
interest rate and inflation rates are positively related, the
independent variable is the rate of inflation,
dependent - nominal interest rate
rate of inflation is extremely low in US, so rates of interest are low
when interest rates (real) are 135%, you’ll have less by the end go the
year bc interest rates are so high

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 D. Gross Domestic Product (GDP)
1. Definition (important) measures economic growth in a country; market
value of all final goods and services produced within a country in
a given period of time

a. What counts and what does not if it’s physically produced in the
country in the given year
ex:
car built by American company in America, GDP
car built by Japanese company in America, GDP
house built in 1906 was part of GDP in 1906
tomato grown in Mexico and bought in US, part of GDP
tomato grown in back yard, not part of GDP, not in market
value of loaf of bread includes all ingredients- loaf is final good

b. Stock and flow variables

stock can be measured at a given point in time (unemployment)
flow must be measured over time (GDP)
2. Two methods of measuring: “a dollar spent is a dollar earned”

A. Measuring GDP: Expenditure Approach (who is spending) in lab notes

1. y = C + I + G + X – IM, where
a. Consumption (C)
b. Investment (I)
c. Government spending (G)
d. Exports (X)
e. Imports (IM)

%change= (new-old)/old
B. Economic Growth, GDP, and Inflation Rates
1. Definition
2. Expansion and recession expansion- period of time when economy is
growing at or above long run rate (in US 2.5%)
recession- substantially more slowly than long run rate
real world definition: “technical” recession-a period which economic growth
is negative for two or more consecutive quarters
3. Nominal growth, Real growth, and the Inflation rate
a. If nominal growth > real growth, then inflation rate > 0
b. If nominal growth < real growth, then inflation rate < 0
c. Examples

C. Money: the basics

1. Definitions money is stock, income is flow (must be over a period of
time)

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 2. Five functions
a. Means of payment
i. Medium of exchange when money is used at the time of
transaction, can be at different points in time
ii. Means of unilateral payment one way transaction, using
money to fulfill an obligation but there is no good or service in the
other direction (ex: donations, gifts, taxes, social security payment,
tickets/ fines)
b. Unit of account written, recorded
c. Standard of value
d. Store of value to be used to buy at a later date, saving, storing
e. Standard of deferred payment get the product now, pay later
3. What gives Federal Reserve notes their value?

B. Money: How (and why) is it measured?

1. Money as a Medium of Exchange
a. M1 checking, cash
2. Money as a Store of Value
a. Concept of Liquidity
b. M2 savings, money market

C. Money: How do commercial banks create it?

1. Model: Money Supply = MB x money multiplier
a. Where: MB = Monetary Base = bank reserves + currency in
circulation

Final Exam ————————————————

Money: How do commercial banks create it?
1. Model: Money Supply = MB x money multiplier, where:
a. MB = Monetary Base = bank reserves + currency in circulation
MS= currency in circulation + checking deposits
MB=currency in circulation + banking reserves
MS= MB x money multiplier
2. Multiple Deposit Creation
3. Conclusions
a. More deposits, more loans, greater money supply, greater
multiplier
b. Fewer deposits, fewer loan, smaller money supply, smaller
multiplier
4. Examples tooth fairy
when a loan is taken out,
the bank reserves = act you have in bank amount of loan

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 -money multiplier cannot be any less than 1
-all money is both an asset and a liability, asset for who it’s for, liability for
whoever holds it (banks)
-deposits and withdrawals do not change the monetary base, just the form by
which it’s held- monetary base does not change
-LOANS change multiplier and money supply
-we change supply and multiplier with our decision to deposit money
-the bank lends less during recessions because people have less money, smaller
multipliers, smaller money supply— opposite with expansion
-private banking system leads to destabilization of macro economy; makes
recessions worse and expansions better

B. The Federal Reserve (Fed): Structure created by congress

1. 12 Federal Reserve Banks (FRBs)
operate independently of the federal government
1 BOS 2NY 3PHI 4CLE 5RICH 6ATL 7CHI 8STLOU 9MIN 10KAN
11DAL 12SF
none west of dallas except SF, 2 in missouri
need banks where people are borrowing money
2. Board of Governors (BoG): 7 members
a. 14-year, nonrenewable terms
b. Chair: 4-year renewable term
3. Federal Open Market Committee (FOMC)
a. 12 voting members (7 committee and 5 banks)
i. 2016: NY, CLE, BOS, KC, STL
ii. 2017: NY, CHI, DAL, MIN, PHIL
iii. 2018: NY, CLE, ATL, RICH, SF

C. Tools of monetary policy

1. Again: MS = MB x money multiplier
2. Open market operations (FOMC)
controlled by open market committee
“open market purchases/sales” always the fed, will change the monetary
base; buying and selling government bonds to the public
a. Federal funds market
b. Government bonds bond- like a loan, periodic payment
i. Key relationship inverse relationship- if the market price of
a bond goes up, the market rate of interest on the bond goes
down
price goes up when it is more desirable
best time to buy- when you expect price to go up (interest
rates will decrease)

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 c. Purchase: expansionary monetary policy actions- open market
purchases- increasing money supply allows fed to buy more, lower
interest rates, make credit cheaper
more borrowing, more spending, more production, more employment
eventually bad- price goes up, leads to inflation
d. Sale: contractionary open market sales
good- puts downward pressure on prices

Expansionary Monetary Policy Action

Open market purchase
Fed buys government bonds from public
(ex: MB up by $100)
increase MS
increase MB
increase price
decrease interest

Ms = MB x money multiplier

Contractionary Monetary Policy Action

Open market sale
decreases MB
decrease MS
decrease price
increase interest

bad- slows economy

where does the fed get the funds to buy and sell government bonds?
they create it- they can create as much as they want
they do this to try to insure optimal performance of economic growth

C. Exchange Rates: The basics

1. Introductory comments and motivation
2. Definition the price of a currency in another currency
3. Assumptions
a. Two countries (U.S. and euro area)
b. Two currencies (dollar and euro)
c. Two exchange rates (€ per $; $ per €)
euros per dollar- price of a dollar = 0.95 euro
dollars per euro- price of a euro = $ 1.06
4. More definitions
a. Appreciation price of dollar increases
b. Depreciation price of dollar goes down
5. Relationship between exchange rate, import/export prices, and
macroeconomic performance

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 a. If a country’s currency appreciates, then…
i. Exports become more expensive. US goods e expensive
abroad
ii. Imports become cheaper. foreign goods
US GDP will go down
unemployment up (countercyclically)
aggregate price level will go down
appreciation is good if our major economic concern is inflation
appreciation is bad if major concern is recession (unemployment)

b. If a country’s currency depreciates, then…

i. Exports become cheaper.
ii. Imports become more expensive.

higher inflation rates

C. Exchange Rates: Changes

1. Desirability of currency if a good becomes more desirable, price goes
up
a. To save (short term) more desirable to save, price goes up
most advantageous (desirable) to save at the highest real
interest rate
b. To spend (long term) more desirable to spend, price goes up

2. Examples

B. Federal budget deficits and the national debt

1. Definitions
a. Budget deficit current spending - current income
flow variable medium if exchange - ( taxes - transfer payments)
if deficit, finance through borrowing (bonds)
b. National debt total amount owed: ∑deficits — ∑borrowed$
c. Structural + cyclical deficits = actual deficit
cyclical- short run - function of GDP - at full employment,
cyclical deficit = 0
structural- long run, at full employment, actual = structural
related to govt spending, taxes, and transfer [fiscal
policy]
i. Fiscal policy expansion is good (jobs) but increases debt -
taxes, transfers
ii. Monetary policy
d. Real and nominal deficits
the national debt never has to be paid off
when you borrow, you are promising a share of your future income

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 the bank expects you to pay it back because you’re going to die someday-
people don’t have the ability to borrow forever
people will always be willing to lend to the government
“rolling over the debt”
selling new bonds to pay off old ones

2. Financing deficits government gets interest payments from taxpayers

3. And future generations debt will go up each year (interest)

a. Myths
b. Realities
4. Conclusions

person 1:debt of 200K— income 40K/year

person 2: debt of 1 mil— income 500K/year

person 1 burden = 5 years

person 2 burden = 2 years

debt is relative to income

national debt / national income (or GDP)

if the economy grows faster than the debt, the real debt goes down (less burden)

Final Exam:
50 questions
30% today to final (15 questions)
12 q from first exam
12 q from second
12 q from third
—

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