What is Economics Notes

WHAT IS ECONOMICS - Economics is how people make choices in a world of scarce resources. - Microeconomics is the study of the economy at the small scale level, examining individuals and specific markets. - Macroeconomics is the study of the economy at large scale level, examining total output, the price level and other aggregate measures in the economy. RESOURCES - Any item, whether a gift of nature, the result of production, or the result of human effort, that is used to produce goods and services. - Categories of Resources - Land - Labor - Capital - Entrepreneur Ability - Resources are SCARCE SCARCITY - Scarcity is a condition that results from the inability of limited resources to satisfy unlimited needs Opportunity Cost - What someone gives up in-order to gain something else (next best opportunity) EX: Studying for higher grade instead of going to movies. Rational Decision Making - MB>MC (DO IT) - Self Interest - Optimization - Marginal Decision Making Marginal Benefit and Cost Marginal Benefit: The additional benefit associated with one more unit of an activity Marginal Cost: The addition cost associated with one more unit of an activity - Marginal cost decreases as Marginal Benefit increases Diminishing Marginal Benefit - MB Tends to fall - Diminishing Marginal Benefit: Negative relationship between the marginal benefit associated with the use of a good or service and the quantity consumed - Increasing Marginal Cost: MB rises Optimal Output: Line going up / is MC Line going down \ is MB Comparative Advantage - The ability to produce a good or service at a lower relative opportunity cost than another producer Specialization - Specialization helps make more - Maximize - Results in a more efficient use of resources Terms of Trade - The price of one good, service, or resource in terms of another - Terms of Trade Producer: The price must be greater than the opportunity cost of the seller or producer of the item to make them better off - Terms of Trade Consumer: The price must be less than the opportunity cost of the buyer or consumer of the item to make them better off - Mutually Beneficial - Price is greater than the opportunity cost of the seller or producer - Price is less than the opportunity cost of the buyer or consumer - The terms of trade must be the opportunity costs of the buyer and seller Law of increasing opportunity costs - A principle in economics which holds that as the production of a good or service increases, the opportunity cost of each additional unit rises Market - Any place where, or mechanism by which buyers and sellers interact to trade goods, services, or resources How Trade Happens in a Market - Buyers/Consumer - Sellers/Producers Who Determines The Price? - Buyers and Sellers don't set the price but act based on price. Buyers and sellers can both decided not to buy or sell a produce - Agree on a price that works for both buyer and seller - Prices and quantities traded are determined by the interaction of buyers and sellers in a market - Prices are driven by both the buyer’s demand for the good and service and the producer’s willingness to supply the good or service Demand - Consumers desire to purchase goods and services and willingness to pay the given price for goods and services The Law of Demand - A principle in economics which states that as price of a good, service or resource rises the demand for a good, service, or resources decreases Demand Curve - Graphical representation of the relationship between the price of a good,service, or resource, and the quantity that individuals and formans are willing and able to buy, all else held constant - Demand curves are Downward-Sloping - Price (UP) // Quantity Demanded (DOWN) - When price is high we consume less (why demand curve is downward) Three Reasons Demand Slopes Down - Income Effect - The effect that a change in the price of a good, service, or resource has on the purchasing power of income - As the price of a good goes down, the money that you have gains purchasing power, vise versa - Diminishing Utility Effect- The benefit you get from consuming one unit more. By consuming more you get less benefit. Substitution - The effect that a change in the price of one good, service, or resource has on the demand for another. Market Demand - Total Demand in the market for a good - QD1 + QD2 = MD - The overall or total demand for a good, service, or resource. It represents the summation of individual demand curves, whether they represent individuals, communities, states, or nations Increase in Quantity Demanded vs. Increase in Demand - Increasing Quantity Demanded, price decreases, demand increases down the line - Decrease is vise versa - Increase in demand is a shift of the line to the right and creates a new line “D2” - Decrease is vise versa Determinants of Demand - Income - Demand curves reflect the willingness and ability to buy a good, service, or resource, all else held constant - Number of buyers - Expectations - Taste and preferences - iNET - - Normal Good - A good for which there is a direct relationship between the demand for the good and income EX: Organic Food, Starbucks coffee - Income (up), demand (up) - Income (down), demand (down) Inferior Good - A good for which there is an inverse relationship between the demand for the good and income EX: - Income (up), demand (down) Raman -> Buy Steak - Income (down), demand (up) Raman Related goods - Substitutes : Goods,services, or resources that are viewed as replacements for one another - Prices rises for pepsi, coca cola demand increases (shifting line to right) - Complements : Goods, services, or resources that are used together. - Printers and Ink - PB & J Supply - Supply : The quantity of a good or service, or resource that sellers are willing and able to provide to the market at various prices, all else held constant - The Law of Supply : A principle in economics that states that as the price of a good, service, or resource rises, the quantity supplied will increase, and vice versa, all else held constant Supply Schedule - Upward Sloping - An increase in quantity supplied then move up slope Market Supply - Total supply is supply 1 + supply 2 CHANGE IN SUPPLY - Increase or Decrease in Quantity Supplied, NO SHIFT, only move along line - Increase or Decrease in SUPPLY, shift *Non-Price Determinants* Subsidies - A payment to a business from the government that does not necessarily require an exchange of economic activity in return. Subsidies most often take the form of payments to a business - Subsidy Increase on supplier = Supply Curve increases because you have more money to spend on producing due to help from the government. Taxes - a payment to the government that is the result of economic activity. Taxes are generally collected from both individuals and firms. - Tax Increase on suppliers = Supply Curve shift left (Vice-Versa) Determinants of Supply Resources : The input to produce goods and services; also known as factors of production - Increase Resource Prices = Decrease in Supply Curve - Decreased Resource Prices = Increase in Supply Curve Technology : The knowledge, inventions, and innovations that can potentially increase resource productivity - Increase in use of technology = Increase in Supply Curve - Decrease in use of technology = Decrease in supply curve Price Expectations Sellers Expectations: The anticipated future outcomes, including prices, that sellers associated with the production of a good, service, or resource - Expectations can impact markets Number of Sellers : Increase # of sellers = Supply Curve shifts to right Decrease # of sellers = Supply Curve shifts left Qs = Qd Market disequilibrium-Shortage/Surplus - Market = Qs-Qd - If negative, we have a shortage, excess demand Qs>Qd - If positive, we have a surplus, excess supply QsP*, total surplus is reduced, which results in a deadweight loss - Occurs when PMC= BUY MB Unemployment (goes UP) -> Workers compete -> Wages (goes down(labor costs))-. Output(up) AS (GOES DOWN) -> Unemployment (goes UP) -> Workers compete -> Wages (goes down(labor costs))-> Output(up) AD-AS in the long run - If output is below the full employment level input prices will decrease, which shifts the aggregate supply curve to the right - If output is above the full employment level, input prices (wages) tend to increase which shifts the aggregate supply curve to the right Recession - over time as nominal wages and other input prices fall, aggregate supply increases and output begins to increase Expansionary Adjustment - Overtime, nominal wages and other input prices will rise, resulting in a decrease in aggregate supply Cost-Push- Caused by decrease in aggregate supply// higher price, lower output Demand-Pull Inflation- Caused by increase in aggregate demand//higher price level, as well as higher output Income-Taxes = Disposable income -> consumption OR saving Marginal Propensity to COnsumer - the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it. The Expenditure Multiplier - Tells us how much output will eventually increase for any initial change in income Multiplier effect - Spends 1 extra dollar and how it affects Real GDP Expansionary Fiscal Policy tools - Government Spending (Up) Taxes (Down) ---> Expansionary Fiscal Policy - Aggregate Demand (Up), RGDP (Up), Unemployment (Down) C={a+mpc(Y(income)-T)} (Taxes down) Y* ={a + mpc(Y-T)}+I(UP)+G+NX // (Down) Y* ={a + mpc(Y-T)}+I(UP) +G+NX(UP) // (RGDP Down) Y* ={a + mpc(Y-T(DOWN))}+I(UP) +G+NX(UP)// (DECREASE TAXES) INCREASE GDP TO REDUCE TAXES Contractionary Fiscal Policy tools - Government Spending (Down) , Taxes (Up) Contractionary Fiscal Policy - Aggregate demand (down), RGDP (down), Unemployment (Up) Y*= C + I + G + NX Y= C + I + G + NX (Up) Y= C + I + G + NX Y*= C + I + G + NX Y= {a+ mpc(Y-T)} ——————————————————————————————————————-Money - Any item that both buyers and sellers will generally accept in exchange for goods and services 3 Characteristics of Money - Unit of account - Medium of exchange - Store of value Two was to track the money supply - M1 - Consists of the most liquid assets - M2 - Broader measure of the money supply Liquidity- The degree to which an asset can be readily converted into currency M1 Money Supply What is included - Demand Deposits - Travelers Checks - Other Checkable deposits - Actual Currency M2 Money supply What is included? - M1 - Savings Deposits Small denomination time deposits Retail money funds The Fed - The federal reserve system consists of 12 member banks - The Federal Reserve board of governors oversees the federal reserve system - Washington DC The Board of Governors - Seven members - Appointed by the president - Approved by congress - Have 14 year terms Research at the Fed - Domestic and international financial conditions - The health of the economy - impact of the banking laws - Other issues that consumers and businesses face Activities of the fed - Monetary policy - the actions of the country's central bank to influence the supply of money and credit in the economy - Discount rate - The buying or selling of government securities in the open market to change the money supply - Reserve Requirement - The fraction of checkable deposits that banks must keep on hand as reserves, either as currency or on deposit with the Federal reserve Banking Supervision - Supervise member banks - Identify banks in trouble and avoid a run on banks - Create regulations to promote a stable banking system Financial Services - Clearing Checks - Transferring funds - Receiving and deliver currency - Managing wire transfers - Performing automated clearing house services Serves the federal Government - Maintains accounts for the department of treasury - Processes government checks, postal money orders, and U.S. savings Bonds - Collects federal —————————————————————————————————————BANKS ARE BUSINESSES - receive depositors money Assets for a bank include reserves,buildings, and loans. Banks Banks liabilities include checkable deposits and savings. Banks can loan part of the deposits to other customers, When this happens, banks create money Bank’s net worth = Assets - liabilities Fraction Reserve Banking - A banking system in which banks have to keep only a fraction of checkable deposits on hand and available for withdrawal Reserve Requirements - The fraction of checkable deposits that banks must keep on hand as reserves either as currency or on deposit with the Federal Reserve Required reserves = Deposits x rr Excess Reserves - The amount of reserves that a bank can lend out to earn interest; equal to total reserves minus required reserves Excess Reserves = total reserves - required reserves The Money Multiplier - An increase in reserves in the banking system will generally lead to an even larger increase in money supply - With more reserves on hand, banks will have additional excess reserves and will make more loans Money Multiplier = 1/rr (delta)MS = 1/rr x (delta)reserves (delta) = “The change in…” What is the interest rate - you forego interest earnings when you hold money - Think of the interest rate as the price of money. The Demand for Money - Money is often held to two reasons; -Transaction demand - to buy goods and services -Daily transactions -Asset Demand Asset curve is downward sloping Money Supply --------------------------------------------------------------------------------------------------------------------Interest rate - The price of using money - Helps us make decisions about saving or borrowing money - Interest rate increases as money supply decreases - Interest rate decreases as money supply increases Transaction Demand never changes (Vertical Line) Two Assets Money - No Interest - Safe Bonds - Interest - Riskier Nominal Interest Rate - How many dollars a borrower must repay the lender for each dollar borrowed Real Interest Rate - How much more (or less) the lender can buy once she pays back I + r +π E -----------------------------------------------------------------------------------------------------------Increase of money supply = quantity of investment = decrease in interest rates Aggregate Demand moves to the right when investment increases Expansionary Monetary Policy MS (up), interest rate (down), investment (up), aggregate demand (up), RGDP (up) *decrease in investment = decrease in aggregate demand* Contractionary Monetary Policy MS (down), interest rate (up), investment (down), aggregate demand (down), RGDP (down) Open market operations - the buying and selling of government debt in the form of US treasury bonds Money supply goes down as we buy bonds Money supply goes up when we sell bonds (delta)MS= 1/rr * (delta) reserves Increased loans increase money supply -----------------------------------------------------------------Discount rate- The interest rate at which banks van borrow money directly from the fed. - Borrowing from fed creates excess reserves - Discount rate can influence borrowing and lending patterns Decreasing discount rate - Encourages banks to borrow from the federal reserve - Money supply increases as a result of increase of loans - Fed cannot control inflation *vise versa for increasing discount rate* - Money supply decreases - Higher discount = lower loans Excess Reserves Banks with excess reserves can loan them to other banks - Banks needing excess reserves can borrow them from other banks - Excess reserves are traded in the federal funds market Federal Funds Market- The market for borrowing and lending excess reserves between banks - A banks with excess reserves could keep its excess reserves with the Fed and earn little to no interest - Or the bank could take its excess reserves and lend them to other banks at the federal funds rate Federal Fund rate- the interest rate that banks pay when borrowing reserves from other banks *IN ORDER TO KEEP SAME INTEREST RATE… FED WILL BUY BACK BONDS (IF DEMAND FOR MONEY INCREASES) INCREASED FFR - The fed sells bonds - The quantity of reserves of - Reduce money supply DECREASED FFR -------------------------------------------------------------------------------------------------------------------Expansionary Monetary Policy - Increases level of reserves - Increases the money supply - Lowers interest rates - Increases Investment - Increases aggregate demand - Shift to right with increase investment - Increases RGDP - Reduces unemployment Contractionary Monetary Policy - Decreases the level of reserves - Decreases the money supply - Raises interest rates - Decreases investment - Decreases aggregate demand - Decreases RGDP - Increases unemployment Math for Expansionary Policy - Increases in AD from increased investment are influenced by the expenditures multiplier - Level of investments are influenced by changes in the interest rate, which is determined in the market for money - The impact on the money supply from a change in reserves is influenced by the reserve requirement Recognition Lag : The period between an economic event occurring and recognition of its effects Implementation Lag: The period between the enactment of a policy and the start of its effects Lower interest rates may not stimulate consumption or investment spending if individuals or firms are pessimistic about the future Higher interest rates may not reduce consumption or investment spending if individuals or firms are optimistic about the future. Liquidity Trap - An increase in the money supply does not lower the interest rate - No change in interest rates leaves investment spending, aggregate demand, and real GDP unchanged ECONOMIC GROWTH Can occur if: - We obtain additional resources - Land, labor, capital, entrepreneurial ability - Existing resources become more productive - Invent new technologies Capital : the tools, machinery, infrastructures and knowledge used to produce goods and services Growth rate = GDP2-GDP1/GDP1 * 100 Rule of 72 : A rule of thumb used to estimate, given a constant rate of growth, how long it will take to double it real gdp -------------------------------------------------------------------------------------------------● Inflation is a tax ● Taxing and spending eventually shrinks economy ●