Module 22-24 Notes

MODULE 22-24 Notes


OBJECTIVES
• You will learn the following
- Relationship between savings and investment spending
- Purpose of the four principal types of financial assets
•Stocks
•Bonds
•Loans
•Bank deposits
- How investors achieve diversity

MATCHING UP SAVINGS AND INVESTMENTS
• Physical capital
- Factories, shopping malls, large pieces of machinery, etc.
• Usually paid for by borrowing
• Where does this funding come from?
• Savings = Spending
- Savings - investments spending identity
• In a simple economy (No government intervention)
- All money spent by a person or firm ends up pockets of others as income
• Total income = Total spending = C + I
• So... C + S = C + I

Lets add Government activity
• The government spends on goods services, and transfers and collects tax revenues
• If the budget is balanced...
- Tax revenue = Government spending + transfer payment
- Budget balance (BB) = Tax revenue - G - Transfers
- If BB is > 0, there is a surplus and government is saving money
- If BB is < 0, there is a deficit and the government is borrowing money.

THE FINANCIAL SYSTEM
• Financial markets is where households invest their current savings and their current savings and their accumulated savings (WEALTH) by purchasing financial assets
• FINANCIAL ASSET
- Paper claim that entitles the buyer to the future income from the seller.

THREE TASKS OF THE FINANCIAL SYSTEM
0. Reducing transaction cost
1. Reducing risk
- Financial Risk
- Diversification
3. Providing Liquidity
- Liquid assets
- Illiquid Assets

WHAT IS MONEY?
• Money
- Something that you can turn into a good or service
• Three roles of money
- Medium of exchange
• Gimmie a dollar for a pack of gum
- Store of value
• Retains its value over short periods of time
- Unit of account
• A way of evaluating the "measurements" of goods and services

MEDIUM OF EXCHANGE
• Your employer exchanges dollars for an hour of your labor
• Your exchange those dollars for a grocers pound of apples
• The grocer exchanges those dollars for an orchards apples crop, and on and on

STORE OF VALUE
• So long as prices are not rapidly increasing, money is a decent way to store value. You can put money under your mattress or in a checking account and still useful, with essentially the same value a week or month later
• If i were the town cheese maker, I must quickly get rid of my cheese because if I wait long, moldy cheese loses value quickly.

UNIT OF ACCOUNT
• Units of currency (Dollars, Euro yen...) Measures the relative worth of goods and services just as inches and meters measure distance
• In the barter system all goods are measured in terms of other goods
• Prices in a barter economy: A Ib of cheese dozen eggs = beer or something
• With money the value of cheese and all other goods and services is measured in terms of a monetary unit.

TYPES OF MONEY
• Commodity money
- Something used as money, normally gold of silver, that has intrinsic value to
others
• Commodity backed money
- Medium of exchange with no intrinsic value guaranteed by a promise that it
could be converted into valuable goods on demand
• Fiat money
- Money whose value derives entirely from its official status as a means of
exchange.

MEASURES THE MONEY SUPPLY
• How much money is out there?
• Two different measures on the amount of money supply. M1 and M2
- M1 = Currency and coin in circulation+checking deposits+Travelers checks
- M2 = M1 + Savings accounts + Short term CD, money market accounts.

Review Videos

Understanding the Current Account


Understanding the Capital Account


Consumer Price Index


Business Cycle Rap

Exam Review

I know that there are more than a few of you will not be in class on Thursday. Here's the review for Friday's Exam.


Unit 3 Exam Review Sheet

If you master the following topics, you should have no trouble with Friday’s exam.

• Know what two subaccounts compose the Balance of Payments.

• Know the difference between the two subaccounts and examples that fall into each.

• Know what causes a currency to appreciate and to depreciate

• Know the factors that impact the CPI and how inflation is measured and how it is used to compare economic data from year to year.

• Be able to identify the different components of the business cycle.

• Know how to spot inflation on a graph and to be able to explain the characteristics of an economy during inflation.

• Know who counts in the labor force and the different types of unemployment.

• Know the different phases of the business cycle and the characteristics of each phase.

• Know the steps to go through to exchange one type of currency for another.

• What are the factors that shift the FOREX market and the factors that impact the supply and demand of currencies in the FOREX market-PRACTICE THE SCENARIOS FROM YOUR PACKET

Balance of Trade & Balance of Payments

BALANCE OF TRADE VS BALANCE OF PAYMENTS
• Net exports = Exports - imports
• Trade surplus = Exporting more than is imported.
• Trade deficit = Exporting less than is imported.

BALANCE OF PAYMENTS (BOP)
• Balance of trade includes only goods and services but balance of payments considers all international transactions
• Balance of payments is a broader measure of international trade.

Details
• The BOP summary is within a given year.
• Prepared in the domestic country's currency
• The balance of payments is made up of two accounts. The CURRENT ACCOUNT and the CAPITAL ACCOUNT.

Current account
• Made up of three parts
24. Trade goods and services
• Net exports- difference between a nation's exports of goods and services and
its imports of goods and services.
2. Investment income - Income from the factors of productions including payments
made to foreign investors
• Money earned by a Japanese car company in the US
3. Net Transfers - Money flows from the private or public sectors
• Donations, aids, and grants

CAPITAL ACCOUNT
The capital account measures the purchase and sales of financial assets abroad.
Purchases of things that stay in the foreign country
Examples:
- US company buys hotel in Russia
- A korean company sells a factory in Ohio
- Australian company buys the Temple Mall.

PRACTICE
25. U.S income increases relative to other countries. Does the balance of payments move towards a deficit or a surplus?
- Imports are cheaper
- Americans import more
- Net exports
- The current account balance decreases and moves toward a DEFICIT

FOREIGN EXCHANGE (FOREX)
Exchange rate = Relative price of currencies

EXPORTS AND IMPORTS
26. US sells cars to mexico
27. Mexico buys tractors from Canada
28. Canada sells syrup to the US
29. Japan buys fireworks from mexico
• For all these transactions, there are different national currencies
• Each country must be paid in their own currency
• The buyer (Importer) must exchange their currency for that of the sellers (exporter)

The turnover in forex markets is almost $4 trillion (USD) a day

EXCHANGE RATES
• In the FOREX market we only look at two countries currencies at a time
• Ex. US Dollars and british pounds
• We examine the price of one currency in terms of the other currency
• The Exchange Rate depends on which currency you are converting.
• The price of one US Dollar in terms of the pound is
- 1 Dollar = £1/$2 =£.5
What happens if you need more dollar to buy one pound (the price for a dollar pound to increases?)
• The US Dollar DEPRECIATES relative to the pound
Depreciation:
- The loss of value of a country's currency with respect to a foreign currency
- More units of Dollars are needed to buy a single unit of the other currency
- At this point the dollar is said to be weaker.

What happens if you need less dollars to buy one pound?
• The US Dollar APPRECIATES relative to the pound
Appreciation:
- The increase of value of a country's currency with respect tot the foreign currency
- Less units of dollars are needed to buy a single unit of the other currency
- The dollar is said to be "stronger"

FOREX supply and demand
Imagine a huge table with all the different currencies from another country
This is the foreign exchange market!
• just like the product market, you can't take things without paying
• If you demand one currency you must supply your currency.

FOREX SHIFTERS
30. Changes in Tastes
EX. British Tourists flock to the U>S
- Demand for U.S dollars increases (Shifts Right)
- Supply of British pounds increases (Shifts right)
Pound depreciates
Dollar appreciates
2. Changes in relative incomes
Ex. US growth increases US incomes
- US buys more imports
- US demand for pounds increases
- Supply for US dollars increases.
3. Changes in relative price level
Ex. US Increase relative to Britain
- US demand for cheaper imports increases
- US demand for pounds increases
Supply for US dollars increases
Pound Appreciates
Dollar Depreciates
4. Changes in relative interest rates
EX US has higher interest rate than Britain
- British people want to invest in US
- Capital flow increases towards the US
- British Demand for US Dollars increases
- British supply more pounds
Pound depreciates
Dollar appreciates

CPI & GDP Deflator

CPI VS GDP DEFLATOR
The GDP Deflator measures the prices of all goods produced, whereas the CPI measures prices of only the goods and services bought by consumers.

GDP = Nomial GDP X 100
Deflator Real GDP

• An increase in the price of goods produced by government will show up in the GDP Deflator but not the CPI
• The GDP Deflator includes only those goods and services produced domestically. Since imported goods are not part of GDP they do not show up on the GDP deflator.

PROBLEMS OF THE CPI
Substitution biased
• As prices for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket.
- Result: CPI may be higher than what consumers are really paying.
New Products
• The CPI market basket may not include the newest consumer products.
-Result: CPI measures prices but not the increase in choices
Product Quality
• CPI ignores both improvements and decline in product quality
- RESULT: CPI may suggest that prices stay the same though economic well
being has improved significantly.

THREE CAUSES OF INFLATION
13. If everyone suddenly had a million dollars what would happen?
14. What two things cause prices to increase? Supply and demand

3 causes of inflation
15. The government prints too much money (The Quantity Theory)
• Governments that keep printing money to pay debts endue with hyperinflation
• There are more "rich" people but the same amount of products
• Result: banks refuse to lend and GDP falls
If the real GDP in a year is $400 billion but the amount of money in the economy is only $100 billion, how are we paying for things?
- The velocity of money is the average times a dollar is spent and re-spent in a
year.
• Quantity of money equation
(MONEY SUPPLY)*(VELOCITY) = (PRICE LEVEL)*(QUANTITY OF OUTPUT)
- Notice that P*Y is GDP

Why does printing money lead to inflation?
• Assume the velocity is relatively constant because people's spending habits are not quick to change
• Also assume that output (Y) is not affected by the amount of money because it is based on production, not the value of the stuff produced.
If the government increases the amount of money (M) what will happen to prices (P)
• EX. Assume money supply is $5 and it is being used to by 10 products with a price of $2 each.
• How much is the velocity of money?
• If the velocity and output stay the same, what will happen if the amount of money is increased to $10
- Notice doubling money doubles prices

CAUSES OF INFLATION
2. Demand - pull inflation
• Demand increases but supply stays the same. What is the result?
• A shortage driving prices up
• An over heated economy with excessive spending but the same amount of goods.
3. Cost - Push inflation
• Higher production costs increase prices
• A negative supply shock increases the costs of production and forces producers to
increase prices
- Hurricane Katrina destroyed oil refineries and caused gas prices to go up.
Companies therefore charged more for any good or service requiring gas in the
production.

WAGE PRICE SPIRAL
A Perpetual Process:
16. Workers demand raises
17. Owners increase prices to pay for raises
18. Higher prices cause workers to demand higher raises
19. Owners increase prices to pay for higher raises...
20. ....
21. ....
22. ....
23. ....
24. Stupid unions.

BALANCE OF TRADE VS BALANCE OF PAYMENTS
• Net exports = Exports - imports
• Trade surplus = Exporting more than is imported.
• Trade deficit = Exporting less than is imported.

BALANCE OF PAYMENTS (BOP)
• Balance of trade includes only goods and services but balance of payments considers all international transactions
• Balance of payments is a broader measure of international trade.

Details
• The BOP summary is within a given year.
• Prepared in the domestic country's currency
• The balance of payments is made up of two accounts. The CURRENT ACCOUNT and the CAPITAL ACCOUNT.

Current account
• Made up of three parts
25. Trade goods and services
• Net exports- difference between a nation's exports of goods and services and
its imports of goods and services.
2. Investment income - Income from the factors of productions including payments
made to foreign investors
• Money earned by a Japanese car company in the US
3. Net Transfers - Money flows from the private or public sectors
• Donations, aids, and grants

CAPITAL ACCOUNT
The capital account measures the purchase and sales of financial assets abroad.
Purchases of things that stay in the foreign country
Examples:
- US company buys hotel in Russia
- A korean company sells a factory in Ohio
- Australian company buys the Temple Mall.

5 Effective Study Habits for AP Students

5. Memorize key facts.

There’s much information that AP classes cover that do not find themselves into the tests. AP tests cover very specific takeaway facts, ones judged by the AP committees to be the most important general facts that students should know and understand from the classes. The best way to figure out what key facts the APs test is to go over practice tests from past years. You will begin to notice trends indicating areas of concentration. Focus on these areas of concentration rather than attempting to know everything. The AP tests not only require analytic thinking, but also strategy on the part of the test taker to sift through the wealth of knowledge to find the most pertinent information.

4. Muscle memory.

It’s important to concentrate during test-taking, but it’s also important to train your body to take tests on auto-pilot to make the critical thinking easier. For instance, the AP tests are timed. You can train your body to instinctively keep track of time by taking timed practice tests, so you memorize approximately how long you should spend on each section. This really works. Have you ever found out that, by waking up at the same time each morning, your body begins to naturally wake up at that time, even without aid from an alarm clock? Your muscles can do the same thing during test-taking. If you take practice tests, your body starts to register what it’s doing. The test itself no longer comes as a surprise. You can significantly raise your score by taking away the novelty value of taking the AP test. By becoming familiar with the tests, and by utilizing muscle memory, you can become a more efficient and effective test-taker.

3. Don’t freak out about what you don’t know.

Freaking out during a test wastes precious time. So don’t freak out. Teach yourself effective stress management techniques. There are three important ones to remember. First, if you don’t know a question, skip it. Stalling will only waste you time and no amount of waiting around will magically send a right answer into your brain if it isn’t already there. Second, use your powers of deduction if you believe that you know the answer. Cross out answers you know are not correct and focus on the ones that you are half and half on. Finally, take your test one question at a time. Think of it as climging a set of stairs. Don’t worry about getting to the top of the staircase; focus on each step along the way.

2. It’s only a test — no one is going to die if you don’t get a 5.

Knowing that the AP test is only a test really helps you put things in perspective. High school students beat themselves up over test scores and stress themselves out until they’re experiencing gray hairs and baldness at the age of 17, and that is definitely not healthy. Really, it’s only a test. And by putting things in perspective, you really will score higher, because you’ll be in a calm and centered state where you can perform better by quelling your negative energy and your stress. Why do you think philosophers like Sun Tzu advised meditation and zen before warfare? Because performance really does increase significantly if you put yourself in a balanced mental state.

1. Test yourself.

Practice practice practice. Take practice tests, take after school classes, quiz yourself with study cards and group study sessions. I know I sound like I’m repeating myself, but you can never get enough practice, which is why testing yourself beforehand is the numer one general study skill that will raise your AP score.

Types of Unemployment

CPI Video

CPI, Inflation, Unemployment - The Big Picture

THE BIG PICTURE OF MACROECONOMICS
• Can the whole of something be greater than the sum of its parts?
- In macroeconomics, YES
GOVERNMENT INTERVENTION
• Government intervention is necessary-even though it causes inefficiency.
• Price ceilings, price floors, taxation, and tariffs are all necessary for the long term benefit of the economy.]

ECONOMIC AGGREGATES
• Measures that summarize data across different markets for goods, services, workers, and assets.
• Macroeconomics will focus on aggregates because they represent the big picture.

For all countries there are three major economic goals:
0. Promote economic growth
1. Limit unemployment
2. Keep prices stable (Limit inflation)

How do we know how well the economy is doing?
• National income accounting
- Economists collect statistics on production, income, investment and savings.

The most important measure of growth is GDP
• Gross Domestic Product is the dollar value of all final goods and services produced within a country's border in one year.
- Dollar value-GDP is measured in dollars
- Final goods-GDP does not include the value of intermediate goods.
Intermediate goods are goods used in the production of final goods and
services.
- One year-GDP measures annual economic performance.

WHAT DOES GDP TELL US?
• Just like calculating your own income, GDP measures how well the U.S is doing financially.
• HOW DO WE USE GDP?
1. Compare previous years, (Is there growth?)
2. Compare policy changes (did a new policy work?)
3. Compare to other countries (Are we better off?)

HOW CAN YOU MEASURE GROWTH FROM YEAR TO YEAR?
% Change in GDP = ((year 2 - year1)/Year 1) X 100

Mordor's GDP in 2007 was $4,000
Mordor's GDP in 2008 was $5,000
What is the percent change in GDP?

What is NOT included in GDP?
3. Intermediate goods.
• No multiple counting, only FINAL goods.
- EX. Price of finished car, not the radio, tires...
2. Non-production transactions
• Financial transactions
- EX. Stocks bonds, real estate
• Used goods
- EX. Old cars, used clothes
3. Non market (Illegal) activities
- EX. Illegal drugs, unpaid work.

CALCULATING GDP
Two ways of calculating GDP:
4. Expenditures approach-Add up all the spending on final goods and services in that given year.
5. Income approach-Add up all the income that resulted from selling all the final goods and services produced in a given year.
Both ways generate the same amount since every dollar spent is a dollar of income.

EXPENDITURES APPROACH
Four components of GDP:
6. Consumer spending
-EX. $6.01 little Caesar's Pizza
2. Investment - When business put money back into their own business
- Machinery or tools
3. Government spending
Ex. Bombs and tanks NOT social security
4. Net exports - Exports (X) – Imports (M)
- EX. Value of 3 Ford Focuses minus to Hondas
GDP = C + I + G + X

NOMINAL GDP - REAL GDP
How can you figure out which is the most popular movie of all time?\

THE PROBLEM WITH GDP
If a country's GDP increased from $4 Billion to $5 billion in one year, is the country experiencing economic growth?
• Did the country produce 25% more products?
• Something about apples and not increasing production so no.

Reave V.s Nominal GDP
• Nominal GDP
- GDP measured in current prices. It does not account for inflation year to year.
• Real GDP
- Adjusts for inflation and is a better comparison for economic growth.
Real GDP "deflates" nominal GDP by adjusting for inflation in terms of a base year prices.

Does GDP accurately measure standard or living.
• Standard of living (or quality of life) can be measured in part by the economy by how well the economy is doing.
- But it needs to be adjusted to reflect the size of the nation's population
• Real GDP per capita
- Real GDP divided by the total population. It identifies on average how many
products each person makes
• Real GDP per capita is the best way to measure a nation's standard of living.

PRODUCTIVITY (TECHNOLOGY)
7. Technology
8. Economic system
EX. #1: Capitalist countries have historically had more economic growth.
- Capital (Like robots) can produce more products than people
- Counties with more capital, can produce more products than countries without.
3. Capital machinery, and man-made resources, and tools
Ex 1. India has over a billion people but relatively few capital resources and there
fore
4. Human Capital
5. Natural resources
- Syria has a lower because its a big freaking' desert.

BUSINESS CYCLE
The national economy fluctuates resulting in periods of boom and bust.
• A recession is 6 months drop
• A depression is something that lasts longer than that.

Who cares?
• Macroeconomics measures these fluctuations and guides policies to keep economy stable
• The Government has a responsibility to
- Promote long term growth
- Prevent unemployment (resulting from a bust)
- Prevent inflation
• why does the economy fluctuate?
• Retailer and producers send misleading information about their consumer demand
• Advances in technology, productivity or resources
• Outside influences (Wars, supply shocks, panic)

Characteristics of Expansions and Recession
Expansion
• Less unemployment
• Increase in real GDP
• Rapid job growth
• Increasing prices
• Fewer Social problems (Alcoholism, Suicides Theft...)

Recession
• More unemployment
• Decrease in real GDP
• Decreasing prices
• More Social prices (Alcoholism, Suicides)

WHAT IS ECONOMIC GROWTH?
• An increase in REAL GDP over time
• An increase in real GDP per capita over time (Usually used to determine standard of living)
WHY IS ECONOMIC GROWTH THE GOAL OF EVERY SOCIETY?
• Provides better goods and services
• Increases wages and standard of living
• Allows more leisure time
• Economy can better meet wants.

GOAL #2: Limit unemployment
WHAT IS UNEMPLOYMENT?
• The unemployment rate
-The percent of people in the labor force who WANT a JOB but are not working.
(Unemployment rate = #Unemployed/#in labor force X 100)

LABOR FORCE
• Who is in the labor force?
- Anyone above 16 years old.
- Able and willing to work
- Not institutionalized (Jails hospitals
- Not full time student
- Not retired.

THREE TYPES OF UNEMPLOYMENT
9. Frictional unemployment
• "Temporarily Unemployed" or being between jobs
• Individuals are qualified workers with transferable skills but aren't working.
• High school or college graduates looking for jobs
• Individuals that are fired or are looking for another job.
2. Seasonal unemployment
• This is a specific type of frictional unemployment which is due to the time of
year and the nature of the job,
• These jobs will come back but don't go year 'round.
EX. Lifeguards
3. Structural unemployment
• Changes in the structure of the labor force to make some skills obsolete.
• Workers DO NOT have transferable skills and these jobs will never come back.
• Workers must learn new skills to get a job.
• The permanent loss of these jobs is called "creative destruction"

Technological unemployment
• Type of unemployment where automation and machinery replace workers causing unemployment.
• Auto assemblers in Toyota factories that are replaced with robots.

CYCLICAL UNEMPLOYMENT
• Unemployment that results from economic downturns (recessions)
• As demand for a good or service falls, demand for the labors falls and workers are fired.

NATURAL RATE AND FULL EMPLOYMENT
• Two types of the 3 types of unemployment are guaranteed to happen.
- Frictional
- Structural.
• Together they make up the natural rate of unemployment (NRU)
• We are at full employment if we have only the natural rate of unemployment.
• This is the normal amount of unemployment we SHOULD have
- The number of job seekers = the number of job vacancies.
• Full unemployment = No cyclical unemployment
• Economists generally agree that an unemployment rate should be around 4 and 6% which equals full employment

CRITICISMS OF THE UNEMPLOYMENT RATE
What is wrong with the unemployment rate?
• It misdiagnose the actual unemployment rate because of the following.
•Discourages job seekers
- Some people are not longer looking for a job because the have given up.
•Part time workers
- Someone who wants more shifts but can't get them is still considered
employed.
• Race and age inequalities
- Hispanics - 5.6% in january
- Black - 8.9% for january
- Teenagers - 15.3% in January
• Illegal labor
- Many people work under the table.

GOAL #3 LIMIT INFLATION
Country and Time-
Zimbabwe, 2008
Prices rose at 76,000,000,000%

What is inflation?
• Inflation is rising general level of prices.
• Inflation reduces the purchasing power of money.
• Ex. It takes $2 ti buy what is $1 back in 1982.
• When inflation occurs, each dollar of income will buy fewer goods than before.

HOW IS INFLATION MEASURED?
The government tracks the prices of the same goods and services each year.
• This "MARKET BASKET" is made up of about 300 commonly purchased goods
• Inflation Rate % changes in prices in 1 year.
• They also compare changes in prices to a given base year. (Usually 1982)
• Prices of subsequent years are then expressed as a percentage of the base year.
• Ex.
- 2005 inflation rate was 5.4%
- U.S. Prices have increased 98.3% since 1982
- In bolivia the percentage was 50,000 percent
• This is called hyper inflation

INFLATION: GOOD OR BAD?
Helped or hurt by inflation?
10. A man who lent out $500 dollars to a friend in 1960 and is still waiting to get paid back.
11. A tenant who gets charged $850 a month
12. An elderly couple living offa fixed retirement of $2000 a month


Make a T-Chart
Hurt by Inflation Helped by Inflation
Lenders - people who lend money Debters - people who borrow money
People with fixed incomes A business where the price of the product increases faster than price of resources.
Savers


CONSUMER PRICE INDEX
The most commonly used measurement of inflation for consumers
How it works:
• The base year is given an index of 100
• To compare, each year is given the index # as well.

CPI = Price of market basket X 100
Price of market basket in base year

Market Basket Base year 2009 Base Year 2010 Base Year 2011
2009 $40 $100 $80 $40
2010 $50 $125 $100 $50
2011 $100 $250 $200 $100


• 1997 Market basket:
• Movie is $6 and Pizza is $14
- Total: $20

CPI VS GDP DEFLATOR
The GDP Deflator measures the prices of all goods produced, whereas the CPI measures prices of only the goods and services bought by consumers.

GDP = Nomial GDP X 100
Deflator Real GDP

• An increase in the price of goods produced by government will show up in the GDP Deflator but not the CPI
• The GDP Deflator includes only those goods and services produced domestically. Since imported goods are not part of GDP they do not show up on the GDP deflator.

RPOBLEMS OF THE CPI
Substitution biased
• As prices for the fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket.
- Result: CPI may be higher than what consumers are really paying.
New Products
• The CPI market basket may not include the newest consumer products.
-Result: CPI measures prices but n

GDP VIDEOS!!