Function of fixing standards - The economy functions in an efficient manner

Function of Organizing production - All resources are allocated and coordinated

Function of Distribution - Who gets the goods and how we get them to who deserves them. Maintaining and Improving Social Structure - Such as population, capital, technology and resources.

Adjusting Consumption to Production - Changes in production take time.

• Utilization of natural aptitudes
• Development and utilization of knowledge
• Task specialization - less moving between tasks so less to master
• Natural advantages with regards to Natural Resources
• Artificial specialization of material agents

• Technical cost - involved in assembly and distribution
• Independence - Everyone has to work as a group of specialization to function.

They signal the sacrifice necessary to consumers and the profit to potential producers

-Ration goods to those willing and able to pay

-Relative prices compare sacrifices to satisfaction.

• They influence the incentive to engage in exchange

• -Influence the desirability to establish property rights

• Influence whether a market will develop and whether it will allocate its resources efficiently.

• Simplified version of reality used to analyze real world situations
• Cause/effect relationships

• They state assumptions and then test with data to validate theory
• -If it cannot be tested it is not a theory
• -One must interpret the information correctly, similar to all scientific models
• -The evidence must be viewed an interpreted in an accurate and concise manner, objectivity is important, one shouldn't strive to prove their theory to be correct.

• -Tastes -
• Demographics (Size of Market)
• -Income and Wealth
• -Prices of substitutes
• -Expectation of future prices.

• -Input prices
• -Technology
• -Expectations
• -Size of Market
• -Opportunity costs

• -The sensitivity of quantity demanded to changes in price
• -Inelastic consumers will pay almost any price for a product
• -Elastic if consumers will only pay a certain price or a narrow range of prices
• -If very elastic consumers may switch to substitutes.

-Ratio of the percentage change in quantity demand relative to the percent change in income

-If income increases by 10% and as a result the quantity of a good demanded increases by 20%. It will be 20%/10% = 2

The market value of all final goods produced in a country during a period of time, typically one year. -Represents the productivity of a country

-Adds together the values of multiple products

Y=C + I + G + NX

-More goods and services the better off they are.

Value of final goods and services produced by residents of a country, even if production takes place outside of the country.

• -US firms in foreign countries
• -Used because it more accurately represents the production in foreign countries.

GNP minus depreciation (consumption of fixed capital)

-When you subtract depreciation from Gross National Product

• -Shows how much has been lost due to depreciation
•  -May be an indicator of future investment spending.

Value of sales taxes from Net national product

• -Indirect business tax

Income received by households

• -Subtract earnings that corporations retain rather than pay to shareholders in the form of dividends.
•  -Also add in the payments received by households from the government in the form of transfer payments.

Personal Income minus personal tax payments

• -Eg. Federal personal income tax
• -Best measure of the income households actually have available to spend.

Measures the price level

• -if prices increase while production is held constant, nominal GDP would rise and real GDP would remain the same
• -This would cause the GDP deflator to increase
•  -Monitors the price level over time
• Nominal GDP/ Real Gdp x 100 = GDP Deflator

• -Leisure not included
• -Not adjusted for pollution or other negative effects, particularly environmental
• -Not adjusted for crime
• -Measures pie, but not how divided up (disparity)

• -The sum of employed and unemployed workers in the economy
• -People who don't have a job and are not looking for a job are not considered in the labor force.

• -Short term unemployment that arises from the process of matching workers with jobs
• -Some unavoidable
• -Seasonal factors, such as weather, fluctuate the demand for some products
• -Workers have different skills, interests and abilities and jobs have different skill requirements.

• -Persistent mismatch between job skills or attributes of workers and the requirement of jobs
• -Can last for longer periods (Workers need to learn skills)

• -Increases in GDP per Capita depends on labor productivity.
• -Which is the quantity of goods or services that can be produced by one worker or by one hour of work.
• Two factors influence
• Quantity of capital per hour worked
• -manufactured goods used to produce other goods and services (cpu's, factories and machines)
• -Physical capital
• -Human capital - accumulated knowlege and skills workers acquire from educating, training and experience.
• Technological change -Increase in the quantity of outputs firms can produce given a number of inputs.

• Not equal to zero because there will always be some frictional and structural unemployment because jobs are always being created and destroyed
• -Natural rate of employment
• -normal rate of employment from F & S

• Too much power in the hands of employees
• -Employers would be at a disadvantage since demand for work would be low, employees would jump from job to job
• -Cost employers to train and retrain.

1/4 Loser their jobs

1/4 leave their jobs

1/2 due to new entrants and re-entrants

-school -family -seasonal unemployment

• GDP is a measurement of all the income households receive
• -It can be calculated using wages
• -When GDP increases it means that personal income is also rising, leaving households with higher incomes
• -as income increases demand for all products increase, therefore increasing consumption

Business fixed investment -spending by firms on new factories, office buildings, and machinery used to produce other goods

Residential investment -Spending by households on new housing

Change in business inventories -Inventories are goods that have been produce but not yet sold.

• Aggregate Demand The collective demand by consumers in an economy
• -As demand increases so does the level of prices -as prices increase it leads to a greater amount of borrowing and withdrawals from banks
• -An increase in prices signals to firms the potential to make a profit, so investment increases.
• -Eventually, as investment and consumption increase so do interest rates
• -the increase in interest rates leads to less investment and more savings.

• The level of productivity in an economy
• -A high capacity utilization means a large portion of capital is being utilized and output and demand is high
• - This leads to an increase in investment spending by firms because their is an opportunity to make a profit
• -An increase in prices signal an opportunity to make a profit!

• The wear and tear of property and equipment of time
• -The using up of capital
• -If net national product is low, as a result of large amounts of depreciation, it signals for an increase in capital
• -If market interest rates are reasonable firms will invest and replace capital, especially during an expansion.

Real interest rates = nominal interest rates - inflation

-High real interest rates, people more likely to save because they receive a greater return on their money

-If someone has 1,000 dollars trying to buy dvds at 10 each they could buy 100

-If the interest rate is 6% and inflation is 4$ you could invest the money for a year and DVDs would cost 10.40 but you'd have 1060 and could buy 102.

• When interest rates are high it attracts foreign savings in US banks
• -Increases the demand for the dollar because more people are saving, less dollars in circulation -Causes the value of the dollar to rise
• -Exports become more expensive and imports become cheaper.

Economic growth determined by Capital, Labor and Technology

Labor Productivity -Quantity of goods or services produced by one worker or one hour of work

• -Increases in capital per hour worked and technological change
• Capital - goods used to produce other goods and services
• -Increase in capital = an increase in worker productivity
• -Ex. one shovel vs. multiple shovels Human capital
• - the accumulation of knowledge through work or education Growth cannot be only capital
• -Must be accompanied by technological change -turning inputs into outputs
• -rearrange storeroom floor/efficiency.
• Other factors -Political/financial stability -Enforcement of property rights
• -Innovation and invention more efficient ways of doing things
• -ex. patents and copyrights
• -Technology is nonrivalrous and non-excludable

Industrial revolution/ mass production and high rates of expansion

-prior economic growth was at a standstill -technology has increased efficiency

-more constant and stable growth rates.

Technology is turning inputs into outputs

• -An example of an increase in technology would be using the same amount of inputs but increasing outputs
• -Governments have patents/trademarks -Encourages firms to invest in R & D
• -Come up with more efficient ways of doing things
• -Without patents everyone would copy ideas and no one would be innovative.

Technology x 1/3 Capital x 2/3 Labor -Determines the growth rate of GDP

-Predicts how fast a country will grow, an economy that grows too slowly will fail to raise living standards

-There is a relationship between growth rates, health and prosperity.

Usually poor countries are predicted to grow faster according to the growth model

• -Poor/developing countries usually have difficulty maintaining a stable growth rate for a variety of reasons.
• -Developed countries invested in capital, technology and work force
• -Ex. Education

Based on the stability of the governments and financial systems

-inability to protect and secure property rights -political corruption and insecure financial markets, foreign investors aren't willing to invest -lack of invest prohibits growth

-People receive little income, unlikely to save, hurts ability for firms to borrow and invest, halting expansion

-Restrictions and regulations such as tariffs, taxes and quotas

-Lack of investment in human capital -

People aren't healthy, educated, willing to be in the actual work force

-Don't enforce contracts and rights.

Export Led Growth (Open Market)

Rationale - benefit mutually, comparative advantages

Strategies - remove tariffs/quotas, free-trade zone, increased incentives for exports (decrease taxes)

Why work? More competition, Less inflation, increased efficiency and choices, balanced budget X>N, Increased productivity

Import Led Growth (Protectionism)

-Rationale - Protect domestic industries, lower dependency

Strategies - tariffs and quotas

Why doesn't work? Increase in prices and inflation, less efficiency and choices.

Assets that people are generally willing to accept in exchange for goods and services or for payment of debts

Unit of Account -You can compare values

Store of Value -Won't go bad

Medium of Exchange -Can be used to exchange goods so you don't have to barter

Three types of demand

Transaction demand - day to day spending

Precautionary demand - emergency and unexpected circumstances -recession/downturn

Speculative - take advantage of opportunities

If the FED buys large amounts of bonds/assets

• -MS increases so that it is constantly higher than GDP - inflation!
• -Producers will know there is more money and raise prices
• -Too much $ will decrease the value

M x V = P x Q dM/M x dV/v = dP/P x dO/O

Change in Money M = Change in Price P + Change in Output O

So if Money goes up 10 either price our output must go up 10

Capital Account (Financial account)

Current account -

Trade Balances

-Interest/profits (made, assets abroad) -Unilateral Transfer (Go to another country to work, send money home)

Capital/Financial Account

International loans/Investment (borrowing/lending)

Buy/sell assets abroad

-If you buy stock in a foreign country it raises the capital account

-But if you pay dividends it increases the current account

-Current account must balance

Merchandise trade balance - the trade balance of just goods (excluding services)

Balance of Goods and services - includes good and services

Current Account Balance - Includes trade and unilateral transfers and interest/profits made on assets abroad.

When I>S (Savings deficit) Credit: [I-S] + [G-T] = Change in MB + [IFCin - IFCout]

When investment goes up, savings goes down

-IR goes up International balance of payments

[IFCin -IFCout] + [Decrease X - Increase] = 0

Demand for US dollar increases

-Exchange rate increases Causing trade deficit to go up!

• US policy has an impact on the rest of the world
• -for example, changes in IR will affect our exchange rates
• -G8 meets to work together

Aggregate demand is income, price, size of market (Total demand in the economy)

Business Cycle - Short run periods of expansion and recession that an economy goes through -

Demand correlates with supply

-When D>S, economy expanding

-Businesses invest, raises total income

-Leads to a raise in prices

-So business cycles influence prices Potential Production

- Capital, Labor and Technology and Full employment

-US sustainable level is U 4-4.5% and Capacity 82%

-They both signal where the economy is at

-If aggregate demand is high, potential production should be high (high demand = high employment

-When aggregate demand is high firms much more likely to invest in capital and technology because they see an opportunity to make a profit, these are determinants of potential production.

For example, increasing AD or D>S could be a signal of upcoming inflation, may influence FED to sell assets.

D greater than S (Demands relation to supply is where we are)

D less than S - no inflation during a recession Decrease in interest rates (After a while investment spending will pick up and people begin borrowing as a result of low interest rates

IFCin increases and Exchange rate decreases -Less demand for $

-Our goods appear cheaper and Exports increase and Imports decrease

-This causes an increase in demand for domestically produced goods

A key component of getting out of a recession is to increase demand

-economy is stimulated

People generally expect small amounts of inflation, but if it rises too much it can hurt loyalty (consumer loyalty)

-Adjusting prices has repercussions

-Producers can adjust quantity rather than price In and expansion when demand is greater than supply just produce more

In a recession when demand is less than supply produce less.

Slashing employee wages hurts employee loyalty

-Want to keep employees happy at a stable wage rate

-Have an implicit contract with consumers, if keep prices stable they'll keep returning

-Better to fire half then cut all wages

Prices are sticky, want prices to remain relatively constant

-Example, don't want to reprint new menu just because the price of an input rises.

-If minimum wage rises you can't just change prices

-Wait until the future, it's inefficient to always be changing prices in reaction to changes in cost of resources.

dY = Final Change in Income (GDP) dY = Autonomous (Initial change) + Induced (Feedback mechanism)

-Multiplier indicates that a small change leads to a big change

dy = dA + dC + dI + dG + dX - dn

dy = dA + .63dy + .15 dy + 0 + 0 - .14dy

-Government spending is not a result of GDP -

They devise their budget separately Exports aren't influenced by our economy, a country may be in a recession while we're in an expansion

-Can't force them to buy our goods Wage starts at 100 - 30(Taxes) PDI = 70

We spend 90% of PDI (70) = 63% is the portion of our income we spend

dy -.64dy = dA + 0.64dy - .64dY

0.36dY/0.36dY = 1dA/0.36 dy= 2.78 dA

-If investment falls by 100 million the final impact on the economy is 278 million.

Various factors are out of our control

-Tax policy could change (especially during an expansion/recession)

- the 0.63C figure will be affected

- People may jump a tax bracket, lowers their PDI

-Causes consumption to be somewhat harder to predict

-Consumption is influenced by money supply

-FED may restrict money supply

-MS less than MD

-Cause our propensity to spend to change

-Also can't control how many imports are produced, even if we are in an expansion.

Constant increase in prices

-Demand greater than supply (usually in an expansion) D>S

Actual GDP greater than potential GDP

-Increase in money supply greater than the increase in GDP

FED decreases money base, therefore decreasing money supply

-FED sells assets IR increase during an expansion -Lowers investments (loans)

-IFCin increases, Exchange rate increases

-Exports become more expensive, demand for domestic goods increase

Taxes may also reduce PDI and lower spending, producers won't raise prices.

Actual GDP is greater than Potential GDP during an expansion Increase in demand leads to price increases and inflation 

Actual less than Potential

-Demand less than supply

Fall in production, excess inventory

-Unemployment increases, total income falls -People are buying few goods, suppliers can't increase prices, inflation decreases/stabilizes

Banks need deposits to be able to lend out money to potential borrowers.

-Ideally, real interest rates should be between (2-5%) encourage people to borrow but also reward people for saving.

Real = Nominal IR - Inflation

3 = 5 - 2

-1= 5 - 6

3 = 9 - 6

-The banks adjust the interest rates naturally in accordance with inflation -no one will invest with a 0 interest rate

Higher Interest rates (vs world)

-Lower investment spending

-Increase foreign investment in and increase ER -Exports decrease and Imports Increase -(X-N) falls and net exports fall.

A price shock is a sudden increase in a key commodity

-Ex. Oil -Price of oil increases (shortage)

-Causes price of most good to Increase (inflation)

-Consumers buy less of all goods

-Income effect - income doesn't stretch as far Demand is less than supply so a decrease in production

-Firms lay off works which increases unemployment Stagflation

- unemployment and inflation.

US - floating exchange rate

Nambia - fixed exchange rate

-In the US

-MS = MB x MM

-MB = FED buys/sells assets

-MM = Banking

system -

Money supply is an indicator of monetary policy

Nambian $dollar is fixed to the African Rand -

Nambia accepts both Nambian dollar and African rand -there is a SA banking system in Nambia -

When MS is less than MD -People then borrow Rand and spend Rand in Nambia

-Nambian central bank has no control over the money supply

Bi-Quarterly

- meet every 6 weeks -

12 Reserve bank presidents -7 members Federal Reserve board

-Discuss goals of next 6 weeks

-Vote 7 FRB and 5 Presidents

-Vote to change interest rates (Monetary Policy)

Daily

- conference call

Federal Open market Committee (staff)

-FED staff (Bernanke)

-Reserve board president (NY president)

-Traders call the banks (Will hold offer for 30 mins) Example.

Want to buy/sell this many (bonds/securities) at a certain price

-Neutralize the economy

Presidents Proposed budget

-All agencies ask for how they need (Office of manpower & budget)

-Submit proposals to congress

-Congress spends next few months figuring out actual budget

Actual Budget -October 1st, passed by congress

Structural - what the deficit would be at full employment

Actual budget - what our deficit would be by just our budget

Structural Deficit - What our deficit would be if we at full employment

In a recession

-Actual greater than structural

Deficit 100 High unemployment 40 Structural 60

In an Expansion Actual less than structural Deficit 100 (3%) low unemployment - (-20) Structural - 120 Deficit - Revenue minus spending

Automatic stabilizers - cushion recessions and expansions (No Policy change - takes time)

-Policy could be too late

Income transfers -transfers from government to people

Unemployment insurance

-in a recession if you lose your job your income falls from 100 to 0 -only falls from 100 to 50 (because of government transfers)

-Doesn't fall as far

Welfare

Social Security - Expansion people less likely to retire

-during a recession people more likely to retire early, so SS is a cusion

-Receive SS

-Instead of being unemployed they receive income in retirement

Progressive tax - different tax brackets

-lower incomes pay less proportion of their income in taxes

-some cushioning effect

Don't want too big of expansions