Unit 7

Unit 7

Balance of payments

• Measure of $ inflows and outflows between the US and the rest of the world (Row)

     *inflows are referred to as CREDITS
     *outflows are referred to as DEBITS

• The balance of payments is % into 3 accounts

     *current account
     *capital/financial account
     *official reserves account

Current Account

• Balance of trade and net exports

     *exports of goods /services -import of goods and services
     *exports create a credit to balance of payments
     *imports create a debit to the balance of payments

• Net foreign income

     *income earned by US owned foreign assets. Income paid to foreign held US assets
     Ex. interest payments on US owned Brazilian bonds. Interest payments on German owned US                  treasury bonds. 

• Net transfers (tend to be unilateral)

    
Capital/Financial Account

• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the US is a credit to the capital account
• Direct investment by US firms/individuals in a foreign country are debits to the capital accounts
• Purchase of foreign financial assets represents a debit to the capital account
• Purchase of domestic financial assets by foreigners represents a credit to the capital account

Official Reserves

• The foreign currency holdings of the US federal reserve system.
• When there is a balance of payments surplus the FED accumulates foreign currency and debits the balance of payments.
• When there is a balance of payments deficit the FED depletes its reserves of foreign currency and credits the balance of payments 
• The official reserves 0 out the balance of payments

Active VS passive official reserves:

The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate

Formula!!
Balance of trade:
     Goods exports + Good imports
Balance on goods and services:
     Goods exports + service exports + goods imports + service imports
Current Account:
    Balance on goods and services + net investment + net transfers
Capital Account:
     foreign purchases + domestic purchases

Foreign exchange (FOREX)

• The buying and selling of currency

     ex: in order to purchase souvenirs in France, it is first necessary for Americans to sell their dollars and buy Euros

• Any transaction that occurs in the balance of payments necessitates foreign exchange

Changes in exchange rates

• Exchange rates (e) are a function of the supply and demand for currency.

1.      An increase in the S of a currency will decrease the exchange rate of a currency
2.      A decrease in S of a currency will increase the exchange rate of a currency
3.      An increase in D for a currency will increase the exchange rate of a currency
4.      A decrease in D for a currency will decrease the exchange rate of a currency

Appreciation and depreciation

• Appreciation of a currency occurs when the exchange rate of that currency increases
• Depreciation of a currency occurs when the exchange rate of that currency decreases

Exchange rate determinants


1. Consumer's taste
2. Relative income
3. Relative price level
4. Speculation

Exports and imports

• The exchange rate is a determinant of both exports and imports
• Appreciation of the $ causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports

Fixed rates

• Based on a country's willingness to distribute currency and to control the amounts
• The US uses a fixed rate the $1 stays $1

Absolute advantage

•      Individual- exists when a person can produce more of a certain good/service than someone else in the same amount of time (or can produce a good using the least amount of resources)
•      National- exists when a country can produce more of a good/service than another country can in the same time period

Comparative advantage

•  A person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner

Specialization and trade

• Gains from trade are based on comparative advantage, not absolute advantage-Examples output:

• tons per acre
• miles per gallon
• words per minute
• apples per tree
• television produced per hour

     Examples input:
-# of hours to do a job
-# of acres to feed a horse
-# of gallons of paint to paint a house

Unit 5

Chapter 16. Extending the Analysis of Aggregate Supply

Short Run:

In macroeconomics, this is the period in which wage (and other inout prices) remain fixed as price level increase or decrease.

Long Run:

-period of time in which wages have become fully responsive to change in price level.

Effects in Short Run:

-In SR, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant

- In LR, wages will adjust to the price level and previous output level will adjust accordingly

Equilibrium in the Extended Model

Long aggregate supply curve is represented without vertical lone at full employment level of real GDP.

Demand Pull Inflation in the AS Model

• Demand-Pull: prices increase based on increase in AD
• SR, Demand pull will drive up prices and increase production
• Long run increases in aggregate demand will return to previous levels

Cost Push and Extended Model

Cost-push arises from factors that will increase per-unit costs such as increase in the price of a key resource

Dilemma for Government

• An effort to flight cost-push, the government can react in two different ways.
• Action such as spending by the government could begin an inflationary spinal
• No action however could lead to recession by keeping production and employment levels declining


The Phillips Curve

Long Run Phillips Curve

note: natural rate of unemployment is held constant

• Because the LRPC exists at the natural rate of unemployment (Un), structural changes in the economy that effect Un will also cause the LRPC to shift

•  Increase in Un will shift LRPC to the right
• Decrease in Un will shift LRPC to the left
• There is no trade-off between inflation and unemployment in the long run
• It occurs at the natural rate of unemployment
• It is represented by a vertical line
• LRPC will shift if the LRAS curve shifts

Short Run Phillips Curve

    

• There is a trade-off between inflation and unemployment
• When one goes up the other goes down. (inverse)

Supply Shocks 

• A rapid and significant increase in resourse cost which causes SRAS curve to shift
• SRAS most likely to shift left and SRPC to shift right

Misery Index

• The combination of inflation and unemployment in any given year
• Single digit misery is good

Unit 4: 3 Tools of Montary Policy

3 Tools of Monetary Policy

1) Reserve Requirements: 

• Only a small percent of you bank deposit is in the safe. The rest of your money has been loaned out. This is called Fractional Reserve Banking 
• FED sets the amount that bank must hold
• RR is % of deposits that banks must hold in reserve and NOT loan out.

- When FED increase the MS it increases the amount of money held in bank deposit.

a) if there's a recession, what should the FED do to the RR?

     1) Bank hold less money and have more ER

     2) Banks create more $ by loaning out express

     3) MS supply increases, interest rates fall, AD goes up

b) if there inflation, what should to FED do to the reserve requirements?

     1) Banks hold more money have less ER

     2) Banks create less $

     3) MS decreases, interest rates up, AD down

2) The Discount Rate

the interest rate that the FED charges commercial bank

• To increase the MS, the FED should decrease the discount rate ( easy money policy)
• To decrease the MS, FED should increase the discount rate ( tight money policy )

3) Open Market Policy 

• FED buy/sell government (securities) 
• This is the most important and widely used monetary policy
• to increase MS, FED should buy government securities
• to decrease MS, FED should sell government securities 

When a customer deposits cash or withdraws cash from their demand deposit account, it has no effect on money supply. It only changes:

1. The composition of the money
2. Excess Reserves
3. Required Reserves

How does it effect the three:

Effect ER & RR because the 

Single bank: loan money from ER

Banking System : ER x Multiplier (1/rr) 

                           *total money supply*

Unit 4: Loanable Funds, The Time Value of Money

Loanable Funds

Essential Question: What factor has the biggest impact on the money supply, lending and investment? 

      - Interest Rates (the price of borrowing & using money) 

Nominal v. Real Interest Rates

Nominal:

• Real interest rates + expected inflation
• % increase in money that the borrower pays including inflation

Real:

• Nominal interest rate - expected inflation
• % increase in purchasing power that the barrow pays (adjusted)

What are loanable funds?

-funds available for borrowing or lending

Demand for Loanable Funds

• the quantity of credit wanted and needed at every real interest rate by borrows in an economy
• Loanable Funds demand consists of any and all activities of borrowers who were credit, including: loan application and financial asses sales.

Demand for loanable funds? 

• the quantity of credit wanted and needed at every real interest rate by borrowers in an economy
• Loanable funds demand - consists of any and all activities of borrowers who desire credit, including: loan application and financial asset sales.

Time Value of Money

Is a dollar today worth more than a dollar tomorrow? YES 

Why? 

- inflation and opportunity cost

- this is the reason for charging and paying interest

Let V = future value of $.

       P = present value of $.

       r = real interest rate ( nominal rate - inflation expressed as a decimal)

       n = years 

       k = # of times interest is credited per year

Demand Money

- has an inverse relationship between nominal interest rates and the quantity of money demanded

What happens to quantity demanded money when interest rates increases? 

- quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities

What happens to quantity demand when interest rate decreases? 

- quantity demanded increases.

- There is no incentive to convert cash into interest earning asset.

What happens if price level increase? 

- then money demand shift to the right

   3 Causes:

- change in price level

- change in income

- changes in taxation that affects investment

Increasing Money Supply

If the FED increases the money supply, a temporary surplus of money will occur at 5% interest.

- the surplus will cause interest rate to fall 2%

How does this affect AD?

Increase MS > Decrease interest rate > increase investment > Increase in AD

How do we decrease Money supply?

Decrease MS > Increase interest rate > decrease investment > decrease AD

Fiscal Sector

• Financial assets vs. Financial liability
   - Assets: stocks or bonds that provide expected future benefit.
                : benefits the owner only if the ensure of the asset need certain obligation
   - Liability: it is incurred by the ensure of a financial asset to stand by the issue asset
                   : what you owe
• Interest Rates: it is the price paid used for financial assets
• stock v. bonds
    - stocks: financial asset that convey ownership in cooperation
  
  - bonds: promise to pay a certain amount of money
  and interest in the future

What do Banks do?

A bank is financial intermediary 

• uses liquid assets (i.e bond deposits) to finance the investment of borrowers 
• Process is known as fractional reserve banking 
• system in which depository institution liquid assets less than the amount of deposit
• can take the form of:
  1. currency in bank vaults
  2. bank reserves - deposits held at the Federal Reserve 

Basic Accounting Review

• T-account (balance sheet)
  - statements of assets and liabilities
• Assets (amount owned)
  - items to legal to which a bank holds legal claim
  - the uses of funds by financial intermediates
• Liabilities (amount owned )
  - legal claim against a bank

Federal Reserve Bank 

Function of FED: 

- it issues paper money 

it sets reserve requirement and it hold reserve of the bank 

- lend money to bank and change their interest

-check clearing service for bank

-acts as a personal bank for government

- supervises member banks

- control money supply 

4/4/16 Monetary Policy Video

https://youtu.be/EntQgHxh-IA

Unit 4 – Money & Banking / Monetary Policy Videos

Unit 4: Part 1 - Types and Functions of Money

There are three types of money: commodity money, fiat money, and representative money. Representative money is money that we do not use today, but some argues that we should. These types of money have three kinds of function. Medium of exchange means that through money things exchanges, for example buying an item, you give them the money you get the item. The second one is  store of value, this means that you are putting your money away and you expect it to still have its value. This leads to rapid of inflation, which then your money is decreasing its value. Lastly, money is a unit of account. Unit account establishes economic worth in the exchange process. We believe the price implies worth. For example, the higher the price of an item means the greater the quality it is.

Part 3 - Money Market Graph

In the money market graph, the demand money slopes downward because when the price is high, the quantity demand is low, and when price is low quantity demand is high. The supply money is vertical because it does not varies from the interest rate. Supply money only moves by Fed. When you increase demand, you put pressure on the interest rate.  To bring the interest rate back down or its normal position, you increase the money supply or increase it by shifting it to the right.


The Fed's tools of Monetary Supply

If the Fed wants to increase the money supply, they can lower the reserve requirements. This means that money becomes excess reserves. If they want to contract the money supply, then they would do the opposite which is increasing the reserver requirements. Fed also uses the discount rate. Discount rate is the rate at which banks can borrow money from the Fed. If they want the bank to borrow more money than they lower the discount rate and if they want to discourage the banks from borrowing money they do the opposite. The discount rate is barely used because it is not a guarantee. Lastly, a way to expand the money supply, the Fed buy bonds. If the Fed wants to reduce the money available, they would sell bonds.

Part 7 - The Loanable Funds Market

In loanable funds graph, the slope of demand loanable funds is still downward sloping and supply loanable funds (SLF) is upward sloping. SLF comes from the amount of money people have in their bank. SLF is dependent on savings. The more people save, the more banks can make loans. If people want to save more we increase the SLF. In money market when the government runs a deficit, it increase demand in money, in loanable funds market an increase demand means interest rate also goes up.

Part 8: Money creation & Multiple Deposit Expansion

Banks create money by making loans. The formula for the money multiplies is one over reserve requirements. To find the total money created loan you multiply your reserve requirements by your loan. Loan increases through the process of multiple deposit expansion. This is by adding all potential loans. 

Unit 4 Part 9

Unit 4: Money

Money

3 uses of $$

1) Medium of Exchange

    - to trade

2) Unit of Account

    - establishes economic worth in the exchange process

3) Store of Value

    - money holds value over a period of time where as product do not

3 Types of $$

1) Commodity Money

     - it gets its value from the type of material from which it is made 

   ex: gold and silver coins

 2) Representative Money

      - Paper money backed up by something tangible that glues it value

3) Fiat Money 

    - It's money because the government say so

  [money we use in U.S]

Characteristics of Money

• Portable Money - you can take your money anywhere ..folded, washed, wrinkled
• Durable
• Scarce - credit card
• Divisible - how many ways to break
• Acceptable
• Uniform - save no matter where you go

Money Supply

a) m1 money

• Currency - composed of cash and coins
• checkable deposit or demand deposit
• travel check
• 75% of correlation
• most liquid (easy to connect to cash )

b) m2 Money

• Consist m1 money along with saving account, market account and deposit held by banks outside U.S
• not as liquid money to convert

c) m3 money

• consist m2 money + certificate of deposit (CD) held by private institution