ecma06 full note

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Department
Economics for Management Studies
Course
MGEA06H3
Professor
Iris Au
Semester
Winter

Description
Week 1 To measure GDP: 1) Expenditure approach - GDE = C + I + G+ NX - I = Business fixed/residential/inventory 2) Income approach - Factor/non-factor payments 3) Value-added approach - Output/revenue – intermediate Issues related to national income 1) Excludes NNP = GNP – depreciation/CCA 2) GDP - within country GNP – by a country’s residents GNP = GDP + Net Factor Income earned abroad -> (factor income Canadians outside- factor income foreigners inside) 3) Does GDP really measure the country’s output? - GDP – only sold through the market - Excludes: Pollution, illegal, volunteer, etc 4) Nominal GDP VS Real GDP Nominal – today = Pn x Qn Real – constant = Pb x Qn 5) GDP Deflator = Nominal/ Real (PnQn)/(PbQn) 6) Correcting for price changes GDP b x (Price Index a/ Price Index b) Week 2 Inflation period - % change in price Cost of bundle – quantity doesn’t change 1) GDP Deflator – bundle produced within Canada change – current year bundle (Understate) 2) CPI – by a typical Canadian households – base year bundle (Overstate) GDP Deflator changes when prices of goods bought by firms or government changes CPI changes when prices of imported goods changes Issues with inflation 1) Reduces purchasing power of money 2) Reduces the real value of anything 3) Redistribution of wealth 4) Inefficiency Solution: Indexation (increases the monthly payment by the rate of inflation rate) Unemployment is NEVER 0! Frictions 1) Industries expand/contrast 2) Some do well and some don’t 3) People move in and out of Labor Force Natural UE (NRU) - Always positive - Always someone who quits and actively look for a new job - When the UE % increases, understates 1) Underemployment – workers have jobs but their skills are not fully utilized 2) Discouraged workers – those who want a job but after unsuccessful searches, have given up looking for one. (NILF) Therefore, interpret the UE % with caution! Week 3 Consumption (C ) is Positively related to DI Investment (I) is inversely related to r When r increases, cost of borrowing increases, which in turn makes I less attractive and decreases the level of I Fiscal policy – government intervention to help or shock the economy Firms notices inventories decreases unexpectedly. Firms increases Production, Y increases. Continues until Y gets closer to the equilibrium Paradox of Thrift – households save -> NS doesn’t change -> income decreases Fallacy of composition – what holds true for an individual doesn’t hold true for everyone, the economy. Consumption decreases – savings increases – but NS doesn’t change Week 5 Labour market – dynamic (in and out of LF) Frictional UE (move between jobs) Structural UE (mismatch, not fit for the job) Frictions – some induestries expand but some contrast Structural deficit – bad! – when Y= Y(FE) Cyclical deficit – this is natural! – BB=0 when Y= Y(FE). Government runs occasional budget deficit when Y < Y(FE) Counter-Cyclical Fiscal Policy – running exansionary and contractionary Fiscal policy is for “big events.” It’s hard to forecast! To prevent recession, Automatic stablizers (T,TR) and Protection of Financial structure If the government is smaller, the multiplier tends to be bigger. They are more prone to external forces (more vulnerable) If the government is bigger, the multiplier tends to be smaller. They are less vulnerable. Automatic Stabilizer depends on the size of the multiplier Week 6 Recessionary gap – lots of UE – AS relatively flat (elastic) - huge change in quantity apply Not much UE – AS relatively steep (inelastic) - can’t change much (already utilized) Prices changes by a large amount if the AS is steep - large changes in fiscal policy needed Y (star) changes by a large amount if the AS is flat - small changes in fiscal policy needed AS is important when determining the magnitude of policy to get the economy back to its full employment Y. Week 7 When wages rise, production cost increases, and profit falls. Then willingness to supply decreases and AS shift to the left. Deflationary – pressure for the W to fall Why? UE workers offer lower wages to get a job. Firms may pressure workers to accept lower wages. There is Excess supply. Wages are stick downwards (not easy to lower it in reality!) Inflationary – pressure for the W to rise Why? There is an excess demand for Labour. People may expect for the higher W. BAD Stagflation- simultaneous occurrence of the higher prices and lower leves of output Natural adjustment – too long Counter cyclical Fiscal Policy – rise in prices may remain permanent Functions of Money - Medium exchange - Store of value - Unit of account Motive for money - Transaction - Precautionary - To store our wealth Week 8 The opportunity cost of holding money is the interest rate What happens when interest rate rises? When interest rate rises, opportunity cost of holding money rises. People hold less money and hold more interest bearing assets. (it costs more to hold money) The money demand will decrease The demand for money (MD) depends on (L(r,Y)): 1) Income, Y – holding money – positive relationship between MD and Y 2) Interest rate – negative relationship between r and MD Two assets in the economy: cash and bonds - Money doesn’t give any return to its holders but bonds give a return to its holder (not as liquid) If the current interest rate > the coupon rate, then the bond price will below the face value Yield rate = current interest rate - Yield rate is higher as you go to longer run bonds(earn more money as time goes by) - Higher if the market is more risky to invest Finding the net future value (NFV) = future value of the return on this investment – future value of the cost of this investment If NFV>0 undertake the investment and if NFV<0 don’t undertake the investment Finding the net present value (NPV) = present value of the return on this investment – present value of the cost of this investment If NPV>0 undertake the investment and if NPV<0 don’t undertake the investment A rise in interest rate makes investment less attractive – there is an inverse relationship between r and I Monetary policy is a policy that designs and implements by the central bank to determine the money supply (MS) - Expansionary monetary policy - increases MS – raises output - Contractionary monetary policy – decreases MS – lowers the output - Open market operations – open market sale (sells bonds) MS decreases/ purchase (buys bonds) MS increases MS increases: price of bonds increases, r decreases and cost of borrowing goes down, I increases, and Y increases MS decreases: price bonds decreases, r increases and cost of borrowing goes up, I decreases, Y decreases Week 9 Commercial (Chartered) Banks: privately owned, profit seeking institution Central bank – Bank of Canada (BOC) - Print money, design and implement monetary policy - Lender of last resort: bank rate - Banker to the Canadian government Assets Liabilities - Cash and reserves -demand deposits(amt they owe me) - Loans -Equity Cash and reserves – Cash held by the bank. Commercial bank keeps sufficient cash on hand so that it’s able to meet depositor’s day-to-day cash withdrawals Equity = Assets – Liabilities The reserve ratio refers to the fraction of its deposits that a commercial bank holds as cash and reserves. – Target reserve ratio – the fraction of deposits that commercial banks would like to hold in the form of cash and reserves If the rr is 0.05, that means that commercial bank would like to hold 5% of the deposit in the form of cash and reserves. When the bank tries to adjust its actual reserve ration to the target ration by making loans, the new demand deposits never actually leave the system!! The money never leaves the system, they are just exchanging. How could the chartered bank create money? The banking system does create money. We called this money creation. More loans are being created and get redeposit back into the banking system (MS increases). The process continues until the reserves reach its target ration. The bank will keep making loans until its reserves are 10% of the demand deposits A run on bank (when everyone starts to lose faith in bank) will destabilize the country’s banking system and may lead to a banking crisis. Therefore, to stabilize the banking system: - The BOC acts as lender of last resort - The government of Canada provides deposit insurance These measures aim at stabilizing the banking system and are implemented after the 1930s. (A response to what we learned during the Great Depression) The fact that chartered banks help to generate money could affect the design of monetary policy High powered money/ Monetary base (MB) = currency in circulation + reserves held by charted banks (bank reserves) We believe a country’s central bank has the power to control the monetary base (by changing the monetary base, the country’s money supply would change) How the Central Bank affects the Money Supply? 1) Open market operations 2) Changing the overnight rate – changing the interbank rate to affect commercial bank’s
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