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ECON 102
Maryann Vaughan

Macroeconomics Chapter 1: Ten Principles of Economics Scarcity- (limited resources) which leads to trade offs The management of scarce resources is referred to as economics Ten Principles - Four principles of individual decision making; - People face trade offs - The of cost of something is what you give up - Rational people think at margin - People respond to incentives - Three principles of how people interact; - Trade can make everyone better off - Markets are usually a good way to organize economic activity - Governments can sometimes improve market outcomes - Three Principles of how the economy works as a whole; - A country’s standard of living depends on its ability to produce goods and services - Prices rise when the government prints too much money - Society faces a short run tradeoff between inflation and unemployment Efficiency vs. Equity - Efficiency is using all resources such as money evenly - Equity is distributing all resources fairly - Government faces a tradeoff between efficiency and equity Opportunity cost – best alternative forgone Incentive – induces you to act Market economy – decentralized, decision made by the market (prices set by demand and supply) Property rights- how the government helps us keep a market economy running smoothly, done to promote efficiency and equity Market failure- when the market does not allocate resources efficiently , caused by externalities ( one person’s actions affecting the well being of others) Market power- another reason for the government to step in , one person / group has too much power to influence the market( monopoly / price makers) High productivity = higher standard of living Chapter 2: Thinking like an economist Circular flow diagram – an economic model, which includes households and firms and their decisions, it organizes all transactions that occur between both parties Households- sell factors of production (labor, land, capital), buy goods and services Firms – buy factors of production and sell goods and services Production Possibility Frontier – shows tradeoffs and opportunity cost Positive statements: descriptive, how the world is, can be proven, not necessarily have to be true can be false as long as it can be proven Normative statements: prescriptive, how the world ought to be , more opinion based The reason why economist usually don’t agree is because their normative statements / view on the world differ, therefore when trying to fix problems that they see their solutions/ normative view also differ Chapter 5: Measuring a nation’s income Macroeconomics- tells us about the whole economy, goal is to explain the economic changes that affect many households, firms and markets simultaneously GDP- gross domestic product, measures how well off a country is, income and total expenditure, income must equal expenditure, the market value of all final goods and services produced within a country in a given period, it does not include the sale of illegal goods and it is adjusted seasonally to prevent misinterpretation This is true because someone’s expenditure is another’s income, and since you are looking at the economy as a whole it includes both GDP- consists of four components, consumption, investment, government purchases, and net exports Y= C+I+G+NX Consumption- spending done by households and firms Investment - purchases of goods to be used in the future, sum of purchases of capital equipment, inventory, and structures Government purchases- spending on goods and services by all level of governments, includes salaries to government workers, not including transfer payments (paying for services already provided in another period , CPP) Net exports – (exports- imports) , only includes goods made / produced in Canada Real GDP- the value of goods produced during a period if they were valued during a past year (base year) , a measure not tainted by changes in price, shows changes in production not price Nominal GDP – amount of production at the current price, accounts for both changes in price and production Using both real and nominal GDP we can calculate the GDP deflator – which measures the current level of prices to the prices in the base year Nominal X 100 = GDP deflator Real A decline in real GDP over two consecutive quarters signals recession, since there is a lower quantity produced, therefore, less sold, less money Chapter 6 : Measuring the Cost of living CPI – Consumer Price Index, used to measure the cost of living, overall cost of goods and services bought by a typical consumer, Statistics Canada is responsible for calculating CPI Inflation – overall price level of economy is rising Inflation rate – the percentage change in the price level from the previous period How CPI is calculated 1. Determine the basket – the typical goods and services that a consumer buys 2. Find the prices- find the price of each item in the basket for each time period 3. Compute the basket’s cost – only takes into account the price change not quantity change since basket is made up of fixed goods 4. Choose a base year and compute - base year is the benchmark which you compare everything too , CPI = price of basket X 100 Price of basket in base year 5. Compute inflation rate – the percentage change in the price index from preceding period the rate of core inflation – excludes the most volatile components of CPI , helps determine the trends of change in CPI , Inflation Rate = CPI year 2- CPI year 1 X100 CPI year 1 CPI – gauges how much income must rise in order to maintain a constant standard of living Problems when calculating CPI Substitution bias- when prices change at different levels consumers will substitute for the cheaper good but since CPI is a fixed basket of goods it does not account for substitution making it seem like a sharper increase in the cost of living Introduction of new goods- the greater the variety the more value a dollar has , since you now have the ability to buy a wider range of goods with the same dollar, fixed basket of goods does not reflect this increase in the value of a dollar which occurs with the introduction of new goods Unmeasured quality change- does not measure the change in value of a dollar as quality changes GDP vs. CPI GDP – measures the change in price of goods produced domestically CPI- measures the change in price of goods customers bought (domestic or imported) CPI – measures prices of a fixed basket of goods GDP – compares prices of currently produced products, always changing Indexed – the correction of a dollar amount for the effected of inflation by law or contract, some wages are indexed to CPI this is called the cost of living allowance Nominal interest rate – measure the change in dollar amounts Real interest rate – interest rate corrected for inflation, measure the purchasing power of a dollar Real interest rate=nominal interest rate – inflation rate Chapter 7: Production and Growth - Higher living standards are due to higher productivity (the # of goods and services a worker can produce per each hour of work), what determines productivity ? Productivity and its determinants: - Physical capital – tools used to produce, better tools = higher productivity , factor of production - Human capital- knowledge and skills, that workers gain through education and training - Natural resources- renewable and nonrenewable , not crucial to be productive, it helps but not necessary - Technological Knowledge – understanding of best way to produce goods, society’s understanding of how things work How does the government help to improve productivity? - Invest in production of capital so later we make more ( invest now , consume later) - Increasing saving now , so we spend less on goods and services, so later we can make more goods and services from unused capital - Subject to diminishing returns there is only so much you can produce , no matter how much capital you put in - Easier for poor countries to grow than rich one due to the catch up effect - Foreign investment raises the productivity of a country , helps it grow - Education – helps increase human capital which increases human capital , brain-drain smart people from poor countries emigrate to other rich countries in order to make money - Health and nutrition – helps in order to maintain us happy = productive, healthier which leads to increase in wages and increase in productivity - Enforcing property rights –keeps firms producing , political instability causes there to be untrustworthy property rights - Outward oriented policies - trade with the world and not have to produce all goods yourself (use all resources efficiently to produce what your best at comparative advantage). - Research and development - patent systems , idea can’t be stolen , therefore patent holder makes all the money creating an incentive to produce - Population growth – bigger labour pool , more productive but also more consumption which leads to GDP per worker and lower capital per worker , the likelihood for investors is greater since it’s a bigger pool of people Chapter 8: Saving ,Investment, and the Financial System - Financial system- institutions that bring together saver and investors - Savers – supply their money the financial system with the knowledge that they will get it back with interest - Borrowers – demand money from system with knowledge that they will be required to pay it back with interest - The Financial institutions are made up of : financial markets and financial intermediaries - Financial markets- an institution through which a person who wants to save directly supplies to those who want to borrow - Broken up into the bond market and stock market - Bond market- bond is an IOU a loan , a promise of repayment+ interest, two characteristics term ( length of time until bond matures), credit risk ( probability that payer will default ) , the longer the term the higher the credit risk therefore the higher the interest received - Stock Market – ownership of the firm , form of equity financing, bond is debt financing - The demand for a stock represents people’s perception of the corporation’s future profitability - Stock index – an average of a group of stock prices - Financial Intermediaries - savers indirectly provide funds to borrowers, broken up into banks and mutual funds - Banks use money from depositors to lend to borrowers, they also facilitate the purchase of goods and services by allowing people to write cheques ( medium of exchange) - Mutual funds – sells shares to public and uses the proceeds to buy a selection or portfolio of stocks and bonds, allows for diversification , the company that sells the mutual fund charges the shareholder a fee for putting together the shares - A closed economy , is one that does not interact with other economies ( international trade) - Y= C+I+G+ NX(0, since there is no trade) - I= Y-C-G - Investment is the amount left over after paying for consumption and government purchases , this is called saving , S=I must be equal for the whole economy - S=Y-C-G , S= (Y-T-C) + (T-G) Public saving , amount of revenue government has left over after purchases, amount of money consumers have left over after paying taxes and consumption , T= taxes acquired ( revenue for government , expenses for consumers) - Budget surplus T> G , more revenue than expenses for government - Budget deficit G>T , more spending than revenue for government - Investment = purchases of new capital goods - Saving = deposits money in the bank , buy a stock /bond - S=I does not have to be true for individual firms or households only for the whole economy The market for loan able funds - One market economy , where all savers go to deposit and all borrowers borrow, one interest rate, for both savers and borrowers - Saving is the source of the supply of loan able funds - Investment is the source of demand for loan able funds - Interest rate = the price of a loan ( real interest rate corrected for inflation ) Policy 1: Saving Incentive -people in Canada don’t save because of taxes , which decreases the amount they earn , provinces use taxes on consumption which encourage saving ( don’t buy , don’t pay taxes) , buying an RRSP reduces your amount of taxable income , therefore encouraging saving, this cause the supply curve to shift to the right since there is an increase in supply - causing equilibrium to be lower more supply than demand Policy 2 : Investment incentives - Investment tax credit , way to encourage investing - Increases in the demand for funds, shift curve to the right , making interest higher, results in a higher demand for funds and greater quantity supplied Policy 3 : Government and Budget surplus - When a government runs a deficit they discourage investment ( supply shifts to the left ) and investment and growth in the economy falls - Budget surplus increases investment, lowers interest rate, leads to a virtuous cycle - Vicious cycle – deficits reduce the supply of loan able funds , increases the interest rate, discourages investment , results in slow economic growth , low tax revenue , higher spending on income support programs which results to even higher deficits - This virtuous cycle results when surpluses increases supply of loan able funds , reduces interest rates, results in a fast economic growth , which leads to high tax revenue, and lower spending on income support, results in even higher budget surpluses Chapter 9 : Unemployment and its natural rate - Employment = higher standard of living = higher GDP - Employment is divided into two categories ; long run problems (natural rate of unemployment , normal amount economy experiences )\ - Short run problems (short run problems , cyclical unemployment year to year fluctuations ) - Statistics Canada measures unemployment every month - You are considered employed if you spent some of the previous week working at a paid job - Unemployed – if you are on temporary layoff, or job searching - Not in the labour force – catch all for those who do not meet the previous categories, children not of age to work, senior citizens - Labour force = sum of employed and unemployed people - Unemployment rate = % of labour force unemployed, # unemployed / labour force - Labour force participation rate = % of total adult population that is in the labour force , labour force / adult population - It is difficult to distinguish the unemployed from those who do not belong to the workforce - Unemployed does not necessarily mean no job , you could be getting paid under the table or lying to qualify for employment insurance - Discouraged searchers , would like to work but have given up on the job search - Average spell of unemployment is imperfect because it does not paint a clear picture ( huge range ) - We have people unemployed because demand does not equal supply - Natural return to unemployment , what employment rate tends to return to in the long run , estimate , exact number is not known - Cyclical unemployment – is the cause for a change in natural and observed rate , caused by short term fluctuations Reasons for unemployment - Takes time for workers to search for jobs best suited for them , skill level ( frictional unemployment ) , this is inevitable , due to sectoral shifts ( substitution ( consumers go for cheaper products, those who make the product more costly will be out of business) , - can be controlled by making job openings and availability more readily available ,government helps reduce quantity by running programs to facilitate job search; employment agencies, training programs , some believe government should not be involved since they are no better than the private sector at providing this info - Employment insurance , eases the burden to the unemployed, by providing them with temporary income - The higher the unemployment rate in you region ,the longer you can collect EI for and the less you have to work to be eligible for it - EI increases unemployment rate ( people only work till they get their insurance then they quit after, so that they collect ) , it does facilitate the job search because causes you to find a job with higher wage - Unemployment is mainly due to minimum wages ( supply not at an equilibrium affects the least skilled the most - Unions ( worker associations that bargains with employers over wages and working conditions) , type of cartel , collective bargaining when unions agree / discuss terms - If conditions are not met , the union goes on strike which reduces profit, production , and sales, therefore employer agrees to terms - Workers in unions reap the benefits of collective bargaining, those outside the union reap the costs - Unions are good because they limit the control a firm has over its employees - They are bad because they cause inefficient and inequitable distribution of resources - Not enough jobs ( structural unemployment ) - Job search , matching people to appropriate jobs - Efficiency wages , another way that economies experience unemployment , the for it is the higher you pay the more efficient workers are ( has the same effect as minimum wages , unions) , keeps wages above equilibrium , causing workers to try harder Four Reasons for Efficiency wages - More money , more food, more productive due to workers health - Worker turnover, more money less likely to quit , less money spent on training - Worker effort , makes workers work harder so that they can keep their high paying job - Worker quality , attract better pool of applicants Chapter 10: The monetary system - An economy that relies on barter will have trouble allocating scarce resources efficiently ( for this to work the economy would require the double coincidence of want s , both people want the service or good that the other offers ) , money makes it easier to trade and exchange goods , it allows trade to be roundabout , money = wealth - Money is the set of assets in the economy that people use to buy goods and services The functions of money - Medium of exchange ; an item you give to sellers when you want to purchase goods and services - Unit of account ; a yard stick ,to measure value of goods and services - Store of value ; can be used to transfer the purchasing power from one person to another - Wealth ; the total of all store values of all monetary and non monetary assets - Liquidity; ease of transfer to cash - Commodity money – when money has intrinsic value ( would have value even if not used as money ) , economies operating on a gold standard are an example of t=commodity money, the money holds the value that gold has - Fiat money – non intrinsic value, the government is the one that determines that this money or medium of exchange is legitimate ( regular money , cash ) - Money stock – the quantity of money circulating in the economy - Currency – paper bills and coins in the hands of the economy - Demand deposits – balance in the back account ( includes debit cards) , this is included in the money stock plus any other deposits that can be readily accessed to buy goods and services - M1 and M2 are ways to measure the money stock in the economy - M1- includes currency + debit card - M2- includes currency + debit card+ savings + term deposits - The BOC controls the stock of fiat money , which is a central bank that controls the amount of money in the economy , controlled by the government which has four jobs ; - Issue currency - Acts as a banker to commercial banks - Act as a banker to the government - Controls the money supply ( monetary policy ) - Reserves – deposits kept in a bank and are not loaned out, if all money is kept in reserve then we have 100% reserve banking, which causes the bank to have no influence over the supply of money ( all currency decreases by the same amount that demand deposits increase) - Fractional reserve banking , keeps some money in reserve the rest is used to loan out , the amount leftover in reserve is called the reserve ratio ( determined by the government and bank people , in Canada there is no set reserve ratio ) - Some banks have a minimum amount that they must keep in reserve ( reserve requirement ) or you can have excess to make sure you don’t run out of cash - When banks have only a fraction of deposits in reserve, banks can then create money , increase currency more liquid but wealthier - Money multiplier the amount of money that the banking system makes from each dollar of reserves it is the reciprocal of the reserve ratio - The more reserves the less deposits the bank loans out, smaller money multiplier - Ways central bank can control money supply - Open market options ; buying things increases money supply, selling things decreas
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