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Econ201 Exam 2 Study Guide.docx

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University of Maryland
ECON 201
Naveen Sarna

CHAPTER 13- Saving, Investment, Financial System Financial Market- institution which savers directly provide Gross Domestic Product (GDP)= Y= C+I+G+NX funds to borrowers - Bond Market- bonds are certificates of indebtedness Private saving- household’s income not used for consumption [length of time until bond matures, credit risk- or paying taxes probability that borrower will fail to pay back, bonds = Y – T – C issued by gov pay lower interest rate b/c usually pay Public Saving- tax revenue left after gov spending back] = T – G o Bonds w/ longer maturity= higher interest National Saving- private saving + pubic saving rate S = (Y-T-C)+(T-G)= Y – C – G - Stock Market- stocks are claims to partial ownership Closed economy – doesn’t engage in international trade in a firm [stock index is average of a group of stock - NX= 0 and Y= C + I + G prices] Financial Intermediaries- institutions where savers indirectly - National saving: I= Y – C – G provide funds to borrowers [Banks] - I= Y- C-G  Saving=Investment - Mutual funds- sell shares to public and use - Each unit sold is consumed, invest, bought by gov proceeds to buy portfolio of stocks/ bonds - investment leads to the accumulation of capital which leads to increased labor productivity which leads to economic Crowding Out- dec in investment resulting from government growth (which is a good thing). So having high amounts of borrowing savings is good for economic growth. - When gov borrows to finance budget deficit (dec Budget Surplus= T > G in Tax revenue – gov spending national saving), crowds out private borrowers trying - Surplus represents public saving to fiancé investment Budget Deficit= G > T public saving is negative - High interest rate discourages demanders of LF - Fewer families buy new homes, fewer firms build new factories Market for Loanable Funds- savers supply funds by Nominal Interest Rate- monetary return to saving and depositing their savings and borrowers invest demand funds monetary cost of borrowing and take out loans Real Interest Rate- nominal interest rate corrected for - Supply: from household buying bond from firm, inflation makes deposit in bank  funds make loans - More accurately reflects real return to saving and real o Savings is source of supply of LF cost of borrowing b/c inflation erodes value of money - Demand: families taking out mortgages, firms borrow over time to buy new equipment o Investment is source of demand of LF - Interest rate: price of loan (amount borrowers pay for loans and lenders receive on their saving) Less tax on saving= inc saving= inc supply of LF= S shifts right HIGH interest rate makes Saving MORE attractive (LF - Encourage saving dec interest rates more investment supplied inc as interest rate rises), Demand falls b/c Tax laws encourage more investment  D curve shift right (S borrowing more expensive curve stays the same) - higher interest rates and greater savings (Q of LF inc) Savings: buy bonds Budget deficit dec Supply of LF  inc interest rate  dec Q of Investment: take out mortgage, buy new equipment for LF business CHAPTER 16- The Monetary System Money- set of assets in economy people use to buy g/s Money Supply (money stock)- currency + demand deposits Medium of Exchange- dollar bills, used to purchase g/s (a Demand deposits- balances in bank accounts that check) depositors can access by writing a check Unit of Account- goods are measured in dollars (price of - Each deposit in bank reduces currency and raises computer greater than price of vacation) demand deposits by exact same amount (MS stays Store of Value- item used to transfer purchasing power from same) present to future (money in checking account) If banks hold all deposits in reserve, banks don’t influence - hold money and buy another good later, hold MS nonmonetary assets (stocks and bonds) M1 M2 - wealth is total of all stores of value Currency +M1 Demand deposits Saving deposits Liquidity- ease assets can be converted into medium of Traveler’s checks Small time deposits exchange $50 bill/ funds in money market account/ bond/ house Checkable deposits + Money market mutual Federal Reserve- a central bank that oversees banking withdraws funds system Certificate of deposit - Regulate banks and control money supply (Q of money available in economy) Money Multiplier- amount of money banking system Fed’s Tools of Monetary Control generates w/ each dollar of reserves - Is reciprocal of reserve ratio Open Market Operations- buy/ sell US gov bonds by Fed Each dollar of reserves generates 1/R dollars of money - Inc money supply- Fed buy bonds from public (pay w/ - Ratio is 1/20 then MM=20, so each dollar of reserves new dollars  held as currency or deposited= in reserves and loans so MS inc) generate $20 of money Higher reserve ratio= less of each deposit banks loan out and - Dec MS- Fed sells gov bonds (take dollars out of smaller the money multiplier circulation, reduce amount of lending) Reserve Requirement- min amount of reserves that banks Fractional Reserve Banking- banks hold only fraction of must hold, set by Fed deposits as reserves and loans out the rest - Inc MS by reducing RR (banks make more loans form Reserves- deposits that banks have received but not loaned each $ of reserve  inc MM and MS out Reserve Ratio- fraction of total deposits bank holds as - Dec MS by raising RR (banks must hold more reserves reserves and loan less, raises ratio, dec MM, dec MS) Discount Rate- interest rate on loans that Fed makes to Excess Reserves- amount of reserves above reserve Banks requirement - When banks low on reserves, borrow reserves from Fed which allows banking system to create more Ex. Reserve Ratio of .10 – keep 10% of deposits in reserve Liabilities: Deposits ($100) money Assets: Reserves ($10) and Loans ($90) - Inc MS- by dec discount rate (encourage bank to Money supply = currency (borrowers holding $90 in loans) + borrow more reserves) demand deposit (depositors’ $100)= $190 - Dec MS- by raising discount rate (discourages BANKS CREATE MONEY WHEN BANK HOLD FRACTION borrowing reserves from Fed, dec Q of reserves) OF DEPOSITS IN RESERVE (more of medium exchange, no wealthier) Federal Funds Rate- banks w/ insufficient reserves can borrow from other banks w/ excess reserves Ex. Required reserve ration= .2 - Inc FFR- fed sells gov bonds (removes reserves from 150,000 in demand deposits and 45,000 in outstanding loans banking system, reduce supply of federal funds and Reserves: demand deposits – loans= 150000-45000= curve shifts left and FFR inc) $105000 Required Reserves: demand deposits x Required Reserve Problems Controlling Money Supply Ratio = 150000 x .2= $30000 1. Fed can’t control amount of money households deposit or holdas currency Excess Reserves: reserves – required reserves - Households hold more of money as currency, banks - 105000- 30000= $75000 have fewer reserves and fewer loans  MS falls - more deposits, more reserves in bank, more money created 2. Fed doesn’t control amount bankers choose to lend - Banks hold more reserves than required, make fewer loans and less money created  MS falls CHAPTER 17- Money Growth and Inflation Value of Money dec when Price increase Quantity theory of money- Q of money available determines P Money Supply- set/ determined by Federal Reserve, level, and growth rate in Q of money available determines banking system and consumers inflation rate Money Demand- how much wealth people want to hold in Classical Dichotomy- separation of real and nominal variables liquid form (currency) - Nominal variables- variables measured in monetary - Inc Q of MD- higher P requires more money to buy units (change in NV can affect inflation rate and g/s nominal interest rate) - If P above equilibrium- people want to hold more - Real variables- variables measured in physical units money than supplied so P must fall to balance (real GDP, production, employment, real wages, real - Demand curve downward sloping- value of money interest rates, Q of good) low, P is high, people demand larger Q of it to buy g/s Relative price- (real variables) P of one good relative/ divided by another Velocity of Money- rate at which money changes hands Real wage- dollar wage adjusted for inflation, P of labor - Divide nominal GDP by quantity of money= times relative to P of output - real variable b/c measures rate people exchange g/s dollar bill changes hands on average __ times per for a unit of labor year - V= (P x Y)/ M - balances the supply/ demand for labor (unemployment Quantity Equation- M x V = P x Y when real wage above equilibrium) - Inc in Q of money  P rise, the Q of output rises, real interest rate- real variable- measures rate people exchange g/s today for g/s in the future velocity of money must fall Monetary Neutrality- changes in money supply doesn’t affect - real variables Explain Equilibrium P level and Inflation Rate Seigniorage- revenue raised from printing money 1. Velocity is stable - to spend more w/o raising taxes or selling bonds, gov 2. change in quantity of money (M) causes nominal GDP to can print money instead change by same % - print money to raise revenue causes inflation 3. change in M doesn’t affect Y (Y determined by tech/ Nominal Interest Rate (i)- how fast the number of dollars in resources) 4. P changes by same % as P x Y and M account will rise over time, not adjusted for inflation 5. rapid money supply growth cause rapid inflation - payment on a loan, set when loan is made Real Interest Rate (r)- how fast the purchasing power of savings account will rise over time, adjust
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