Comparative Advantage

I.            Specialization - Individuals and countries can be made better off if they will produce in what they have a comparative advantage and then trade with others for whatever else they want/need.

II.            Absolute Advantage: The producer that can produce the most output OR requires the least amount of inputs (resources).

III.            Comparative Advantage - The producer with the lowest opportunity cost.

IV.            Countries should trade if they have a relatively low opportunity cost.

V.            Input VS Output

VI.            An output problem presents the data as products produced given a set of resources. (ex. Number of pens produced)

VII.            An input problem presents the data as amount of resources needed to produce a fixed amount of output. (Number of labor hours to produce 1 bushel)

When identifying absolute advantage, input problems change the scenario from who can produce the most to two can produce a given product with the least amount of resources.

 

Foreign Exchange

I.            The buying and selling of currency.

II.            Any transaction that occurs in the Balance of payments necessitates foreign exchange.

            a.            The exchange rate is determine in the foreign currency markets.

            b.            The exchange rate ( e ) is the price of a currency.

III.            Exchange rates are a function of the supply and demand for currency.

            a.            Supply and value are inverse

            b.            Demand and value are direct.

             c.            Appreciation is when the e increases

           d.            Depreciation is when the e decreases.

IV.            Consumer tastes (buying American increases the American dollars value)

V.            Relative income  (evening out or expansions and recessions among nations)

VI.            Relative price level

VII.            Speculation

Balance of Payments

I.            Measure of money inflows and outflow between the US and the world.

a.      Inflows are credits

b.      Outflows are debits

II.            Three accounts

a.      Current Account

                                                  i.      Balance of trade: Exports are a credit while imports are a credit

                                                ii.      Net foreign income: Income earned by American foreign assets- income paid to foreign held US assets

                                             iii.      Net Transfers (unilateral): Foreign aid is a debit.

b.      Capital Account

                                                  i.      The balance of capital ownership

                                                ii.      Purchase if real and financial assets

                                             iii.      Direct investment in the US is a credit to the capital account.

                                             iv.      Direct investment by US firms in a foreign country is a debit.

                                                v.      Purchase of foreign financial assets is a debit

                                             vi.      Purchase of domestic financial assets by foreigners is a credit.

c.       Official Reserves

                                                  i.      Foreign currency holdings of the Fed.

                                                ii.      When there is a balance of payments surplus Fed accumulates foreign currency and debits the balance of payments.

                                             iii.      When there is a balance of payments deficit the fed depletes foreign currency and credits the balance of payments.

                                             iv.      Official Reserves + balance of payments = 0

III.            Current + Capital= 0

IV.            Balance of Trade:

a.      Exports - imports

V.            Balance of Goods & Services:

a.      (Goods exports + services exports) - (Goods imports + services imports)

VI.            Balance on Current Account:

a.      Balances of Goods & Services + Net investment + net transfers

VII.            Balance on Capital Account:

VIII.            Official Reserves

a.      Add current account + capital account = 0

Reaganomics

I.            Reaganomics

a.      Manipulating AS by policies to stimulate incentives to work, save, and invest

b.      Tax cuts

II.            Laffer Curve

a.      Displays the theoretical relationship between tax rates and tax revenues

b.      As taxes increase, people spend less.

c.       Criticisms:

                                                  i.      Empirical evidence suggests that the impact of tax rates on incentives to work, save, and invest are small.

                                                ii.      Tax cuts also increase demand which can fuel inflation

                                             iii.      Where the economy is actually located on the curve is difficult to determine

The Phillip's Curve

I.            In the short run it's a trade-off between inflation and unemployment.

II.            They have an inverse relationship.

III.            Each point on the PsC corresponds to a different level of output.

IV.            Higher inflation = lower unemployment

V.            Long-run Phillip's Curve: LRPC

a.      Occurs at the natural rate of unemployment.

                                i.            Frictional (normal)

                              ii.            Seasonal

                           iii.            Structural (creative destruction)

                           iv.            Not Cyclical

b.      Represented by a vertical line.

c.       No trade-off between inflation and unemployment in the long run

d.     The economy produces at the full employment output level

e.      Will only shift if the LRAS curve shifts.

f.        An increase in unemployment (a decrease in employment) will shift LRPC ->

g.      A decrease in unemployment (an increase in employment) will shift LRPC <-

h.      A movement in AD will mirror on the Phillip's Curve

VI.            When SRAS goes right, SRPC goes left

VII.            When SRAS goes left, SRPC goes right

VIII.            Short-run Phillip's Curve: SRPC

a.      If inflation persists and expected rate of inflation rises, then the entire SRPC moves up.

b.      Stagflation: simultaneous rise in inflation and unemployment.

c.       Supply shock: rapid and significant increase in resources' costs which causes SRAS curve to shift.

                                i.            Depreciation of the dollar

                              ii.            Oil embargo

d.     If inflation expectations drop due to new technology, then the SRPC will move down.

IX.            Misery Index

a.      A combination in inflation and unemployment in any year.

b.      Single-digit index is good.

Phillip's Phillip's Curve

Phillip's Phillip's Phillip's Curve

Phillip's Phillip's Phillip's Curve Curve

FRQ video

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Loanable Funds Market

I.            High interest rates are good for borrowers, but not lenders.

II.            The LFM s the private sector supply and demand of loans

III.            This market brings together those who want to lend money and those who want to borrow and shows the effect on Real Interest Rate.

IV.            Demand- Inverse relationship between real interest rate and quantity loans demanded

V.            Supply- Direct relationship

VI.            The supply is not vertical

Tools of Monetary Policy

I.            Tools:

            a.            Reserve Requirement

                                i.            FED sets the amount that banks must hold to control the amount of money that may be loaned out.

                              ii.            When someone deposits, the bank deposits in the bank it loans out excess reserves.

                           iii.            Except for FED purchase of bonds. None of the FED money needs to be reserved.

                           iv.            In recession, FED lowers rrr to enact expansionary policy. Money supply & AD increase while interest rates descend.

                              v.            In inflation, FED raises rrr to enact contractionary policy. Money supply & AD decrease while interest rates augment.

            b.            Open Market Operations

                                i.            My name is Bund, James Bund

                              ii.            OMO is the FED transactions of government bonds or securities.

                           iii.            Most used policy.

                           iv.            Buying bonds puts money in the banks and increases money supply.

                              v.            Selling bonds takes money from the banks and decreases money supply.

                           vi.            Bonds to banks have no rrr. Bonds to individuals have rrr.

             c.            Discount Rates

                                i.            Many different interest rates that flow together up and down.

                              ii.            Federal funds rate is the interest rate that banks charge one another for overnight loans.

Money Market Video

Fractional Reserve System

I.            Demand deposits are created through the fractional reserve system.

II.            FRS is when banks withhold some of their deposits in reserve and not loan it all out.

III.            The cash  kept on hand is required reserves (RR). The cash loaned out is excess reserves.

IV.            Total reserves or Actual reserves (TR or AR)= RR + ER

V.            A single bank can create money by lending out excess reserves

VI.            MM x ER = the new addition of money (+ER would be new total)

VII.            New money

a.      Deposit in a bank comes from a FED, bank purchase of a bond, or other money that's out of circulation. The deposit increases money supply.

b.      The deposit then leads to further expansion of the money supply through the money creation process.

c.       Total change in money supply if the initial deposit is new money is (deposit plus money created by banking system)

d.     ER x MM + RR

VIII.            Existing money

a.      If the money is existing money (m1) then the deposit does not immediately change money supply.

b.       Therefore the change in the money supply is only MM x ER

The Federal Reserve Bank in Dallas

Money Market

I.            Inverse relationship between nominal interest rate and the quantity (of money) demanded.

II.            Money demand shift determinants (MD):

            a.            Δ PL

            b.            Δ Income

             c.            Δ Taxation

III.            Money Supply is vertical

IV.            If the FED increases the money supply, a temporary surplus of money will occur at 5% interest. The surplus will cause the interest rate to fall to 2%.

V.            Increase in money supply -> Decreases interest rate -> Increases investment -> Increases AD