Transcript Macro Review Day 1 and 2x

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Homework:
1. Macro Review Quiz 2—Make sure
you have a scantron!
Note:
• All students taking the AP Exam
must attend a pre-registration
meeting…if you missed please
handle it ASAP
• Book return any time this week
• Complete all late assignments!
Check Pinnacle!!!
Macro Review: Day 1
Subjects included:
•
Comparative Advantage and Terms of
Trade
•
GDP, Inflation, Unemployment
•
AD/AS Model—SR to LR
•
Phillips Curve
•
•
•
Multiplier (Spending, Tax, Balanced
Budget)
Crowding-Out Effect
Fiscal Policy: Discretionary vs.
Nondiscretionary
Comparative
Advantage
&
Terms
+
of Trade

Comparative Advantage: produce with lowest opportunity cost

Absolute Advantage: produce more outright

Terms of Trade: set using the opportunity cost of production—A
trade partner must make back what they missed out on
• Goal of trade is to consume beyond our
nations PPC—increasing well-being
+ Sample Problems
**HINT: INPUT vs. OUTPUT METHODS
Output: Opposite Over
TRAINS
1.
PLANES
4
2
CAN. 5
1
USA
Hours/TRAIN
2.
Hours/PLANE
4
2
CAN. 5
1
USA
Input: Opposite Under
a. Absolute advantage in trains?
b. Comparative advantage in
trains?
c. Acceptable trade: 1 Train for
1/3 Plane?
a. What country will export trains?
b. Set acceptable terms of trade for
1 train.
c. Comparative advantage in
planes?
+ Sample Problems—Answers
**HINT: INPUT vs. OUTPUT METHODS
Output: Opposite Over
1.
USA
Input: Opposite Under
TRAINS
PLANES
4(1T=1/2P)
2(1P=2T)*
CAN. 5(1T=1/5P)* 1(1P=5T)
Hours/TRAIN
2.
USA
4(1T=2P)*
CAN. 5(1T=5P)
Hours/PLANE
2(1P=1/2T)
1(1P=1/5T)*
a. Absolute advantage in trains?
Canada
a. Comparative advantage in
trains? Canada
b. Acceptable trade: 1 Train for
1/3 Plane? Yes.
a. What country will export trains?
USA
a. Set acceptable terms of trade for
1 train. Between 2 and 5 planes.
b. Comparative advantage in
planes? Canada
+ Short Cut

Take the PPC and create an output chart!
Trains
5
Canada
TRAINS
=
4
USA
1
2
Planes
PLANES
4
2
CAN. 5
1
USA
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PPC: Quick Note
3 Shifters: Technology, New Resources, Population

Be weary of sector specific changes
+
Measuring Economy: GDP
C + I + G + NX = AD
 GDP: dollar
value of all final goods and services
produced in country during a given year
 Nominal
 Real
GDP: Not adjusted for inflation
GDP: inflation adjusted
Use the Deflator to adjust nominal GDP to get Real GDP
 Deflator: broad measure of PL in an economy
 Use CPI to account for inflations changes over time
(consumer specific)
 CPI: market basket of consumer goods

+ Sample Problems—CPI
CPI =
PriceMB in year your looking for
PriceMB in base year
PriceMB
× 100
Base Year Base Year Base Year
2009
2010
2011
2009
$20
100
2010
$40
2011
$50
a. 200
b. 250
c. 50
100
e. 40
f. 80
d. 125
100
The big idea: the difference in CPI from the base year (100) is
the percent difference in price level for the economy…
Ex: In 2010, using 2009 as the base year, prices increased 100%
or doubled
Sample
Problems:
GDP
Deflator
+
Nominal GDP
GDP Deflator =
×
Real GDP
1.
1.
100
If Nominal GDP is $100 B and Real GDP is $80 B, what is the
deflator?
BIG IDEA:
• Base year is always 100
125
• Deflator indicates the
If Real GDP is $200 Bmagnitude
and the deflator
of price is 120, what is
changes using percentages
Nominal GDP?
from a base year
$240 B
2.
If Nominal GDP is $300 B and the deflator is 150, what is
Real GDP?
$200 B
AD/AS
&
Fiscal
Policy
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*Most Important Macro Unit
PL
LRAS
SRAS
PL
OFE
AD
GDPR
Fiscal Policy: Discretionary!!!!
1. Expansionary: increase AD
1. Increase gov’t spending
2. Decrease taxes
3. Increase transfer payments
AD Shifters: Think GDP
1. Consumer Spending
2. Investment Spending
(business spending on
capital)
3. Government Spending
4. Exports − Imports
SRAS Shifters: Think Business Expenses
1. Price of resources (including labor)
2. Taxes/subsidies to businesses
3. Productivity/Technology
2. Contractionary: decrease AD
1. Decrease gov’t spending
2. Increase taxes
3. Decrease transfers
AD/AS
&
Fiscal
Policy
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*Most Important Macro Unit
PL
PL
LRAS
A
A
A
A
A
A
Aa
A
A
A
A
Aa
a
a
Recessionary
Gap
SRAS
Fiscal Policy: Automatic Stabilizer!
Kick-in without gov’t action!
Enter recession:
1. Income’s fall (GDP): taxes reduced =
AD
2. Income’s fall: Gov’t transfers increase
=AD
AD
GDPR Enter Inflationary Gap:
OFE
1. Incomes increase (GDP): taxes increase =
AD
Inflationary
2. Incomes increase: Gov’t transfers
Gap
decrease = AD
*Progressive Tax System
AD/AS
&
Fiscal
Policy
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*Most Important Macro Unit
From the short-run to long-run: classical/self-correcting
model

SRAS always acts to return the economy to LREQ

Input costs in the form of wages will change in the LR

These changes in wages, based on PL change, will increase or
decrease SRAS back to LREQ

“STICKY WAGES”
Self-Correcting
Review
Questions
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1. Use the graph below to answer.
a. What happens to real and nominal
wages in SR?
b. If gov’t does nothing what happens
to model?
c. Automatic stabilizers?
2. Use the graph below to answer.
a. What happens to real and nominal
wages in SR?
b. If gov’t does nothing what happens?
c. Automatic stabilizers?
Self-Correcting
Review
Questions
+
Answers
1. Use the graph below to answer.
2. Use the graph below to answer.
a. What happens to real and nominal
a. What happens to real and nominal
wages in SR?
wages in SR? N: n/a R: decreases
N: nothing R: increased
b. If gov’t does nothing what happens?
b. If gov’t does nothing what happens
to model? SRAS increases (lower wages)
SRAS decrease (increase wages)
a. Automatic stabilizers? Tax,
c. Automatic stabilizers? Tax, Transfers  Transfers 
+
Real vs. Nominal Wages
• SR:
• SR:
• Nominal wages sticky—no change
• Nominal wages sticky—no change
• Real wages decrease—PL rise
• Real wages increase—PL fallen
• LR: SRAS increases as nominal wages • LR: SRAS decrease as nominal wages
+ The Multiplier Effect

MPC: marginal propensity to consume, given $1

MPS: marginal propensity to save, given $1
 MPS
+ MPS = 1
Spending Multiplier =
1
MPS
• Ripple effect of new income/gov’t
spending on aggregate economy
1. Gov’t increases spending $100 B, given
MPC of .75, what is the impact of initial
spending?
$400 B
Tax Multiplier =
−MPC
MPS
• Impact a change in taxes will have
on aggregate economy
• Always negative (increase in tax
causes decrease in spending)
2. Gov’t increases income tax by $200
B, given MPS of .2, what is the impact
of the change in tax?
−$800 B
The
Phillips
Curve
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
Illustrates the trade-off between Unemployment and Inflation
in the short-run
LRPC
Inflation
BIG CONCEPT: LR Adjustment
• SRAS behaves the exact
opposite way the SRPC
does
A Inflationary:
1. SARS shifts left, returning
economy to LREQ
2. SRPC shifts right and
returns economy to LREQ
at higher expected/nonaccelerating rate of
inflation
*With inflation
expectations are
everything!
A
Inflationary 
Nonaccelerating/natural
rate of
unemployment
LREQ (C)
B

Recessionary
SRPC
Unemployment
LRAS
SRAS

B
A
C
AD2

AD3
AD
The
Phillips
Curve
+
Inflation
PL
LRAS
SRAS

B
AD2

AD3
A
A
C
LRPC
Inflationary 
B

AD
Recessionary
SRPC
GDPR

AD shift equals a move along SRPC

SRAS shift equals a shift (opposite) of SRPC

Always arrive back at a LREQ in both models

Nonaccelerating/natural
rate of
unemployment
LREQ (C)
Practice FRQ on Macro Review Quiz #2
Unemployment
+ Loanable Funds Market

In my opinion, this is the model we had the most problem
with all year…which is good because it’s easy!
Interest
RateREAL
• Model will behave the exact same
as s/d accept focused on the s/d for
loans in an economy
• Real IR tied to capital investment for
businesses
• Implications in FOREX…tomorrow
S
IRCO
IR1
DCO
D
Q
QCO
QLF
Crowding-Out Effect:
When the gov’t decides to
undertake a new piece of
spending and they need to borrow
the money.
Problem: Real IR increase. That
means for businesses to get a loan
they need to pay higher interest!
Businesses will not invest @ higher
IRs
+ Loanable Funds Market Sample
Problem
Interest
RateREAL
S
a. Assume the gov’t partakes in
deficit spending. What happens
to Real IR?
a. What happens to capital
investment?
IR1
a. Effect on AD?
a. Effect on LR growth?
D
Q
+ Loanable Funds Market Sample
Problem
Interest
RateREAL
S
a. Assume the gov’t partakes in
deficit spending. What happens
to Real IR? Increases.
a. What happens to capital
investment? Decreases.
IR1
a. Effect on AD? Decreases.
a. Effect on LR growth? Slows.
D
Q
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Homework:
1. Review Macro!!! No Review Quiz
2. Please review the Macro Review
PowerPoint
Macro Review: Day 2
Subjects included:
•
•
•
•
•
The FED and the Money Supply
Monetary Policy
Calculating Real Values
Balance Sheet Analysis
Money Multiplier
•
•
•
Balance of Payments Accounts
Net Export Analysis
FOREX and Implications on Net Exports
+ Money

Types of Money:



Function of Money:




Unit of Account: widely accepted measure of cost (what $20 can
get you)
Store of Value: holds purchasing power over time
Medium of Exchange: use to trade for goods/services
Calculating Nominal and Real Interest Rates



Fiat: no value other than gov’t backing
Commodity: has an intrinsic value, e.i. tied to gold/silver
Real = Nominal − Inflation
Nominal = Real + Inflation
M1 and M2


M1: cash and checkable deposits  changes in deposits don’t
affect M1
M2: “near monies”
+
The FED and the Money Market
Key Concepts
• MS fixed amount controlled by the
FED
• MD is the opportunity cost of holding
money
• MD also affected by price level in
the aggregate economy
• If PL increases, MD increases
• When IRN are low, businesses will
invest
• When IRN are high, businesses will not
invest
The changing of the money supply is
called MONETARY POLICY
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The FED and the Money Market

The FED has 3 tools: 1. Open Market Operations (buy/sell
bonds), 2. Discount Rate, 3. Reserve Requirements


Use these tools to try and achieve the targeted Federal Funds Rate!
The big idea is the connection between how these tools can be
used to increase AD (expansionary monetary policy) and
decrease AD (contrationary monetary policy)
Expansionary (MS, AD)
Contractionary (MS, AD)
1. OMO: Buy Bonds
2. DR: decrease
3. RR: decrease
1. OMO: Sell Bonds
2. DR: increase
3. RR: increase
All of these actions will increase
the amount of money in circulation
and stimulate consumer
spending/business investment
All of these actions work to
decrease the amount of money in
circulation and decrease
spending/business investment
Short Cut: MS and AD always mirror each other in their respective models
+
Money Market Sample Problems
Assume the US is experiencing a period of
economic recession. What actions could the FED
take in their open market operations to move the
US out of the recession?
1.
a.
b.
c.
d.
Illustrate both the money market and our AD/AS model.
What happens to capital investment as a result of FED
actions?
What happens to aggregate price level?
How does your answer to part (c) impact the money
market in the long-run?
+
Money Market Sample Problems
1.
FED can buy bonds (expansionary monetary policy)
Money Market
MS1
AD/AS
MS2
LRAS
SRAS
IR1
PL2
PL1
IR2
MD
QM1
QM2
AD
Q1
AD2
QF
b. Investment increases as a result of lower IR
c. PL will increase as a result of AD increase
d. In the LR, the demand for money will increase. People need to
hold a greater amount of cash on a day-to-day basis as a result of
more expensive goods/services.
+

Banks and the Creation of Money
Fractional Reserve banking system is based on the premise
that only a portion of the money individuals deposit
(checkable deposits) are held in bank vaults (based reserve
requirement) and the rest is loaned out…money creation
The Money Multiplier =
• Reflects the ripple effect of a deposit/OMO on the M1 money supply
1
RR
Huge Concept:
• Buying/selling bonds are not subject to the reserve requirement because they are
not expected to be paid back upon a depositor’s request
• A deposit/withdrawal must first be subject to the reserve requirement before we
can analyze the effect of the money being used to create new loans
1. The FED buys $100 B worth of bonds. The reserve requirement is 10%. What is the
total change in the M1 money supply? $1,000 B in new loans.
2. You deposit $100 into your checking account. The reserve requirement is 10%.
What is the effect on the M1 money supply? M2 money supply? M1 $900. M2 n/a
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Bank’s Balance Sheet Analysis

We really struggled with this throughout the year!!!
a. Calculate the reserve requirement.
b. Mr. Davey withdrawals $5,000 from his checking account.
a. How much will the reserves change as a result of the
withdrawal?
b. M1 money supply effect?
c. New value of excess reserves based on part (a)?
c. The next day, Mr. Davey shows up and withdrawals an amount
greater than the bank is holding in excess reserves. How can Mi
Tierra cover their required reserves?
d. Based on the loans being issued and the reserve requirement from
part (a), how much new money is being created from Mi Tierra?
Bank’s
Balance
Sheet
Analysis
+
b. Mr. Davey withdrawals $5,000 from his checking account.
Assets
Required Reserves
Excess Reserves
Loans
Liabilities
$9,500 Demand Deposits
$95,000
$500
$85,000 Equity
+
Bank’s Balance Sheet Analysis

We really struggled with this throughout the year!!!
a. Calculate the reserve requirement. 10%
b. Mr. Davey withdrawals $5,000 from his checking account.
a. How much will the reserves change as a result of the withdrawal?
$5,000
b. M1 money supply effect? None. Change M1 components.
c. New value of excess reserves based on part (a)? $500
c. The next day, Mr. Davey shows up and withdrawals an amount greater
than the bank is holding in excess reserves. How can Mi Tierra cover their
required reserves? Borrow from the FED’s discount window.
d. Based on the loans being issued and the reserve requirement from part
(a), how much new money is being created from Mi Tierra? $850,000
+
Trade and Foreign Accounts
 Balance
of Payments Account: used to measure all
international transactions and calculate their effect
in FOREX and Loanable Funds market



Current Account: goods and services planes, wheat,
foreign aid
 Current account—no liability in future
 Net Exports!!! Exports−Imports (trade deficits)
Financial Account: financial assets bonds, stocks
 Financial account—future payments will be made
 Inflows and outflows of loanable funds!
A surplus in one results in a deficit in another
+
Sample Problems
1.
The US and China are trade partners. How would you
categorize the buying of 1 million cotton t-shirts from
china?
2.
If the US is currently running a current account surplus,
what must be the standing of our financial account?
a.
How does this affect the US’s market for loanable funds?
+
Sample Problems Answers
The US and China are trade partners. How would you
categorize the US purchase of 1 million cotton t-shirts from
China?
1.
Current account transaction (negative)
If the US is currently running a current account surplus,
what must be the standing of our financial account?
1.
Running a deficit. Outflow of investment.
a.
How does this affect the US’s market for loanable funds?
Supply of loanable funds decrease.
+ The FOREX &
Appreciation/Depreciations

Remember: the FOREX is an island in the middle of the ocean!!!
Theorize who demands there and who supplies there.
¥/$
YEN
USD
S
$/¥
ER1
S
ER1
D
D
Q$
Q
¥
Remember the bottom-bottom rule!!! The market you are analyzing (USD) is the
Quantity on the X-axis, and the other currency (Yen) per $ on the Y-axis.
+ The FOREX &
Appreciation/Depreciations
¥/$
YEN
USD
S
$/¥
ER1
S
ER1
D
D
Q$
4 Factors that Shift Demand/Supply in FOREX:
Q
¥
1.
Tastes: prefer one nations goods over the other
2.
Income: if one nation has more wealth, we assume they spread it around
3.
Price Level (price tags): always go towards cheaper goods
4.
Interest Rates: investors seek the highest potential returns (Interest
Rates)
+ Net Exports and
Appreciation/Depreciation

Appreciation: increase in value of currency

Depreciation: decrease in value of a currency


USD appreciates:



One is not necessarily better than the other
“Stronger” dollar  US households can afford foreign
goods/services, which are comparatively weaker, ceteris paribus
This results in a decrease of GDP (Imports , negative component
of NX)
USD depreciates:

“Weaker” dollar  foreign households can afford US goods/
services, which are now relatively cheaper, ceteris paribus
+ FOREX Sample Problems
1. Draw a model for the US loanable funds market. Show the
impact on the real interest rate of increasing purchases of US
government securities by China. How would this impact the
international value of the US dollar? Explain.
2. Show how an increase in the demand for Japanese cars
would affect the market for the dollar and the market for the
yen. What would happen the Japan’s GDP as a result of the
change in the value of the Yen?
+ FOREX Sample Problems Answers
1.
Draw a model for the US loanable funds market. Show the
impact on the real interest rate of increasing purchases of
US government securities by China. How would this impact
the international value of the US dollar? Explain.
Interest
RateREAL
S
S2
IR1
IR2
D
Q
Q2
Financial account surplus for
the US leads to an increase in
the supply of loanable funds
(capital inflow).
In order for Chinese
investors to obtain US
securities, they must supply
Yuan in FOREX and demand
USD. This appreciates the
USD.
+ FOREX Sample Problems Answers
2. Show how an increase in the demand for Japanese cars
would affect the market for the dollar and the market for the
yen. What would happen the Japan’s GDP as a result of the
change in the value of the Yen?
¥/$
USD
Depreciates
S
$/¥
S2
S
ER2
ER1
ER1
ER2
D
YEN
Appreciates
D2
D
Q$
Q
US households will supply USD in FOREX and demand Yen. Since it would ¥
now be “cheaper” for Japanese households to purchase foreign
goods/services, Japan will import more. This will decrease Japan’s GDP.