Unit IV Blog Response: Video Summaries

AP Macroeconomics Unit 4 - Part 1- Types and Functions of Money

          There are three types of money: commodity, representative, and fiat. Commodity money is the most primitive, using objects as money, such as cows, that can serve other purposes. Representative money is backed by the value of the precious metal, such as gold and/ or silver, however, the fluctuation of the gold or silver from a day to day basis causes the currency to be unstable. Fiat money is backed by the government’s words that it has value.  

          Money serves three functions, the first being a medium of exchange, in which the transaction of purchasing an item represents this exchange. The second function, store of value, is represented by saving money in a savings account, however, inflation combats this function, as the saver will instead spend it rather save it since inflation diminishes the purchasing power. Lastly, money serves as a unit of account, accounting for worth that is usually associated with quantity.

AP Macroeconomics Unit 4 – Part 3- Money Market Graphs

         

          The price in terms of money is the interest rate, usually represented by “i” goes on the y-axis, while the quantity of money is on the x-axis noted by QM. Demand for money (DM) is downward sloping, according to the law of demand. The supply of money (SM) is vertical and is fixed, set by the FED and does not vary unless the FED increases the money supply to stabilize the interest rate when demand has increased. However, if the demand has increased without the FED increasing the money supply, the interest rate will be increasing in the result of demand increasing. Although the FED usually tries to stabilize interest rates since an unstable does not allow one to predict the level of investment to manipulate aggregate demand for the wanted economic change.

AP Macroeconomics Unit 4 - Part 4- The FED’s Tools of Monetary Policy

          The FED’s three tools of monetary policy are required reserves, the discount rate, and buying and selling bonds and securities. Required reserve is the mandated percentage of a bank need to reserve of deposits; the discount rate is the interest rate banks can borrow money from the FED though it is not used quite often. Buy and selling bonds and securities is one used most often.

  For the expansionary policy, required reserves are decreased, increasing the excess reserves, which can become loans and increases the money supply. The discount rate is lowered, wanting banks to borrow more money that increases the money supply in the economy overall. Bonds are bought by the FED to expand the money supply. Under the contractionary policy, required reserves are increased, the discount rate is raised, and bonds will be sold to reduce the money supply.

 

  AP Macroeconomics Unit 4 – Part 7- Loanable Funds Graph

 

The y-axis remains to be “i” or the interest rate, and the x-axis becomes the quantity of loanable fund.  Demand for loanable is downward sloping, and supply is upward sloping. The supply of loanable funds is dependent on savings, as the more savings, there is the more money banks can use for loans, contributing to the loanable funds. A government deficit is first shown on the money supply graph as an increase in demand, resulted in an increase in interest rates and quantity. This is shown on the loanable funds graph as an increase in the demand for loanable funds increasing and shifting to the right causing the interest rate and quantity increase as a result of.

 

AP Macroeconomics Unit 4 – Part 8- Money Creation and Money Deposit Expansion

 

          Banks create money by loaning out money. The total money created is taking the money multiplier (one divided by the required reserve ratio) and multiplying it by the amount of the loan, however, this is only a potential amount of money created under the assumption that there are no excess reserves. The reason why the total money created is a potential amount is due to the assumption that the loan will be deposited and loaned out to another person following the required reserves percentage. The total of all the potential loans will equal to the potential amount of created money. Having excess reserves will reduce the initially calculated amount of potential money created.

 

AP Macroeconomics Unit 4 – Part 9- Relating the Loanable Funds Market, the Money Market, Aggregate Demand and Aggregate Supply

 

A change in the money market will carry through the loanable funds graph, and the aggregate demand and supply graph. In this case of a government deficit, the increase in demand, results in an increase in the interest in the money market applies to the loanable funds graph. The aggregate demand is an increase, causing a rise in the price level and GDP. According to the equation of exchange, MV=PQ, a change in the supply of money causes a change in price, shown as an increase in interest rates will increase the price level. This concept is known as the Fisher Effect; it can be seen as a one-to-one direct ratio.

Unit IV: Time Value of Money, Interest Formulas, What Banks Do

Time  Value of Money

       I.            Is a dollar today worth more than a dollar tomorrow? Yes

    II.            Why? Opportunity Cost and inflation. This is the reason for charging and paying interest

Let v= future value of $

      p= present value of $

                     r= real interest rate (nominal rate minus inflation rate) (express as decimal)                                                                                               

                     n= years

                     k= number of times interest is credited per year

Demand for money has an inverse relationship between the nominal interest rate the quantity of money demanded

       I.            What happens to the quantity of money of moneyed when the interest increases? Quantity demanded falls

    II.            What happens to the quantity demand when interest rates decrease? Quantity demanded increases.

Demand Always Downward

Money Demand Shifters

I.                   Changes in the price level

II.                Changes in income

III.             Changes in taxation that affects investment

Increase money supply, decreases interest rates, investment increases, AD increases and shifts right

Decreasing money supply, increases interest rates, investment decreases, AD decreases and shift left

Financial Sector

-Financial assets are what you own

-Financial Liabilities is what you owe

Interest Rate

-the cost of borrowing money

Stocks

-simply conveying ownership in a company

Bonds

-loaning money to the government

Bonds are safe; stocks are not.

What Banks Do

A bank is a financial intermediary

                               i.            Uses liquid assets (i.e. bank deposits) to finance the investment of borrowers

                             ii.            The process is known as Fractional Reserve Banking, a system in which deposits institution hold liquid assets less than the amount of deposits

                          iii.            Can take the form

a.    Currency in bank vaults

b.    Bank reserve deposits held at the Federal reserve

What Bank Do (continued)

T- Account (balance sheet)

Assets- Items to which a bank hold legal claim

Uses of funds by financial intermediates liabilities (amount owned)

Legal claims against sources of fund financial  intermediaries

       

Unit IV: Money: Introductory Notes

I.                   Uses of Money

a.    Medium of exchange (trade or barter)

b.    Unit of amount (establishes economic worth in exchange process)

c.     Store of value (money holds it value over a period of time, where products may not)

II.                Types of money

a.    Commodity money (get its value from the type of material which it is made). An example would be gold and silver coins

b.    Representative money (paper money that is backed by something tangible that gives it value)

c.     Fiat money (is money because the government says so)

III.             Characteristics of money

a.    Durable

b.    Portable

c.     Scarce

d.    Divisible

e.    Acceptable

f.      Uniform

IV.             Money Supply

a.    M1 money

-75%

-Most liquid

-Easy to convert into cash

i.                   Currency (coins and cash)

ii.                 Checkable deposits also are known as deposits demand (checking accounts, however, the term checking accounts is not used)

iii.              Traveler’s check

b.    M2 money

                                                       i.            Consist of M1 money + savings account + money market accounts+ deposits      held by banks outside of the U.S.

                                                     ii.            Not as liquid as M1 money

c.     M3 money

i.                   Includes M2 money + certificate of deposit’s (CD’s)

ii.                 When money is kept in CD’s, it will grow 

Unit III: Fiscal Policy

Fiscal Policy

-Two option: taxes and spending

-Taxes- government can increase or decrease

-Spending- government can increase or decrease

Deficits, Surpluses, Debt

-Balanced budget: revenues= expenditures

-Budget deficit: revenues < expenditures

-Budget surplus: revenues > expenditures

-Government debt: sum of deficit-  of surpluses

-Government must borrow money when it runs a budget deficit

- Government borrows from individuals, corporation (both in the form of taxes), financial institutions, foreign entities or foreign government

Fiscal Policy Two Options

-Discretionary fiscal policy (action)

-Expansionary fiscal policy- deficit

-Contractionary fiscal policy- surplus

-Non-discretionary fiscal policy (no action)

-Discretionary: Increasing or decreasing government spending resulting in the economy to return to full employment.

-Automatic: Unemployment compensation and marginal tax rates.

Takes place without policy makers having to respond to current economic problems.

-Expansionary fiscal policy (“Easy”:

        i.            Combat a recession

      ii.            Increase government spending

    iii.            Decrease taxes

-Contractionary fiscal policy (“Tight”)

        i.            Combats inflation

      ii.            Decrease government spending

    iii.            Increase taxes

Automatic or Built-in Stabilizers

-Anything that increases the government deficit during recession yet increases budget surplus during inflation without requirement explicit action by policy maker

Examples: unemployment compensation, Social Security, Medicare/ Medicaid, Welfare

Progress Tax System

-Average tax rate (tax revenue/ GDP) rise with GDP

Proportional Tax System

-Average tax rate remains constant as GDP

Regressive Tax

-Average tax rate falls with GDP

Unit III: Consumption and Savings,DI, and Multipliers

Consumption and Savings

            Disposable Income (DI)

-Income after taxes or net income

-DI= gross income taxes

-Two options: to spend or save

-Two choices: with DI, households can either consume or save

Consumption

-Household spending

-The ability to consume is constrained by the amount of DI and the propensity to save

-Do households consume if DI=0?

Autonomous consumption

Saving

-Household NOT spending

- Ability of constrained by disposable income and propensity to consume

 Do households save if DI=0?

No, household do not save if DI=0

APC and APS

APC + APS= 1

1-APC= APS

1-APS= APC

APC <1= dissaving

-APS= dissaving

MPC

-Marginal propensity to consume- fraction of any change in disposable income that is consumed

MPC= change is consumption/ change in DI

MPS

-Marginal propensity to save- fraction of any charge is DI that is saved

-MPS= change is saving/ change is DI

Marginal Propensities

MPC + MPS =1

1-MPC=MPS

1-MPS= MPC

DI can be consumed or saved

Spending Multipliers

Initial Change in C, Ig, G, Xn in spending cause a large charge in aggregate spending or AD

Multiplier= change in AD/ change in C, Ig, G, Xn

Multiplier= 1/1-MPC or 1/MPS

+= increase in spending

-= decreasing in spending

Tax Multiplier

-When government taxes, multipliers work in reverse due to the money leaving the circular flow

 Tax multiplier= -MPC/1-MPC or -MPC/MPS

If there is a tax cut, then the multiplier is positive.

Unit III: Classical vs. Keynesian Debate

Classical vs. Keynesian Debate

Topic	Classical	Keynesian
Modern Followers	Adam Smith, J.B. Say, David Ricardo, Alfred Marshall	J.M. Keynes
Say’s Law	-Supply creates its own demand -Product=income=spending -Underspending is unlikely -Whatever output is produced, it will be demanded	-Depressions refute Say’s Law -Demand creates its own supply -Underspending persists
Savings and Investments	-Savings= investment income -Savings (leakage)= investment (injection)	-Savings does not equal investment Savings: futures needs, precaution, habit, income level, interest level, rate of profit expectation
Loanable Funds Market IG= Gross investment R= interest rate SM= Supply of money		-Investment from savings, cash, checking accounts -Lending create money, SM increase -Inflation and unemployment are unstable
Wage/price flexibility	Prices and wages are flexible downward	Prices are inflexible downward (ratchet effect)
Supply Curve	Vertical	Horizontal
Output and Employment	AS determines output and employment	AD determines output and employment
Unemployment S= savings I= investment	It rarely exists due to wage price flexibility; the cause is external (war).	It usually exists due external causes (wars) and internal causes savings does not equal investment.
Aggregate Demand (AD)	-AD determines price level -AD is reasonably stable if the money supply is stable	-AD changes to the determinants -AD is unstable due to the fluctuation in investment spending
Basic Equation	MV=PQ	C+Ig+G+Xn= GDP
Role of Government	-Monetary rule -Maintain steady money supply -Laissez-faire is best -Economy is self- regulating	-Fiscal policy is believed (tax and spend) -Believes in active government -Economy is not self-regulating
Inflation (Percent change in PL increase)	Caused by too much money	Caused by too much demand
How long the short run is	Short time	Very long time
Emphasis today	Microeconomics	Macroeconomics
Additional information	-Competition is good -Believes in invisible hand (government and economy regulates itself) -In the long run, economy balance at full employment -Economy is always close or at full employment -They support the trickle-down effect, helping the rich first	- Competition is flawed -AD is the key, not AS -Leaks and savings cause recession -  Ratchet effects and sticky wages blocks Say’s Law -In the long run, we are dead.

Unit III: Interest Rates and Investment Demand

Interest Rates and Investment Demand

What is Investment?

Money spent or expenditures on

          i.            New plant (factories)

         ii.            Capital equipment (machinery)

       iii.            Technology (hardware and software)

       iv.            New homes

         v.            Inventories (goods sold by producers)

Expected rates of returns

-How does business determine the benefit?

Cost/ benefit analysis

-How does business determine the benefit?

Expected rate of return

-How does business count the cost?

Interest cost

-How does business determine the amount of investment they undertake?

Compare expected rate of return of interest

If expected rate of return > invest cost, then invest

If expected rate of return < invest cost, then do not invest

Real (r%) versus nominal (i%)

Nominal is the observable rate of interest.

Real subtracts out inflation Interest Rates and Investment Demand

What is Investment?

Money spent or expenditures on

          i.            New plant (factories)

         ii.            Capital equipment (machinery)

       iii.            Technology (hardware and software)

       iv.            New homes

         v.            Inventories (goods sold by producers)

Expected rates of returns

-How does business determine the benefit?

Cost/ benefit analysis

-How does business determine the benefit?

Expected rate of return

-How does business count the cost?

Interest cost

-How does business determine the amount of investment they undertake?

Compare expected rate of return of interest

If expected rate of return > invest cost, then invest

If expected rate of return < invest cost, then do not invest

Real (r%) versus nominal (i%)

Nominal is the observable rate of interest.

Real subtracts out inflation (π%) and is the only known ex post facto

r%= i%- π%

computes real interest rate

-What determines the cost of an investment decision?

The real interest rate (r%)

Investment Demand Curve

What is the shape of the Investment Demand Curve?

Downward sloping

-Interest rates high, fewer investment profitable interest rates are low investments are profitable

Shifts in Investment Demand

-cost of production

-Lower cost shifts ID->

-higher cost shifts ID <-

-Business taxes

-lower business taxes ID ->

Higher business taxes ID <-

Technology

-New technology ID ->

-lack of technology change ID <-

Stock of capital

If an economy is low ID->

If an economy capital increases, then ID <-

Expectations

-positive= ID ->

-negative = ID <-