Alex's AP Macroeconomics Blog: 2016

Sunday, May 15, 2016

ABSOLUTE AND COMPARATIVE ADVANTAGE

Absolute Advantage

-Individual- exists when a person can produce more of a certain good/service than someone else in the same amount of time (or can produce a good using the least amount of resources).

National- exists when a country can produce more a good/service than another country can in the same time period.

Comparative Advantage
A person or a nation has a comparative advantage when it can produce the product at a lower domestic opportunity cost than can a trading partner.

Examples of output problems
1. Words per minute.
2. Miles per gallons.
3. Tons per acre
4. Apples per tree
5. Televisions produced per hour

Examples of input problems
1. Number of hours to do a job.
2. Number of acres to feed a horse
3. Number of gallons of paint to paint a house.

Specialization and trade
-Gains from trade are based on comparative advantage, not absolute advantage.

MECHANICS OF THE FOREIGN EXCHANGE

-The buying and selling of currency.
-Any transaction that occurs in the balance of payments necessitates foreign exchange.
-The exchange rate (e) is determined in the foreign currency markets.

Changes in exchange rates

Exchange rates (e) are a function of the supply and demand for currency.

An increase in the supply of a currency will decrease the exchange rate of a currency.

A decrease in supply of a currency will increase the exchange rate of a currency.

An increase in demand for a currency will increase the exchange rate of a currency.

A decrease in demand for a currency will decrease the exchange rate of a currency

Appreciation and depreciation

Appreciation of a currency occurs when the exchange rate of that currency increases. (e increases)
Depreciation of a currency occurs when the exchange rate of that currency decreases (e decreases)

Determinants of Exchange rate
1. Consumer tastes (buyers taste)

2. Relative income

3. Relative price level

4. Speculation

Exports and imports
The exchange rate is a determinant of both exports and imports.

Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports.

Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive, thus increasing exports and reducing imports.

As two currencies trade:
1. One supply line will change; the other demand line will change.

2. They will move in the same direction.

3. One currency will appreciate, the other will depreciate.

Flexible rate
Based on the supply and demand of that currency versus the other currency. It is very sensitive to the business cycle and it provides options for investment.

Fixed rates
It is based on a countries willingness to distribute currency and to control the amount

Balance of Payments

Measure of many inflows and outflows between the U.S and the rest of the world (ROW)

Inflows are referred to as CREDITS
Outflows are referred to as DEBITS
Balanced of payments is 8 into 3 accounts

current
capital/financial
official reserves

Current Account

Balance of trade or net exports

Exports of goods/services.
Exports create a credit to balance of payments.
Imports create a debit to the balance of payments.
Net foreign income
Income earned by U.S foreign held U.S assets.

Ex: interest payments on U.S owned Brazilian bonds-interest payments on German owned U.S Treasury bonds

Net transfers (Tend to be unilateral)
Foreign aid-debit to the current account

Ex: Mexican migrant workers send money to their families in Mexico.

Capital/Financial Account

Balance of capital ownership
includes purchase of both real and financial assets.
Direct investment in the U.S is a credit to the capital account.

Ex: Toyota Factory in San Antonio

Direct investment by the U.S firms/ individuals in a foreign country are debits to the capital account.

Ex: Wareen Buffet by stock in Perochina

Purchase of domestic financial assets by foreigners represents a credit to the capital account.

United Arab Emirates \wealth funds purchases a large state in the NASPAQ

Relationship between current and capital account

Remember double entry bookkeeping.

Current account and capital account should zero each other out.

That is if current account has a negative balance (deficit), then the capital account should then have a positive balance (Surplus)

Official Reserves

Foreign currency holdings of the U.S Federal Reserve System
When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments.
When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.
Official reserves zero the balance of payments.

Active V. Passive Official Reserves

U.S is passive in its use of official reserves. It does not seek to manipulate the money exchange rate.

Balance of Trade

Goods + goods

Exports Inputs

Balance on goods and serves

Goods + Services + Goods + service

Exports Exports Inputs Inputs

Current Account

Balance on goods and services + Net investments + net transfer

Capital Account

Foreign Purchase + domestic purchase.

Unit V: The Phillips & Laffer Curve

April 8, 2016

The Long-Run Phillips Curve

Natural rate of unemployment is held constant.
Because the Long Run Phillips curve exists at the natural rate of unemployment (UN) Structural changes in the economy that UN will also cause the Long-Run Phillips Curve to shift.
Increase in UN will shift Long-Run Phillips Curve right.
Decrease in UN will shift Long-Run Phillips Curve left.

Short Run Phillips Curve:

Trade of between inflation and unemployment.

Long Run Phillips Curve:

NO trade of between inflation and unemployment in the long run.
Occurs at natural rate of unemployment.
Represented by vertical line.
Long Run Phillips Curve will shift if the LRAS shifts.

Natural rate of unemployment is equal to frictional +structural + seasonal unemployment.

Maj LRPC assumption is that more worker benefits creates higher natural rates and fewer worker benefits creates lower natural rates.

Supply Shock

Rapid and significant increase in resource cost, which causes SRAS curve to shift.

Most likely shift to left and SRPC will shift right.

Misery Intex

combo of inflation and unemployment in any given year.
Single digit misery is good.

Reaganomics/supply side economics

Show change in AS not in AD, which determines the level of inflation, unemployment notes and economy growth.

April 11, 2016

Inflation: a general rise in the price level
Deflation: A general rise in the price level
Disinflation: a decrease in inflation rate over time
Stagflation: unemployment and inflation increasing at the same time

April 13, 2016

Supply side economists

Support policies that promote GDP growth by arguing that high marginal tax votes along with the current system of transfer payments : Unemployment compensation welfare programs provide disincentive to work, invest, innovate and undertake entrepreneurial ventures.

Low marginal tax rates

induce more work, thus AS increase.
also makes leisure more expensive and work more attractive.

Incentives to save and invest:

High marginal tax rates reduce the rewards for saving and investment.
Consumption might increase, but investments depend upon saving.
Lower marginal tax rates encourage savings and investing.

Laffer Curve:

Theoretical relationship between tax rates and government revenue.
As tax rates increase from (0) tax revenues increase from 0 to some max level and then declines.

Criticism of Laffer Curve:

Research suggests that the impact of the tax rates on incentives tow work, save, and invest are small.
Tax cuts increase demand, which can fuel inflation and demand may exceed supply.
Where the economy is actually located on the curve is difficult to determine.

Unit V - Short & Long Run

April 7, 2016

Short Run Aggregate Supply:

Period in which wages and other input prices remains fixed as price level increase or decrease.

Long Run Aggregate Supply:

Period of time in which wages have become fully responsive to change in price level.

Effects over short-run:

In short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increase while wages remain constant.
In the long run, wages will adjust to the price level and previous output levels will adjust accordingly.

Equilibrium in the Extended Model:

The extended model means the inclusion of both the short run and long run AS curves.
The long run AS curve is representative with a vertical line.

Demand pull inflation in the AS model

Demand-pull: prices increase based on the increase in AB
In Short run, demand pull will drive up prices and increase production.
In long run, increase in AB will eventually return to previous level.

Cost Push and the Extended Model

cost-push arises from factors that will increase per unit cost such as increase in the price of a key resource.
Short run shifts left. What is important is that in this case, it is the cause of price level increase, not the effect.

Dilemma for the Government

In an effort to fight cost-push. The government can react in two different ways.
Action such as spending by the government could begin an inflationary spiral.
No action however could lead to recession by keeping production and employment levels declining.

Monday, April 11, 2016

Unit 4: Single Bank vs. Banking System

When a customer deposits cash or withdrawals cash from their demand deposit account, it has no effect on money supply. It only changes:

The composition of $
Excess reserves
Required reserves
Single Bank

loan from your excess reserves. (ER)

Banking system

Money increases by the multiple in the change of ER. ER * multiplier.

FED

When the FED buys or sells bonds, ER is created. # bought/sold * multiplier

Countercyclical Policies: Keynesian Fiscal Policy vs. Monetary Policy

In the early 21st century, here in the USA:
An efficient, "full employment" economy will probably have:

An annual unemployment rate of 4-5%.
An annual inflation rate of 2-3%.

If the economy goes into recession:
3. The real GDP will decrease for at least 6 months.
4. The real unemployment rate will go to 6% or more.
5. The inflation rate will probably go to 2% or less.

If congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:
6. The policy will try to improve C, or G (parts of AD0
7.Congress will out federal taxes.
8. Congress will increase job and spending programs.
9. The federal budget will probably create a deficit.
10. Due to changes in Money Demand, interest rates will increase.

If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then:
11. The policy will target improvements in IG (part of AD)
12. The Fed will target a lower federal fund rate.
13. The Fed can lower the discount rate.
14. The Fed can buy bonds (Open Market Operations).
15. The Fed can lower the reserve requirement, but probably wont because it is too complex for the banks.
16. These Fed policies will lower the interest rates through changes in the Money Supply.
17. These options should increase Ig.

If the economy suffers from too much demand-pull inflation or cost-push inflation, then18. The unemployment rate will go to 4% or less.
19. The inflation rate will probably go to 4% or more.
If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation problems, then:
20. The policy will try to decrease C, or G (parts of AD)
21. Congress will increase federal taxes.
22. Congress will decrease job and spending programs.
23. The federal budget will probably create a surplus.
24. Due to the changes in Money Demand, interest rates will decrease.

If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:25. The policy will target decreases in IG (part of AD).
26. The Fed will target a higher federal fund rate.
27. The Fed can increase discount rate.
28. The Fed can sell bonds (Open Market Operations).
29. The Fed can raise the reserve requirement, but probably wont because it is too complex for the banks.
30. These Fed policies will raise the interest rates through changes in Money Supply.
31. These options should decrease Ig.

The Components & Definitions

March 11, 2016

Liabilities:

Cash Deposits from the public = DD
Owner's equity or stock shares = Values of the bank stocks as held by the public

Assets:

Required Reserves = The percentage of DD in the Vault = RR
Excess Reserves = The remaining % of DD, used for loans = ER
Property = Usually a statement of the bank's property values
Securities or Bonds = Previously purchased bonds held by the bank as investments.
Loans = Previously loaned funds now owed back to the bank.

Assets:

Required Reserves
Excess Reserves
Property
Securities

Liabilities:

Demand Deposits
Owner's Equity

Remember: DD = RR + ER
Bonds can move two ways:

The Fed sells to the banks and increases the amount.
The Fed buys from the banks and decreases the amount.

Banks and The Creation of Money

How do banks create money?

By lending out deposits/money.

Where do the loans come from?

From depositors who take cash and place it in accounts at the bank.

How are the amounts of potential loans calculated?

By using a T-account that consists of assets and liabilities.

Bank Liabilities (the right side of the T Account Sheet):

#1 Demand Deposits (DD)/Checkable Deposits (CD); Theses are cash deposits from the public, they are a liability because they belong to the depositors and can be withdrawn by the depositors.
#2 Owner's Equity; The values of stocks held by the public ownership of bank shares.

Key concept for AP concerning Liabilities:

If the DD comes in from someone's cash holdings, then that DD is already part of the $ supply.
If the DD comes in from the purchase of bonds (by the Fed) then it creates new cash and therefore creates new $ supply.

Bank Assets (the left side of the T Account Sheet):

#1 Required Reserves (RR); The percentages of demand deposits that must be held in the vault so that some depositors have access to their money.
It is usually anywhere from 5%, 10%, or 20%.
#2 Excess Reserves (ER); Source for new loans
#3 Property
#4 Securities (Bonds); bonds that are purchased by the bank.
#5 Loans; This can be amounts held by banks from previous transactions owed to the bank by prior costumers.

Money Creation (Using Excess Reserves)

Banks want to create profit --> (lending)

The Monetary Multiplier (also known as):

Loan Multiplier
Reserve Multiplier
Checkable Deposits Multiplier

The formula is simple: 1 divided by the reserve requirement (ratio)
Excess Reserves are multiplied by the multiplier

To create new loans for the entire banking system, and this creates new $ supply.

FISCAL POLICY (Recession)

Congress will cut taxes or increase government spending.
Consumption and government spending will increase.
Aggregate demand will increase.
GDP will increase, BUT a deficit occurs.
Supply of loanable funds decreases.
i increases
IG decrease.

INTERNATIONAL TRADE

D$ increases
Appreciate
Exports Dec.
Xn Dec.
AD Dec.
GDP Dec.

MONETARY POLICY (Recession)

The FED will:

Buy Bonds
Lower the Reserve Requirement
Lower the Discount Rate
Lower the Federal Fund Rate

Money supply increases
Interest will increase
Ig increases
AD increases GDP increases

INTERNATIONAL TRADE

D$ dec.
Depreciate
Exports inc.
Xn inc.
AD inc.
GDP inc.

Unit 4: Crowding Out

What is it?

A critique fall of Keynesian policies that are applied to fight a recession. (An expansionary policy)

Why does it happen?

The policy of cutting taxes and raising spending will create a budget deficit.

So?

The budget deficit must be funded and to do this Congress orders the sale of US bonds. (This is NOT a Monetary Policy tool used by the Fed)

This money comes from?

Mostly from US citizens and companies and investment firms.

Therefore?

Money that could be spent on consumption or used for Private Savings is now being used to buy bonds.

On the Money Market?

This will cause the $ demand curve to shift outward. Remember this is a Fiscal event!

On the Loanable Funds Market?

This will cause the supply curve to shift inward because we are not saving money privately anymore.

Also, on the Loanable Funds?

This can cause the demand curve to shift outward because the private and public demand for $ increases.

On both graphs?

The nominal and real interest rate will increase.

Therefore, on the investment D graph

The increase in nominal and real interest rates will cause Ig to decrease.

Isn't this counterproductive ?

Why do it?

Fiscal Policy supporters (Keynesians) insist that gains in consumption (C) and spending (G) will outweigh any loss in the future IG.

Why?

C and G are greater than IG and they are short run improvements. IG is longer run and Keynesians don't worry about that. In the long run we are all dead.

Anymore?

Yes, this is summarized on the Aggregate Model. The AD will move outward due to the increases in C and G and the "maybe" move inward due to a loss ofIG, but not as much as the increase. Therefore the economy improves.