Economics - Unit 4 Flashcards
Transaction costs
The costs associated with the time and effort needed to search out, negotiate, and consummate an exchange
Barter economy (3)
An economy in which trades are made in goods and services instead of in money
Dependent on a “double coincidence of wants”
Barter economies are small, and commerce is slow
Money
A good that is widely accepted for purposes of exchange and in the repayment of debt
Medium of exchange
Anything that is generally acceptable in exchange for goods and services
Unit of account
A common measurement used to express values
Store of value
An item that maintains value over time
Fractional reserve banking
A banking arrangement in which banks hold only a fraction of their deposits and lend out the remainder
Money supply (3)
The total supply of money in circulation, composed of currency, checking accounts, and traveler’s checks
Economists believe that the change in the money supply causes economic contractions and expansions
Economists say the ups and downs of the business cycle are caused by the erratic behavior of the monetary authorities or the Fed
- sometimes the monetary accelerator to the floor dramatically increases the money supply and causes expansion
- other times it slams on the monetary brakes causing the money supply to decrease (fall) and the economy to dive into a contraction
Currency
Coins issued by the U.S.
Federal reserve note
Paper money issued by the federal reserve system
Demand deposit
An account from which deposited finds can be withdrawn in currency or transferred by a check to a third party at the initiative of the owner
Savings account
An interest-earning account
Near-money
Assets, such as nonchecking savings accounts, that can be easily and quickly turned into money
Loanable funds market (3)
The market for loans
Demand for loans - borrowers
Supply of loans - lenders
Interest rate is determined in the loanable funds market
Federal reserve system (the Fed)
4
Central bank of the U.S.
As population grows, the economy needs more money
Increasing the money supply more than needed will cause inflation
Hyperinflation only occurs when the money supply increases very rapidly
Board of governors of the federal reserve system
The governing body of the federal reserve system
Federal open market committee (FOMC)
The 12-member policy-making group within the Fed.
This committee has the authority to conduct open market operations
Reserve account
A bank’s checking account with its Federal Reserve district bank
Total reserves
The sum of a bank’s deposits in its reserve account at the Fed and its vault cash
Required reserves
The minimum amount of reserves a bank must hold against its deposits as mandated by the Fed.
Reserve requirement
The regulation that requires a bank to keep a certain percentage of its deposits in its reserve account with the Fed or in its vault as vault cash
Excess reserves
Any reserve held beyond the required amount
Open market operations
Buying and selling of government securities by the Fed
Federal funds rate
The interest rate one bank charges another for a loan
Discount rate
The interest rate the Fed charges a bank for a loan
Gross domestic product (GDP)
The total market value of all final goods and services produced annually in a country
Double counting
Counting a good more than once in computing GDP
Consumption
Funds spent from the household sector
Investment
Funds spent by the business sector
Export spending
The amount spent by the residents of other countries for goods produced in the U.S.
Import spending
Amount spent by Americans for foreign produced goods
Base year
“A benchmark year” - a year chosen for a point of reference for comparison
Real GDP (2)
Gross domestic product that has been adjusted for price changes
GDP measured in base-year, or constant, prices
Price index
A measure of the price level, or the average level of prices
Consumer price index (CPI)
5
The most widely cited price index
A measure of price level based on a ‘basket’ of goods
CPI is calculated by the bureau of labor statistics (BLS)
The BLS defines a market basket of household goods
The CPI is also used to determine the purchasing power of money
Aggregate demand curve
A curve that shows the quantity of goods and services that buyers are willing and able to buy at different price levels
Aggregate supply curve
A curve that shows the quantity of goods and services that producers are willing and able to supply at different price levels
Unemployment rate
The percentage of the civilian labor force that is unemployed
Employment rate
The percentage of the noninstitutional adult civilian population that is employed
Inflation (4)
An increase in the price level, or average level of prices
- decreases purchasing power
- doesn’t mean the price of everything changes
- the percent of change in the consumer price index (CPI) is inflation
Demand-side inflation (3)
Demand increase = price increase
Demand increase for all goods (on average) will cause inflation
A growing population will cause inflation
Supply-side inflation (3)
Supply decrease = price increase
Supply decrease for all goods (on average) will cause inflation
A supply shock will cause inflation
Velocity
The average number of times a dollar is spent to buy final goods and services in a year
Simple quantity theory of money
A theory that predicts that changes in the price level will be strictly proportional to changes in the money supply
M x V = P x Q
M = money supply V = velocity P = price level or average price Q = quantity of output (quantity of goods and services)
Hedge
To try to avoid or lessen a loss by taking some counterbalancing action
Deflation
A decrease in the price level, or average level of prices
Business cycle
Recurrent swings (up and down) in real GDP
Recession
A slowdown in the economy marked by real GDP falling for two consecutive quarters
Commodity money (3)
Money that has essential (intrinsic) value
Commodity money has utility beyond a simple medium of exchange
Ex. Gold and other precious metals
Anything that might be bartered
Flat money
Money that has nonessential (extrinsic) value
Flat money has value by authoritative decree
Examples:
- most modern currencies including the U.S. dollar
Characteristics of flat money (3)
Durable - won’t disintegrate or evaporate
Portable - can be carried from one place to another
Divisible - can be broken into smaller units
Bank panic (2)
‘Bank run’
Occurs when too many depositors simultaneously attempt to withdraw their deposits from a bank, which depletes the bank’s reserves
Panic of 1907 (2)
No mechanism for expanding the amount of money in circulation
Resulted in the creation of the federal reserve system
Structure of the federal reserve system (2)
Decentralized central bank
The federal reserve is independent from the rest of the federal government
Responsibilities of the FED (3 total but 7 with extra info)
Regulates bank’s to ensure they follow federal laws
- U.S. Banks are required to hold a percentage of their deposits in reserve
A bank for banks
- holds required reserves of all banks
- makes loans to banks as a lender of last resort
Conducts monetary policy by controlling the money supply
- in the U.S. The Fed is solely responsible for monetary policy
Tools of the FED
What are they used for?
What are they?
Tools used to change the amount of money in the U.S. economy
- The reserve ratio - amount of $ banks are required to have in reserve (in percent)
- The discount rate - the interest rate the FED charges banks (lower than prime rate)
- Open market operations - buying or selling of Federal securities (treasury bonds)
The reserve ratio (2)
Amount of money banks are required to have in reserve (in percent)
Reserve ratio: ^
Money supply: v
The discount rate (2)
The interest rate the FED charges banks (lower than prime rate)
Discount rate: ^
Money supply: v
Open market operations (2)
Buying or selling of federal securities
FED sells securities; money supply = v
FED buys securities; money supply = ^
Deregulation of the financial industry (3)
Deregulation = process or removing or reducing regulations
Since 1980, Congress has consistently removed regulations on banks
Banks can earn more money, but depositors’ money is at risk
The subprime mortgage debacle (2-3)
Unscrupulous lenders sell and irresponsible borrowers buy subprime loans (subprime = typically having unfavorable conditions)
Subprime loans = riskier because…
- borrowers’ ability to pay back the loan is questionable
- if a borrower cannot pay back the loan, home “goes into foreclosure”
- foreclosure = process of taking possession of mortgaged property
The credit-default scandal (2-3)
Banks that purchase subprime mortgage securities also bug credit-default swaps
Swaps = insurance (why use term swap instead of insurance?)
- insurance must be regulated
- ‘swaps’ are unregulated
What are the components of the money supply ? (3)
Currency (federal reserve notes)
Checking accounts (demand deposits)
Travelers checks
Travelers checks (3)
A check issued by a bank in any of several denominations ($10, $20, $59, etc.)
Sold to travelers or anyone who wants one
Buyers sign it at the time it’s issued by the bank and then again in the presence of the person cashing it
Final goods
Example?
A good sold to its final user
Ex. The ice cream cone that Sam buys from Dairy Queen
Ex 2. The Big Mac that terry buys from McDonald’s
Intermediate good
Example?
A good that has not reached its final user
Ex. The sugar come that dairy when buys for its inventories
Ex 2. The hamburger bun that McDonald’s buys for its inventories
BRIC countries (2)
Countries with rapidly increasing GDP and vast resources that will be the economic leaders and competitors of the U.S. In the future
Brazil, Russia, India, China = BRIC
What does GDP omit? (5)
Illegal goods and services
- illegal drugs
- Cuban cigars
Legal goods and services with no record of the transaction
- mowing your neighbor’s lawn
- making dinner for your family
Used goods
- used goods have already been counted
- garage sales
Stocked and bonds
- nothing produced
- stocks and bonds are traded
Government transfer payments
- social security and welfare payments are entitlements
- government received nothing in return
Components of GDP
GDP = C + I + G + NX = y
Consumption
Investment
Government
Net exports
Consumption (C)
Examples?
(3)
Anything that households purchase in the product market
NOT new housing
Ex. TV sets, telephones, clothes, lamps, cars
Investment (I)
Examples?
(4)
Anything that firms purchase in the resource market
Inventories of finished goods
New housing
Ex. Tools, machines, factories
Government (G)
Examples?
(4)
Government purchases in the product market
Military spending and road construction
NOT social security or welfare
Ex. Paper, pen, tanks, planes
Net exports (NX)
Examples?
(5)
Exports - imports
Exports: products manufactured in the U.S. and sold to other countries
Imports: products manufactured in foreign countries and sold in the U.S.
Example of exports- cars, wheat, computers
Example of imports - cars, radios, computers
GDP Calculation
Nominal GDP = current yr price x current yr quantity
Real GDP and how to calculate (4)
GDP that has been adjusted for price changes
Allows economists to compare output from year to year
Real measured in base year prices
Real GDP = base yr price x current year quantity
What are the two possibilities that can account for the doubling of GDP (2)
- The economy produced twice as much goods and services
2. The prices in the economy doubled
The birth of fractional reserve banking (5)
Goldsmiths - first bankers due to gold coins in old days
- took in ppls gold and stored it
- issued “warehouse receipts” to acknowledge that they held deposited gold (receipts later became exchangeable)
Goldsmiths start charging interest
- increase in supply of money was a result of the lending activity of the goldsmith
- the process of fractional reserve banking: banks create $ by holding on reserve only a fraction of the $ deposited with them and lends them the remainder
Are credit cards money? (2)
No because money had to be widely used for exchange and it also has to be used in repayment of debt
Credit cards don’t repay debts, rather they incur them. (Makes it easier to obtain a loan)
If demand for loans increase (rise)?
*supply = constant
The price of a loan (interest rate) rises
If demand for loans decreases (falls)?
Interest rate falls
If supply of loans increases (rises)?
Interest rate falls
If supply of loans decreases (falls)?
Interest rate increases
Is every good that is produced also sold?
Yes because the government statisticians who measure GDP assume that everything that is produced is purchased by someone
GDP vs. Quality of life
GDP = population
Quality of life = greater production of goods and services
- being better off takes into account much more than simply how much output is produced
- a bigger country GDP doesn’t necessarily mean a bigger per capita GDP
Purchasing power
The quantity of goods money buys
Supply shock
An unforeseen disruption in supply
Effects of inflation on individuals on fixed income? (4)
Incomes don’t change, but the costs of goods increases, and inflation occurs
Lowers purchasing power
Material standard of living = reduced
Includes senior citizens and/or retirees
Effects of inflation on savers (4)
Earned interest increases the purchasing power of money
Inflation decreases the purchasing power of money
If interest rate > inflation rate; purchasing power of savings increases
If interest rate < inflation rate; purchasing power of savings decrease
Effects of inflation on borrowers (2)
Incomes eventually increase with inflation
Debts become easier to repay with inflation
The market basket (3)
Contains goods that households typically purchase
Contains food, transportation, clothing, energy, and more
Most expensive good in the basket is housing
Calculating CPI (4)
Each year, the BLS calculates the value of the basket
The BLS designates a ‘base year’
CPI Value = [(basket current yr value) / (basket base year value)] x 100
Base year CPI value always equals 100
How to find “how much that would be today”?
Year 1 price x (CPI yr 2 / CPI yr 1) = equivalent year 2 price
What are the 5 phases of a business cycle? (5)
- Peak
- Contraction
- Trough
- Recovery
- Expansion
The peak (of a business cycle)
Real GDP is at a temporary high (Q₁)
Contraction (in a business cycle) (4)
If real GDP decreases, the economy is said the be in a contraction
- recession: a slowdown in the economy marked by real GDP falling for 2 consecutive quarters
- usually when the economy contracts (real GDP falls), unemployment rate rises
- hurts unemployed and whole world
- more unemployment = fewer goods and services produced
Overall material standard of living declines
Trough (in a business cycle)
Low point in real GDP, just before it begins to turn up
Recovery (in a business cycle)
Period when real GDP is rising, begins at the trough, and ends at the initial peak
Expansion (in a business cycle)
Refers to the increases in real GDP beyond the recovery
Indicators used in forecasting business cycles (3)
Leading - leads economic upturns or downturns (in real GDP)
Coincident - coincides with economic upturns or downturns
Lagging - lags behind economic upturns or downturns
Leading indicator
Expected to rise before an upturn in real GDP and to fall before a downturn in real GDP
- tend to be more often cited in the news than either coincident or lagging indicators (maybe b/c of the ppl’s interest in predicting the future)
Ex. Stock prices, money supply (in inflation-adjusted dollars), consumer expectations, and average weekly hours worked in manufacturing
Coincident indicator
Should reach its high point at the same time as a peak of a business cycle and each its low point either the trough of a business cycle
Lagging indicator
Would be expected to reach its high sometime after the peak of a business cycle and to reach its low sometime after the trough
Prediction when the stock market is up?
Down?
Up - good economic times
Down - bad economic times ahead
What reflects good/bad times ahead? (2)
Increase in average weekly hours worked reflects good times ahead
Decrease in average weekly hours worked reflects bad times ahead
What did some economists say about the up and down movement in the money supply? (3)
The up and down movement in the money supply is what causes the up and down economic activity (real GDP)
- increasing the price of supply acts as a “stimulant” to the economy
- reducing the price of supply acts as a “depressant” on the economy
Some economists point to changes in… As to explain the cause of a business cycle
Economists point to changes in…
business investment (firms cut back on buying factories and machinery)
Residential construction (contractors stop building as many homes)
Government spending (gov. spending is cut substantially)
Politics (7)
Some economists believe that at least some of the business cycles have been caused by politicians trying to get reelected to office
- chances of reelection = great, if the economy is in good shape
- greater aggregate demand = firms sell more goods and services and hire more workers –> more jobs, higher income
- when times are good, voters are more likely to reward the people in office who (they believe) made this possible
- a higher aggregate demand can cause inflation
- congress can reverse strategy by trying to cut spending to lower aggregate demand to cool off the economy
- if the congress cuts spending too much, though, the economy could slide into a contraction
Innovation (3)
What happens in a hypothetical situation involving competition?
Some economists believe that major innovations are the seeds of business cycles
Ex. A company’s new product = skyrocketed with sales –> other companies try to mimic a similar idea –> copycat firms invest heavily to maintain market positions relative to the innovator (for a time)
- in time, investment spending tends slow and the economy turns down
Inflation rate =
[(CPI later yr - CPI earlier yr)/CPI earlier yr] x 100
