Mankiw book Flashcards
1
Q
The word economy comes from
A
Greek word oikonomos which means the one who manages a household.
2
Q
Rational people make decisions by
A
comparing marginal benefits and marginal costs.
3
Q
Market failure happens because of
A
market power and externalities
4
Q
different living standards are because of
A
productivity
5
Q
Albert Einstein once put it:
A
“The whole of science is nothing more than the refinement of everyday thinking.”
6
Q
Economists at the Office of Management and Budget
A
help formulate spending plans and regulatory policies.
7
Q
Economists at the Department of the Treasury
A
help design tax policy.
8
Q
Economists at the Department of Justice
A
help enforce the nation’s antitrust laws.
9
Q
Problems with graphing:
A
omitted variable and reverse casuality. Expectations as well.
10
Q
comparative advantage developed by
A
David Ricardo developed it.
11
Q
A 10% increase in the price of cigarettes causes
A
a 4% reduction in the quantity demanded. Teenagers are especially sensitive to the price of cigarettes: A 10% increase in the price causes a 12% drop in teenage smoking.
12
Q
A 10% increase in gasoline prices reduces gasoline consumption by
A
about 2.5% after a year and by about 6% after five years.
13
Q
THINGS THAT INFLUENCE PRICE ELASTICITY OF DEMAND
A
- Availability of close substitutes - A good with close substitutes tends to have more elastic demand
- Necessities vs Luxuries - Necessities tend to have inelastic demands, whereas luxuries have elastic demands.
- Definition of the Market - Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods.
- Time Horizon – more elastic in the long run
14
Q
What shifts the demand curve?
A
Income
Prices of related goods
Tastes
Expectations
Number of buyers
15
Q
What shifts the supply curve?
A
Input prices
Technology
Expectation
Number of sellers
16
Q
Is demand curve elastic the same at all places?
A
No. At points with a low price and high quantity, the demand curve is inelastic. At points with a high price and low quantity, the demand curve is elastic.
17
Q
Income elasticity of demand
A
Normal goods +
Inferior –
18
Q
Engel’s Law
A
(named after the statistician who discovered it): As a family’s income rises, the percent of its income spent on food declines, indicating an income elasticity less than one.
19
Q
Cross-Price Elasticity of Demand
A
Substitiues +
complements –
20
Q
The typical study finds that a 10 percent increase in the minimum wage depresses teenage employment by
A
1 to 3 percent.
21
Q
Payroll tax
A
a tax on the wages that firms pay their workers.
22
Q
Arthur Laffer
A
in 1974 suggested that the United States was on the downward-sloping side of the Laffer curve curve. Tax rates were so high, he argued, that reducing them might actually increase tax revenue. – he captured the imagination of Ronald Regan – known as supply side economics because cut in taxes is intended to encourage q of labor supplied.
23
Q
Benefits of international trade:
A
- Increased variety of goods
- Lower costs through economies of scale
- Increased competition
- Increased productivity - When a nation opens up to international trade, the most productive firms expand their markets, while the least productive are forced out by increased competition.
- Enhanced flow of ideas
24
Q
The arguments for restricting trade:
A
- The jobs argument - Opponents of free trade often argue that trade with other countries destroys domestic jobs.
- The National-Security argument – example steel – it is overused and exaggerated
- The Infant-Industry argument – it is difficult to implement and you cannot predict future profitable companies
- The Unfair Competition Argument – its dumb
- The Protection as a Bargaining-Chip Argument – it may not work and leave the country worse off
25
Two approaches to achieving free trade:
1. Unilateral – remove restrictions on its own
2. Multilateral – reduce trade restrictions with other countries – can result in freer trade but if something fails it can result in more restricted trade. It also has political advantages.
26
negative externalities
shown on supply curve
27
technology spillover
positive externality. the impact of one firm’s research and production efforts on other firms’ access to technological advance.
28
positive externalities
shown on demand curve
29
Public policies toward externalities:
1. Command and Control policies: regulation
2. Market based policies:
1. Corrective taxes and subsidies Taxes enacted to deal with the effects of negative externalities are called corrective taxes. They are also called Pigovian taxes after economist Arthur Pigou (1877–1959), an early advocate of their use.
2. Tradable pollution permits
30
Coase theorem
after economist Ronald Coase - if private parties can bargain over the allocation of resources at no cost, then the private market will always solve the problem of externalities and allocate resources efficiently. The initial distribution of rights does not matter for the market’s ability to reach the efficient outcome.
31
For government to provide a public good, it must
do the cost-benefit analysis before. Studies using this approach conclude that the value of a human life is about $10 million.
32
Ben Franklin’s observation
“in this world nothing is certain but death and taxes.”
33
A corporation is
is a business set up to have its own legal existence, distinct and separate from its owners. The government taxes each corporation based on its profit. Profits are taxed twice, first when corporation earns profit and then as personal income tax,
34
Costs of taxes to tax payers:
1. Cost of the tax itself
2. The deadweight losses that result when taxes distort the decisions people make
3. The administrative burdens that taxpayers bear as they comply with the tax laws on April 15.
35
Lump – sum tax
tax that taxes everyone the same amount regardless of their income, it is the most efficient tax but they are not good for equity.
36
Taxes and equity – principles to make tax system more equitable:
1. The benefits principle - states that people should pay taxes based on the benefits they receive from government services. – it tries to make public goods similar to private goods. Example gasoline tax
2. The ability to pay principle(horizontal and vertical equity) - taxes should be levied on a person according to how well that person can shoulder the burden.
37
Types of tax systems:
proportional, regressive, and progressive
38
quintiles
Households are ranked according to their income and placed into five groups of equal size, called quintiles.
39
industrial organization
the study of how firms’ decisions about prices and quantities depend on the market conditions they face.
40
efficient scale of the firm
The bottom of the U-shape occurs at the quantity that minimizes average total cost. This quantity is sometimes called the efficient scale of the firm.
41
For all types of firms, average revenue equals the price of the good.
For competitive firms, marginal revenue equals the price of the good.
For all types of firms, average revenue equals the price of the good.
For competitive firms, marginal revenue equals the price of the good.
42
Shut down if
if TR < VC.
if P < AVC
43
Exit if
TR < TC.
If P < ATC
44
The competitive firm’s short-run supply curve is
the portion of its marginal-cost curve that lies above the average-variable-cost curve.
45
The competitive firm’s long-run supply curve is
the portion of its marginal-cost curve that lies above the average-total-cost curve.
46
The process of entry and exit end when
P=ATC
47
2 reasons that the long-run market supply curve might slope upward:
1. The first is that some resources used in production may be available only in limited quantities.
2. A second reason for an upward-sloping supply curve is that firms may have different costs. Costs vary in part because some people work faster than others and in part because some people have better alternative uses of their time than others. For any given price, those with lower costs are more likely to enter than those with higher costs.
48
The fundamental cause of monopoly is
barriers to entry
* Monopoly resources: A key resource required for production is owned by a single firm. monopolies rarely arise for this reason (DeBeers, the South African diamond company
* Government regulation: The government gives a single firm the exclusive right to produce some good or service. The patent and copyright laws are two important examples. The benefits are the increased incentives for creative activity.
* The production process: A single firm can produce output at a lower cost than can a larger number of firms. Natural monopolies because of economies of scale. (distribution of water
49
Marginal revenue is negative when
when the price effect on revenue outweighs the output effect.
50
When a monopoly increases the amount it sells, there are two effects on total revenue
* The output effect: More output is sold, so Q is higher, which increases total revenue.
* The price effect: The price falls, so P is lower, which decreases total revenue
There is no price effect in competitive firm.
51
Socially efficient quantity is found where
the demand curve and the marginal-cost curve intersect.
52
arbitrage
the process of buying a good in one market at a low price and selling it in another market at a higher price to profit from the price difference.
53
Policymakers in the government can respond to the problem of monopoly in one of four ways:
* By trying to make monopolized industries more competitive – antitrust laws - The first and most important of these laws was the Sherman Antitrust Act, which Congress passed in 1890 to reduce the market power of the large and powerful “trusts” that were viewed as dominating the economy at the time.
* By regulating the behavior of the monopolies
* By turning some private monopolies into public enterprises
* By doing nothing at all
54
synergies
Sometimes companies merge not to reduce competition but to lower costs through more efficient joint production. These benefits from mergers are sometimes called synergies.
55
There are two noteworthy differences between monopolistic and perfect competition:
excess capacity and the markup.
The quantity that minimizes average total cost is called the efficient scale of the firm. In the long run, perfectly competitive firms produce at the efficient scale, whereas monopolistically competitive firms produce below this level. Firms are said to have excess capacity under monopolistic competition.
Markup over marginal cost – in perfectly competitive P=MC and in monopolisticly competitive P>MC
56
One experiment showed that advertising
reduced prices by more than 20%.
57
If there is larger oligopoly, when deciding about pricing owners look at:
* The output effect: Because price is above marginal cost, selling one more gallon of water at the going price will raise profit.
* The price effect: Raising production will increase the total amount sold, which will lower the price of water and lower the profit from all the other gallons sold.
58
The winning program for prisoners dilemma
Robert Axelrod - The winning program turned out to be a simple strategy called tit-for-tat. According to tit-for-tat, a player should start by cooperating and then do whatver the other player did last time.
59
Controversies over antitrust policy:
1. Resale price maintenance – If prodecer requires retailer to charge a certain price. Defense is that these do not aim to reduce competition and second is that they have a legitimate goal to solve free-rider(good costumer service) problem.
2. Predatory pricing – cuting prices to make competition exit and than raising them again. - predatory pricing is rarely, if ever, a profitable business strategy.
3. Tying – for example, offers theaters the two films together at a single price, rather than separately, the studio is said to be tying its two products. – it is still unclear if this works because it does not increase willingness to pay
60
Why could labor demand curve shift?
1. The output price - when the output price changes, the value of the marginal product changes, and the labor-demand curve shifts.
2. Technological change - Advances in technology typically raise the marginal product of labor, increasing the demand for labor and shifting the labor-demand curve to the right(labor-augmenting). Technological change can also reduce labor demand(labor-saving).
3. The supply of other factors - The quantity of one factor of production that is available can affect the marginal product of other factors. For example, ladders affect productivity of apple pickers.
61
the labor supply curve depends on
income effect and substitution effect
62
What can cause a shift in labor-supply curve?
1. Change in tastes
2. Changes in alternative opportunities - The supply of labor in any one labor market depends on the opportunities available in other labor markets.
3. Immigration - When immigrants come to the United States, for instance, the supply of labor in the United States increases and the supply of labor in the immigrants’ home countries falls.
63
When you receive interest on your bank account and dividends, that income is part of the
economy’s capital income.
64
The equilibrium purchase price of a piece of land or capital depends on
both the current value of the marginal product and the value of the marginal product expected to prevail in the future.
65
Black Death
In 14-th-century in Europe – population reduced – marginal product of labor rises – raise in wages – marginal product of land fell because there were less workers to farm it – lower rents. During Black Death wages doubled and rents declined 50%. It led to economic prosperity for the peasant classes and reduced incomes for the landed classes.
66
Why did the gap between skilled and unskilled labor rise over time?
International trade and technology
67
Some determinants of equilibrium wages:
1. Compensating differentials - Some jobs are easy, fun, and safe, while others are hard, dull, and dangerous.
2. Human capital - workers with more human capital(education) earn more on average than those with less human capital. – in US almost twice as much. It also states that education raises productivity.
3. Ability, effort and chance - people differ in their physical and mental attributes, Some people work hard; others are lazy
4. An alternative view of education: Signaling – education a way of sorting between high-ability and low-ability workers. Education doesn’t raise productivity.
68
Superstars arise in markets with two characteristics:
1. Every customer in the market wants to enjoy the good supplied by the best producer. 2. The good is produced with a technology that makes it possible for the best producer to supply every customer at low cost.
69
Above equilibrium wages reasons
minimum wage laws(Most workers in the economy are not affected by these laws because their equilibrium wages are well above the legal minimum.)¬, unions(Studies suggest that union workers earn about 10 to 20 percent more than similar, nonunion workers.) and efficiency wages(to increase productivity).
70
statistical discrimination
It is based on the assumption that employers have imperfect information about possible employees. Some employers, for instance, prefer not to hire workers with criminal records. There is a “ban the box” law that does not allow to ask for criminal records.
71
The top quintile in US takes X of total income and the bottom quintile y.
50%, 3.8%
72
Quintile ratio
is the income of the richest quintile divided by the income of the poorest quintile.
73
Most equal countries
Pakistan and Sweden
74
Least equal country
South Africa
75
Problems in measuring inequality:
1. In-Kind transfers – measuring income is usually based on monetary incomes, and it is also based on pre-tax incomes so it does not look at tax credits or in-kind transfers
2. The economics life cycle – incomes vary over people’s lives
3. Transitory vs Permanent Income - A family’s ability to buy goods and services depends largely on its permanent income, which is its normal, or average, income.
76
Utilitarianism
English Philosophers Jeremy Bentham and John Stuart Mill. The starting point of utilitarianism is the notion of utility—the level of happiness or satisfaction that a person receives from his circumstances. The utilitarian case for redistributing income is based on the assumption of diminishing marginal utility – the government should try to achieve a more equal distribution of income.
77
liberalism
Founder John Locke. Philosopher John Rawls develops this view in his book A Theory of Justice. we should aim to raise the welfare of the worst-off person in society. That is, rather than maximizing the sum of everyone’s utility as a utilitarian would, Rawls would strive to maximize the minimum utility. Rawls’s rule is called the maximin criterion. From the perspective of the original position behind the veil of ignorance, income redistribution is like an insurance policy.
78
libertarianism
Libertarians conclude that equality of opportunities is more important than equality of outcomes. They believe that the government should enforce individual rights to ensure that everyone has the same opportunity to use his talents and achieve success. Robert Nozick. israel and greece
79
Policies to reduce poverty:
1. Minimum-wage laws - Critics view it as hurting those it is intended to help. Causes unemployment.
2. Welfare – supplement the incomes of the needy. A common criticism of welfare programs is that they create incentives for people to become “needy.”
3. Negative Income Tax - High-income families would pay a tax based on their incomes. Low-income families would receive a subsidy. A negative income tax provides what is sometimes called a universal basic income.
4. In-Kind Transfers
5. Antipoverty programs and work incentives – because some people would stop working from government giving them money One is to require any person collecting benefits to accept a government-provided job—a system sometimes called workfare. Another possibility is to provide benefits for only a limited period of time.
80
Plato, the ancient Greek philosopher, concluded
an ideal society the income of the richest person would be no more than four times the income of the poorest person.
81
Four properties of indifference curves:
* Property 1: Higher indifference curves are preferred to lower ones. People usually prefer to consume more rather than less.
* Property 2: Indifference curves slope downward. The slope of an indifference curve reflects the rate at which a consumer is willing to substitute one good for the other.
* Property 3: Indifference curves do not cross.
* Property 4: Indifference curves are bowed inward. The slope of an indifference curve is the marginal rate of substitution—the rate at which the consumer is willing to trade off one good for the other. The bowed shape of the indifference curve reflects the consumer’s greater willingness to give up a good that she already has in abundance.
82
2 extreme examples of indifference curves:
1. Perfect substitutes - In the case of straight indifference curves, we say that the two goods are perfect substitutes.
2. Perfect complements - right-angle indifference curves
83
Demand curves can sometimes slope upwards because
theory of consumers choice.
Economists use the term Giffen good to describe a good that violates the law of demand. (The term is named for economist Robert Giffen, who first noted this possibility.) In this example during the Irish potato hunger crisis of the 19th century., potatoes are a Giffen good. Giffen goods are inferior goods for which the income effect dominates the substitution effect. Therefore, they have demand curves that slope upward.
84
The income effect of higher wages dominates the substitution effect.
The income effect of higher wages dominates the substitution effect.
85
Employers can respond to moral hazard in various ways:
* Better monitoring. Employers may plant hidden video cameras to record workers’ behavior. The aim is to catch irresponsible actions that might occur when supervisors are absent.
* High wages. According to efficiency-wage theories (discussed in Chapter 19), some employers may choose to pay their workers a wage above the level that balances supply and demand in the labor market. A worker who earns an above-equilibrium wage is less likely to shirk because if he is caught and fired, he might not be able to find another high-paying job.
* Delayed payment. Firms can delay part of a worker’s compensation, so if the worker is caught shirking and is fired, he suffers a larger penalty.
86
Condorcet paradox
FAILS Transitivity: If A beats B, and B beats C, then A should beat C.
87
Borda count
ranking preferences with points most points win fails independence of irrelevant alternatives) for the 18th-century French mathematician and political theorist, Jean-Charles de Borda, who devised it. It is often used in polls that rank sports teams.
88
Arrows impossibility theorem
Economist Kenneth Arrow took up this question in his 1951 book Social Choice and Individual Values. He then assumes that society wants a voting system to choose among these outcomes that satisfies several properties:
* Unanimity: If everyone prefers A to B, then A should beat B.
* Transitivity: If A beats B, and B beats C, then A should beat C.
* Independence of irrelevant alternatives: The ranking between any two outcomes
A and B should not depend on whether some third outcome C is also
available.
* No dictators: There is no person who always gets his way, regardless of
everyone else’s preferences.
89
Some mistakes people make:
1. People are overconfident
2. People give too much weight to a small number of vivid observations
3. People are reluctant to change their mind. This behavior is sometimes called confirmation bias.
90
Gross national product (GNP)
total income earned by a nation’s permanent residents (called nationals).
91
Net national product (NNP)
total income of a nation’s residents (GNP) minus losses from depreciation. = national income
92
Robert Kennedy did not like
GDP because it does not measure the health of our children, quality of education, beauty of poetry…
93
Who computes CPI
the Bureau of Labor Statistics (BLS), which is part of the Department of Labor
94
Problems with CPI:
1. Substitution bias – some prices rise more than others and because of that consumers substitute more expensive goods for cheaper ones.
2. Introduction of new goods – consumers have a greater variety which reduces the cost of maintaining the same level of well-being. But because the CPI is based on a fixed basket of goods and services, it does not reflect the increase in the value of the dollar that results from the introduction of new goods.
3. Unmeasured quality change - you are getting a lesser good for the same amount of money, so the value of a dollar falls.
95
COLA
cost-of-living allowance (or COLA), automatically raises the wage when the CPI rises.
96
Determinants of productivity:
1. Physical capital per worker – available tools
2. Human capital per worker – knowledge and skills
3. Natural resources per worker(not necessary such as Japan) – renewable and nonrenewable
4. Technological knowledge – the understanding of best ways to produce goods and services
Y = AF(L, K, H, N)
97
each year of schooling
historically raised a person’s wage by an average of about 10 percent.
98
Robert Fogel studied
how healthier workers are more productive. Fogel found that as nations develop economically, people eat more and the population gets taller. Taller people are more productive and tend to earn more.
99
Thomas Robert Malthus argued
increasing population would continually strain society’s ability to provide for itself. As a result, mankind was doomed to forever live in poverty.
100
Michael Kremer found
world growth rates have increased with world population
101
Why is Africa so poor? Botswana does good
1. Low capital investment – it is 5% lower in sub-Saharan Africa
2. Low educational attainment – average 5.6 years of schooling compared to 8.4 years worldwide.
3. Poor health
4. High population growth – 2,8% per year
5. Geographical disadvantages – 25% live in landlocked nations while in the rest of the world that is 7%
6. Restricted freedom
7. Rampant corruption – Somalia is most corrupt in the world
8. Colonization. We had inclusive and extractive institutions, institutions in Africa were extractive and exploited the population and resources
102
Most corrupt country
Somalia
103
4 bond characteristics
1. term
2. credit risk Standard & Poor ’s rates bonds from AAA (the safest) to D (those already in default)
3. tax treatment
4. inflation protection
104
perpetuity
bond that never matures issued by the British government
105
default
failure to pay off a bond
106
municipal bonds
bonds free of federal income tax
107
TIPS
Beginning in 1997, the U.S. government started issuing such bonds, called Treasury Inflation- Protected Securities (TIPS). Because TIPS offer inflation protection, they pay a lower interest rate than similar bonds without this feature.
108
equity finance and debt finance
The sale of stock to raise money is called equity finance, whereas the sale of bonds is called debt finance.
109
Most famous stock index
Dow Jones Industrial Average
110
A company is insolvent when
its liabilities exceed the value of its assets.
111
Two building blocks of finance
time and risk
112
a portfolio with a single stock, the standard deviation is
49 percent. Going from 1 stock to 10 stocks eliminates about half the risk. Going from 10 stocks to 20 stocks reduces the risk by another 10 percent. As the number of stocks continues to increase, risk continues to fall, although the reductions in risk beyond 20 to 30 stocks are small.
113
The trade-off that is most relevant for understanding financial decisions is the trade-off between
risk and return
114
Over the past two centuries, stocks have generated an average real return of
about 8 percent per year with standard deviation of 20%, while short-term government bonds have paid a real return of only 3 percent per year with standard deviation 0%.
115
Dividends
the cash payments that a company makes to its shareholders
116
John Maynard Keynes suggested
asset markets are driven by the “animal spirits” of investors—irrational waves of optimism and pessimism.
117
Measuring unemployment is the job of
the Bureau of Labor Statistics (BLS), which is part of the Department of Labor.
118
Structural unemployment is there because wages are set above equilibrium for 3 reasons:
minimum-wage laws, unions, efficiency wages.
119
National Labor Relations Act
(enacted in 1935 and subsequently amended) prohibits employers from interfering in certain ways with workers trying to organize unions, and in unionized companies, it requires employers and unions to bargain in good faith when negotiating the terms of employment.
120
Efficiency wages happen because of
worker health, worker turnover(prevents frequent quitting), worker quality, worker effort.
121
barter
the exchange of one good or service for another. In such an economy, trade is said to require the double coincidence of wants
122
Money has three functions:
It is a medium of exchange, a unit of account, and a store of value.
123
Cryptocurrencies rely on a technology
called blockchain to maintain a decentralized, public ledger that records transactions. Bitcoin was introduced in 2009. It was conceived by a computer expert called Satoshi Nakamoto.
124
How much US currency is there?
1.7 trillion dollars
125
Monetary policy is made by
Federal Open Market Committee (FOMC) in FED
126
traditional financial center of the U.S. economy is
New York
127
leverage ratio
the ratio of the bank’s total assets to bank capital. In this example, the leverage ratio is $1,000/$50, or 20. A leverage ratio of 20 means that for every dollar of capital that the bank owners have contributed, the bank has $20 of assets. Of the $20 of assets, $19 are financed with borrowed money—either by taking in deposits or issuing debt.
128
Although many variables affect the demand for money, one variable is particularly important:
the average level of prices in the economy.
129
David Hume suggested that
variables should be devided into nominal(measured in monetary units) and real(in physical units)
The separation of real and nominal variables is now called the classical dichotomy.
130
monetary neutrality
Changes in the supply of money, according to classical analysis, affect nominal variables but not real ones. Valid only in the long-run.
131
Quantity theory of money
M x V = P x Y
132
Hyperinflation is generally defined as inflation that exceeds
50 percent per month.
133
four classic hyperinflations that occurred during the 1920s
in Austria, Hungary, Germany, and Poland.
134
Fisher effect
adjustment of the nominal interest rate to the inflation rate is called the Fisher effect, after Irving Fisher (1867–1947), the economist who first studied it. There is no Fisher effect if inflation is unexpected.
135
Costs of inflation:
1. Shoeleather costs - the time and convenience you must sacrifice to keep less money on hand than you would if there were no inflation.
2. Menu costs - the costs of deciding on new prices, printing new price lists and catalogs, sending these new price lists and catalogs to dealers and customers, advertising the new prices, and even dealing with customer annoyance over price changes.
3. Relative-price variability and the misallocation of resources - When inflation distorts relative prices, consumer decisions are distorted and markets are less able to allocate resources to their best use.
4. Inflation-induced tax distortions - tax code ignores inflation
5. Confusion and inconvenience
6. A Special Cost of Unexpected Inflation: Arbitrary Redistributions of Wealth - These redistributions occur because many loans in the economy are specified in terms of the unit of account—money. Inflation is especially volatile and uncertain when the average rate of inflation is high.
136
Friedman rule
He wanted the nominal interest rate to be 0 so he advocated moderate deflation. deflation would lower the nominal interest rate (via the Fisher effect) and that a lower nominal interest rate would reduce the cost of holding money. But deflation would need to equal real interest rate.
But deflation is often a symptom of deeper economic problems.
137
Factors that influence international trade:
* Consumer tastes for domestic and foreign goods
* The prices of goods at home and abroad
* The exchange rates at which people can use domestic currency to buy foreign
currencies
* The incomes of consumers at home and abroad
* The cost of transporting goods from country to country
* Government policies toward international trade
138
Some of the more important variables that influence net capital outflow:
* The real interest rates paid on foreign assets
* The real interest rates paid on domestic assets
* The perceived economic and political risks of holding assets abroad
* The government policies that affect foreign ownership of domestic assets
139
The euro started circulating on
January 1, 2002, when 12 nations began using it as their official money. As of 2019, there were 23 nations using the euro. Now 20
140
There are two reasons the theory of purchasing-power parity does not always hold in practice:
1. Goods are not easily traded (eg. Haircut)
2. Even tradable goods are not perfect substitutes when produced in different countries
141
In forex, demand for money comes from
net exports
142
In forex, supply of money comes from
net capital outflow. it connects it with market for loanable funds
143
Three key facts about economic fluctuations:
1. Economic fluctuations are irregular and unpredictable: fluctuations are often called the business cycle.
2. Most macroeconomic quantities fluctuate together but in different amounts. Even though investment averages about one-sixth of GDP, declines in investment account for about two-thirds of the declines in GDP during recessions.
3. As output falls, unemployment rises
144
Three reasons why aggregate demand curve slopes downward:
1. The price level and consumption: The Wealth Effect - A decrease in the price level raises the real value of money and makes consumers wealthier, thereby encouraging them to spend more. The increase in consumer spending means a larger quantity of goods and services demanded. Conversely, an increase in the price level reduces the real value of money and makes consumers poorer, thereby reducing consumer spending and the quantity of goods and services demanded.
2. The price level and investment: The Interest-Rate Effect - A lower price level reduces the interest rate, encourages greater spending on investment goods, and thereby increases the quantity of goods and services demanded. Conversely, a higher price level raises the interest rate, discourages investment spending, and decreases the quantity of goods and services demanded.
3. The price level and net exports: The Exchange-Rate Effect - When a fall in the U.S. price level causes U.S. interest rates to fall, the real value of the dollar declines in foreign exchange markets. This depreciation stimulates U.S. net exports and thereby increases the quantity of goods and services demanded. Conversely, when the U.S. price level rises and causes U.S. interest rates to rise, the real value of the dollar increases, and this appreciation reduces U.S. net exports and the quantity of goods and services demanded.
145
Why the Aggregate-demand curve might shift?
1. Change in consumption - any event that changes how much people want to consume at a given price level shifts the aggregate-demand curve. One policy variable that has this effect is the level of taxation.
2. Change in investment
3. Change in government purchases – most direct way to shift the aggregate-demand
4. Change in net exports
146
Why the Long-run aggregate-supply curve might shift:
1. Shift arising from changes in labor (such as immigration)
2. Shifts arising from changes in capital (land, minerals, and weather)
3. Shifts arising from changes in natural resources
4. Shifts arising from changes in technological knowledge - most important reason that the economy today produces more than it did a generation ago is that our technological knowledge has advanced.
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Although many forces influence the economy in the long run and can in theory cause such shifts, the two most important forces in practice
are technology (aggregate supply) and monetary policy (aggregate demand).
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Why aggregate-supply curve slopes upward in the short run:
1. The sticky-wage theory - the short-run aggregate-supply curve slopes upward because nominal wages are slow to adjust to changing economic conditions. Nominal wages are based on expected prices and do not respond immediately when the actual price level turns out to be different from what was expected.
2. The sticky-price theory - This slow adjustment of prices occurs in part because there are costs to adjusting prices, called menu costs.
3. The misperception theory - changes in the overall price level can temporarily mislead suppliers about what is happening in the individual markets in which they sell their output. They might be confused and think that only prices in their markets changed.
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Why the short-run aggregate-supply curve might shift:
all the same as long-run we just add expectations about the price level. An increase in the expected price level reduces the quantity of goods and services supplied and shifts the short-run aggregate-supply curve to the left.
A decrease in the expected price level raises the quantity of goods and services supplied and shifts the short-run aggregate-supply curve to the right.
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subprime borrowers
borrowers with a higher risk of default based on their income and credit history
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quantitative easing
when a central bank purchases securities to increase money supply
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For the U.S. economy, the most important reason for the downward slope of the aggregate-demand curve is the
interest-rate effect.
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theory of liquidity preference
the short-term interest rate in an economy is determined by the supply and demand for the most liquid asset in the economy - money
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The Fed now conducts policy by setting a target for
the federal funds rate—the interest rate that banks charge one another for short-term loans. This target is reevaluated every six weeks at meetings of the Federal Open Market Committee (FOMC).
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liquidity trap
Some economists describe federal funds rate at 0 a situation as a liquidity trap. One option is to have the central bank commit itself to keeping interest rates low for an extended period of time. Such a policy is sometimes called forward guidance. Even if the central bank’s current target for the interest rate cannot fall any further, the promise that interest rates will remain low may help stimulate investment spending. A second option is to have the central bank conduct expansionary open-market operations using a larger variety of financial instruments. This type of unconventional monetary policy is sometimes called quantitative easing because it increases the quantity of bank reserves.
During the Great Recession, the Fed engaged in both forward guidance and quantitative easing.
A liquidity trap occurs when interest rates are low but consumers prefer to hoard cash rather than spend or invest it
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crowding-out effect
when fiscal expansion raises the interest rates and crowds out investment
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the words of economist George Akerlof
“Probably the single most important macroeconomic relationship is the Phillips curve.”
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Monetary policy cannot influence the natural rate of unemplyment.
Monetary policy cannot influence the natural rate of unemplyment.
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The sacrifice ratio
the number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point. A typical estimate of the sacrifice ratio is 5.
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Should the Government Fight Recessions with Spending Hikes Rather Than Tax Cuts?
Pro: it should use spending hikes - Traditional Keynesian analysis indicates that increases in government purchases are a more potent tool than decreases in taxes. When households get extra disposable income from a tax cut, they will likely save some of that additional income rather than spend it all (especially if households view the tax reduction as temporary rather than permanent). The fraction of the extra income saved does not contribute to the aggregate demand for goods and services. By contrast, when the government spends a dollar buying a good or service, that dollar immediately and fully adds to aggregate demand.
Con: it should use tax cut - Tax cuts have a powerful influence on both aggregate demand and aggregate supply. When the government reduces marginal tax rates, workers keep a higher fraction of any income they earn. As a result, the unemployed have a greater incentive to search for jobs, and the employed have a greater incentive to work longer hours. Increased aggregate supply, along with the increased aggregate demand, means that the production of goods and services can expand without putting upward pressure on the rate of inflation. Tax cuts have the advantage of decentralizing spending decisions, rather than relying on a centralized and highly imperfect political process.
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Unsafe at Any Speed
In 1965, Ralph Nader
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1776 book An Inquiry into the Nature and Causes of the Wealth of Nations
economist Adam Smith – Invisible hand - American revolutionaries signed the Declaration of Independence. - described a visit he made to a pin factory. Smith was impressed by the specialization among the workers and the resulting economies of scale.
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1817 book On the Principles of Political Economy and Taxation
David Ricardo developed the principle of comparative advantage as we know it today. he further developed the labour theory of value
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Trumponomics
Arthur Laffer(he encouraged the candidate to propose a large tax cut), Stephen Moore
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who won the Nobel Prize for his work in industrial organization
George Stigler
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one of the early developers of the theory of monopolistic competition, concluded from this argument that brand names were bad for the economy.
Edward Chamberlin
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whose life was portrayed in the book and movie A Beautiful Mind
John Nash Nash equilibrium
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A Theory of Justice. 1971
liberalism. Philosopher John Rawls
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1974 book Anarchy, State, and Utopia
Robert Nozick libertarianism
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19th-century industrialist Andrew Carnegie
warned that “the parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to lead a less useful and less worthy life than he otherwise would.”
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1951 book Social Choice and Individual Values.
Kenneth Arrow
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Robert Fogel won the Nobel Prize in Economics in 1993 for his work in
economic history. “improved gross nutrition accounts for roughly 30 percent of the growth of per capita income in Britain between 1790 and 1980.”
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An Essay on the Principle of Population as It Affects the Future Improvement of Society.
Thomas Robert Malthus (1766–1834)
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that asset markets are driven by the “animal spirits” of investors—irrational waves of optimism and pessimism.
John Maynard Keynes
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Secrets of the Temple: How the Federal Reserve Runs the Country
William Greider
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The General Theory of Employment, Interest, and Money
In 1936, economist John
Maynard Keynes Keynes’s main message was that recessions and depressions can occur because of inadequate aggregate demand for goods and services. Theory of liquidity preference.
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Hard Heads, Soft Hearts
Economist Alan Blinderpolicymakers should not make this choice of 0 inflation.
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Lowest mortality in Europe
Sweden
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J.B. Say(Jean-Baptiste)
Says law - production of goods(supply) creates its own demand. production is the source of demand
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father of economics
Adam smith
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Gary Becker
he applied the methods of economics to aspects of human behaviour, rational economics choices
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Carl Menger
contributed to development of marginalism and marginal utility. Subjective theory of value. did not believe that goods provide utility
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Francois Quesney
the first systematic school of political economy. developed economic table
