Section 1 - Economic Concepts & Strategy Flashcards
1
Q
Demand or Demand Curve (Quantity Demanded)
A
Demand Curve (Starts with a D, slopes Down .) Shows the inverse relationship between the price and the quantity of a product or service that a group of consumers are willing and able to buy at a particular time (i.e. the quantity demanded.)
2
Q
Demand Curve Shift
A
The precise placement of the demand curve on the graph may change regularly. These changes are known as demand curve shifts. A demand curve shifts if there are changes in relevant factors other than a change in price.
3
Q
Demand Curve Shifted Upward
A
Changes in the demand curve where quantity demanded becomes larger for each and every price are described as “the demand curve sifted upward,” the demand curve shifted outward, “the demand curve shifted to the right,” or “demand increased.”
4
Q
Demand Curve Shifted Downward
A
Changes in the demand curve where quantity demanded becomes smaller for each and every price are described as “the demand curve shifted downward,” “the demand curve shifted inward,” “the demand curve shifted to the left,” or “demand decreased.”
5
Q
Direct Relationships with Demand Curve
A
Some factors exhibit direct relationship with the demand curve, meaning that increases in that factor cause the demand curve to shift upward (or demand to increase) - The price of a substitute good, expectations of price changes, income (for normal goods), and extent of the market. (Positive shift outward due to these changes.)
6
Q
The Price of a Substitute Good
A
When product A may be an acceptable alternative to product B, an increase int he price of product A will make product B more attractive. Example: an increase in the price of hamburgers will increase the demand for hotdogs.
7
Q
Expectations of Price Changes
A
Consumers are more likely to buy now if they think prices will increase in the future. Example: if cigarette taxes are expected to double next year, some will bring forward some of their purchases, increasing the demand this year until the tax increase goes into effect.
8
Q
Income for Normal Goods
A
For many goods (e.g., cars or smartphones) when income increases (wealth increase), demand increase. All goods are not normal goods.
9
Q
Extent of the Market
A
New consumers may increase demand, therefore increasing the size of the market. Example: the remove of trade barriers by foreign governments will increase the demand for American products that can be exported. A baby boom will increase demand for baby food. A large inflow of immigrants from a country to the U.S. will increase demand for that country’s ethnic food in the U.S.
10
Q
Inverse Relationships
A
Inverse relationships with the demand curve, meaning that increases in that factors cause the demand curve to shift downward ( or demand to decrease, negatively). Examples are the price of a complement good, income (for inferior goods), and consumer boycott.
11
Q
The Price of a Complement Good
A
When products are normally used together, an increase int he price of one of the goods decreases demand for the other. Example: an increase in the price of chips will cause downward shift in the demand for salsa.
12
Q
Income for Inferior Goods
A
For some goods (e.g., used cars) when income increase (wealth), demand decreases as consumers shift their spending to other goods (e.g., new cars).
13
Q
Consumer Boycotts
A
An organized boycott will, if effective, temporarily decrease the demand of a product. Example: members of unions commonly refuse to buy from businesses that are involved in labor disputes.
14
Q
Change in Consumer Tastes
A
Change in consumer taste may, of course, affect demand but whether demand increases or decreases as a result depends on whether the change in tastes favor or disfavors the specific product. These are said to have an indeterminate relationship.
15
Q
Elasticity
A
How flexible is the economic.
16
Q
Whether total revenue will increase or decrease when prices change turns out tot depend on the Price Elasticity of Demand.
A
The concept of price elasticity of demand measures how responsive the quantity demanded (of a good or service) is to a change in price. Economists often refer to the “price elasticity of demand” simply as “elasticity of demand.”
17
Q
Elastic, Inelastic, or Unit Elastic
A
For example, goods that represent a larger fraction of consumers’ budgets tend to be elastic (automobiles) and those that represent a smaller fraction of consumers’ budgets tend to be inelastic (table salt).
18
Q
Income Elasticity of Demand
A
Measures the effect of changes in (consumer) income on changes int he quantity demanded of a product.
19
Q
A positive income elasticity indicates a normal good, which means that as consumer income increases the quantity demanded of the normal good also increases. A negative number indicates an inferior good, so as income increases, the quantity demanded of the inferior good will decrease.
A
Example: if incomes increase and the quantity demanded of a new cars also increases, new cars are a normal good. However, incomes increase and the quantity demanded of used cars decreases, used cars are an inferior good.
20
Q
Cross-Elasticity of Demand
A
Measures the change in the quantity demanded of a good to a change in the price of another good, and is used to determine if two different goods are substitutes (competition - butter and margarine), which would result in a direct relationship (positive number), or complements (relationships - chips and salsa), which would result in an inverse relationship (negative number). If the coefficient is zero, the products are unrelated.
21
Q
Supply or Supply Curve (Quantity Supplied)
A
Supply Curve includes the letters UP, slopes up. A supply curve shows the direct relationship between the price of a product or service and the quantity that a group of producers and/or sellers are wiling to supply at a particular time (i.e., the quantity supplied).
22
Q
Supply Curve Shifted Outward
A
Changes in the supply curve where quantity supplied becomes larger for each and every price are described as “the supply curve shifted outward” (not upward), “the supply curve shifted to the right,” or “supply increased.”
23
Q
Supply Curve Shifted Inward
A
Changes in the supply curve where quantity supplied becomes smaller for each and every price are described as “the supply curve shifted inward” (not downward), “the supply curve shifted to the left,” or “supply decreased.”
24
Q
Some factors exhibit a direct relationship with the supply curve, meaning the increases in that factor cause the supply curve to shift outward (or supply to increase)
A
Number of producers, government subsides, price expectations, and reductions in costs of production and technological advances.
25
Number of Producers
More producers normally increase the quantity supplied or a product at a given price, Entry by foreign suppliers into the U.S. auto market increases the supply of cars in the U.S.
26
Government Subsides
Additional funding permits producers to purchase more inputs and, thus, increase quantity supplied at any given price.
27
Price Expectations
If producers expect higher prices, producer will increase their quantity supplied at any given price. Expecting prices to increase.
28
Reductions in Costs of Production and Technological Advances
Reductions in costs of production mean producers will increase their quantity supplied at any given price.
29
Other factors exhibit an inverse relationship with the supply curve, meaning that increases in that factor cause the supply curve to shift inward (or supply to decrease).
Increases in production costs (e.g., production taxes) and prices of other products.
30
Increases in Production Costs
If producers' costs increase, producers will decrease their quantity supplied at a given price.
31
Prices of Other Products
If producers may produce both product A and B, and producing A becomes more profitable, producers will decrease their quantity supplied of B at any given price.
32
Price Elasticity of Supply
A measure of how sensitive quantity supplied of a good or service is to a change in price or cost. Tells us how a change in prices will affect the quantity supplied by firms.
33
Owners of factors of production (labor, natural resources, capital, and entrepreneurship) aim to shift those factors to their most productive uses (Price elasticity of supply)
These efforts are reflected in economic rents or surpluses, which are the excess of the payments for these factors when used most productively over their best alternative use, which is known as opportunity cost.
34
Owners of factors of production (labor, natural resources, capital, and entrepreneurship) aim to shift those factors to their most productive uses (price elasticity of supply)
These efforts are reflected in economic rents or surpluses, which are the excess of the payments for these factors when used most productively over their best alternative use, which is known as opportunity cost.
35
Opportunity Cost
Is also known as the benefit given up from not using the resource for another purpose (the foregone benefit from alternatives not selected). Ex: if a worker accepts a job paying $60,000 instead of another offering $50,000, the worker would have received an economic rent of $10,000 from accepting the higher paying job, and faced an opportunity cost of $50,000 by doing so.
36
Market Equilibrium
Quantity Demanded = Quantity Supplied (perfect market, everything being demanded is big sold).
37
Market Equilibrium
Quantity Demanded = Quantity Supplied (perfect market, everything being demanded is big sold).
38
Some government actions that affect equilibrium
If governments impose a price ceiling (setting the maximum legal price at which a product or service may be sold - price can not go above ceiling price), resulting in shortages of goods. If governments impose a price floor (setting the minimum legal price at which a product or service may be sold - price can not go below floor price), resulting in unpurchased surpluses of goods or services.
39
Consumers
Microeconomic theory assumes that consumers, whether buying for their own personal, family, or household uses, seek to maximize their satisfaction (which economists commonly refer to as utility (ratification)).
40
Marginal Utility (Additional Satisfaction)
Spending more on one thing rather than another such that the marginal utility of spending money on the product or service chosen will be greater than from the alternatives they did't choose.
41
Law of Diminishing Marginal Utility (next not enjoyable as previous or last one)
According to the law of diminishing marginal utility, the more a consumer consumes of a particular product, the less satisfying will be the next unit of that product. A consumer maximizes total satisfaction when the last dollar spent on each product generates the same amount of marginal utility.
42
Indifference Curve
IC represents the combination of quantities of each product that yield a certain total utility. The choice that maximizes a consumer's utility is found at the intersection between the consumer's budget constraint (which is determined by what the consumer plans to spend and the relative price of the two goods) and the indifference curve with the highest level of utility the consumer may attain.
43
Personal Disposable Income
Consumers do not, of course, have unlimited amounts of money to spend. The available income of a consumer after subtracting mandatory payment of taxes (or adding receipt of government benefits, if applicable) is known as personal disposable income. Consumers have only two choices with each dollar of personal disposable income: they can either spend (consume) it or save it.
44
Marginal Propensity to Consumer (MPC)
The percentage of the next dollar of income that the consumer would be expected to spend (change in consumption / change in income). 1 - MPC = MPS
45
Marginal Propensity to Save (MPS)
The percentage of the next dollar that the consumer would be expected to save (change in savings / change in income). 1 - MPS = MPC
46
Production Costs
Over short periods of time and limited ranges of production, firms have costs that include both fixed and variable components.
47
Fixed Costs (FC)
Costs that won't change even even when there is a change in the level of production. Average fixed costs (AFC) are total fixed costs divided by the number of units produced. Ex. of a fixed cost is rent paid on the production facility.
48
Variable Costs (VC)
Costs that rise as production rises. Average variable costs (AVC) are total variable costs divided by the number of units produced. Ex. is materials used int he manufacture of the product.
49
Total Cost (TC)
The same of fixed and variable costs (TC = FC +VC). Average total costs (ATC) are total costs divided by the number of units produced.
50
Marginal Cost (MC)
The increase in cost that results from producing one extra unit. Only variable costs are relevant, since fixed costs won't increase in such circumstances.
51
Marginal Revenue (MR)
The change in total revenue (TR) associated with the sale of one more unit of output
52
Marginal Revenue Product
The increase in total revenue received by the addition of one additional unit of an input or resource (e.g. one more worker). If the marginal revenue of producing one extra unit exceeds its marginal cost, it is profitable to increase production.
53
Return to Scale
Are the increase in unit produced (output) that result from increases in production costs (i.e., cost of inputs).
54
At lower levels of production (and of use of inputs), many firms face returns to scale greater than 1, or increasing returns to scale.
Alternatively, these firms may be described as facing economies of scale, or increased efficiencies from producing more units of a product. Thus, in the long run firms may that increase their size by some amount may experience increasing returns, operate more efficiently, and lower their average costs.
55
However, ever larger levels of production (and of use of inputs), may eventually result in returns to scale smaller than 1, or decreasing returns to scale. These firms may be described as facing diseconomies of scale, or increased inefficiencies.
Note: Firms should not increase production beyond levels at which marginal revenue from output exceeds marginal costs from inputs.
Increasing returns to scale - output increases by a greater proportion > 1.0
Constant returns to scale - output increases in same proportion = 1.0
Decreasing returns to scale - output increases by a smaller proportion < 1.0
56
Market Structure and Industry Analysis
Ranging from most to least competitive, these models are perfect or pure competition, monopolistic competition, oligopoly or oligopolistic competition, and pure monopoly.
57
Market Structure and Industry Analysis
Ranging from most to least competitive, these models are perfect or pure competition, monopolistic competition, oligopoly or oligopolistic competition, and pure monopoly.
58
Perfect or Pure Competition
It includes a large number of sellers, each of which is too small to affect the overall market price, all firms sell a homogeneous (i.e., largely identical) product (wheat, soybeans, corn, etc.), there is non non-price competition (e.g., no advertising), firms may enter or exit the market very easily (there are no significant barriers to entry, ceilings or floors), and each individual firm faces a demand curve that is perfectly elastic (horizontal).
59
Monopolistic Competition
It includes a large number of sellers, firms sell heterogeneous products, there is lots of non-price competition (advertising, products with slightly differing features, actual quality differences) Ex. restaurants, cereal, and cell-phone companies. It is relatively easy to enter and exit to market, and each individual firm faces a demand curve that is slightly or somewhat downward sloping.
60
Oligopoly (or Oligopolistic Competition) - In some cases, a company's decision to gain market share by lowering its prices may result in other companies matching its pricing ( i.e., there would be a price war and market shares might not change appreciably). Governments seek to regulate oligopolistic competition variously, for instance forbidding formal quantity agreements among competitors, known as cartels and price fixing (or collusive pricing).
A small number of larger sellers, barriers to entry (cost or patents), non-price competition exists, rival actions are observed, and the firm's demand curve is kinked (limited quantity released).
61
Pure Monopoly
Ex: Walmart, Cable Companies
Natural monopolies may exist as economies of scale would permit the largest firm to underprice, and eliminate , all others. Companies with lower costs may seek to engage
62
Pure Monopoly - various laws have been passed to reduce anticompetitive market practices including:
The Sherman Act (1890) - prohibited price fixing, boycotts, market division, and restricted resale agreements among suppliers.
The Clayton Act (1914) - prohibited stock mergers that reduce competition, price discrimination, and common directorships among competing firms. (buying all grocery stores)
The Robinson-Patman Act (1936) - prohibited discounts to large purchasers not based on cost differentials.
The Celler-Kefauver Act (1950) - prohibits acquisition of the assists of a competitor if it would reduce competition.
Ex: Walmart, Cable Companies
Natural monopolies may exist as economies of scale would permit the largest firm to underprice, and eliminate , all others. Companies with lower costs may seek to engage in predatory pricing, charging temporarily low prices to drive their competitors out of existence, only to increase their prices as monopolists, once they have eliminated their competitors.
There is only one producer, no close substitutes are available, there is blocked entry (patent or Government franchise-public utility) and the firm's demand curve is substantially downward sloping (almost vertical).
63
Competition Analysis - To analyze their industry, firms may use competitor analysis to understand and predict the behavior of a major competitor.
The two components of competitor analysis are collecting information and using that information to understand, predict and respond to that competitor. Firms must also analyze their target market which involves determining who their customers are and why they are purchasing their products.
64
Strategic Planning
Involves organizations' efforts to identify their long-term goals and to determine how best to reach those goals.
65
Formal strategic planning typically involves several steps:
A typical first step involves creating (or updating) an organization's mission statement, which outlines the long-term purposes of an organization. After the organization has a mission statement, it may set its goals and objectives. Next organizations determine what actions should be taken to meet their goals and objectives and establish mechanisms to collect data to be able to engage
66
Formal strategic planning typically involves several steps:
A typical first step involves creating (or updating) an organization's mission statement, which outlines the long-term purposes of an organization. After the organization has a mission statement, it may set its goals and objectives. Next organizations determine what actions should be taken to meet their goals and objectives and establish mechanisms to collect data to be able to engage in assessment of whether the goals and objectives were met.
67
Product Differentiation Strategies (modified product and cost more)
Products may differ in many ways:
Physical Differences - individual features, quality, appearance
Perceived Differences - image, brand name, advertising
Customer Support Differences - return polices, technical support
Involve developing a range of slightly different products that are more attractive to one's target markets or simply to ensure atet they differ substantially from competitions' offerings. This strategy will (1) make the firm's sales less responsive to changes in the prices charged by other competitors, (2) allow the firm to charge different prices (i.e., some higher) for different products, and (3) ultimately allow the firm to charge higher prices than otherwise (and potentially higher than those of one's competitors).
68
Cost Leadership Strategies (decide how to create the cheapest product)
Concentrate on cutting the costs of producing, selling, and distributing a firm's range of products.
Process Reengineering - In-depth redesigns of firms' existing processes to improve performance.
Lean Manufacturing - Identifying and removing the misuse of resources in there firms' existing production processes.
Supply Chain Management - Sharing relevant information in the chain of sales that ranges from the final consumer to the various levels of suppliers, independently of whether each step took place within one's firm or not.
69
Microeconomics
Is the study of the decisions of, and interactions among, various individual economic agents (household and firms). The interaction of demand and supply determine the price, quantity produced and consumed, and the allocation of products and services.
70
Economics
The study of how we allocate scarce resources to satisfy unlimited wants.
71
Macroeconomics is the study of the economy as a whole.
Key concerns in macroeconomics include: unemployment, inflations, and long-term economic growth. Other subsidiary concerns in macroeconomics include: lending growth, interest rates, exchange rates, the trade balance and government budget deficits and debts. Macroeconomics studies the roles of households (consumers), (non financial) businesses, governments, the financial sector, and foreign economies in causing and/or alleviating undesired fluctuations in domestic economic conditions.
72
Economic systems may generally be classified as one of three broad categories: capitalism, communism (or socialism), and mixed economies.
Capitalism (USA) - also known as free enterprise, refers to a system where private parties (i.e., non-government ones) own most of the means of production and make most economic decisions (i.e., what and how much to produce, at what prices, and given their incomes and available prices, what and how much to consume.)
Communism (or socialism) - refers to a system where government entities own most of the means of production and make most economic decisions.
Mixed Economies (USA) - refers to the "in between" systems where both private parities and governments own substantial fractions of the means of production and make substantial fractions of economic divisions.
73
Some of the most important measures and indicators of economic conditions are (benchmarks to measure economic activities)
Gross Domestic Product (GDP, also known as nominal GDP) (most important), Real GDP, Gross National Product (GNP), Inflation, and Deflation
74
Gross Domestic Product (GDP, also known as nominal GDP)
The total dollar value, at current (or nominal) market prices, of all the "final" goods and services produced within one country's borders (regardless of the citizenship of the individual residents or the country of headquarters of the companies involved, within country, within borders) during a period of time (typically a year). The word "final" refers to the fact that GDP aims to avoid double counting of inputs used in the production of other products.
75
Gross Domestic Product (GDP, also known as nominal GDP)
GDP may be computed using either of two theoretically- equivalent approaches:
1/MPS x change in spending = increase GDP
The income approach sums all income earned in the production of final goods and services, such as wages, interest, rents, business profits, plus adjustments for indirect taxes and economic depreciation (expenditures to replace physical equipment that wears out).
The expenditure approach sums all expenditures to purchase final goods and services by households (personal consumption expenditures), businesses (gross private investment, e.g., machinery), the government, and the foreign sector (exports), minus adjustments for expenditures produced abroad (imports).
76
Real GDP
Real GDP is the total dollar value of all the final goods and services produced expressed using a price level that is constant (chained) over time. Nominal GDP is adjusted to yield Real GDP by removing the effects of increases in prices (i.e., inflation) from the sum of total purchases of goods and services (i.e., to focus on the changes in units sold, not on the changes in prices).
77
Real GDP (often simply referred to as GDP, economic production, or output) is the most commonly used and most comprehensive measure of economic production.
Adjusted For Inflation
78
Economists use a variety of terms and concepts that imply that there is a "sort of" speed limit for economic growth that economies may sustainably attain, but should be careful to not to exceed. Thus, aside from the "actual" nominal and real GDP. the Congressional Budget Office (CBO) also computes potential GDP (in nominal and real versions.
Which helps to estimate the degree to which the economy is either underutilizing resources or "overheating." If, for instance. actual real GDP falls short of potential real GDP, resources will be underused (unemployment rates will be higher). If actual real GDP exceeds potential real GDP, the economy will be overheating (resulting in unsustainably low unemployment rates, boom conditions in various markets, and eventually price inflation).
79
Concepts similar to potential GDP are the "natural" or "non-accelerating-inflation" rate of unemployment (NAIRU)
Where if the actual unemployment rate falls below NAIRU, boom conditions follow in the short-term and problems such as higher inflation eventual follow.
80
A key problem in macroeconomic management is that the negative consequences of exceeding these speed limits take place with long and variable lags.
i.e., it may take several years before there is clear evidence of a problem. Economists "joke" that macroeconomic policymaking is similar to driven a car being able to use only one's rearview mirrors.
81
Gross National Product (GNP) - is the total dollar value of all goods and services produced by a country's residents (including companies headquartered there) regardless of whether they were produced within or outside that country's borders. GNP differs from GDP in that GNP includes, for instance, earnings of U.S. companies abroad, and excludes earnings of foreign companies within the U.S.
By Our Residents
82
Inflation (shift demand curve)
Commonly defined as the percentage rate of increase in the price level of goods and services. Rising inflation means that individuals can purchase less either if they are on fixed incomes or with their past savings.
83
Inflation
While some parties include inflation adjustments in contracts (e.g., cost of living adjustment clauses), such clauses remain relatively rare in the U.S. Also while such clauses may benefit one party, they may be costly and ultimately shift the risk to a counter-party.
Protecting oneself against inflation effectively is difficult: The price of some assets (e.g., commodities, precious metals such as gold, and real estate) tend to outpace overall consumer inflation (i.e., provided a hedge) during some periods when inflation is climbing or expected to climb. However, these same assets may fall in price when he risk of inflation subdues. Thus, while precious metals may provide protection over short periods of climbing inflation, over the long term, common stocks, for instance, have delivered far higher returns.
84
Deflation
| Results, in low interest rates
A term describing a general decline int he price level (i.e., not a decline in the prices of just a few goods ) or a negative inflation rate. The solution for deflation (that is most commonly cited and that is most theoretically accepted) is to increase the money supply (easier in theory, than practice).
85
The Consumer Price Index (CPI) - compares the price of a fixed basket of goods and services that a typical urban consumer might purchase in an earlier base period (e.g., 100 in 1982-84) and the price of the same basket of goods and services at later times.
The CPI is commonly used to convert "nominal" figures that are not readily comparable across years into "real" figures that use the same level of prices and are therefore more comparable.
86
The Producer Price Index (PPI)
Compares the price of a fixed basket of goods, inputs, and materials purchases by producers at the wholesale level instead of focusing on the prices paid at the retail level by consumers.
87
The GDP Deflator
Is the most comprehensive measure of price levels, including prices paid by all parties included in GDP instead of only consumers. The GDP deflator is the index used to convert nominal GDP into real GDP.
88
Aggregate Demand and Supply
Just as there are demand and supply curves for individual products, some economists find it helpful to use aggregate demand and supply curves for the overall levels of prices and production of goods and services of an entire economy.
89
Aggregate Demand Curve
Seeks to represent the relationship between (1) total expenditures by consumers, businesses, government, and the foreign sector and (2) the price level, at a given point of time.
90
(Due to inflation) The aggregate demand curve may slope downward for several reasons:
Interest Rate Effect- higher inflation rates increase nominal interest rates and may decrease consumer borrowing, reducing the quantity demanded (negative shift in the demand curve) of items whose purchase is typically financed, such as houses and automobiles.
Wealth Effect - higher inflation rates reduce the value of most fixed income investments (such as conventional bonds). Having less wealth, individuals may consume less.
International Purchasing Power Effect - domestic inflation makes domestic goods and services more expensive relative to foreign goods and services, increasing the quantity demanded of foreign products and decreasing the quantity demanded (negative shift in the demand curve) of domestic goods and services.
91
Aggregate Supply Curve
Seeks to represent the relationship between (1) total goods and services produced (production, output, or quantity) and (2) the price level, at a given point of time. Economists don't often agree on the precise shape of the supply curve, but for the purposes of the CPA exam, we will simply assume that it is generally upward sloping.
92
Demand-Pull Inflation (i.e., the demand curve sifted upward - consumers demand more, demand curve shifts out and people are willing to pay more)
When aggregate spending increases, the demand curve moves to the right, causing the market equilibrium to occur at higher price levels. Excess demand bids up the cost of labor or other resources. Excess demand may be a result, for instance, of improved expectations by consumers or businesses, of the foreign sector, or from government fiscal and monetary policy that turned out to be too loose.
93
Demand-Pull Inflation
We often observe that when economies are growing quickly and unemployment rates fall particularly low (e.g., below NAIRU), wages, company costs, and consumer inflation rates rise more quickly. Conversely, when economies are not growing as fast and unemployment rates are higher (above NAIRU), wages, company costs, and consumer inflation rates rise less quickly, if at all.
This short-term tradeoff between inflation and unemployment is known as the short-term Philips Curve. However, this tradeoff holds only in the short-term. In the long-term (i.e., after a few years) , unemployment rates rise back to NAIRU.
Policies that seek to reduce unemployment below NAIRU may seem to succeed in the short-term, but do not yeild sustainable reductions in unemployment, but increases in inflation.
94
Demand-Pull Inflation
We often observe that when economies are growing quickly and unemployment rates fall particularly low (e.g., below NAIRU), wages, company costs, and consumer inflation rates rise more quickly. Conversely, when economies are not growing as fast and unemployment rates are higher (above NAIRU), wages, company costs, and consumer inflation rates rise less quickly, if at all.
This short-term tradeoff between inflation and unemployment is known as the short-term Philips Curve. However, this tradeoff holds only in the short-term. In the long-term (i.e., after a few years) , unemployment rates rise back to NAIRU.
Policies that seek to reduce unemployment below NAIRU may seem to succeed in the short-term, but do not yield sustainable reductions in unemployment, but increases in inflation.
95
Cost-Push Inflation (i.e, the supply curve shifted inward) - Push cost to consumers and prices go up.
If producers (or suppliers) within one country face increases in the costs of using some inputs (e.g., commodities such as oil), the aggregate supply curve would shift to the left, causing the market equilibrium to occur at a higher price level and at a lower quantity. Since the prices of many production inputs are set in international markets, individual countries may experience changes in those input costs that are not directly, or strictly, related to economic conditions within that country.
96
Cost-Push Inflation
Stagflation - a term that combines the words stagnation and inflation, but it is vernally used to describe periods of high inflation and high unemployment
97
Multiplier Effect - Stimulate Economic
If an economy is producing below it potential, increases in spending by consumers, businesses, the government, or the foreign sector may cause increases in output that exceeds the increase in spending. Any initial increase in spending my act with that is called a multiplier effect mobilizing otherwise idle or unemployed resources, as the first round of increased spending becomes income to previously underutilized suppliers, who in turn will spend more, increasing the income of other suppliers, etc. (stimulus pack given out to individuals)
98
Business Cycle
Business Cycles are fluctuations in economic production (GDP output) typically lasting several years. Some business cycles have been shorter (barely a couple of years) and others longer (over one decade).
99
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
Expansion - typically extended period (i.e., several years) of increased economic production. The final stages of many expansions during the twentieth century were marked by booming economic conditions including GDP above potential and higher rates of inflation. Increased spending will cause a positive shift in the demand curve to the right (higher equilibrium GDP). Technological advances will also cause a positive shift in the supply curve also resulting in a higher equilibrium GDP.
100
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
Expansion - typically extended period (i.e., several years) of increased economic production. The final stages of many expansions during the twentieth century were marked by booming economic conditions including GDP above potential and higher rates of inflation. Increased spending will cause a positive shift in the demand curve to the right (higher equilibrium GDP). Technological advances will also cause a positive shift in the supply curve also resulting in a higher equilibrium GDP.
101
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
Recession (or Contraction) - typically briefer periods (i.e., several months or only a few years) of decreased economic production.
102
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
Recession (or Contraction) - typically briefer periods (i.e., several months or only a few years) of decreased economic production. As a rule of thumb, economists describe recessions as periods of at least two consecutive quarters of negative growth in real GDP.
103
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
Recession (or Contraction) - typically briefer periods (i.e., several months or only a few years) of decreased economic production. As a rule of thumb, economists describe recessions as periods of at least two consecutive quarters of negative growth in real GDP.
104
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
The declines in economic production during recessions are accompanied by declines in employment and increases in unemployment rates (Okun's law provides a commonly-mentioned rule of thumb relating declines in GDP and increases in unemployment.) At the end of recessions, GDP is well below potential. Periods of decreased aggregate spending will shift the demand curve to the left and result in a lower equilibrium GDP. Trade wars cause a negative shift in the supply curve and also cause a decline in GDP.
105
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
Depression - A recession that is either particularly deep or long lasting. There is no formal agreement as to the4 boundary between recession and depression.
106
```
Terms used in connection with the business cycle include:
Expansion
Recession (or Contraction)
Depression
Recovery
```
Recovery - the early stages of an expansion, commonly thought to become a full expansion when the peak from the previous expansion is passed.
107
Expansion, Contraction, Expansion, Contraction, Expansion
Economist track many indicators to gauge, evaluate, and predict current future economic conditions. These indicators may be classified into three broad categories: leading indicators, coincident indicators, and lagging indicators.
108
Leading Indicators (happens few months before or after recovery) - seek to predict whether expansions (or recessions) are likely to end within the next few months.
Some commonly-used leading indicators include changes in stock market prices, average hours insurance, building permits, and new private housing starts indicate recovery.
109
Coincidence Indicators (at turn) - normally move up and down simultaneously (coincide) with economic expansions and recessions.
Examples include industrial production and manufacturing and trade sales.
110
Lagging Indictors - only move up and down months after economic conditions change.
Example include the average prime rate for bank loans, the average duration of unemployment, and the unemployment rate.
111
Increases in economic growth do not necessarily result mechanically in increases in job growth in the short-term. For instance, if businesses are afraid that growth is temporary, they may rely on overtime from existing employees rather than hiring new workers. However, in the long term, subject to long and variable lags, economic growth does tend to result in job growth. In a sense, sustained declines in the unemployment rates serve as one of the most important lagging indicators of economic recovery.
Economists commonly identify three or four types of unemployment: frictional unemployment, structural unemployment, cyclical unemployment and institutional unemployment.
Note: The "Full-employment," "natural," or "non-accelerating-inflation" rate of unemployment (NAIRU) rates, are the rates below which unemployment may not fall sustainably without causing boom conditions that eventually may result in higher rates of inflation. If we identify only the three types of unemployment above, NAIRU would largely be the same of frictional and structural unemployment.
112
Frictional Unemployment - affects workers who are unemployed as a result of the normal turnover of works between jobs or of new entrants into the workforce (friction between you and your boss).
Structural Unemployment - affects workers who lose their jobs as a result of changes int he demands for goods and services (e.g., manufacturers of horse buggies when automobiles take off) or of technological advances that reduce the need for their current skills (e.g., car mechanics unused to electronics in automobiles). Technological advances - changes in technology.
113
Cyclical Unemployment - involves job losses resulting from the fluctuations in the business cycle. This type of unemployment is the key concern during recessions and decreases during expansions.
Institutional Unemployment - some economists identify this type of unemployment as that affecting workers who cannot find employment as a result of government restrictions on the economy.q
114
Interest Rates (price borrowers pay) - refer to the prices that various borrowers (households, businesses, governments, even financial institutions) pay in exchange for "funds" (i.e., loans and bonds), and the prices that lenders (or depositors) receive in exchange for forgoing the use of their funds of various periods of time (ranging from long periods as in mortgages and certificates of deposit to potentially "zero" time, as in checking and savings accounts). Interest rates are determined by the demand and supply of funds.
(Effected by supply and demand) The supply of funds is affected by past and current saving by households (e.g., older ones) and many firms, but also by government monetary policy. Increases in the demand for loans (whether by households, businesses, or governments) put upward pressure on interest rates.
115
```
Types of Interest Rates Include:
Nominal Interest Rates
Real Interest Rates
Risk-Free Interest Rates
Federal Funds Rate (Discount Rate)
Prime Rate
```
Nominal Interest Rates - are those regularly quoted by financial institutions. Setting interest rates, financial institutions and markets will include "premiums" to protect themselves against expected problems such as inflation, loan defaults ("credit risk"), etc. Of course, actual levels of inflation and loan defaults often vary from those expected when interest rates are originally set.
116
```
Types of Interest Rates Include:
Nominal Interest Rates
Real Interest Rates
Risk-Free Interest Rates
Federal Funds Rate (Discount Rate)
Prime Rate
```
Real Interest Rates - are adjusted for inflation. Calculations of real interest rates often seek to incorporate the rate of inflation that is expected in the future. In practice, such expectations typically largely mimic recent historical experience.
117
```
Types of Interest Rates Include:
Nominal Interest Rates
Real Interest Rates
Risk-Free Interest Rates
Federal Funds Rate (Discount Rate)
Prime Rate
```
Risk-Free Interest Rates - are those that would be charged to borrowers if lenders had an absolute certainty of being repaid (i.e., no credit risk).
U.S. Treasury securities
118
```
Types of Interest Rates Include:
Nominal Interest Rates
Real Interest Rates
Risk-Free Interest Rates
Federal Funds Rate (Discount Rate)
Prime Rate
```
Federal Funds Rate (Discount Rate) = are those that commercial banks charge and pay one another for short-term loans of reserves (i.e., unlent cash, also called "federal funds) at the Federal Reserve System (the US central bank, commonly called the "Fed"). Federal Reserve loan money to banks, in turn, banks loan money to consumers.
119
```
Types of Interest Rates Include:
Nominal Interest Rates
Real Interest Rates
Risk-Free Interest Rates
Federal Funds Rate (Discount Rate)
Prime Rate
```
Prime Rate - the rate banks charge their most creditworthy business customers on short-term loans. Throughout the last two decades, most banks have routinely set their prime rate at a 3% premium over the federal funds rates.
120
Government Involvement in the Economy -
Fiscal Policy
Monetary Policy
Regulatory Policy
Government intervene in many aspects of the economy through these policies.
121
Fiscal Policy - (government internals to fix things, for the better - control taxes, government spending).
Involves governments setting, applying, and changing levels of taxes, subsides, and government spending. Many economists argue that, if (1) economic production (GPD) is below potential, (2) the financial sector is failing to lend funds adequately, (3) unemployment rates are too high, then governments may successfully use deficit spending as expansionary fiscal policy to increase aggregate demand and, thus, output. Deficit spending involves increasing spending levels without increasing tax revenues by an equivalent amount, or lowering tax revenues without decreasing spending by an equivalent amount.
122
The federal (deficit) is the amount by which (federal) government expenditures (or spending or outlays) exceed (federal tax) revenues (or inlays) within a period of time (typically, reported for one year, or one month). The U.S. government finances its deficits through the sale of U.S. Treasures (called bills, notes, and bonds depending on their maturity).
The (federal or national) debt is the total amount of outstanding U.S. Treasurys or the sum of past deficits (subject to some adjustments as some government agencies hold securities issued by other branches of government).
123
Conversely, if (1) economic production is above potential and (2) there are concerns about boom economic conditions and current or upcoming rates of inflation that are too high, then governments may run budget surplus as concretionary fiscal policy (increase taxes) to reduce aggregate demand and, thus, inflation. Historically far rarer, (federal) surpluses involve revenues exceeding expenditures.
Types of taxes include income and payroll taxes (like those for social security and Medicare) and International trade tariffs (all of the above chiefly used by the Federal government), sales (consumption or excise) taxes (chiefly used by state governments), and property taxes (chiefly used by local governments). Current income taxes use "progressive" tax rates that are higher for those with higher incomes and zero or, even negative, for those with lower incomes. Some economists argue that income taxes reduce incentives for individuals to work and, conversely, that switching to consumption taxes would increase incentives for individuals to save.
124
Monetary Policy - (control increase or decrease of money)
Involves efforts by the central bank of the U.S., the Federal Reserve System (or "Feds") to manage credit conditions, interest rates and the money supply. Like other elements of macroeconomic policy, the key goals of monetary policy include (1) maximizing economic growth, (2) minimizing unemployment rates, (3) minimizing inflation rates, and (4) minimizing economic and financial fluctuations, i.e., ensuring financial stability, minimizing boom-bust cycles, avoiding financial crises, and minimizing failures of financial institutions. The Fed has several tools at it disposal to carry out expansionary monetary policy (e.g., to reduce unemployment rates) and contractionary monetary policy (e.g., to reduce inflation rates. Reserve requirements (ratio), discount rate and open-mark operations
125
Reserve Requirements (Ratio) - (Feds tell banks what ratio to hold of money).
The Fed may affect the total amount of lending in the economy (e.g., tighten/loosen credit conditions) by changing (i.e., increasing/decreasing) the percentage of customer's deposits that the Fed requires baks to hold in reserve (i.e., bot to be loaned out).
126
Discount Rate - (Rate bank can borrow money from Feds)
The Fed may affect the total amount of lending in the economy (e.g., tighten/loosen credit conditions) by changing (i.e., increasing/decreasing) the interest rate (called the discount rate) that it charges banks for short-tern emergency loans. Few banks request these types of loans to avoid the stigma of informing the Fed that they need emergency help.
127
Open-Market Operations (Feds buy or sell government securities)
When the Fed is concerned about high unemployment rates, it can engage in expansionary (stimulate economy) monetary policy by lowering its target for the federal funds rate, buying government securities on the open market, thereby increasing the amount of reserves available for banks to lend (the money supply).
When the Fed is concerned about boom conditions or expected high inflation rates, it can engage in contractionary monetary policy by increasing its target for the federal funds rate, or selling government securities on the open market, or both, thereby decreasing the amount of reserves available for banks to lend (the money supply).
128
Monetary policy may impact economic conditions because looser (or tighter) credit conditions may affect the decisions of individual economic agents (households and businesses).
Looser credit conditions (e.g., lower interest rates and more readily available credit) tend to stimulate consumer and business spending (and thus aggregate demand). Tighter credit conditions (e.g., high interest rates and less readily available credit) tend to discourage consumer and business spending of course. Because monetary policy is beset with long and variable lags that may be several years long, achieving the many goals of monetary policy sustainable is not easy in practice.
129
Regulatory Policy
Governments may further influence economic activity through regulations affecting environmental issues, labor issues (e.g., immigration and minimum wage laws), occupational health and safety, energy policy, healthcare, bank capital, lending practices, etc.
