Topic 1: Introduction & Concepts Flashcards
Economics is the study of allocating scarce resources amongst competing ends: (4)
- Land
- Labour
- Capital Goods
- Finance
Roles of Money (3)
- Medium of exchange (increased efficiency over barter)
- Unit of account (measure value)
- Store of value (purchasing power over time, more liquid than other stores of value)
Money turns your income into a financial asset. The price of money is controlled by the central bank. If inflation is high, income is eaten away. Control inflation through the cash rate
Economic theory and finance theory assume (6)
- perfect competition
- rational economic agents
- rational expectations
- low transaction costs
- excellent political systems, legal structures and property rights
- markets always moving to market clearing equilibrium - EMH
Keynes “animal spirits”: (5)
- Confidence
2,. Fairness (too little macroeconomic work reflects fairness) - Corruption
- Money illusion (some people don’t see through inflation)
- Stories
Describe
Stocks,
flows
& change of pace in flows
Stocks: Balance Sheet, Assets & Liabilities - Wealth
Flows; Production, Income & Spending - GDP etc
Change of Pace in flows - Usually the 1st (ie growth) and sometimes 2nd differentials)
The main aggregate components of GDP
EXPENDITURE
PRODUCTION
INCOME
GNE = Private Consumption (C) + Private Investment (I) + Public Final Demand (G); and Exports (X) and Imports (M)
GDP (P) = Business Output + Dwelling output + General Government Output (+ X-M)
GDP (I) = Business wages, salaries supplements + Business GOS (profits) + Dwelling GOS + Gen Govt GOS + Gen Govt WSS) + Gen Govt GOS + Indirect taxes less subsidies
The Main components of GDP
S>I: ?
X-M>0 = ?
S<I = ?
C + S = Y = GDP = C + I + X - M
Consumption + Savings = Income
S = I + (X-M)
S>I: National savings > national investment
X-M>0: trade surplus, adds to external assets
S<I: Trade deficit: adds to external borrowings. Aus = generally deficit.
Balance Sheets
Economic Agents & Sectors (name 5)
- Households
- Non Financial Corporations
- Financial Corporations
- Government
- Rest of the World
Balance of Payments = Current Account & Capital Account
Current + Capital Account must balance
Current account components:
Merchandise trade (export of goods, import of goods)
Balance of trade in goods
+ Net Services
= Balance of trade in goods & services
Balance of trade in goods & services
+ net income (Aus borrows from ROW, pays interest & divs)
+ unilateral transfers (eg foreign aid)
= Current account balance
Balance of Payments = Current Account & Capital Account
Current + Capital Account must balance
Capital Account - components
Direct investment (FDI)
+ Portfolio capital (equities, bonds, bank debt)
+ Private short term capital flows
+ Official capital flows (changes in central bank holdings of foreign assets & gold (increase = -ve)
= Capital account balance
Balance of Payments = Current Account & Capital Account
Current Account Deficits - when to be concerned
Twin deficits = ?
IMF rule is that deficit of more than 5 - 6% of GDP needs to be watched. More than 10% is probably unsustainable
Twin deficits = government deficit and current account deficit
Why Debt Matters
Good debt (?) Good debt supports growth and allows: (4)
Good debt supports growth and allows:
- individuals to smooth consumption in the face of a variable income
- corporations to smooth investment & production in the face of variable sales
- govts to smooth spending across lifetimes & generations & smooth taxes in the face of variable expenditures. Also liquidity services
- Good debt improves the efficiency of capital allocation across the economy & should shift risk to those most able to bear it.
Why Debt Matters
High Debt = ?
Bad Debt = ?
High Debt:
- risky for borrowers & lenders
- borrowers more likely to default
- lenders can stop lending and consumption / investment falls - Real volatility, financial fragility, reduces growth
- Procyclical behaviour can cause credit fuelled booms & default driven busts
Excessive Debt: Bad for growth & stability
1. beyond certain high point / threshold, private & public debt is dangerous
2. wise to keep room for extraordinary shock
3. avoid spirals
BIS cross country study = govt debt beyond 85% GDP detracts 0.1% from GDP for a further 10%.
Savings & Wealth effect
- feel wealthy, spend more
- Definition of saving - that bit of disposable income that is left over and not spent on consumption
- income (therefore savings) excludes capital gains whether realised or not realised
Business Cycle considerations
- accelerator / multiplier (eg housing, IT investment)
- Inventory cycle
- Trade & commodity price cycles
- Pro-cyclical behaviour of finance & financiers
- :Policy mistakes
- Unanticipated shocks
