Unit 4

Uses of money:
-Medium of exchange: trade or batter with the money.
-Unit of account: established economic worth.
-Store of value: money holds it's value over a period of time.


Types of money:
-Commodity money: gets it's value from material it's made. Ex: gold and silver coins.
-Representative money: paper money back by something tangible.
-Fiat money: money because government says so.

Characteristics of money:
-durability: money lasts through many transaction.
-portability: transport money
-uniformity: even/uniform
-divisibility: divide your bill into smaller units
-scarcity: may not have money at the moment in time
-acceptability: it is acceptable anywhere

M1 money:
-currency: cash and coins
-checkable deposits or demand deposits (checking accounts)
-travelers check
-75% money in circulation
-more liquid- more easy to convert to cash

M2 money:
-savings account
-money market accounts
-CDs (certificate deposits)
-deposits held by banks outside the US.
-plus M1 money
-25% money in circulation
   
*Assets= Liabilities+ net worth
*Bank deposits are subject to a reserve requirement.

1. Excess Reserves= actual reserves- required reserves (assume 20% reserve requirement)

*bank creates money by lending excess reserve and destroy it by loan repayment. Purchasing bonds from the public also creates money.

Monetary policy:
-Influencing the economy through changes in reserves which influences the money supply and available credit.
-Controlled by Fed (Federal reserve bank)
- Fed = bankers bank

4 options if monetary policy:

1. Reserve requirement- Percent that is set by the fed of the minimum reserve a bank must have
2. Discount rate- banks barrow money from the federal reserve
(Last resort)
3. Federal fund rate- banks loan each other overnight funds
4. Omo (Open Market Operation)- Fed buys bonds > expands money supply
Fed sells bonds> decrease money supply
"Fed"= buy or sell secueities (bonds)

Single bank: amount of money single bank can create (loan out) = ER

AR-RR=ER

Banking system: can create money by a multiple of it's initial ER deposit multiplier = 1/RR = 1/.10 = 10

System new $: Deposit multiplier X initial ER

*Total change in the money supply as a result of the deposit. 

*If initial deposit is not new money, the total change in MS is only the new money created by the banking system. 

Unit 4 – Money & Banking / Monetary Policy

BASIC CONCEPTS

Types of money: 
1. Commodity money- a good that has other purposes that also functions as money.
Ex: african tribes using cows as money
2.Representative money- whatever you are using as currency represents a specific quantity of precious metal.
Ex: gold, silver
3. FIAT money- money not backed by precious metal, it must be money accepted by transaction, backed by the word of the government.
Ex: United States dollar bill

Three functions of money:
1. Medium of exchange- through money, exchanges happen
2. Store of value- when money is put away, you expect it to still have its same value
3. unit of account- price implies worth

Money market graphs:
-Vertical axis - interest rate (price) = i
-Horizontal axis- quantity = QM
-Demand for money slopes downwards = DM
-Why downwards? price is high = quantity demanded is low (vise versa)

Supply of money (SM) is vertical because it does not vary. It ties in with interest rate and fixed by FED.

Demand line -> = demand in more money, but decreases interest rates (vise versa)
*quantity doesn't change due to fixed SM

*SM moves right if the federal government doesn't want a high IR

The FED: Tools of money policy:

Expansionary (easy money):
-RR = decrease
-DR= decrease
-FED buys bonds
Contractionary (tight money)
-RR= increases
-DR= increases
-bank sells bonds
*Federal Open Market Committee makes market decisions
*Required reserve ratio is % of DD that can't be loaned out

Loanable funds graph:

-Vertical axis - interest rate (price) = i
-Horizontal axis- quantity of funds = QLF
-Demand of funds (DLF) = downward slope
*Why? IR is high = demand is low
- Supply of funds(SLF) = upward slope
*Demand curve -> increase in IR

Money Creation Process: creates money by making loans

-Money multiplier: 1/RR

-Multiple deposit expansion: money loaned out and put into another bank and the money used for different loan, cycle repeats.

*Reserve Requirement: % of the banks total deposits that has to be kept in reserves either loan cash or deposits.
*multiplier x loan given = total amount money created
*higher excess reserve, less money created

Money Market, Loanable Funds, AD-AS:
*change in price = change in money supply
*increase demand for money = higher IR
*MV=PQ (change in M =change in P)
*Fisher effect: IR is proportional to price and change in inflation

Fiscal policy

Expansionary and contractionary policy Deficit and Surpluses Built-in-stability

Fiscal policy-changes in the expenditures or tax revenues of the federal gov. 
- 2 tools:
- taxes- gov. can increase or decrease taxes
- spending- gov. can increase or decrease spreading
Fiscal policy is enacted to promote nations Economic goals:
Full employment
Price stability
Eco growth

Balance budget:
-revenues= expenditure
Balance deficit:
-revenues < expenditures
Budget surplus:
-revenues> expenditures 
Government debt:
-sum of all deficit-sum of all surpluses

Government can borrow from:
-individuals
-corp.
-financial instit.
-foreign entities

Discretional fiscal policy (action)
-expansionary fiscal policy (DEFICIT)
-contractionary fiscal policy (SURPLUS)
Non-discretionary fiscal policy (non action)

Discretionary:
-increasing or decreasing gov. spending and/or tax order to return the economy to full employment. 

Automatic:
-unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation. 

Contractionary: policy that designed to decrease AD
-for controlling inflation

Expansionary F.P: policy designed to increase AD
-for increasing GDP, controlling recession, and reduce unemployment. 

Automatic or Built-in-Stabilizers
-anything that increases the gov. budget deficit during a recession and increases it's budget surplus during inflation without requiring help from policy makers 
-Progressive tax system
- average tax rate (tax revenue/ GDP) rises with GDP
-Proportional tax system
-average tax rate remains constant as GDP changes
-Regressive Tax system 
-average tax rate falls with GDP

Interest rate and Investment Demand

How does business make investments decision?
-cost/benefit analysis
How determine business?
-expected rate of returns
How business count cost?
-interest cost
How business determine amount investment they undertake?
-compare expected rate of return to interest cost
-if expected return> interest cost, then invest 
- if expected return< interest cost, then do not invest. 


Real vs. Nominal:
 
What is the difference?
-nominal is the observable rate of interest. Real subtracts out inflation (pi%) and is only known ex post facto. 
What then determines the cost of investment decisions? 
-the real interest rate (r%)

What is the shape of the investment demand curve? 
-downward sloping
Why?
-when interest rates are high, fewer investments are profitable; when interest rates are low, more investments are profitable. 

Shifts in investment Demand:
-cost of production
-business taxes
-technology change
-stock of capital
-expectations

Consumption and Savings

Consumption

-Household spending

-The ability to consume is constrained by

          -The amount of disposable income

          -The propensity to save

-Do households consume if DI = 0?

          -Autonomous consumption

          -Dissaving

Saving

-Household NOT spending

-The ability to save is constrained by

          -The amount of disposable income

-The propensity to consume

          -Do households save if DI = 0?

               -No

APC & APS (Average Propensity to Consume & Average Propensity to Save)

-APC + APS = 1

-1 – APC = APS

-1 – APS = APC

-APC > 1 = Dissaver

-–APS = Dissaver

MPC & MPS

-Marginal Propensity to Consume

          -Change in consumption / change in disposable income

          -% of every extra dollar earned that is spent

-Marginal Propensity to Save

          -Change in saving / change in disposable income

          -% of every extra dollar earned that is saved

          -MPC + MPS = 1

          -1 – MPC = MPS

          -1 – MPS = MPC

Determinants of C & S

-Wealth

-Expectation

-Household Debt

-Taxes

MPC, MPS & Multipliers
-The Spending Multiplier Effect
          -An initial change in spending (C, IG, G, Xn) causes a large change in aggregate spending or
           Aggregate Demand (AD).
          -Multiplier = change in AD / change in spending
          -Multiplier = change in AD / change in C, I, G, or Xn
          -Why does it happen?
               -Expenditures and income flow continuously which sets off a spending increase in the economy.
  
Calculating the Spending Multiplier
-The spending multiplier can be calculated from the MPC or the MPS
-Multiplier = 1/1-MPC or 1/MPS
-Multipliers are (+) when there is an increase in spending and (-) when there is a decrease

Calculating the Tax Multiplier
-When the government taxes, the multiplier works in reverse
-Why?
          -Because now money is leaving the circular flow
-Tax Multiplier (note: it’s negative)
          -= -MPC / 1-MPC or –MPC / MPS

-If there is a tax cut, then the multiplier is +, because there is now, more money in the circular flow

Aggregate Supply & Aggregate Demand

Recessionary Gap
-A recessionary gap exists when equilibrium occurs below full employment output


Inflationary Gap
-An inflationary gap exists when equilibrium occurs beyond full employment output



Classical

-Competition is good
-Believes in the invisible hand
-In the LR the economy will balance at FE
-Trickle Down Effect - Help the rich first and everybody else second


Keynesian

-Competition is flawed
-In LR, we are all dead


LRAS (Long Run Aggregate Supply)
-Deals with potential output

LRAS Shifts

-Technology
-Capital Resources
-Growth
-Entrepreneurship
-Resources Available