Unit 6

Long-Run Economic Growth, Phillips Curves, and the Laffer Curve

• Focus on Real GDP per Capita
• Last 50 Years Real GDP grew by about 3.5% per year
• Last 50 Years Real GDP per Capita grew by about 2.3% per year

The Sources of Long-Run Growth:

• Productivity—output per unit of input
• Labor Productivity – output per worker
* What leads to higher productivity?
* Stock of Physical Capital – buildings, machines, robots, etc.
* Human Capital – Knowledge, skills, educations, etc.
* Technology – technical means for producing goods and services
* Improved Resource Allocation – Trade allows us to shift labor services from low-productive jobs to high productive jobs.
* Economies of Scale – reductions in per-unit cost that result from increases in the size of markets and firms.

Production Possibilities Curve and LRAS:

• Economic Growth = Shift in Production Possibilities Curve outward
• Economic Growth = Shift in the Long-Run Aggregate Supply Curve to the RIGHT

Why Growth Rates Differ among Countries:

• Rates of Savings
• Foreign Investment
• Education
• Infrastructure – roads, power lines, ports, and information networks, etc.
• Research and Development
• Political Stability
• Protection of Property Rights
• Economic Freedom versus Excessive Government Intervention

The Phillips Curves – Short and Long Run

• Tradeoff between inflation and unemployment
• Stagflation leads to shifts in the SRPC.
* Aggregate Supply Shocks: Oil Embargo, Major Agriculture Shortfalls, Depreciating U.S. Dollar, Wage Hikes, Inflationary Expectations.
• Long-Run Phillips Curve (LRPC)
* Vertical line at the natural rate of unemployment

Supply-side Economics and the Laffer Curve

• Stress that changes in Aggregate Supply are an active force in determining the levels of inflation, employment, and economic growth.
• Concentrate on tax levels
• Lower taxes are an incentive for business to invest in our economy
• Lower taxes are an incentive for workers to work more and harder thereby becoming more productive.
• Lower taxes are incentives for people to increase savings and therefore create lower interest rates for increases in business investment
• Focus on the marginal tax rates

The Laffer Curve:
• Relationship between tax rates and tax revenues
• Used to support the supply-side argument
• Reaganomics = Supply-Side Economics
• Idea = The government could lower tax rates and actually increase tax revenues.
• Has been severely criticized.

Unit 5

Unit 5
Sras- time too short for wages to adjust to the price level. The reason is that workers may not be aware of changes in their real wages due to inflation therefore they adjust their labor decisions accordingly as well as wage demands.

Nominal wage- is the amount of money received per day, per hour, per year
Real wage- adjusted for inflation and everything else.

Long run AS- time long enough for wages to adjust to the price level. Key assumptions:
1. Wage and price is flexible
2. Changes in wage and price offset eachother
3. LRAS = vertical line
4. Changes:

Phillips Curve:

3 generalization:
-Inverse relationship between inflation and unemployment
-Aggregate supply shock can case higher rates of inflation and higher rates of unemployment
-No significant trade off between inflation and unemployment in the long run

If inflation persists, and the expected rate if inflation rises then the entire SRPC moves upwards (stagflation is possible or probably)
If inflation expectations drop due to new technology then the SRPC moves downwards.

Increase in AD = up/ left movement along SRPC
Decrease in AD = down\ right along SRPC

*SRPC label at the bottom

SRAS -> = <- SRPC

SRAS <- = -> SRPC (Stagflation)

LRPC:
-vertical at full employment
-major LRPC assumption is that more worker benefit create higher natural rates of unemployment and fewer worker benefit create fewer natural rate of unemployment

-shift= same as LRAS

Misery index:
-a combination of inflation and unemployment in a given year.
-single digit misery is good.

*seasonal, structional, frictional = Natural rate of unemployment

Supply Shock- it is a rapid an significant increase in resource prices which cause the SRAS to shift which results in producing a shift in the SRPC curve.
Ex: Oil embargo
increase in input prices
Wage height
(Positive or negative)

Disinflation- reduction in inflation rate from year to year which can be seen in the long run Phillips curve.


Stagflation- increase in inflation and unemployment.


Supply side economics(Raeganomics) -Tends to believe AS curve will determine levels of inflation, unemployment, and economic growth.

Increase economy= shift AS right

-focus on marginal tax rate

Marginal tax rate- amount of tax payed on an addition dollar of income

* by reducing marginal tax rate it will encourage more people to work longer

* high marginal tax rates may end up reducing savings since when you save money you are then taxed at a higher rate on your profit of interest

As tax rate increase from zero, tax revenues increase from zero to maximum number then they decline.

3 criticisms of laffer curve:
1. Where the economy is actually located on the curve is difficult to determine.
2. Tax cuts increase demand which can fuel inflation and demand may exceed supply
3. Research states that tax rates impact peoples incentives to work, invest and save.

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