Economic Review Resource page
Use this to help complete the Semester review
Four Market Structures
Ignore graphs in video
1. Economic growth – produce more and better goods and services
2. Full employment – suitable jobs for all citizens who are willing and able to work
3. Economic efficiency – achieve the maximum production using available resources
4. Price-level stability – avoid large fluctuations in the price level (inflation +
5. Economic freedom – businesses, workers, consumers have a high degree of
freedom in economic activities
6. Equitable distribution of income – try to minimize gap between rich and poor
7. Economic security – provide for those who are not able to earn sufficient income
8. Balance of trade – try to seek a trade balance with the rest of the world
FACTORS OF PRODUCTION
Land – all natural resources usable in the production process
Capital – all manufactured aids to production (tools, machinery, equipment, and
factory, storage, transportation, and distribution facilities used in producing goods
Labor – physical and mental talents of individuals available and usable in producing
goods and services
Entrepreneurial ability – the entrepreneur 1) takes the initiative in combining the
other resources to produce a good or service, 2) makes basic business-policy decisions,
3) is an innovator, and 4) is a risk bearer.
Production Possibilities Curve
The production possibilities curve represents the combinations of maximum output
that can be reached in the economy. It is a frontier because it shows the limit of
output. Anything under the curve is attainable, but involves inefficient use of
resources. Anything outside the curve is unattainable with current resources.
Usually, the curve is some type of consumer goods versus some type of capital goods.
Each point on the curve represents a maximum output of the two goods. Different
points on the curve mean different production combinations of the two goods.
The curve bows outwards because of the Law of Increasing Opportunity Cost, which
states that the amount of a good which has to be sacrificed for each additional unit of
another good is more than was sacrificed for the previous unit. The rationale for this
law is that some economic resources are not completely adaptable to alternative uses,
so the resources will yield less of one product.
Shifts in this curve can be caused by increases in resource supplies or advances in
technology. Also, if an economy favors “future goods” (technology, etc), the curve will
shift faster because of more economic growth.
DEMAND AND SUPPLY
H - has preferences
e- expectation in future price
A - allowance income
P - price of related goods
e- expectation of future price
S- change in the number of suppliers
P - Productivity
A - advancement in technology
i - input costs
D - demand for related goods
•Comparative Advantage and Specialization allows for economic growth and efficiency. (More of each good can be obtained by trading-Trading line illustrates this)
•Trade barriers create more economic loss than benefits.
•Today there is a trend towards free trade and a reduction in trade barriers.
•Strongest arguments for protection are the infant industry and military self-sufficiency arguments.
•WTO oversees trade agreements and disputes, but has become a target of protesters lately.
A nation should specialize in producing goods in which it has a comparative advantage: ability to produce the good at a lower opportunity cost.
GROSS DOMESTIC PRODUCT
GDP (Gross Domestic Product): The total dollar (market) value of all final goods and services produced in a given year.
Expenditures approach: GDP = C + Ig + G + Xn
C = personal consumption expenditures (durable consumer goods, nondurable
consumer goods, consumer expenditures for services)
Ig = gross private domestic investment (all final purchases of capital by businesses, all
construction, changes in inventories)
G = government purchases (government spending on products and resources)
Xn = net exports (exports – imports)
Some types of transactions do not involve purchasing of a final good or service, so they
should not be counted in GDP. These include public transfer payments (social
security, welfare, etc), private transfer payments (monetary gifts, etc), security
transactions (stocks and bonds), and secondhand sales (they don’t reflect current production)
Goods Produced but not Sold (I)
•Goods produced by a foreign country (Japan) in the U.S. (Honda, Toyota)
•Government spending on the military
•Increase in business inventories
GDP:What does not count
Intermediate Goods (Tires sold by Firestone to Ford)
•Non-Market Activities (Illegal, Underground)
•Transfer Payments (Social Security)
REAL and NOMINAL GDP
Nominal GDP: GDP measured in terms of current Price Level at the time of measurement. (Unadjusted for inflation)
•Real GDP: GDP adjusted for inflation; GDP in a year divided by a GDP deflator (Price Index) for that year
Real GDP= Nominal GDP adjusted for inflation.
Shortcomings of GDP
Nonmarket activities: (services of homemakers) does not count.
•Leisure: Does not include the value of leisure.
•Does not include improvements in product quality.
Real GDP per Capita
Most commonly used to compare and measure each country’s standard of living and overall economic growth.
• CALCULATION :Real GDP/Nation’s Population
The increases and decreases in Real GDP consisting of four phases:
•Peak: highest point of Real GDP
•Recession: Real GDP declining for 6 months
•Trough: lowest point of Real GDP
•Recovery: Real GDP increasing (trough to pe
Inflation is a rise in the general level of prices
•Reduces the purchasing power of money
•Measured with the Consumer Price Index (CPI)
•Reports the price of a market basket , more than 300 goods that are typically purchased by an urban household
The effects of unexpected inflation are:
It hurts people with fixed nominal incomes, since the money they earn isn’t worth as
much anymore. It hurts people who save in fixed-value accounts It benefits debtors
(borrowers) while hurting creditors (lenders).
The effects of inflation can be lessened if people expect it (anticipated inflation), since
then they can get a chance to prepare for the damages that the inflation may cause.
For example, a person who has a fixed nominal income can try to adjust it if they know
that its value is going to decrease. Many unions have labor contracts with cost-of living
adjustment (COLA) clauses, in which workers’ wages increase if there is inflation.
•Calculation: Number of Unemployed/Labor Force((Multiplied by 100 to put as a %)
The Labor Force is the total of employed and unemployed workers.
U.S. unemployment should be about 5%
You are considered to be employed if:
•You work for 1 hour as a paid employee (so part-time workers count)
•You are temporarily absent from work (illness, strike, vacation)
•You work 15 hours or more as an unpaid worker (family farms are common)
Must be looking for work (at least 1 attempt in the past 4 weeks)
•Are reporting to a job within 30 days
•Are temporarily laid off from their job
Not In Labor Force
A person who is not looking for work:
•Stay at home parents
•Discouraged workers: those who have given up hope of finding a job.
Types of Unemployment
•Frictional - temporary and unavoidable
•Structural - results from changes in technology or a business restructure (ex. Merger)
•Seasonal- occurs when industries slow or shut down for a season
•Cyclical - results from a decline in the business cycle.
MONEY AND MONETARY POLICY
Money is anything that can be used as:
–A medium of exchange
–A store of value
–A unit of account / Standard of Value
Characteristics of Money
Money works best when it meets these criteria:
The Supply of Money
In the United States, the Federal Reserve System is the sole issuer of currency.
–This means the Fed has monopoly control over the money supply.
There are two important measures of the Money Supply today.
- •M1 serves primarily as a medium of exchange. It includes:
–Currency and Coin
- M2 serves as a store of value. It includes:
–Money Market Mutual Funds
THE FEDERAL RESERVE
The Federal Reserve and the Banking System -
Federal Reserve Act of 1913 – which created the Federal Reserve Bank System.
Board of Governors: The FED (Federal Reserve System) is run by a 7 person board called the Board of Governors. Each member is appointed to a 14 year term – and the terms of office are staggered (one governor is appointed every two years). The Governors are appointed by the President and confrimed by the Senate.
Federal Open Market Committee (FOMC): This committee is responsible for performing what is called Open market Operations (OMO). It consists of 12 members:
- The 7 members of the Board of Governors
- the President of the NY Regional Fed
- 4 of the other 11 regional Fed Presidents on a rotating basis
The 12 Federal Reserve Banks: The FED has 12 regional branches – which perform the duties of the FED.
Central bank: While the FED is our central bank – it isn’t a central bank in the traditional sense. It isn’t one bank – it’s a system (part of our traditional American resistance to big centralized government).
Quasi-Public Banks: The Regional FEDs are owned by the banks they serve – but are led by administrators appointed by government.
Bankers’ Banks: The FED is a bank for banks – and does not have private citizens as customers. The accounts at the FED banks are banks’ bank accounts. They make loans to banks – not corporations or individuals.
Federal Open Market Committee (FOMC)
Made up of 12 people: Board of Governors + New York FED President + 4 other regional presidents (who rotate)
•Meets regularly to direct OPEN MARKET OPERATIONS (buying or selling of bonds) to maintain or change interest rates
Fed Functions and the Money Supply
- setting Reserve Requirement and holding reserves – the FED requires Banks to hold a portion of each deposit at the FED to help stabilize the banking system. They can change the rate required to be held at the FED as a tool of Monetary Policy
- lending money to bank and thrifts – the FED lends money to banks and thrifts to make loans or to use as reserves at the FED. They charged an interest rate for this loan – called the discount rate (often incorrectly called the prime rate in the press). Changing this discount rate is another tool for performing monetary policy.
- supervising banks – the FED checks the books of banks to make sure that they are making a wise economic choices – a balanced loan portfolio etc. If they are not, they can refuse to make loans to these banks as well as other measures to make the bank want to change their loan portfolio.
- controlling the money supply – the FED uses the Money Supply to effect the interest rates and through that to make monetary policy.
Required Reserve and Excess Reserves
RRR – the required reserve ration (minimum reserve ratio set by the FED). The money set aside to meet this requirement is not on hand to be loaned out. The more the FED requires them to sdet aside – the less they have to loan out and the less money gets created.
Excess Reserves are the reserves a bank keeps over and above the minimum RRR. This is often referred to as Vault Cash. ( ER= deposit - RR)
RR = is the ratio of total reserves (required and excess) to deposits ( RR = deposit x RRR)
Open-market operations –
These are the most important means the Fed has to control the money supply. It refers to the buying and selling of government bonds (securities) by the Federal Reserve Banks. *Buying bonds increases the money supply; selling them decreases it.
The discount rate –
The discount rate is the rate that Federal Reserve Banks charge for loans to commercial banks. When commercial banks borrow from FRBs, their reserves increase.
* Therefore, if the discount rate increases, banks are less encouraged to borrow, keeping their excess reserves the same and therefore restricting money supply.
Using Taxes and Government spending to stabilize the economy.
•Controlled by the President and Congress
•Discretionary Fiscal Policy: Congress must take action (change the tax rates) in order for the action to be implemented.
•Automatic Stabilizers: Unemployment benefits, Progressive Tax System, these changes are implemented automatically to help the economy
Types of Fiscal Policy
•Used to Fight a Recession
•INCREASE GOVERNMENT SPENDING
•Used to fight Inflation
•DECREASE GOVERNMENT SPENDING
Believes that the government SHOULD NOT interfere in the economy. And believes in self-correction of economic problems.
Supply-side economics (Hayek & Milton Friedman)
Their theory is that when the economy occasionally diverges from its full-employment output, internal mechanisms within the economy automatically move it back to that output. In their opinion, government should refrain and cut corporate taxes.
Believes that GOVERNMENT SHOULD interfere in the economy (taxes, government spending). Most “mainstream” economists are Keynesians