Monetary Policy Video

Video Responses

Video 1
There are three types of money. Those types are commodity money, representative money, and fiat money. Commodity money are the things that also work as if it is money. Representative money is not the the real currency but it represents the same amount of value of the actual currency. A drawback of representative money is when the value of the metal changes, then the value of the currency is affected. Fiat money is the value of money the government says the money is worth.

Video 2
To graph the money market, you have to make sure the axes are labeled correctly. The Y-axis is the interest rate and the X-axis is the quantity of money. Demand of money is downward sloping, this shows the prices and money are inversely related. Supply of money is vertical because it doesn't change based on the interest rate. It is fixed and set by the Fed. Quantity equilibrium and the interest rate must be labeled also.

Video 3
 There are things the Fed does to increase money supply (expansionary or easy money) and decrease money supply (contractionary or tight money). The Fed has three choices they can use to obtain their goal.  They can change the required reserves, discount rate, and the OMO, which is buy or sell bonds, Open Markets Operations. Reducing or increasing the required reserves and discount rate are reasons for the banks to react to the the change, and does not promise a change in the money supply.

Video 4
 The loanable fund market is labeled and is connected to the money market.  Identical to the money market the interest rate goes to the y-axis and quantity goes to the x-axis, but converted to loanable funds. The supply of loanable funds in this case is upward slopping depending on savings for banks to be able to loan out.  The demand for more increase demand of loans thus increasing the interest rate, but i can as well decrease the supply of loanable funds.

Video 5
Banks make loans to create money. To find the monetary multiplier you take 1 and divide it by the reserve ratio. One of the Fed's tools for monetary policy is the ability to adjust the reserve requirement. The Reserve requirement tells how much money will be availiable for the public.

Fiscal Policy

Fiscal policy is the change in the expenditures or tax revenues of the federal government. Two tools of fiscal policy are Taxes & Spending.

• Deficits, Surpluses, & Debt
• Balanced budget ( Revenues = Expenditure)
• Deficit budget ( Revenues > Expenditures )
• Surplus budget ( Revenues < Expenditures )
• Government debt ( Sum of all deficits - sum of all surpluses)
• Government must borrow money when it runs a budget deficit, from
• Individuals
• Corporations
• Financial institutions
• Foreign entities or foreign countries

Fiscal policy option

• Discretionary fiscal policy (action)
• Expansionary fiscal policy (Think deficit) Designed to increase aggregate demand. Strategy for increasing GDP, combatting a recession, and unemployment. Recession countered with Increase government spending, & decrease taxes.
• Contractionary fiscal policy ( Think surplus) Designed to decrease aggregate demand. Strategy for controlling inflation, countered with increasing taxes, & decreasing government spending.
• Non-Discretionary fiscal policy (No action)

Discretionary vs Automatic fiscal policies

• Discretionary, increasing or decreasing government spending & lower taxes in order to return to economy to full employment. Involves policy makers doing fiscal policy in response to an economical problem.
• Automatic unemployment compensation & marginal tax rates are examples of automatic policies, that help mitigate the effects of recession as well as inflation. They take place without policy makers having to respond to current economic problems. Anything that increase the government budget deficit during a recession & increase its budget surplus during inflation without requiring explicit action by policy markers.

Non-Discretionary fiscal policy (Automatic stabilizer)

• Transfer payments
• Welfare checks 
• Food Stamps
• Unemployment checks
• Corporate dividend
• Social security 
• Veterans benefits
• Progressive income taxes

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

Disposable Income

With disposable income (DI) theres 2 choices households have, either consume (spend money on goods & services) or save (not spending money)

DI is income after taxes or net income. DI = Gross income - Taxes

Consumption (household spending) The ability to consume is constrained by

• The amount of DI
• The propensity to save

Do households consume if DI=0

• Autonomous consumption
•  Dissaving

        APC= C/DI = %DI that is spent

Savings (household not spending) The ability to save is constrained by

• The amount of DI
• The propensity to consume

Do households save if DI = 0

• No

       APS= S/DI = %DI that is not spent

APC & APS 

• APC + APS = 1
• 1- APC = APS
• 1- APS = APC
• APC > 1 therefore Dissaving
• APS therefore Dissaving

MPC & MPS

• Marginal propensity to consume (MPC)
• ∆ C / ∆ DI
• % of every extra dollar earned that is spent
• Marginal propensity to save (MPS)
• ∆ S / ∆ DI
• % of every dollar earned that is saved
• MPC + MPS = 1
• 1 - MPC = MPS
• 1 - MPS = MPC

The spending multiplier effect 

• An initial change in spending (C, Ig, G, Xn) causes a large change in aggregate spending or aggregate demand
• Multiplier = ∆ in AD / ∆ in spending
• Why does this happen? Expenditures and income flow continuously which sets of a spending increase in the economy.

The spending multiplier

• Can be calculated from the MPC or MPS
• Multiplier = 1 / 1 - MPC or 1 / MPS
• Positive when there is increase in spending Negative when there is a decrease

The tax multiplier

• When government taxes, the multiplier works in reverse
• Why? Because now money is leaving the circular flow 
• Tax multiplier (Its negative) = - MPC / 1 - MPC  or - MPC / MPS
• If there is a tax cut, then the multiplier is positive, because there is now more money in the circular flow.

Three Schools of Economics

Three schools of economy ( Classical, Keynesian, Monetary)

Points of Classical school

•  Investment (Injection)
• AS determines output
• Market works by it self (No government intervention)
• Savings increase with interest rate
• AS=AD at full employment equilibrium
• In the LR the economy will balance at full employment (economy close to or at full employment)
• Believe in the trickle down effect ( this is were you help the rich first and everyone else latter)
• Prices and wages are flexible downward

Points of Keynesian school

• Competition is flawed (AD is key not AS)
• Demand creates its own supply
• Savers and investors save for different reasons
• Saving are inverse to interest rate
• Leaks cost constant recessions and savings cause recessions
• Ratchet effects and sticky wages block state law
• Price/wages are inflexible downward
• No mechanism capable of guaranteeing full employment
• The economy is not close to or at full employment
• Government intervention (expansionary & contractionary policies (Fiscal policy) 

Points of Monetary school

• Fine tuning is needed, congress can't time the policy options (voters wont allow it)
• Contractionary option
• Easy and tight money 
• Change the required reserves if needed
• Buy & sell bonds in open market
• Change in interest rate for the discount rate & federal fund rate

Investment Demand Curve (ID)

The investment demand curve is downward sloping. This is because when interest rates are high, fewer investments are profitable; when interest rate are low, more investments are profitable.

Shifts in Investment Demand

• Cost of production
• Lower cost  Shift ---->
• Higher cost Shift <---
• Business Taxes
• Lower business taxes Shift --->
• Higher business taxes Shift <---
• Technological ∆
• New technology Shift--->
• Lack of technological changes Shift <---
• Stock of capital
• If an economy is low on capital Shift --->
• If an economy has much capital Shift <---
• Expectations
• Positive expectations Shift --->
• Negative expectations Shift <---

Interest Rate and Investment Demand

• Investment
• Money spent or expenditures
• New plants (factories)
• Capital equipment
• Technology
• New Homes
• Inventories (goods sold by producers)
• Expected Rates of Return
• How does business make investment desicisions?
• Cost/Benefit
• How does business determine the benefits?
• Expected Rate of Return
• How does business count the cost?
• Interest costs
• How does business determine the amount of investment they undertake?
• Compare expected rate of return to interest cost
• If expected return > interest cost, then invest
• If expected return < interest cost, don't invest
• Real (r%) v. Nominal (i%)
• Difference
• Nominal is the observable rate of interest. Real subtracts out inflation and is only known ex post facto.
• How do you compute the real interest rate (r%)/

• r% = i% -

Full Employment

Full employment equilibrium exists where AD intersects SRAS & LRAS at the same point.

Recessionary gap exists when equilibrium occurs below full employment output.

                                       

Inflationary gap exists when equilibrium occurs beyond full employment output.

                                              

Aggregate Supply

The aggregate supply curve depicts the quantity of real GDP that is supplied by the economy at different price levels.

Long Run vs Short Run

• Long run: Period of time where input prices are completely flexible and adjust to changes in the price level. In the long run the level of real GDP supplied is independent of the price level.
• Short run: Period of time where input prices are sticky and do not adjust to changes in the price level. In the short run the level of real GDP supplied is directly related to the price level.

Long Run Aggregate Supply (LRAS): Marks the level of full employment in the economy (analogous to PPC) because input prices are completely flexible in the long run, changes in price level do not change firm's real profits and therefore do not change firms level of output. Meaning that LRAS is vertical at the economy's level of full employment.

Short Run Aggregate Supply (SRAS) Because input prices are sticky in the short-run, the SRAS is upward sloping.

                                           

An increase in SRAS is seen as a shift to the right. A decrease in SRAS is seen as a shift to the left
The key to understanding shift in SRAS is per unit cost if production
Per unit production cost= total input cost/total output

Determinant of SRAS

• Input prices 
• Domestic resource prices 
• Wages (75% of all business cost)
• Cost of capital
• Raw materials (commodity prices)

Foreign resource prices

• Strong $ = lower foreign resource prices
• Weak $ = higher foreign resource prices

Market power-monopolies and cartels that control rss control the price if those rss

• Increase In resource prices (AS Shift <)
• Decreases In resource prices (AS Shift >)

Productivity

• productivity = total output/ total inputs
• More productivity= lower unit production cost (AS Shift >)
• Lower productivity = higher unit production cost (AS Shift <)

Legal institutions environment (Taxes and subsides)

• taxes ($ to government) on business increase per unit production cost (AS Shift <)
• subsidies ($ from government) to business reduce pet unit production cost (AS Shift >)

Government regulation

• Government regulation created a cost of compliance (AS Shift <)
• Government deregulation reduces compliance costs (AS Shift >)

Aggregate Demand

The aggregate demand shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level. The relationship between the price level and the level of real GDP is inverse.

Three reasons AD is downward sloping

• Real-Balance effect: When the price level is high households and businesses cannot afford to purchase as much output. When the price level is low households and businesses can afford to purchase more output
• Interest-Rate effect: A higher price level increase the interest rate which tends to discourage investment. A lower price level decreases the interest rate which tends to encourage investment.
• Foreign purchases effect: The higher the price level, an increase in demand for relatively cheaper imports.

Shifts in AD

• Two parts to a shift in AD
• A ∆ in C, Ig, G, and/or Xn
• A multiplier effect that produces a greater change than the original ∆ in the 4 components.
• Increase in AD = AD >
• Decrease in AD = AD <

Consumption

• Households spending
• Consumer Wealth: More spending (AD Shifts >)
• Less wealth: Less spending (AD Shifts <)
• Consumer expectations
• Positive Expectations: More spending (AD Shift >)
• Negative Expectations: Less spending (AD Shift <)
• Household indebtedness
• Less debt: More spending (AD Shift >)
• More debt: Less spending (AD Shift <)
• Taxes
• Less taxes: More spending (AD Shift >)
• More taxes: Less spending (AD Shift <)

Gross private investment

• Te real interest rate
• Lower real interest rate: More investment (AD Shift >)
• Higher real interest rate: Less investment (AD Shift <)
• Expected returns
• Higher expected returns: More investment (AD Shift >)
• Lower expected returns: Less investment (AD Shift <)

Government spending

• More government spending (AD Shift >)
• Less government spending (AS Shift <)

Net exports

• Exchange rates (International value of $)
• Strong $ : More Imports and fewer exports (AD Shift <)
• Weak $ : Fewer imports and more exports ( AD Shift >
• Relative income
• Strong Foreign Economies: More exports (AD Shift >)
• Weak Foreign Economies: Less exports (AD Shift <)

Unemployment

Unemployment: Is the percentage of people who do not have a job but are part of the labor force.

Labor force: The number of people in a country that are classified as employed or unemployed.
Unemployment rate =                                       Number of unemployed

                                                   Number of unemployed + Number of Employed         X 100

Not in the labor force: 

• Kids 
• Retired people
• Military personal
• Mentally insane 
• Incarcerated
• Full time students
• Stay at home parents
• Discourage workers

Forms of Unemployment:

• Voluntary- Between jobs, new opportunities, new choices, new lifestyle, educational level.
• Seasonal- People wait for the right moment to conduct their trade. Ex: School Bus Driver, construction workers.
• Cyclical - Down turn in the business cycle, recession, down price.
• Structural- Associated with lack of skills, decline in industry, change in technology.

Full Employment when there is not cyclical unemployment present in the economy. Natural Rate of Unemployment (NRU) achieved when labor markets are in balanced 4-5%
NRU = Structural UNP + Frictional UNP

Unemployment is good, because its less pressure to raise wages, more workers available in future expansions.

Unemployment is bad because, there is not enough consumption (GDP). There is too much poverty, too much government is needed

Okun's law - For every 1% unemployed above NRU causes a 2% decline in real GDP

Inflation

Inflation: A rise in general level of prices. The Inflation Standard: 2% - 3%

Inflation Rate: Measures percent increase. Key indicator of Economies Strength.

Deflation: Decline in general price level

Disinflation: Occurs when inflation rate declines

CPI: "Consumer Price Index" measures inflation by tracking the yearly price of consumer goods and services. Indicates changes in price levels and price of living.

Formulas:

• Finding Inflation Rate Using market base data.                                                                            Current  Year Market Basket value - Base Year Market value X 100                                                 Base Year Market value
• Finding Inflation Rate using price index                                                                                         Current year price index - Base year price index    X 100                                                           Base year price index
• Estimating Inflation Using Rule of 70. Used to calculate the number of years it would take for the price level to double at any given rate of inflation.                                      Years Needed to double inflation =                     70

                                                                     Annual inflation rate

• Determining real wages                                                                                                                        Real Wages = Nominal wages / Price level  X 100
• Finding real Interest rate                                                                                                                 Real interest rate = Nominal interest rate - Inflation Premium 
• Cost of borrowing/lending money that's adjusted for expected inflation; expressed as percentage.

Cause of inflation: 

• Demand-pull inflation- Cost by excess of demand over output that pulls prices upward.
• Cost-push inflation- Cause by a rise in per unit production rise due to increase resource cost

Effect of inflation: Hurt people with fixed income, savers, lenders/creditors. Helps borrowers and fixed contracts.

• Anticipated: People are told that they will get laid off (Get a new job or spend less money)
• Unanticipated: People told its their last day in the job.

Inflation Helps:

• Borrowers 
• Debt will be repaid with cheaper dollars than those that were loaned out 
• Fixed Contract 

Inflation Hurts:

• Fixed income 
• Social security 
• Savors 
• People that save money  
• Lenders / Creditors  
•  Not going to be repaid back 

Nominal and Real GDP

Nominal GDP - Value of output produced in current prices  

• P x Q 
• Can increase from year to year if either output or price increase 

Real GDP - Value of output produced in constant or based year prices  

• Adjusted for inflation  
• Based Price x Quantity 
• Can increase from year to year only if output increases  

Price index - measure inflation by tracking changes in the price of a market basket of goods compared to the base year 

• Price of market basket of goods in current year / price of market basket of goods in base year 

GDP Deflator 

• Also a price index that is used to adjust from nominal to real GDP 
• In the base year the GDP deflator is
•  =100 Years after base years
• >100 For years before the base year  
• <100 (Nominal GDP/ Real GDP)  ×100 

Inflation 

• (New GDP deflator - Old GDP deflator / Old GDP deflator) ×100 

Expenditure and Income Approach

Expenditure Approach:  C + Ig + G + Xn = GDP 

• Add up the market value of all the domestic expenditures made on final goods and services in a single year.

Income Approach: W + R + I + P + Statistical Adjustments

• Add up all the income earn by households and firms in  a single year.
• W: Wages
• R: Rents
• I: Interest
• P: Profits (Proprietor's income)

Budget: Government Purchases of goods and services + Government Transfer Payments - Government tax and Fee collection.

• If the number is positive its Budget Deficit.
• If the number its negative its a Budget Surplus.

Trade: Exports - Imports

GNP: GDP + Net Foreign Factor Payment 

NNP (Net National Product): GNP - Depreciation

NDP (Net Domestic Product):GDP - Depreciation

National Income:

• GDP - Indirect Business Taxes - Depreciation - Net Foreign Factor Payment
• Compensation Of Employees + Proprietors Income + Rental Income + Interest Income + Corpus Profits

Disposable Personal Income: National Income - Personal Household Taxes + Government transfer payments

GDP and GNP

GDP: Gross Domestic Product is the total money value of all final goods and services produced within a countries borders within a year.

GNP: Gross National Product is the total value of all final goods and services produced by Americans in a year.

What's Included in GDP

• C - "Consumption" its the 67% to the economy, purchasing finished goods and services.
• Ig - "Gross Private Domestic Investment"
• Factory Equipment maintenances
• New factory equipment
• New construction Housing
• Unsold Inventory of Products build in a year.
• G - "Government Spending"
• Xn - "Net Exports  
• Formula: Exports - Imports

What's Excluded from GDP

• Used or Second Hand Goods
• Intermediate goods are the goods or services purchase to resale or further processing or manufacturing. This is excluded to avoid multiple or double counting.
• Non Market Activity
• Illegal drugs
• Any unpaid work
• Prostitution
• Baby Sitting
• Growing own food for personal consumption
• Fixing your own things
• Financial Transactions
• Bonds
• Stock
• Real-estate
• Gift or Transfer Payments
• Private: Produces no output transfer fund from one private individual to another.     Ex: Scholarships
• Public: Various contribute nothing to the current output or production.                       Ex: Welfare, Social Security 

Business Cycle

Expansionary: Real output in the economy increasing and unemployment rate declining.The population is able to buy more.

Peak: Real GDP is at its highest.

Contraction (Recession): Real output in a economy its decreasing and unemployment rate rising. Inflation rate is rising.

Trough: It the lowest point of real GDP, means the end of a recession. 

Equilibrium

Equilibrium is a point where the supply and demand curves intercept. "All resources are being used efficiently"

• Shortage-  QD > QS     Quantity Demanded > Quantity Supply
• Surplus- QS > QD     Quantity Supply < Quantity Demanded

Terms :

• Price Floor- a government imposed price limit on how low a price can be changed for a product 

• Price Ceiling- a government imposed limit on how high a price can be charged for a product.

• Fixed Cost- a cost that does not change no matter how many are produced.

• Variable cost- a cost that changes.

• Marginal Cost- a cost of producing one more unit of goods.

• Marginal Revenue- the additional income from selling one more until of a good.

Formulas: 

• Total Cost: Total Fixed Cost + Total Variable Cost  &  Average Total Cost / Quantity
• Average Fixed Cost: Total Fixed Cost / Quantity 
• Average Variable Cost: Total Variable Cost / Quantity
• Average Total Cost: Average Fixed Cost + Average Variable Cost  &  Average Variable Cost
• Marginal Cost: New Total Cost - Old Total Cost 
• Total Revenue: Price x Quantity 

Elasticity of Demand

Price Elasticity Demand: Tells how drastically buyers will cut back or increase their demand of a good when price rises or fall.

• Elastic Demand: The demand that will change greatly if theres a change in price "many substitute" E > 1
• Inelastic Demand: The demand for product will not change regardless of the price "few or no substitute" E < 1
• Unit Elastic (Unitary Elastic): The price elasticity of demand is equal to 1. E = 1

The Formulas to solve Elasticity Problems.

1. % Δ in quantity
                         New Quantity - Old Quantity
                                    Old Quantity

2. % Δ in price
                        New Price - Old Price
                                 Old Price

3. PED - Price Elastic of Demand
                        Δ in quantity
                         Δ in price

Demand and Supply

Demand is the quantities that people are willing or able to buy at various prices.

• The law of demand- There's an inverse relationship between price and quantity demanded. 
• The causes of a change in quantity demanded


•  Δ in buyers taste (Advertisement)
•  Δ in number of buyers (Population)
•  Δ in income 
• Normal goods that buyers buy more of when income rises. 
• Inferior goods that buyers buy less when income rises.
•  Δ in price in relative goods.
• Substitute good that server roughly the same purpose to buyers.
• Complementary goods often consume together.
•  Δ  in expectation

Supply is the quantities that producers/sellers are willing and able to produce/sell at various prices.

• The law of supply- There's a direct relationship between price and quantity supply.
• The causes of a change in quantity supply

• Δ in weather
• Δ in technology
• Δ in cost of production
• Δ in number of sellers
• Δ in taxes 
• Δ in expectation