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Economics (Macroeconomics: study of a national economy as a whole (Sectors…
Economics
Macroeconomics: study of a national economy as a whole
Sectors
Primary: activities revolve around getting raw materials from Earth (fishing, farming, mining, etc.)
Secondary: activities deal with processing raw materials acquired through primary activities into finished products of greater value (factories, manufacturing, etc.)
Tertiary: activities focus on moving, selling, and trading the products made in primary and secondary activities (banks, fast food, carpet cleaning, doctors, lawyers, etc.)
Underground: all the illegal production of goods and services (drug dealing, prostitution, sports betting); also anything unofficial (babysitting)
Economic Indicators
Gross Domestic Product (GDP)
Total market value of all goods and services produced in a country over 1 year;
Equation: GDP = C + I + G + NX
(C: consumption, I: business investment,
G: government, NX: net exports)
nominal GDP = raw numbers
real GDP accounts for inflaiton
Note: GDP does not include illegal activities, does not include value of non-market activities, does not measure secondary sales, does not count transactions that are purely financial, does not count intermediate goods used in production
Unemployment
natural rate: 4-6%
frictional: between things (jobs, school,etc.)
structural: job becomes obselete
cyclical: caused by recession; government concern; preventable
Consumer Price Index ("measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services")
Libertarian Paternalism: designing choice architecture to alter people's behavior in a predictable way, without forbidding any options or significantly changing their economic incentives; nudges are not mandates
Choice Architect: person/organization responsible for organizing the context in which people make decisions
Libertarianism: belief that people should be free to opt out of doing things if they choose to, especially if outcome only affects individual in question
Paternalism: attempting to influence choices in order to make someone else better off
Recessions: 2 consecutive quarters (6 months) of declining GDP
Cycles of economy
"paradox of thrift" - idea that people people scared to take risks and spend money, thus driving cycle
emotions in economy are confidence and fear
“business cycle” is comprised of an expansion and a contraction
expansionary phase = economy grows faster than average
contractionary phase = real GDP in decline (2 consecutive quarters = recession)
How can government affect the business cycle?
fiscal policy: changes to the way government taxes and spends $; Congress and president do this
expansionary - used to fight recession, high unemployment; involves increasing spending and lowering taxes (government must run a deficit)
contractionary - used to fight inflation, prevent and economy from “overheating”; involves decreasing spending & raising taxes to lower deficits and reduce government debt
government should get things in order during peak of the business cycle to be prepared to deficit spend during trough
fiscal policy multipliers - government changes to taxes/spending have magnified effect on economy; $1 spent will multiply, creating more spending as money moves through economy
Marginal Propensity to Consume (MPC): how much is spent out of an extra dollar of income
Young people MPC = 1 (give them an extra dollar and it is spent); Middle-aged people = .85? (thinking about retirement/college fund)
for money to circulate most effectively, government should target fiscal policy spending toward groups with high MPC
Fiscal policy multiplier equation:
multiplier = 1 / (1 - MPC)
to figure out total increase in spending that will result once government’s initial spending has multiplied through the economy, use equation:
Change in Real GDP = Initial Change in Spending * Multiplier
debt vs deficit:
deficit = difference between what government spends and what it takes in
debt = result of the government borrowing money to cover budget deficits
monetary policy: changes to the supply of $; Federal Reserve does this
money is all about liquidity: the ability to turn an asset into cash rapidly, without loss.
fiat money: currency with nothing of value backing them up, except for the fact that it’s legal tender
no country still operates on gold standard (most did at some point)
money is good for...
spending = money is a “unit of exchange”
measure/compare value of something = “unit of account”
accumulate value = “store of value”
Federal Reserve controls supply of money
The "Fed" is America’s “central bank”; controls the money supply; supervises all banks; independent from politics
Banks can borrow money from the Fed, can store excess cash at the Fed
Goals of the Fed = the “Dual Mandate”:
Maximize sustainable employment
Maintain stable prices (limit inflation)
Specific tools of the federal reserve
Change the “discount rate”; setting the discount rate low is expansionary; raising interest rates is contractionary
Change the reserve requirements; setting low reserve requirement is expansionary; higher reserve requirements are contractionary
Open market operations; Fed buying Treasury bonds is expansionary; Fed selling Treasury bonds is contractionary
Pay banks interest on “excess reserves”; setting this interest rate higher is contractionary; setting this interest rate lower is expansionary
2009 Recession
Mortgage-backed security (MBS): bonds that represent investment in group of home loans; asset-backed securities that are formed when lending banks bundle their mortgages into pools and sell them to investment banks/government agencies in form of bond; banks categorize loans according to credit ratings and sell them to investors.
Credit default swap (CDS): investment where you pay someone so they will pay you if a certain company gives up on paying its bonds; similar to insurance on bonds
Morgage
Subprime: type of loan awarded to people w/ poor credit histories, pose a higher risk to lenders; rates are higher than a prime mortgage to make up for the potential risk to the lenders; most common mortgage is the adjustable rate mortgage
Prime: type of loan awarded to people w/ good credit history; mortgages also feature rates lower than average; most common mortgage is fixed rate mortgage
Economic Philosophies
Keynes vs. Hayek
Keynes - suggested monetary policy plays little role in stimulating the economy and aggregate demand; suggested fiscal policy to help prime pump to recovery after recession (government stimulus packages prop up economy?)
Hayek - opposed to monetary policy (believes implementation is what causes boom-bust cycles in the first place); opposed fiscal policy intervention on the basis of interfering with market process (actions of a “stimulus” and inflation sow the seeds to next bust)
“Animal spirits”: confidence/gut instincts of businessmen on their future business prospects; coined by Keynes, who explained how economic cycle could be volatile due to changing spirits of the businessmen involved
Paradox of thrift: individuals try to save more during an economic recession, leading to fall in aggregate demand and economic growth; coined by Keynes
"Sugar high": what tax bill is likely to do to the U.S. economy – provide some short-term energy for growth before petering out or pushing the country toward crash
Microeconomics: study of economics at an individual, group or company level
Paycheck
Gross pay: pay before deductions :)
Net pay: pay after deductions :(
Voluntary deductions
Mandatory deductions
State tax
CO: 4.63%
FICA taxes
Social Security
Medicare
Federal tax
Marginal taxation
Prices
Prince controls
Price floor: imposed price control/limit on how low price can be charged for a product
creates surplus
Prince ceiling: imposed price control/limit on how high price can be charged for a product
creates shortage
Law of Supply: at higher prices, people choose to produce more; at lower prices, people choose to produce less
Supply shifters
change in future expectations about prices
if supplier expects P of good to inc in future, may stockpile and sell later to reap higher profits
technological change
advancements = increase in supply
cost of production
resources used to produce goods impact cost
shortage of ingredients
government policy
factors of production
number of producers or sellers in area
decrease in number of sellers = decrease in supply
increase in number of sellers = increase in supply
Law of Demand: at lower prices, people choose to buy more; at higher prices, people choose to buy less
Price Elasticity of Demand
Allows us to determine how steep demand curve is;
Equation: (% change in Q demanded) / (% change in P),
where % change = |(orig # - final #) / (orig #)|
Determinant factors
the time horizon on which the change is considered
how much of consumer's budget is spent on good
whether the good is necessity or luxury
whether close substitutes available
if <1 inelastic; if >1 elastic;
if =1 unit elasticity
Demand shifters
change is tastes/preferences
change in consumer info
change in expectation about future prices
change in prince of related goods
supplementary if inc in P of x result in inc in D of y
complementary if inc in P of x results in dec in D of y
change in income
inferior is shift L as income inc
normal if shift R as income inc
change is population of available consumers
Incentives
perverse = accidentally encourage bad behavior
negative = punishments
positive = rewards
Scarcity, Choice, Production Possibility Curves
Factors of Production
entrepreneur (person who brings factors together)
capital (tools of production)
labor (human effort)
land (natural resources before they are changed by human effort)
Production Possibility Graphs
point inside frontier represents inefficiency, point outside of frontier is impossible without changing factors of production
Reflect how scarcity forces us to make choices
Opportunity cost: the next best alternative given up when choice is made
Marginal Analysis
Decreasing marginal utility states that the costs will eventually outweigh the benefits
Suggests that you will engage in more of an activity if the additional benefits exceed the additional costs
Economy: system of production, consumption, and distribution of goods and services in a particular geographic region
3 goals of every economy:
growth
high employment
stable prices