+ Macro Review: Day 1 Subjects included: Comparative Advantage and Terms of Trade GDP, Inflation, Unemployment AD/AS Model—SR to LR Phillips Curve Multiplier (Spending, Tax, Balanced Budget) Crowding-Out Effect Fiscal Policy: Discretionary vs. Nondiscretionary Homework: 1.Macro Review Quiz 2—Make sure you have a scantron! Note: All students taking the AP Exam must attend a pre-registration meeting…if you missed please handle it ASAP Book return any time this week Complete all late assignments! Check Pinnacle!!!

+ Comparative Advantage & Terms of Trade Comparative Advantage: produce with lowest opportunity cost Absolute Advantage: produce more outright Terms of Trade: set using the opportunity cost of production—A trade partner must make back what they missed out on Goal of trade is to consume beyond our nations PPC—increasing well-being

+ Sample Problems **HINT: INPUT vs. OUTPUT METHODS Output: Opposite Over Input: Opposite Under USA CAN. TRAINS PLANES a.Absolute advantage in trains? b.Comparative advantage in trains? c.Acceptable trade: 1 Train for 1/3 Plane? USA CAN. Hours/TRAIN Hours/PLANEa.What country will export trains? b.Set acceptable terms of trade for 1 train. c.Comparative advantage in planes?

+ Sample Problems—Answers **HINT: INPUT vs. OUTPUT METHODS Output: Opposite Over Input: Opposite Under 4(1T=1/2P)2(1P=2T)* 5(1T=1/5P)*1(1P=5T) 1. USA CAN. TRAINS PLANES a.Absolute advantage in trains? Canada a.Comparative advantage in trains? Canada b.Acceptable trade: 1 Train for 1/3 Plane? Yes. 4(1T=2P)*2(1P=1/2T) 5(1T=5P)1(1P=1/5T)* 2. USA CAN. Hours/TRAIN Hours/PLANEa.What country will export trains? USA a.Set acceptable terms of trade for 1 train. Between 2 and 5 planes. b.Comparative advantage in planes? Canada

+ Short Cut Take the PPC and create an output chart! Trains Planes Canada USA CAN. TRAINS PLANES =

+ PPC: Quick Note 3 Shifters: Technology, New Resources, Population Be weary of sector specific changes

+ Measuring Economy: GDP C + I + G + N X = AD GDP: dollar value of all final goods and services produced in country during a given year Nominal GDP: Not adjusted for inflation Real GDP: inflation adjusted Use the Deflator to adjust nominal GDP to get Real GDP Deflator: broad measure of PL in an economy Use CPI to account for inflations changes over time (consumer specific) CPI: market basket of consumer goods

+ Sample Problems—CPI CPI = Price MB in year your looking for Price MB in base year × 100 Price MB Base Year 2009 Base Year 2010 Base Year $20100c.e. 2010$40a.100f. 2011$50b.d The big idea: the difference in CPI from the base year (100) is the percent difference in price level for the economy… Ex: In 2010, using 2009 as the base year, prices increased 100% or doubled

+ Sample Problems: GDP Deflator 1. If Nominal GDP is $100 B and Real GDP is $80 B, what is the deflator? 1. If Real GDP is $200 B and the deflator is 120, what is Nominal GDP? 2. If Nominal GDP is $300 B and the deflator is 150, what is Real GDP? GDP Deflator = Nominal GDP Real GDP × $240 B $200 B BIG IDEA: Base year is always 100 Deflator indicates the magnitude of price changes using percentages from a base year

+ AD/AS & Fiscal Policy *Most Important Macro Unit PL GDP R SRAS AD LRAS O FE PL AD Shifters: Think GDP 1.Consumer Spending 2.Investment Spending (business spending on capital) 3.Government Spending 4.Exports − Imports SRAS Shifters: Think Business Expenses 1.Price of resources (including labor) 2.Taxes/subsidies to businesses 3.Productivity/Technology Fiscal Policy: Discretionary!!!! 1.Expansionary: increase AD 1.Increase gov’t spending 2.Decrease taxes 3.Increase transfer payments 2.Contractionary: decrease AD 1.Decrease gov’t spending 2.Increase taxes 3.Decrease transfers

+ A Aa a AD/AS & Fiscal Policy *Most Important Macro Unit PLSRAS AD LRAS PL GDP R O FE Fiscal Policy: Automatic Stabilizer! Kick-in without gov’t action! Enter recession: 1. Income’s fall (GDP): taxes reduced =  AD 2. Income’s fall: Gov’t transfers increase =  AD Enter Inflationary Gap: 1. Incomes increase (GDP): taxes increase =  AD 2. Incomes increase: Gov’t transfers decrease =  AD *Progressive Tax System A Aa a Recessionary Gap Inflationary Gap

+ From the short-run to long-run: classical/self-correcting model SRAS always acts to return the economy to LREQ Input costs in the form of wages will change in the LR These changes in wages, based on PL change, will increase or decrease SRAS back to LREQ “STICKY WAGES” AD/AS & Fiscal Policy *Most Important Macro Unit

+ Self-Correcting Review Questions a. What happens to real and nominal wages in SR? b. If gov’t does nothing what happens to model? c. Automatic stabilizers? 1. Use the graph below to answer. 2. Use the graph below to answer. a.What happens to real and nominal wages in SR? b.If gov’t does nothing what happens? c.Automatic stabilizers?

+ Self-Correcting Review Questions Answers a. What happens to real and nominal wages in SR? b. If gov’t does nothing what happens to model? c. Automatic stabilizers? 1. Use the graph below to answer. 2. Use the graph below to answer. a.What happens to real and nominal wages in SR? b.If gov’t does nothing what happens? SRAS decrease (increase wages) a.Automatic stabilizers? Tax , Transfers  N: nothing R: increased SRAS increases (lower wages) Tax , Transfers  N: n/a R: decreases

+ Real vs. Nominal Wages SR: Nominal wages sticky—no change Real wages increase—PL fallen LR: SRAS increases as nominal wages SR: Nominal wages sticky—no change Real wages decrease—PL rise LR: SRAS decrease as nominal wages

+ The Multiplier Effect MPC: marginal propensity to consume, given $1 MPS: marginal propensity to save, given $1 MPS + MPS = 1 Spending Multiplier = Ripple effect of new income/gov’t spending on aggregate economy 1.Gov’t increases spending $100 B, given MPC of.75, what is the impact of initial spending? 1 MPS Tax Multiplier = Impact a change in taxes will have on aggregate economy Always negative (increase in tax causes decrease in spending) 2. Gov’t increases income tax by $200 B, given MPS of.2, what is the impact of the change in tax? − MPC MPS $400 B − $800 B

+ The Phillips Curve Illustrates the trade-off between Unemployment and Inflation in the short-run LRPC SRPC Inflation Unemployment LREQInflationary    Recessionary A B (C) LRAS SRAS AD  C  A AD 2  B AD 3 BIG CONCEPT: LR Adjustment SRAS behaves the exact opposite way the SRPC does A  Inflationary: 1.SARS shifts left, returning economy to LREQ 2.SRPC shifts right and returns economy to LREQ at higher expected/non- accelerating rate of inflation *With inflation expectations are everything! Non- accelerating/natural rate of unemployment

+ The Phillips Curve AD shift equals a move along SRPC SRAS shift equals a shift (opposite) of SRPC Always arrive back at a LREQ in both models Practice FRQ on Macro Review Quiz #2 LRAS SRAS AD  C  A AD 2  B AD 3 LRPC SRPC LREQInflationary    Recessionary A B (C) Non- accelerating/natural rate of unemployment Inflation Unemployment PL GDP R

+ Loanable Funds Market In my opinion, this is the model we had the most problem with all year…which is good because it’s easy! Interest Rate REAL Q LF S D IR 1 Q Model will behave the exact same as s/d accept focused on the s/d for loans in an economy Real IR tied to capital investment for businesses Implications in FOREX…tomorrow Crowding-Out Effect: When the gov’t decides to undertake a new piece of spending and they need to borrow the money. Problem: Real IR increase. That means for businesses to get a loan they need to pay higher interest! Businesses will not higher IRs D CO Q CO IR CO

+ Interest Rate REAL S D IR 1 Q Loanable Funds Market Sample Problem a.Assume the gov’t partakes in deficit spending. What happens to Real IR? a.What happens to capital investment? a.Effect on AD? a.Effect on LR growth?

+ Interest Rate REAL S D IR 1 Q Loanable Funds Market Sample Problem a.Assume the gov’t partakes in deficit spending. What happens to Real IR? Increases. a.What happens to capital investment? Decreases. a.Effect on AD? Decreases. a.Effect on LR growth? Slows.

+ Macro Review: Day 2 Subjects included: The FED and the Money Supply Monetary Policy Calculating Real Values Balance Sheet Analysis Money Multiplier Balance of Payments Accounts Net Export Analysis FOREX and Implications on Net Exports Homework: 1.Review Macro!!! No Review Quiz 2.Please review the Macro Review PowerPoint

+ Money Types of Money: Fiat: no value other than gov’t backing Commodity: has an intrinsic value, e.i. tied to gold/silver Function of Money: Unit of Account: widely accepted measure of cost (what $20 can get you) Store of Value: holds purchasing power over time Medium of Exchange: use to trade for goods/services Calculating Nominal and Real Interest Rates Real = Nominal − Inflation Nominal = Real + Inflation M1 and M2 M1: cash and checkable deposits  changes in deposits don’t affect M1 M2: “near monies”

+ The FED and the Money Market Key Concepts MS fixed amount controlled by the FED MD is the opportunity cost of holding money MD also affected by price level in the aggregate economy If PL increases, MD increases When IR N are low, businesses will invest When IR N are high, businesses will not invest The changing of the money supply is called MONETARY POLICY

+ The FED has 3 tools: 1. Open Market Operations (buy/sell bonds), 2. Discount Rate, 3. Reserve Requirements Use these tools to try and achieve the targeted Federal Funds Rate! The big idea is the connection between how these tools can be used to increase AD (expansionary monetary policy) and decrease AD (contrationary monetary policy) The FED and the Money Market Expansionary (MS , AD  )Contractionary (MS , AD  ) 1.OMO: Buy Bonds 2.DR: decrease 3.RR: decrease All of these actions will increase the amount of money in circulation and stimulate consumer spending/business investment 1.OMO: Sell Bonds 2.DR: increase 3.RR: increase All of these actions work to decrease the amount of money in circulation and decrease spending/business investment Short Cut: MS and AD always mirror each other in their respective models

+ Money Market Sample Problems 1. Assume the US is experiencing a period of economic recession. What actions could the FED take in their open market operations to move the US out of the recession? a. Illustrate both the money market and our AD/AS model. b. What happens to capital investment as a result of FED actions? c. What happens to aggregate price level? d. How does your answer to part (c) impact the money market in the long-run?

+ Money Market Sample Problems 1. FED can buy bonds (expansionary monetary policy) b. Investment increases as a result of lower IR c. PL will increase as a result of AD increase d. In the LR, the demand for money will increase. People need to hold a greater amount of cash on a day-to-day basis as a result of more expensive goods/services. Money Market AD/AS MS 1 MS 2 MD LRAS SRAS AD IR 1 IR 2 Q M1 Q M2 PL 1 Q 1 Q F AD 2 PL 2

+ Banks and the Creation of Money Fractional Reserve banking system is based on the premise that only a portion of the money individuals deposit (checkable deposits) are held in bank vaults (based reserve requirement) and the rest is loaned out…money creation The Money Multiplier = Reflects the ripple effect of a deposit/OMO on the M1 money supply Huge Concept: Buying/selling bonds are not subject to the reserve requirement because they are not expected to be paid back upon a depositor’s request A deposit/withdrawal must first be subject to the reserve requirement before we can analyze the effect of the money being used to create new loans 1.The FED buys $100 B worth of bonds. The reserve requirement is 10%. What is the total change in the M1 money supply? 2.You deposit $100 into your checking account. The reserve requirement is 10%. What is the effect on the M1 money supply? M2 money supply? 1 RR $1,000 B in new loans. M1  $900. M2 n/a

+ Bank’s Balance Sheet Analysis We really struggled with this throughout the year!!! a.Calculate the reserve requirement. b. Mr. Davey withdrawals $5,000 from his checking account. a.How much will the reserves change as a result of the withdrawal? b.M1 money supply effect? c.New value of excess reserves based on part (a)? c.The next day, Mr. Davey shows up and withdrawals an amount greater than the bank is holding in excess reserves. How can Mi Tierra cover their required reserves? d.Based on the loans being issued and the reserve requirement from part (a), how much new money is being created from Mi Tierra?

+ Bank’s Balance Sheet Analysis b. Mr. Davey withdrawals $5,000 from his checking account. AssetsLiabilities Required Reserves $9,500Demand Deposits $95,000 Excess Reserves $500 Loans $85,000Equity

+ Bank’s Balance Sheet Analysis We really struggled with this throughout the year!!! a.Calculate the reserve requirement. 10% b. Mr. Davey withdrawals $5,000 from his checking account. a.How much will the reserves change as a result of the withdrawal? $5,000 b.M1 money supply effect? None. Change M1 components. c.New value of excess reserves based on part (a)? $500 c.The next day, Mr. Davey shows up and withdrawals an amount greater than the bank is holding in excess reserves. How can Mi Tierra cover their required reserves? Borrow from the FED’s discount window. d.Based on the loans being issued and the reserve requirement from part (a), how much new money is being created from Mi Tierra? $850,000

+ Trade and Foreign Accounts Balance of Payments Account: used to measure all international transactions and calculate their effect in FOREX and Loanable Funds market Current Account: goods and services  planes, wheat, foreign aid Current account—no liability in future Net Exports!!! Exports − Imports (trade deficits) Financial Account: financial assets  bonds, stocks Financial account—future payments will be made Inflows and outflows of loanable funds! A surplus in one results in a deficit in another

+ Sample Problems 1. The US and China are trade partners. How would you categorize the buying of 1 million cotton t-shirts from china? 2. If the US is currently running a current account surplus, what must be the standing of our financial account? a. How does this affect the US’s market for loanable funds?

+ Sample Problems Answers 1. The US and China are trade partners. How would you categorize the US purchase of 1 million cotton t-shirts from China? Current account transaction (negative) 1. If the US is currently running a current account surplus, what must be the standing of our financial account? Running a deficit. Outflow of investment. a. How does this affect the US’s market for loanable funds? Supply of loanable funds decrease.

+ The FOREX & Appreciation/Depreciations Remember: the FOREX is an island in the middle of the ocean!!! Theorize who demands there and who supplies there. USD YEN Q$ ¥/$ Q¥Q¥ $/¥S S D D ER 1 Remember the bottom-bottom rule!!! The market you are analyzing (USD) is the Quantity on the X-axis, and the other currency (Yen) per $ on the Y-axis.

+ 4 Factors that Shift Demand/Supply in FOREX: 1. Tastes: prefer one nations goods over the other 2. Income: if one nation has more wealth, we assume they spread it around 3. Price Level (price tags): always go towards cheaper goods 4. Interest Rates: investors seek the highest potential returns (Interest Rates) The FOREX & Appreciation/Depreciations USD YEN Q$ ¥/$ Q¥Q¥ $/¥S S D D ER 1

+ Net Exports and Appreciation/Depreciation Appreciation: increase in value of currency Depreciation: decrease in value of a currency One is not necessarily better than the other USD appreciates: “Stronger” dollar  US households can afford foreign goods/services, which are comparatively weaker, ceteris paribus This results in a decrease of GDP (Imports , negative component of N X ) USD depreciates: “Weaker” dollar  foreign households can afford US goods/ services, which are now relatively cheaper, ceteris paribus

+ FOREX Sample Problems 1. Draw a model for the US loanable funds market. Show the impact on the real interest rate of increasing purchases of US government securities by China. How would this impact the international value of the US dollar? Explain. 2. Show how an increase in the demand for Japanese cars would affect the market for the dollar and the market for the yen. What would happen the Japan’s GDP as a result of the change in the value of the Yen?

+ FOREX Sample Problems Answers 1. Draw a model for the US loanable funds market. Show the impact on the real interest rate of increasing purchases of US government securities by China. How would this impact the international value of the US dollar? Explain. Interest Rate REAL S D IR 1 Q S2S2 IR 2 Q2Q2 Financial account surplus for the US leads to an increase in the supply of loanable funds (capital inflow). In order for Chinese investors to obtain US securities, they must supply Yuan in FOREX and demand USD. This appreciates the USD.

+ FOREX Sample Problems Answers 2. Show how an increase in the demand for Japanese cars would affect the market for the dollar and the market for the yen. What would happen the Japan’s GDP as a result of the change in the value of the Yen? USD Depreciates YEN Appreciates Q$ ¥/$ Q¥Q¥ $/¥S S D D ER 1 S2S2 ER 2 D2D2 US households will supply USD in FOREX and demand Yen. Since it would now be “cheaper” for Japanese households to purchase foreign goods/services, Japan will import more. This will decrease Japan’s GDP.