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Rule of 70: 70/x = # years to double where x equals growth rate.
Y = C + I + G + NX – the spending approach to calculating GDP.
S = I in a closed economy (no trade) and S = I + NX in an open
economy
Calculating Nominal GDP: Multiple the number of each good
produced times the price of each good: Photdog*Qhotdog +
Phamburger*Qhamburger.
Calculating Real GDP: this proceeds just as calculating nominal
GDP, but instead of current prices you use base prices:
Photdog(base year)*Qhotdog(current year) + Phamburger (base
year)*Qhamburger (current year). Side implications: In the base
year Nominal GDP = Real GDP, with inflation Nominal GDP > Real
GDP.
GDP deflator: A measure of the cost of living (substitute for the CPI).
GDP deflator = (Nominal GDP/Real GDP)*100. Remember that this is
an index. Side implication: In the base year the GDP Deflator = 100.
Constructing the CPI: step 1: compute the cost of a market basket in
each year (prices times quantities), step 2: choose a base year. Step
3: Calculate the CPI for the current year by: (Cost current
year)/(cost in base year)*100. Side implication: in the base year the
CPI = 100. With inflation, CPI increases.
The inflation rate via the CPI: (CPI current year – CPI previous
year)/CPI previous year all times 100. Note that this is just a
percentage change. The inflation rate is the percentage change in the CPI
from one period to the next. You could also calculate the percentage
change in the GDP (implicit) price deflator from year to year to derive at
an alternative measure of inflation.
Correcting for inflation: Let’s adjust for inflation so we can, in a more
meaningful way, compare the dollar values of different points in time.
Convert a figure in 1990 to its current value: current value = value
in 1990 * (CPI in 2000/CPI in 1995). For example, Babe Ruth earned
$80,000 in 1931. Translating to current dollars means: current value
= 80,000 * (107.6/8.7) = $989,000. So $80,000 back then is equivalent
to $989,000 today…THIS ONE IS CRUCIAL!!!!!!
Real interest rate = nominal interest rate – inflation rate.
Unemployment Rate = (Number of Unemployed/Labor Force)*100.
Key, first get the labor force – all the folks who are actively seeking
employment!
Labor force participation rate: (Labor force/adult population)*100.
Money Multiplier = 1/R where R = reserve ratio. Application: an
initial injection of $1000 of new money into an economy with a reserve
ratio of 10% (.1) will generate $1000*(10) = $10,000 in total money.
Y= Total output or incomes to households
C= Consumer expenditures from households
I = Business Investment
Circular Flow: Y= C+I
NX= Net Exports = X-M (exports-imports)
CPI= Consumer Price Index
G= Goods and Services
GDP= Gross Domestic Product
Money Multiplier: 1 million increase in the monetary base increases the
quantity of money to 2.5 million then the money multiplier is 2.5
CHAPTER 7
TEXT
Capital, (physical capital), is a real productive resource; financial capital
is the funds used to buy capital.
Gross investment increases the quantity of capital, and depreciation
decreases it. Saving increases wealth.
The markets for financial capital are the markets for loans, bonds, and
stocks.
Financial Institutions ensure that borrowers and lenders can always find
someone with whom to trade.
Investment in capital is financed by household saving, a government
budget surplus, and funds from the rest of the world.
The quantity of loanable funds demanded depends negatively on the real
interest rate and the demand for loanable funds changes when profit
expectations change.
The quantity of loanable funds supplied depends positively on the real
interest rate the supply of loanable funds changes when disposable
income, expected future income, wealth, and default risk change.
Equilibrium in the loanable funds market determines the real interest rate
and quantity of funds.
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A government budget surplus increases the supply of loanable funds,
lowers the real interest rate, and increases investment and the
equilibrium quantity of loanable funds.
A government budget deficit increases the demand for loanable funds,
raises the real interest rate, and increases the equilibrium quantity of
loanable funds, but decreases the investment in a crowding-out effect.
The Ricardo-Barro Effect is the response of rational taxpayers to a
budget deficit. The real interest rate remains constant and the crowding
out effect is avoided.
SLIDES
The financial markets and institutions play a crucial role in the economy.
They provide the channels through which saving flows to finance
investment in new capital that makes the economy grow.
Finance is the activity of providing the funds that finance expenditures
on capital. The study of finance looks at how households and firms
obtain and use financial resources and how they cope with the risks that
arise in this activity.
Money is what we use to pay for goods and services, factors of
production, and to make financial transactions. The study of money
looks at how households and firms use it, how much money they hold,
how banks create and manage it, and how its quantity influences the
economy.
Wealth increases when the market value of assets rises-called capital
gains- and decreases when the market value of assets falls- called capital
losses.
Saving is a source of funds used to finance investment. These funds are
supplied and demanded in three types of financial markets: loan, bond,
and stock.
Loan Markets: short term finance, household loans, mortgage.
Stock Market: A stock represents ownership and is a claim to a firms
profits. Equity finance is the sale of a stock to raise money. Stock index
is an average group of stock prices. B/C stock prices reflect expected
profitability, stock indexes are watched as closely as possible indicators
of future economic conditions.
Securitization: The securitization of assets is broadly defined as the
process by which loans, consumer installment contracts, leases,
receivables, and other relatively illiquid assets with common features are
packaged into interest bearing securities with marketable investment
characteristics.
A financial institution is a firm that operates on both sides of the markets
for financial capital. It is a borrower in one market and a lender in
another. Key financial institutions are: banks, trust and loan companies,
credit unions and caisses populaires, mutual funds, pension funds,
insurance companies.
A financial institutions net worth is the total market value of what it has
lent minus the market value of what it has borrowed. If the net worth is
less than 0, the institution is solvent. If net worth is more than 0, the
institution is insolvent.
A firm can be solvent but illiquid. A firms illiquid if it has made long
term loans with borrowed funds, and is faced with a sudden demand to
repay more of what it has borrowed than is available in cash.
Both insolvency and illiquidity were at the core of the financial
meltdown.
David Ricardo was an English economist in the 18th century.
CHAPTER 8
TEXT
Money is the measure of payment. It functions as a medium of exchange,
a unit of account, and a store of value.
Today, money consists of currency and deposits.
Chartered banks, credit unions, trust and mortgage companies, and loan
companies are depository institutions whose deposits are money.
Depository institutions provide four main economic services: they create
liquidity, minimize the cost of obtaining funds, minimize the cost of
monitoring borrowers, and pool risks.
The BOC has two main policy tools: open market operations & the bank
rate.
When the bank buys securities in an open market operation, the
monetary base increases; when the bank sells securities, the monetary
base decreases.
Banks create money by making loans.
The total money that can be created depends on the monetary base, the
desired reserve ratio, and the currency drain ratio.
The quantity of money demanded is the amount of money people plan to
hold.
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The quantity of real money equals the quantity of nominal money
divided by the price level.
The quantity of real money demanded depends on the GDP and financial
innovation.
The nominal interest rate makes the quantity of money demanded qual
the quantity supplied.
When the BOC increases the quality of money, the nominal interest rate
falls. (short term effect.
In the long run, when the BOC increases the quality of money, the price
level rises and the nominal interest rate returns to its initial level.
The Quantity Theory of Money is the proposition that money growth and
inflation move up and down together in the long run.
SLIDES
A medium of exchange is an object that is generally accepted in
exchange for goods & services. This diminishes barter, which requires a
double coincidence of wants.
A unit of account is an agreed measure for stating the prices of goods &
services.-Simplifies price comparisons.
As a store of value, money can be held for a time and later exchanged for
goods & services.
The aim of financial innovation- the development of new financial
products- is to lower the cost of deposits or to increase return from
lending.
Financial Instability Hypothesis: The speculative and innovative
elements of capitalism will eventually lead to financial usages and
relations that are conducive to instability.
CHAPTER 9
TEXT
Foreign currency is obtained in exchange for domestic currency in the
foreign exchange market.
Demand & Supply in the foreign exchange market determine the
exchange rate.
The higher the exchange rate, the smaller the quantity of Canadian
dollars demanded and the greater is the quantity of Canadian dollars
supplied.
At the equilibrium exchange rate, the quantity of Canadian dollars
demanded equals the quantity of Canadian dollars supplied.
A change in demand for Canadian exports, changes the demand for
Canadian dollars and a change in the Canadian demand for imports,
changes the supply of Canadian dollars.
A change in the Canadian Interest Rate Differential or the expected
future exchange rate change both the demand for & supply of Canadian
dollars but in opposite directions.
Arbitrage in the foreign exchange market achieves interest rate parity
and purchasing power parity.
Speculation in the foreign exchange market can bring excess volatility to
the exchange rate.
In the long run, the exchange rate is determined by the real exchange rate
and the relative quantities of money.
An exchange rate can be flexible, fixed or a crawling peg.
To achieve a fixed or crawling exchange rate, a central bank must either
buy or sell foreign currency in the foreign exchange market.
A countries international transactions are recorded in its current account,
capital account, and official settlements account.
The current account balance is similar to net exorts and is determined by
the govt. sector balance plus the private sector balance.
International borrowing and lending take place in the loanable funds
market.
SLIDES
Currency Depreciation: fall in value
Currency Appreciation: rise in value
Arbitrage Achieves four outcomes: the law of one price, no round trip
profit, interest rate parity, purchasing power parity.
The law of one price: states that if an item can be traded in more than
one place, the price will be the same in all locations.
No round trip profit: a round trip is using currency A to buy B then using
B to buy A. Arbitrage removes profit from all transactions of this type.
Speculation: Contrast with arbitrage, the certainty of making a profit.
Real Exchange rate: RER=(E X P)/ P*
E= nomincal exchange rate
P= Canadian price level
P* = foreign price level
Current Account Balance= (exports-imports) + net interest income + net
transfers
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Current account balance + Capital Account balance + Official
settlements balance = 0
o National Accounts: Y = C+I+G+(X-M)=C+S+T
To, (X-M) = (S-I) + (T-G)
Therefore, net exports = sum of private sector balance(S-I) + govt. sector
balance (T-G)
T= taxes paid by consumers TR= transfers paid by govt. to consumers
Key Terms:
Default Risk: The risk that a borrower, also known as a creditor, might
not repay a loan.
Mortgage-backed security: A type of bond that entitles its holder to the
income from a package of mortgages.
Nominal Interest Rate: the # of dollars that a borrower pays and a
lender receives in interest in a year expressed as a percentage of the # of
dollars borrowed and lent.
Real interest rate: The nominal interest rate adjusted to remove the
effects of inflation on the buying power of money. It is approx. equal to
the nominal interest rate minus the inflation rate.
The supply of loanable funds: The relationship between the quantity of
loanable funds supplied and the real interest rate when all other
influences on lending plans remain the same.
Bank rate: The interest rate that the BOC charges big banks on loans.
Chartered Bank: A private firm, chartered under the bank act of 1991
to receive deposits and make loans.
Currency drain ratio: The ratio of currency to deposits.
Demand for money: The relationship between the quantity of real
money demanded and the nominal interest rate when all other influences
on the amount of money that people with to hold remain the same.
Desired Reserve Ratio: The ratio of reserves to deposits that banks plan
to hold.
M1: A measure of money that consists of currency held by individuals
and businesses plus chequable deposits owned by individuals and
businesses.
M2: A measure of money that consists of M1 plus all other depositisnon-chequable deposits and fixed term deposits.
Means of Payment: A method of settling debt.
Monetary Base: The sum of BOC notes, coins, and depository
institution deposits at the BOC.
Money Multiplier: The ratio of change in the quantity of money to the
change in the monetary base.
Reserves: A banks reserves consist of notes and coins in its vaults plus
its deposit at the BOC.
Velocity of Circulation: The average # of times a dollar of money is
used annually to buy the goods & services that make up GDP.
Arbitrage: The practice of seeking profit by buying in one market and
selling for a higher price in another market.
Balance of Payments Accounts: A countries record of international
trading, borrowing, and lending.
Canadian Interest Rate differential: The Canadian interest rate minus
the foreign interest rate.
Canadian Official Reserves: The Canadian govt.s holdings of foreign
currency.
Capital and Financial Account: A record of foreign investment in a
country minus it’s investment abroad.
Crawling Peg: An exchange rate that follows a path determined by a
decision of the govt. or the central bank and is achieved in a similar way
to a fixed exchange rate.
Creditor Nation: A country that during its entire history has invested
more in the world than other countries have invested in it.
Current Account: A record of receipts from exports of goods and
services, net interest income paid aborad, and net transfers received from
abroad.
Fixed Exchange Rate: Determined by govt. or central bank, and is
achieved by central bank intervention in the foreign exchange market to
block the unregulated forces of demand and supply.
Flexible Exchange Rate: determined by supply & demand, no direct
intervention.
Govt. Sector Balance: An amount equal to net taxes minus govt.
expenditure on goods and services.
Interest Rate Parity: A situation in which the rates of return on assets in
different currencies are equal.
Purchasing Power Parity: prices of two countries are equal @ exchange R.
Private Sector Balance: Saving minus Investment.