CFA ECON #5
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- Total market value of goods and services prodcued in a country within certain time period. GDP only includes purchases of newyly produced goods. Transfer Payments are payments made by governmetn (unemployment, retirement, etc) not included in GDP.
- Only value of final goods. (computer chip is not included bc it's value is included in final value of a Computer)
- GDP includes value of owner occupied houseing, and rental housing.
Value of labor not sold (i.e. homeowner making changes to his house) do not factor into GDP.
Also byproducts of production are not included in GDP.
Expenditure Aprroach? Difference between sum of value and svalue of final oupt approach? Income Approach?
Expenditure is sum of amounts spent on goods and service. Sum of value is increase of incremental value after each process, value of final ouput is value of the final ouput. Income, is amount received during period.
Nominal GDP, Real GDP? GDP Deflator?
Nominal GDP is Price of goods in year multiplied by quanitty.
Real GDP is price of good in base year multiplied by quantity produced.
GDP Deflator is Nominal GDP/Real GDP in base year multiplied by 100.
Expenditure approach components?
- C=consumer spedning
- I=Business Expenditure
- G=Government Purchasing
- X-M= Trade Deficit Exports minus imports
Income Approach Components are National Income+Capital Consumption allownance+Statistical Discrepancey. What are each.What is Personal Income and Personal Disposabla.
CCA - Capital Consumption Allowance is the measure of depreciaton of physical cpaitla from production of good.
Statistical Disctrepancy is adjustment for diff between GDP and INcome.
National Income = sum of income recevied by all factors of production that go into creation of final ouptu. (employee compensation, corporate and govt profits before taxes, interest income, unicorporated business net income, rent, indirect taxes.
Personal Inocme is pretax income received by households. Includ national income, transfer payments, minus indirect business tax, coroporate income tax, undistriubted corporate prfoits.
Personal Dsposable is income tax minus personal taxes.
What is funadmental relationship between saving, investment, fiscal, and trade balance.
MPC and MPS?
Marginal Propensit to Consume is percent of Income on conumption. Marginal propensity to save is percent on save.
What is IS curve.In terms of SI curve. Which way does it go? How do we justify?
IS curve iplots combinations of income and the real interest rates for which aggregate output equal planned expenditures. Goes down to right. As interest rates lower, Investment increases, meaning S-I gets lower.
LM Curve? Which ways does it go? Quantify movements?
LM curve shows combination of GDP/Real income and interest rate that keeps quantity of real money demanded equal to quanitty of real money supplied. Goes up to the right. Equation is M/P=(1/V)*Y money supply/price level= % of income pepople wnat to hold as cash * real GDP.
As interest rate decreases, people cash so 1/V goes up. Postive relationship between real income and real interest rate. but to maintain M/P balance, as 1/V goes up Y(real GDP) must go down. Therefore interest rates and Real GDP have a postive relation and go up together.
Aggregate Deamnd Curve is? Which Way does it go?
Shows relationship between quanity of real ouput demanded and price level. M/p=(1/v)*Y. Holding M constant what relationship P and Y have on one another. If P is greater, Y is less. Therefore a negative relationship.
Aggregate demand curve slopes downard bc at higher prices, Wealth is less, Interes rates are higher, and domestically produced goods get more expensive compared to abroad.
Aggregate Supply Curve?VSRAS, LRAS, SRAS?
Describels relationship between Price level and quantiy of real GDP supplied. In other words amount of ouput firms will produce at different price levels.
- LRAS = Inelestaic. Price level does not affect ouput in long run.
- VSRAS = Elastic, You can change input factors in short term without affedting price
- SRAS = Inbetween
What is a shift in aggregate demand? What causes?
AD refelcts level of expenditure in an economy by consumers, busines, govt, foregners. Remember C+I+G+(X-M)
- -Increase in consumer wealth (C increases)
- -Increase in business Expectation (I Increase)
- -Consumer expectation of future increases (C increases)
- -High capacity utilization (I increases, when company produce at high eprcentage of capacity, tend to increase more in plant and equpment)
- -Expansionary monetary policy - Growth of money supply increases, lower money supply (C & I increase).
- -Expansionary Fiscal Polic (C increases for tax cut, G increases for Spending Increases) Decreasing government budget.
- -Exchange Rates: decrease in relative value of acountry's currency will increase exports decrease imports (net x increases)
- -Global Econmic growth
What represents Fiscal Deficit? Monetary Deficit? Trade Deficit?
- Fiscal - G-T
- Monetary S-I
- Trade X-M
Shift in Short Run Aggergat Supply? Causes?
Shift in Short Run Aggergat Supply refelct changes in ouptut and price level when wage/other inputs are constant.
- 1. Labor Productivity: Holding pay constant as productivity gets better, so does output (increase SRAS)
- 2. Input Prices - Decrease in Nominal Wage or price of inputs, can cause production to increase.
- 3. Expectations of futre ouput prices: when they expect higher prices, business ouput increases in short term
- 4. Tax and government subsidies
- 5. Exchange rates: Appreciation of country's currency cause foreign inputs to decrease and prices to decrease, while supply increase.
Shift in long run aggregat supply curve? Causes?
Changes in factors affecting real ouput that an economy can proudce at full employment shift LAS. Affecting potential Supply.
- Increas in supply and quality of labor
- Increase in supply of natural resources
- Increas in stock of physical capital
- Increase in technology
Movements along demand and supply aggregate? Recesionary/ Output Gap? Oppositte?
reflect impacts of a change in price level on quantiy demanded and quanity supplied.
Recesionary Gap is when Aggregate demand and SRAS curve are higher in price level and less GDP. This means that prices are too high, and wage pressure decreased and resource prices decrease to equilibrium.
Opposite is when above employment, menaing price levels too low, puts upward pressure on prices, infaltion, back to equilibrium.
What would happen if aggregate demand increases?
Aggregate demand increases, means demand shifts up the SRAS. Bc up original SRAS, and Wages are still held constant, Production is increased which puts a pressure to increase hired workers and increase wages. SRAS Shifts up left and same production on LRAS curve.
Investor implications for decrease in aggregate demand, increase.
Decrease - Inc rease investment defensive companies, increase investment in Governmetn/Safer investment, Increas in long maturity fixed income securitys bc prices react more to falling interest rates, decrease investment in commodites and companies producing
Increase is vice versa.
Stagflation? Investor should.
Sharp Up left shift in supply curve. Assocaited with Increase in price of inputs. Demand Increases because of shortage, and prices increase. This is an inflation and Unemployment.
Investor should decrease invesment in fixed income securityies bc of expected higher inflation, decrease investment in equity as revenue and profit margins decrease, increase invesment related to commodities.
4 Stages of business Cycle? What constitutes Begging of expansion?
- Expansion - Increase in employment, Consumer Spending, Business Investment
- Peak - As rate of spending, investment, and employment slow, but remain positive, inflation accelerates.
Contraction/Recesion - Declines in most sectors with inflation decreasin.
Trough- begins to slow decline.
Recovery, Happens right after trough. Employment growth may not start to increase unitl expansion has taken hold convincingly.
Economic growth can be explained by examinging 5 important sources.
Labor supply - # of people over age 16 who are working or available for work but currently unemployed. Affected by Poopulation growth, net immigration, and labor force participation rate.
Human Capital - Eduatcion and skill level of a country's labor force
Physical capital stock - High rate of investment increases country's stock of physical capital.
Technology - Improvements in tech increase productivity and potential GDP.
Natural Resources - Rw material inpust necessary to purduce. Countriees with more have more potential for greatr rate of growth.
Growth in Potential GDP?
Sustainable Rate of economic Growth?
Potential GDP = Aggregat hours Worked x Labor Productivity
Growth in potential GDP = growth in labor force + growth in labor productivity
Sustainble rate of growth, important bc long term equity returns dependent on economic growth over time. This rate is determined by rate of increase in conomy's productive capacity potential GDP.
Total Factor Productivity?
Relationship between ouput and labor, capital stock, and productivity.
Total Factor Productivity is multiplier quanitfies amount of ouput growth cannot be explained by increases in labor and capital. (technological advances). Residual Factor.
- Labor productivity increased by impoving technology or increasying physical capital per worker.
- In developed countries where high level of capitl per worker is high,a nd capital inputs experience diminishng marginal retruns, Tech advances that increase total factor productivity are main sourcde of sustainable conomic growth.
Concept of business cycles pertain's to econmy's mostly comprised of? 4 Business cycles?
Businesses. Agriculture, or state planned do not work as much.
Trough, Expansion, Peak, Recession
Do business cycles recur at regular intervals? How many consecutive quarters of growth is considered expansion?
- They do not occur at regular intervals.
What Particular ratio is good to indicate business cycles? What does it mean if high/Low?
When ecnomy entering a peak, sales begin to slow, invetory's increase, and ratio is higher.
When economy reaches trough, sales pick up, inventory's decrease, ratio is lower. This is a prime example of a Lead Economic Indicator
NEoclassical School? Keynesian School?New Keynesian School? Monetarist School?Austrian School?New Classical School or RBC theory?
Neo Classical - Shift in aggregate demand and supply are driven by changes in technology over time. Busniess cycles are temproary devations from Long run equilibrium.
Keynesian School - Shifts in aggregate deamnd due to expectations. Swings are due to changes in level of optimism of people who run businesses. Fiscal Policy through effects on aggregate demand can have strong effect on economic growth.
New Keynesian- Add assertion that prices of productive inputs other than labor are also downard sticky. Which present additonal barriers to restoration of full employment equilibrum.
Monetarist school beleive money supply causes variations in aggregate demand. Beleive that effect of fiscal stimullus is only temporary adn that monetary policy should be used to increase or decrease inflationary pressuryes. Do NOT beleive monetary policy should be used in an attempt to smooth cyclical changes in economic activity,
Austrian School beleives business cycles are caused by government intervention in the ecobnonmy.
New Classical emphazie effect of real economic variables suhc as change in tech and external shocks opposed to other variables that cause cycles.
3 types of unemployment?
Frictional - lag time from matching jobs with unemployed.
Structural - caused by long run changes in which unemployed workers do not have skills needed to perform jobs availbable.
Cyclical - caused by changes in level of econmic activity. Postive when economy is operating less than full capacity, and negative when expansion leads employment to ove full employment level.
What kind of ratio is unemployment rate?
- Unemployed - is percent of people that are in the labor force who are unemployed
- Labor force- people that are looking for jobs and or have jobs.
- Voluntarily Unemployed - People who are do not have job and are not looking for one. Not included in Unemployment Rate.
- Underemployed- people who are more qualified for the current job
- Participation ratio - percent of working age popoulation who are employed or activley seeking employment
- discouraged workers - are voluntarily unemployed.
Unemployment is a laggard variable, because the unemployment rate can go down when expansion begins bc discouraged workers can start looking for jobs when economy gets better, and more people in labor force
Inflation, Disinflation, deflation.
- Inflation is increases over time, Not just one period. Also can not just be one good, must be multiple.
- Disinflation, is inflation rate cdecreasing over time but greater than zero.
Deflation is persisten decrease in price level. Associated with deep recession
Headling and Core Inflation
Fisher Index/ Chain Weighted
Consumer Price Index, basket of goods. (Cost of basket current price/Cost of basket at base period)*100
Headline inflation refers to prices of all goods. Core inflation refers to prices excluding food and energy (more volatile).
Laspeyeres Index measure like CPI. 3 factors causing upward are New goods, quality changes, and substituion.
Hedonic Pricing - Adjust price index for product quality
- Chain Weighting/Fisher - Adjust for Substituion
- Paasche - uses current consupmtion weights, prices from base periods, and price in current periods.
Is (current prices*Quantity/Past Prices*Quanity)*100.
Cost Push Inflation
Cost push inflation means Supply goes up to the left
Fiscal Policy? Monetary Policy?
Fiscal is government use of tax and spending to influence economy. Monetary deals with determining quanity of money supplied by centra bank. Both policies aim to achieve economic growth with price level stablility.
Money Multiplier equation
money multiplier = 1/Reserve Requirement.
3 Factors influencing money Demand
- -Transaction demand for buying goods and services
- -Precautionary demand, to meet unforseen future needs
- -speculative demand to take adv of investment opportunity
Nominal Interest rate is equat to real interest rate + Expected Inflation
Effective central banks have what 3 characteristics?
- Independance- free of political interference
- Credibility - will follow through with stated intentions
- Transparcey - bank makes clear what economic indicators it uses
Monetary policy affects Mmarket interest rates, asset prices, growth expectations, and exchange rates.
Real Trend rate? Neutra interset rate? What happens if policy rate is above neutral below.
Real trend - Long term sustainable real growth rate of economcy.
Neutral is sum of real tren rate and target inflation rate.
When above neutral, contractionary below expansionary.
Reasons moneatary policy may not work
May affect inflation expectations so that long term rates move opposite of short term
Individuals willing to hold greater cash balances without change in shor term rates (liquidity trap)
Banks unwilling to lend greater amounts, even with excess reserves
Short term rates can be rudeced below 0
Objectives of fiscal policy
- Influnce level of economic activity
- redistriubting wealth or income
- allocating resources among industries.
Arguments for being concerned with deficit. against?
- -Higher future tax lead to disincentives to work, negativle affect long term growth
- -Fiscal deficit may not be financed by market when debt levels are high
- -Crowding-out as govt borrowing increases I/R, private sector decreses.
- -Debt financed by domestic citizens (Can be)
- -Deficits for capital spending can produce productive capacity
- -fiscal deficits may prompt tax reform
- -Ricardina equivalence prevail: savings rrise in anticipation of need to repay principal on gov't debt
- -When economy sioperating below full employment, deficits do not crowd out
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