Econ 102 Part two

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Econ 102 Part two
2013-03-11 23:23:08
Between two midterms

Chapter 9,10,11
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  1. Identifying Unemployment
    • Produced by Stats. Canada
    • Based on regular survey of 50,000 households- Labour Force surey
    • Based on "adult population" (15 yrs or older)
  2. Employed
    A person is considered employed if he or she has spent most of the previous week working at a paid job
  3. Unemployed
    A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job.
  4. Not in the labour force
    Everyone else, not working the previous week, on temporary layoff, looking for a job, or waiting for the start sate of a new job.
  5. Labour force
    Is the total # of workers, including the employed and unemployed
  6. 3 divisions that Stats Canada divides the population into
    Employed, unemployed, and not in the labour force
  7. Unemployment rate (u-rate)
    • 5 of the labour force that is unemployed
    • = 100 x (#of unemployed/labour force)
  8. Labour force participation rate
    • % of the adult population that is in the labour force
    • =100 x (labour force/adult population)
  9. Labour Market Experiences of Various Demographic Groups
    • Stats. Canada publishes these statistics for demographic groups within the population
    • These data reveal widely different labour market experiences for different groups
    • High unemployment for 15-24 year olds
  10. Does Unemployment rate measure what we want it to?
    • It is difficult to distinguish between a person who is unemployed and a person who is not in the labour force
    • Discouraged searchers, people who would like to work but have given up looking for jobs after an unsuccessful search, don't show up in unemployment stats.
    • Other people may claim to be unemployed in order to receive financial assistance, even though they aren't looking for work
  11. How long are the unemployed with work?
    • Most spells of unemployment are short
    • In 2009, the average spell of unemployment lasted 15.6 weeks
    • Economists and policymakers must be careful when interpreting data on unemployment and designing policies to help the unemployed
    • Most people who become unemployed will soon find job
    • Policy solutions directed toward fixing the unemployment problem should be directed toward those suffering prolonged spells of unemployment
  12. Natural rate of unemployment
    • a reason why some people are unemployed
    • Is the rate of unemployment to which the economy tends to return in the long run
    • In Canada, it is estimated that the natural rate of unemployment is currently between 6 and 8
  13. Cyclical unemployment
    • a reason why some people are unemployed:
    • The deviation of unemployment from its natural rate
    • Associated with business cycles, which we'll study later
  14. Frictional unemployment
    • a reason why some people are unemployed:
    • Occurs when workers spend time searching for the jobs that best suit their skills and tastes
    • Short-term for most workers
  15. Structural unemployment
    • a reason why some people are unemployed:
    • Occurs when there are fewer jobs than workers
    • Usually longer-term
  16. Job search
    The process of matching workers with appropriate jobs
  17. Sectoral shifts
    • Changes in the composition of demand across industries or regions of the country
    • Such shifts displace some workers, who must search for new jobs appropriate for their skills & tastes
    • The economy is always changing, so some frictional unemployment is inevitable
  18. Public Policy and Job Search
    • Govt employment agencies: provide information about job vacancies to speed up the matching of workers and jobs
    • Public training programs: aim to equip workers displaced from declining industries with the skills needed in growing industries
  19. Employment Insurance (EI)
    • A govt program that partially protects workers' incomes when they become unemployed
    • EI increases frictional unemployment. Remember, People respond to incentives
  20. Minimum-Wage Laws
    • The min. wage may exceed the eq'm wage for the least skilled or experienced workers, causing structural unemployment.
    • But this group is a small part of the labour force, so the min. wage can't explain most unemployment in the economy.
    • Structural unemployment that arises from an above-equilibrium wage is, in an important sense different from the frictional unemployment that arise from the process of job search
    • When job search is the explanation for unemployment, workers are searching for the jobs that best suit their tastes and skills
    • When the wage is above the equilibrium level, the quantity of labour supplied exceeds that quantity of labour demanded, and workers are unemployed because they are waiting for jobs to open up
  21. Unions and Collective Bargaining
    • Union, a worker association that bargains with employers over wages, benefits, and working conditions
    • As of 2009, 30% of all Canadian workers belonged to unions
    • Unions exert their market power to negotiate higher wages for workers
    • The typical union worker earns 20% higher wages and gets more benefits than a non-union worker for the same type of work
    • The process by which unions and firms agree on the terms of employment is called collective bargaining
    • When unions raise the wage above eq'm quantity of labour demanded falls and unemployment results
    • "Insiders" - workers who remain employed, they are better off
    • "Outsiders" - workers who lose their jobs, they are worse off
    • Some outsiders go to non-unionized labour markets, which increases labour supply and reduces wages in those markets
  22. Union
    A worker association that bargains with employers over wages, benefits, and working conditions
  23. Collective bargaining
    The process by which unions and firms agree on the terms of employment
  24. Strike
    • Refers to when the union organizes a withdrawal of labour from the firm
    • Will be organized if the union and the firm cannot reach an agreement
  25. Efficiency wages
    • Firms voluntarily pay above-equilibrium wages to boost worker productivity
    • Different versions of efficiency wage theory suggest different reasons why firms pay high wages
  26. 4 reasons for efficiency wages
    • 1. Worker health: In less developed countries, poor nutrition is a common problem.  Paying higher wages allows workers to eat better, makes them healthier, more productive
    • 2. Worker turnover: Hiring & training new workers is costly. Paying high wages gives workers more incentive to stay, reduces turnover
    • 3. Worker quality: Offering higher wages attracts better job applicants, increases quality of the firm's workforce
    • 4. Worker effort: Workers can work hard or shirk.  Shirkers are fired if caught.  Is being fired a good deterrent?  Depends on how hard it is to find another job.  If market wage is above eq'm wage there aren't enough jobs to go around, so workers have more incentive to work not shirk
  27. What is Money and Why it's important
    • Without money, trade would require barter, the exchange of one good or service for another
    • Every transaction would require double coincidence of wants - the unlikely occurrence that two people each have a good the other wants
    • Most people would have to spend time searching for others to trade with - a huge waste of resources
    • This searching is unnecessary with money, the set of assets that people regularly use to buy g&s from other people
    • It is the lubricant tat makes economy run smoothly
  28. 3 Functions of Money
    • 1 Medium of exchange: an item buyers give to sellers when they want to purchase g&s
    • 2 Unit of account: the yardstick people use to post prices and record debts
    • 3 Store of value: an item people can use to transfer purchasing power from the present to the future
  29. 2 kinds of Money
    • Commodity money: takes the form of a commodity with intrinsic value. Examples: gold coins, cigarettes in POW camps
    • Fiat money: money without intrinsic value, used as money because of govt decree. Example; the Canadian dollar
  30. The money supply (or money stock):
    the quantity of money available in the economy
  31. What assets should be considered part of the money supply? (2)
    • Currency: the paper bills and coins in the hands of the (non-bank) public
    • Demand deposits: balances in bank accounts that depositors can access on demand by writing a cheque or using a debit card
  32. M1+
    • Chequable deposits
    • Currency
  33. M2
    • Nonpersonal demand and notice deposits
    • A few minor categories
    • Everything in M1+ (chequabl deposits and currency)
  34. Central bank
    An institution designed to regulated the money supply in the economy
  35. Bank of Canada
    The central bank (institution designed to regulate the money supply in the economy) of Canada
  36. The bank of Canada
    • was established in 1935 and nationalized in 1938, so it is now owned by the Canadian government
    • The Structure of BOC:
    • Managed by a board of directors, composed of the governor, the senior deputy governor, and 12 directors, including the minister of Finance
    • Current governor, Mark Carney, was appointed in 2008
    • All members in the board of directors are appointed by the minister of Finance, with 7-year terms for the governor and senior deputy governor, and 3-year terms for the other directors
  37. 4 primary function of the Bank of Canada
    • Issue currency
    • Act as banker to the commercial banks
    • Act as banker to the Canadian government
    • Control the money supply
  38. BOC
    Controlling the money supply
    • The money supply is the quantity of money available in the economy
    • Decisions by policymakers concerning the money supply constitute monetary policy
  39. Commercial Banks and the Money Supply
    • Although the BoC alone is responsible for Canadian monetary policy, the central bank can control the supply of money only through its influence on the entire banking system
    • Commercial banks include credit unions, caisses populaires, and trust companies
    • Commercial banks can influence the quantity of demand deposits in the economy and the money supply
  40. Fractional reserve banking system
    • Banks keep a fraction of deposits as reserves and use the rest to make loans
    • Banks may hold more than this minimum amount if they choose
    • The reserve ratio, R = fraction of deposits that banks hold as reserves
    • =total reserves as a percentage of total deposits
  41. Reserve ration R
    • =fraction of deposits that banks hold as reserves
    • =total reserves as a percentage of total deposits
  42. T-account
    • A simplifies accounting statement that shows a bank's assets & liabilities
    • Banks' liabilities include deposits
    • Assets include loans & reserves
  43. 3 different ways to calculate the money cupply
    • 1. No banking system
    • 2. 100% reserve banking system: banks hold 100% of deposits as reserves, make no loans
    • 3. Fractional reserve banking system

    The first 2 options do not change the size of the money supply.
  44. Fractional reserve banking system
    creates money, but not wealth, through the money multiplier
  45. Money multiplier
    • The amount of money the banking system generates with each dollar of reserves
    • The money multiplier equals 1/R
    • In our example, R=105
    • Money multiplier = 1/R=10
    • $100 of reserves creates $1000 of money
  46. The BOC has two tools in its monetary toolbox:
    • Open-market operation
    • Changing the overnight rate
  47. The Bank of Canada's Tools of Monetary Control
    Open-Market Operations:
    • The Bank of Canada conducts open-market operations when is buys government bonds from or sells government bonds to the public:
    • Buying bonds causes the money supply to increase
    • Selling bonds causes the money supply to decrease
  48. The Bank of Canada's Tools of Monetary Control
    Foreign Exchange Market Operations
    • The Bank of Canada conducts foreign exchange market operations when it buys or sell foreign currencies:
    • The money supply increases when the Bank of Canada buys foreign currency with Canadian currency
    • The money supply decreases when the Bank of Canada sells foreign currency
  49. The Bank of Canada's tools of monetary Control
    • Changing the overnight rate
    • Foreign Exchange Market Operations
    • Open-Market Operations
  50. The BOC's tools of monetary control
    Changing the Overnight Rate
    • Central banks like the Bank of Canada act as bankers to the commercial banks: bank rate: the interest rate charged by the Bank of Canada on loans to the commercial banks
    • Since 1998 the Bank of Canada has allowed commercial banks to borrow freely at the bank rate, and has paid commercial banks the bank rate, minus half a percent, on their deposits at the Bank of Canada
    • Commercial banks never need to pay more than the bank rate for short-term loans, because they can always borrow from the Bank of Canada instead
    • Conversely, commercial banks never need to accept less than the bank rate, minus half a percent, when the make short-term loans, because they can always lend to the Bank of Canada instead
    • In practice, the overnight rate, which is the rate of interest on very short-term loans between commercial banks, stays very close to the middle of the operating bank, so the overnight rate will always be about one quarter of a percent below the bank rate
    • The Bank of Canada can alter the money supply by changing the bank rate, which in turn causes an equal change in the overnight rate
    • A higher overnight rate discourages banks from borrowing reserves from the Bank of Canada
    • Thus, an increase in the overnight rate reduces the quantity of reserves in the banking system, which in turn reduces the money supply
  51. Overnight rate
    The interest rate on very short-term loans between commercial banks
  52. Problems in Controlling the Money Supply
    • The BoC's control of the money supply is not precise
    • The BoC must wrestle with two problems that arise due to fractional-reserve banking
    • The BoC does not control the amount of money that: households choose to hold as deposits in banks; and commercial bankers choose to lend
  53. What happens when the government prints too much money?
    • Price rise!
    • this is explained by the quatity theory of money.
    • Most economists believe that quantity theory is a good explanation of the long run behavior of inflation
  54. Classical theory of inflation
    • Inflation is an increase in the over level of prices
    • Hyperinflation is an extraordinarily high rate of inflation (50% increase/month)
    • History: over the past 60 years, prices have risen on average about 4%/ year
    • Deflation, meaning decreasing average prices, occured in Canada in the twentieth century.
    • Hyperinflation refers to high rates of inflation seuch as Germany experienced in the 1920s
    • In the 19702 prices rose by 7%/year
    • During the 19902, prices rose at an average rate of 2%/year
  55. The Classical theory of inflation, using quantity theory of money
    • The quantity theory of money is used to explain the long-runn determinants of teh price level and the inlfation rate
    • Inflation is an economy-wide phenomenon that concerns the value of the economy's medium of exchange
    • When the overall price level rises, the value of money falls
  56. The value of money
    • P=the price level (eg. the CPI or GDP deflator)
    • P is the price of a basket of goods, measured in money
    • 1/P is teh value of $1, measured in goods
    • Inflation drives up prices and drives down the value of money
  57. The quantity theory of money
    • Developed by 18th century philosopher David Hume and the classical economists
    • Advocated more recently by Nobel Prize Laureate Milton Friedman
    • Asserts that the quantity of money determines the value of money
    • We study this theory using 2 approaches:
    • 1. A supply-demand diagram
    • 2. An equation
  58. Money Supply (MS)
    • In real world, the MS is determined by the Bank of Canada, the banking system, and consumers.
    • In the quantity theory of money we assume that BoC precisely controls MS and sets it at some fixed amount
  59. Money Demand (MD)
    • Refers to how much wealth people want to hold in liquid form
    • Depends on P: an increase in P reduces the value of money, so more money is required to buy g&S
    • Thus, quantity of money demanded is negatively related to the value of money and positively related to P, other things equal
  60. A brief look at the adjustment process
    (result from money supply-demand diagram)
    • It works by:
    • At the intial P, an increase in MS causes excess supply of money
    • People get rid of their excess money by spending it on g&S or by loaning it to others, who spend it.  Result: increased demand for good.
    • But supply of goods does not increase, so prices must rise.
  61. Nominal variables
    • Are measured in monetary units
    • Eg. Nominal GDO, nominal interst rate (rate of return measured in $), nominal wage ($/hour worked)
  62. Real variables
    • Are measured in physical units
    • Eg. real GDP, real interest rate (measured in output), real wage (measure in output)
  63. Real vs Nominal variables
    • Prices are normally measured in terms of money
    • A relative price is the price of one good relative to (divided by) another
    • Relative prices are meaured in physical units, so they are real variables
  64. Real vs Nominal wage
    • W=nominal wage=price of labour eg. $15/hr
    • P=price level=price of g&s eg. $5/unit of output
    • Real wage is the price of labour relative to the price of output:
    • W/P = ($15/hr)/($5/unti of output) = 3 units output per hour
  65. Classical dichotomy
    • The theoretical seperation of nominal and real variables
    • Hume and the classical economists suggested that monetary developments affect nominal variables but not real variables
    • If the cnetral bank doubles the money supply, Hume & classical thinkers contend: all nominal variable - including prices- will double; all real variables - including relative prices - will remain unchanged
  66. Monetary neutrality
    The propostition that changes in the money supply do not affect real variables
  67. The neutrality of money
    • Doubling money supply causes all nominal prices to double, what happens to relative prices?
    • The relative price in unchanged
    • Similarly, the real wage W/P remains unchanged, so: quantity of labour supplied does not change; quantity of labour demanded does not change; total employment of labour does not change
    • The same applies to employment of capital and other resources
    • Since employment of all resources in unchanged, total output is also unchanged by the money supply
    • Most economists believe the classical dichotomy and neutrality of money describe the economy in the long run
  68. Velocity of money
    • The rate at which money changes hands.
    • P x Y = nominal GDP
    •         = (price level) x (real GDP)
    • M = money supply
    • V = velocity
    • M x V = P x Y
  69. Quantity equation
    M x V = P x Y
  70. The quantity theory in 5 steps
    • Starts with quantity equation: M x V = P x Y
    • 1. V is stable
    • 2. So, a change in M causes nominal GDP (P x Y) to change by the same percentage
    • 3. A change in M does not affect Y: money is neutral. Y is determined by technology & resources
    • 4. So, P changes by same percentage as P x Y and M
    • 5. Rapid money supply growth causes rapid inflation
  71. Hyperinflation
    • Generally defined as inflatio exceeding 50% / month
    • Recall: prices rise when the governemtn prints too much money
    • Excessive growth in the money supply always causes hyperinflation
  72. The inflation Tax
    • when tax revenue is inadequate and ability to borrow is limited, govt may print money to pay for its spending
    • Almost all hyperinflations start this way
    • The revenue from printing money it the inflation tax: printing money causes inflation, which is like a tax on everyone who holds money
  73. The Fisher Effect
    • Rearrange the defintion of real interest rate:
    • Nominal interest rate = inflation rate + Real interest rate
    • The real interest rate is determined by saving & investment in the loanable funds market
    • Money supply growth determines inflation rate
    • So, this equation shows how the nominal interest rate is determined
    • In the long run, money is neutral, so a change in the money growth rate affects t he inflation rate but not the real interest rate.
    • So, the nominal interest rate adjusts one-for-one with changes in the inflation rate.
    • This relationship is called the Fisher effect after Irving Fisher, who studied it.
  74. The Fisher Effect & the inflation Tax
    • The inflation tax applies to people's holdings of money, not their holdings of wealth
    • The Fisher effect: an increase in inflation causes an equal increase in the nominal interest rate, so the real interest rate (on wealth) is unchanged
  75. The costs of inflation
    • The inflatio fallacy: most people think inflatio erodes real incomes
    • But inflation is a general increase in prices of teh things people buy and teh things they sell (eg. their labour)
    • In the long run, real incomes are determined by real variables, not the inflation rate
    • Shoeleather costs, menu costs, misallocatio of resources from relative-price variablility, confusion & inconvenience, tax distortions, and arbitrary redistributions of wealth
  76. Shoeleather costs
    • One of the costs of inflation
    • The resources wasted when inflation encourages people to reduce their moeny holdings: includes the time and transactions costs of more frequent bank withdrawals
  77. Menu costs
    • One of the costs of inflation
    • The costs of changing prices: Printing new menus, mailing new catalogs, etc
  78. Misallocation of resources from relative-price variability
    • One of the costs of inflation
    • Firms don't all raise prices at the same time, so relative prices can vary...
    • which distorts the allocation of resources
  79. Confusion & inconvenience
    • One of the costs of inflation
    • Inflation changes the yardstick we use to measure transactions.
    • Complicated long-range planning and the comparison of dollar amounts over time
  80. Tax distortions
    • One of the costs of inflation
    • Infaltion makes nominal income grow faster than real income
    • Taxes are based on nominal income, and some are not adjusted for inflation
    • So, inflation causes people to pay more taxes even when their real incomes don't increase
  81. Arbitrary redistributions of wealth
    • One of the costs of inflation
    • Higher-than-expected inflation transfers purchasing power from creditors to debtors.  Debtors get to repay their debt with dollars that aren't worth as much
    • Lower-than-expected inflation transfers purchasing power from debtos to creditors.
    • High inflation is more variable and less predictable than low inflation
    • So, these arbitrary redistributions are frequent when inflation is high
  82. The costs of inflation (high or low inflation)
    • All these costs are quite high for economies experiencing hyperinflation
    • For economies with low inflation (<10%/year) these costs are probably much smaller, though their exact size is open to debate