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Chapter4- Demand and Supply
The demand and supply model can be utilized to explain how prices aredetermined in competitive markets. The model can also determine thequantities of goods bought and sold in financial markets.Consequently, the demand and supply model influences what, for whom,and how goods are produced. The law of demand states that buyerswould ordinarily purchase greater quantities of goods at lowerprices. On the other hand, the law of supply states that sellerswould customarily supply larger quantities of goods at higher prices.A higher price causes a surplus which leads to reduction in price.However, a lower price causes a shortage which in turn leads to anincrease in price. This interaction is referred to as the law ofmarket forces. Ultimately, the forces create a market equilibriumwhereby the price remains constant.
Nevertheless, other factors apart from price have a bearing on thequantity of goods supplied and demanded. In this regard, the demandand supply model pinpoints these external influences and predictstheir impact on equilibrium price and quantity. Some of these factorsinclude expected future prices, income, the prices of complements andsubstitutes, tastes and preferences, and the number of buyers. Anyalteration in a commodity`s price causes a change in the quantitydemanded. Such a change is depicted by movement along the demandcurve. On the other hand, when other factors other than price change,we experience a change in demand. Such a change is depicted by ashift of the demand curve either to the left or right. A demandschedule lists the quantities of goods demanded at different priceswhile a demand curve is obtained as a graph of the demand schedule.
Chapter 5- GDP: A Measure of Total Production and Income
The Gross Domestic Product (GDP) provides a basis for tracking thebooms and busts of the economy. It helps to predict the future growthof the economy. GDP is a measure of the value of a country’sproduction in terms of rising prices or increased production. It isdefined as the market value of all final goods and services producedin a country within a given period. GDP only considers final goodsand services since intermediate products would lead to doublecounting. Also, the GDP encompasses the value of all goods producedin a country by foreign subsidiaries.
In the U.S., the GDP is measured quarterly as the amount of totalexpenditure or income. The circular flow model forms the basis forthe measurement of GDP. For example, firms use entrepreneurship,land, capital, and labor in factor markets. Therefore, they payprofits, rent, interest, and wages respectively to households. On theother hand, consumption expenditure shows how households purchaseproducts and services from firms in goods markets. However,households rarely spend their total incomes on purchasing goods andservices for consumption. In this regard, households save some oftheir incomes in financial markets. Firms also acquire loans fromfinancial markets so as to afford the purchase of new inventories andcapital goods. Firms and households also interact with governments togenerate additional flows of income. Governments receive taxes fromhouseholds and provide benefits in return. Government expenditurerefers to the goods and services purchased from firms.
Real GDP measures the extent to which production grows in comparisonto rising prices. It is also used to evaluate the standard of livingand to establish the progression of the economy. The U.S. Bureau ofEconomic Analysis is responsible for measuring the GDP. Also, theNational Bureau of Economic Research (NBER) comprises a group ofeconomists charged with tracking the dates at which turning pointsoccur in the U.S. business cycle. The boom and bust are alsodetermined by other factors apart from real GDP. For example, someindicators show that the 2008 recession began at least six monthsearlier than the period indicated by the real GDP.
Chapter6- Jobs and Employment
The Bureau of Census and the Bureau of Labor Statistics (BLS) collectmonthly statistics so as to evaluate the U.S. job market status. Inthis regard, they dispatch more than 1,000 people to interview over50,000 households. The survey collects different statistics such asthe number of people with and without regular jobs. Part-time workersare also enlisted in the survey so as to determine the number ofpeople who are unable to find full-time employment. The country’slevel of economic success can be deduced from examining the trendsand fluctuations in labor market data.
In the labor market, there always seems to be some form ofunemployment. New graduates customarily take a few weeks or months tosecure jobs. Also, some jobs are lost to computer technology. Forexample, bank tellers may lose their positions when machines are usedto collect and issue cash payments over the counter. The period ittakes to find a job depends on the country’s position within thebusiness cycle. The working-age population comprises of the number ofcitizens older than 16 years and not in the Armed Forces,institutional care, hospitals, or even incarcerated. The labor forceincludes members of the working-age group that could be eitherunemployed or employed.
Employed persons include those that worked for 15 hours in a familybusiness or one hour in a paid job. Persons that were temporarilyabsent from work were also counted among the employed. On the otherhand, unemployed persons include those who have no jobs or had beenlaid off from previous positions of employment. Eligible workers whohad been unsuccessful in their efforts to secure jobs were alsocounted among the unemployed persons. The BLS deciphers the rates ofunemployment and labor force participation from the numbers of thepopulation, working-age population, and the labor force. Theseindicators show the health of the labor market.
Alternative measures of unemployment are used to capture some peoplethat are customarily excluded from the group of unemployed persons.Some of these people include marginally attached workers andpart-time workers. A marginally attached worker refers to one wholacks a job but has not made particular efforts to find a satisfyingjob. Discouraged workers refer to those who have given up all effortsto find work. On the other hand, part-time workers work less than 35hours a week due to economic reasons.
Chapter7- The CPI and the Cost of Living
The Bureau of Labor Statistics measures the prices of several itemssuch as clothing, recreation, transportation, housing, food anddrink, medical care, and education. These prices are used tocalculate the Consumer Price Index (CPI) on a monthly basis. The CPImeasures the average prices paid by consumers for a fixed basket ofhousehold services and consumer goods. The current reference baseperiod for the CPI is January 1982 through December 1984. Thereference base period is equated to 100. For example, if theSeptember 2012 CPI was 250, this means that the basket cost 2.5 timeswhat it cost in 1982-1984.
Calculating the CPI requires a monthly price survey to be conductedbased on a fixed basket of consumer goods and services. The weightspinned to each item in the consumer basket are determined from thecontinuously updated Consumer Expenditure Survey. For example,housing has a weight of 40.9% while transportation has 17.2%. Foodand beverages account for 15.2% while medical care has a weight of7%. BLS economic assistants check and record prices of over 70,000goods and services in over 20 metropolitan areas. Since the CPImeasures changes in prices, recorded prices must be evaluated onitems that are exactly similar. It is also crucial that exactquantities of goods and services be used to measure and compare CPI.
Inflation refers to the rate of change of the price levels. The rateof inflation is used to measure the percentage change in price levelfrom one year to the next. Therefore, the CPI helps to deduce therate of inflation or deflation in an economy. On the other hand, thecost of living index measures the amount of expenditure that wouldenable people to enjoy a particular standard of living. Nevertheless,the CPI has four sources of bias concerning new goods, commoditysubstitution, quality change, and outlet substitution.
Chapter8- Potential GDP and the Natural Unemployment Rate
Potential GDP is defined as the value of real GDP during periods offull employment. It is determined by equilibrium in the labor market,technology, and factors of production. The production function isused to explain potential GDP. Also, the tools of demand and supplycan be used to determine the equilibrium level of labor employedduring full employment. Real GDP is produced using factors ofproduction such as entrepreneurship, land, capital, and labor. Thestate of technology, quantity of land, capital, and entrepreneurshipare always fixed. However, the quantity of labor can be varied suchas to have a direct impact on the quantity of real GDP produced.
Full employment refers to the situation where the quantity of laborsupplied equals the quantity of labor demanded. The quantity of laborsupplied increases with the real wage rate due to an increase in bothlabor force participation as well as the hours per person. Anequilibrium labor market is characterized by full employment and asituation where real GDP equals potential GDP. Consequently, a risein the real wage rate eliminates shortage of labor while a fall inthe real wage rate eliminates surplus of labor. The observabledifferences in incomes and production across different economies canbe explained through understanding the factors behind potential GDP.
Natural or equilibrium unemployment is caused by job rationing andjob search even during periods of full employment. Job search refersto the situation where workers look for an acceptable, vacant post.Job search depends on factors such as unemployment benefits,structural change, and demographic factors. On the other hand, jobrationing refers to when the real wage rate supersedes theequilibrium level of full employment. In this regard, the real wagerate can be set above the equilibrium level due to union, minimum, orefficiency wages. For example, the U.S. has more productivetechnologies and capital per worker than the European Union.Consequently, American workers produce and earn more than theirEuropean counterparts.
Chapter 9- Economic Growth
Economic growthrefers to the sustained expansion of production capabilities. Suchexpansion is measured as a periodic increase in real GDP over aparticular period. The annual percentage change in real GDP forms theeconomic growth rate. Investment and savings in physical capitalcontribute to the growth of labor productivity. Also, the discoveryof new technologies and expansion of human capital contribute tolabor productivity growth. Human capital comes from health and diet,job experience, and education and training. However, new technologieshave made a greater impact on economic growth than the expansion ofphysical and human capital.
The growth of labor productivity leads to increase in real GDP. Highlevels of economic growth can double the real GDP in a relativelyshort time. Nevertheless, the law of diminishing returns applies inthe case such that additional capital will not ensure unlimitedeconomic growth. The growth of real GDP per person can be attained bysubtracting the population growth rate from the growth rate of realGDP. The real GDP per person would only grow if the real GDP grew ata faster rate than the population growth rate.
Several factors build rich economies. For example, politicalstability helps to provide an enabling environment through whichbusiness can be conducted. Stable governmental structures alsoencourage foreign investments. In rich economies, the rule of lawcustomarily protects property rights. Therefore, the governmentimbibes businesspeople with the confidence to accumulate wealth anddevelop property. The government also exercises minimal interventionin financial markets. Market forces of demand and supply are allowedto determine the prices and quantities of goods demanded. Thesustained growth rate of real GDP per person can transform a poorsociety into a wealthy community.
Chapter10- Finance, Saving, and Investment
Success in the financial markets leads to high levels of investmentand rapid expansion of the economy. On the other hand, weak financialmarkets could lead an economy into recession due to the low level ofinvestments. Understanding financial markets requires the mastery ofseveral definitions. Physical capital refers to buildings,instruments, tools, machines, and constructions that are used in theproduction of goods and services. Financial capital is defined as themoney used to purchase and operate physical capital. Gross investmentrefers to the amount spent on capital goods while net investment isobtained by subtracting depreciation from gross investment. Savingsare used to finance investments in loan markets, bond markets, andstock markets.
A financial institution refers to a firm that borrows in a particularmarket while lending in another. Key financial institutions includecommercial banks, investment banks, insurance companies, pensionfunds, and government-sponsored mortgage lenders. Insolvency refersto when a firm has borrowed more than it has lent leading to anegative net worth. A firm is known as illiquid if it is required topay amounts greater than its available balance of cash. Financialassets refer to loans, bonds, and stocks. An increase in the assetprices causes a reduction in the interest rate.
The aggregate market for financial assets is referred to as theloanable funds market. Loanable funds are used to cater for variousactivities such as government budget deficit, business investment,and international lending or investment. Loanable funds can beobtained from international borrowing, government budget surplus, andprivate saving. The level of investments in a financial marketdepends on the expected profit and the real interest rate.Investments are made only when the firm expects to earn a higher rateof profit compared to the real interest rate.
Chapter 11- The Monetary System
The monetary system is composed of commercial banks under the controlof the Federal Reserve (Fed). The monetary base refers to thequantity of money that banks are required to deposit with the Fed.Maintaining these reserves limits the amount of revenues realized bycommercial banks. The amounts of deposits that a bank can create arelimited by desired currency holding, desired reserves, and themonetary base. The Fed regulates the monetary base and also thequantity of legal tender in the economy. In this regard, the Fed isresponsible for regulating the interest rate so as to attain lowinflation and sustained economic growth. The Fed creates legal tenderby buying bonds from the loanable funds market. Next, it pays for thebonds using the newly created money. The global financial meltdown of2008 prompted the Fed to expand the monetary base using three periodsof quantitative easing (QE). A larger monetary base can support agreater quantity of money.
The U.S. has 12 Federal Reserve districts with different FederalReserve Banks. The Fed structure is composed of a Chairperson, Boardof Governors, the Federal Open Market Committee, and Regional FederalReserve Banks. The Senate confirms the Presidential appointments ofpersons to serve on the Board. FOMC is the major policy-makingcommittee. The Fed employs several tools to regulate the country`scurrency. For example, banks are required to hold a particularpercentage of customer deposits as reserves. The Fed also maintains adiscount rate at which it can lend reserves to banks. The Fed usesopen market operations to buy and sell government securities such asTreasury bills and bonds. The Fed has extraordinary crisis measuressuch as Operation Twist, credit easing, and quantitative easing.
Chapter12- Money, Interest, and Inflation
In the short-run, the interest rate is determined in the moneymarket. However, in the long-run, the price level is determined bythe money market. The quantity theory of money refers to theconnection between the price level and the quantity of money. Thistheory also examines the link between the inflation rate and thegrowth rate of the quantity of money. The rate at which the FederalReserve allows the quantity of money to grow determines the futurelikelihood of deflation or inflation. The rate of inflation isobtained by subtracting the growth rate of real GDP from the growthrate of the quantity of money. Rapid real GDP growth and slow moneygrowth contribute to a low rate of inflation. Contrariwise, slowgrowth of real GDP and rapid money growth lead to high inflation.
The quantity of money refers to the amount of money that firms andhouseholds choose to hold. The benefit of holding money manifests inthe ability to make payments. It is easier to make payments when aperson holds more money. Nevertheless, the marginal benefit derivedfrom holding money reduces while the amount of money held increases.On the other hand, holding money foregoes the interest that wouldhave been earned if the money was invested in an alternative asset.The nominal interest is added as a sum of the expected inflation rateand the real interest rate. Furthermore, the demand for money depictsthe relationship between the nominal interest rate and the quantityof money demanded. A lower nominal interest rate translates to alower opportunity cost of holding money. Hence, this also leads to agreater quantity of money demanded.
Chapter13- Aggregate Supply and Aggregate Demand
The aggregate supply-aggregate demand (AS-AD) model can be used toexplain the fluctuations in real GDP. It can also explain why theinflation rate fluctuates. These fluctuations are referred to asmoney wage rate since they have slow adjustments to shortage orsupply of labor. The aggregate supply curve ordinarily has an upwardslope since the money wage rate does not adjust in an instant. It canbe deduced that fluctuations in aggregate demand have other long-termeffects. For example, they also cause shifts in the real GDP aroundpotential GDP. Also, fluctuations in aggregate demand cause shifts inthe price level from the quantity theory of money.
The 2008 recession stands as a case in point to prove the facts ofaggregate supply and aggregate demand. At that time, businessinvestments collapsed and extinguished all the sources of loanablefunds. American exports also shrank because business partners hadbeen adversely affected by the financial crisis. Consequently,aggregate supply also reduced due to falling oil process and areduction in the money wage rate. Exports and investments influencethe phenomenon of aggregate demand. On the other hand, commodityprices and wages have an impact on aggregate supply. Frequent swingsin the value of aggregate demand lead to the emergence of busts andbooms.
The quantity of real GDP demanded refers to the total value of finalgoods and services produced in the U.S. that foreigners, governments,businesses, and people plan to purchase. This figure is obtained bysumming up investments, real consumption expenditure, governmentexpenditure, and exports minus imports. Aggregate demand can bedefined as the relationship between the price level and the quantityof real GDP demanded when the factors influencing expenditure remainunchanged. An increase in the price level reduces the buying power ofmoney since it decreases the amount of real GDP demanded.
Chapter16- Fiscal Policy
Fiscal policy tools refer to the application of the Federal Reservebudget so as to attain macroeconomic objectives. Some of theseobjectives include full employment and sustained economic growth. Traditionally, people have focused on how fiscal policy affectsdemand. Nevertheless, fiscal policy also has a crucial impact on bothaggregate supply and demand. The 2008 global recession prompted theU.S. to implement a fiscal stimulus package under the AmericanRecovery and Reinvestment Act.
Nevertheless, other factors had bigger contributions towards reducingthe extent of damage caused by the recession. Such measures includedincreased expenditure on unemployment benefits. Also, the countrybenefited greatly from the incidence of lower tax revenues. The exacthelpfulness of the hefty stimulus package is yet to be established.Economists of the Keynesian worldview strongly believed that thepackage had helped to prevent the outbreak of another GreatDepression. On the other hand, some economists criticize the stimuluspackage for increasing the government’s debt and enhancing theproblem of a higher budget deficit.
The Federal budget is prepared annually so as to capture the outlays,revenues, surplus and deficits of the U.S. government. The budget isprepared so as to attain macroeconomic goals and finance theactivities of the national government. The President and the Congressbear the ultimate responsibility to make the annual Federal budgetand create fiscal policy based on the guidelines of a fixed timeline.The fiscal year is set between October 1 and September 30 of thefollowing year. The budget balance is obtained by subtracting theoutlays from the tax revenues. A balanced budget occurs when theoutlays equal the tax revenues. The Federal government repays debtswhenever it has a budget surplus and borrows money so as to balance abudget deficit.
Chapter 18- International Trade Policy
Reliable statistics show that 33% of people use goods and servicesproduced in foreign countries. Comparative advantage mostly governsInternational trade. In this regard, imports are made because othercountries have a lower opportunity cost. This implies that othercountries incur fewer costs during the provision of a commodity. Itwould make little economic sense to pursue local production ofcommodities if importing would lead to lower usage of financialresources. On the other hand, exports would customarily be made whenother countries had a higher opportunity cost of producing thatparticular product.
The case of theU.S. can highlight several factors about exports and imports. Some ofthe greatest exports of the U.S. include private services, Industrialand service machinery, and agriculture. The country also exportspetroleum products, chemicals, automobile parts, and computers. Theseexports contribute to 17% of total production. The United Statesimports about 20% of total expenditure. Some of the country`sbiggest imports include crude oil, private services, automobiles andparts, and computers. The American government also imports Industrialand service machinery and household goods.
Global supply and demand factors would ordinarily determine theprices attached to the commodities of international trade. Importsare justified when the global price is below that of the domesticno-trade price. On the other hand, exports occur when the globalprice is above that of the local no-trade price. Although imports andexports result in gains and losses, the net effect is always a gain.Economists have documented evidence to suggest that Indian workersand American consumers gain from globalization while African farmersand U.S. workers lose. National governments use import quotas, exportsubsidies, and tariffs so as to restrict international trade andprotect local producers from competition.
Chapter19- International Finance
International finance concerns the fundamental facets of trade andcommerce between nations. Each country records the figures andstatistics associated with international trade. International debtsoccur when a country imports more than it exports. The foreignexchange market provides a platform through which internationalpayments are made. Countries customarily have to exchange currency soas to partake in international trade. However, some countries such asthose of the European Union have adopted a common currency. In thisregard, members of the Euro bloc are allowed to use the Euro as theprimary currency of commerce and trade.
The prices of currencies on the foreign exchange market arecustomarily determined by the forces of demand and supply. Thisaccounts for why currencies ordinarily fluctuate in value andstrength. The balance of payments accounts records internationallending, borrowing, and trading. On the other hand, the currentaccount records exports and imports along with net amounts oftransfers and interest. The capital account records the net amountbetween foreign investments in the U.S. and American investmentsabroad. The official settlements account records the changes inAmerican official reserves. Such reserves refer to the Federalgovernment’s holdings of gold and foreign currency. An individualcould also maintain a personal current account that records theincome received from supplying factors of production and the amountsspent on goods and services.
A net borrower refers to a country that borrows more money than itlends to other nations while a net lender provides more money than itborrows. Debtor nations are those that have borrowed more duringtheir entire history. Such a nation also has outstanding debt that isgreater than claims. Contrariwise, a creditor nation has investedmore in other countries compared to the value of other countries’investments in it. While debts are classified as stock, borrowing andlending are categorized as flows.