(3/6) Creating a bank 

Transaction #2 

•Vault cash: cash held by the bank 

Transaction #3

•Commercial bank functions 

-accepting deposits 

-making loans 

Transaction #4 

•Depositing reserves in a federal reserve bank 

- required reserves

- reserve ratio 

Reserve ratio= commercial banks required reserves / commercial banks Checkable -deposit liabilities 

Excess reserves 

• actual reserves - required reserves 

•required reserves 

- checkable deposits x reserve ratio 

3/5)  The three types of multiple deposit expansion question 

Type 1: calculate the initial chance is excess reserves

-aka the amount a single bank can loan from the initial deposit.

Type 2: calculate the change in loans in the banking system 

Type 3: calculate the change in the money supply. 

   • sometimes type 2 and type 3 will have the same result (ie. No fed involvement)

Type 4: calculate the change in demand deposits.  

Time value of money (3/4)

Is a dollar today worth more than a dollar tomorrow? 

Yes.

Why? 

Inflation and opportunity cost. 

This is the reason for charging and paying interest. 

V= future value of $

P= present value of $

R= real interest rate (nominal rate-inflation rate) expressed as a decimal.

N= years 

K= number of times interest is credited per year.

The simple interest formula 

• v= (1+r) ^n •p

The compound interest formula 

• v= (1+r/k)^nk•p

Monetary equation of exchange 

•MV=PQ

-M= money supply (M1 or M2) 

-V= money's velocity (M1 or M2) 

-P= price level (PL on the AS/AD diagram) 

-Q= real GDP (sometimes labeled Y on the AS/AD diagram) 

Functions of the FED 

•it issues paper currency 

•sets reserve requirement and holds reserves of banks 

•it lends money to banks and charged them to interest

•they are check clearing service for banks

•it acts as personal bank for the government 

•supervises member banks 

•controls the money supply in the economy 

Banks and the creation of money

How do banks "create" money?

By lending out deposits that are used multiple times. 

Where do the loans come from? 

From depositors who take cash and place it in their banks.

How are the amounts of potential loans calculated?

Using their bank balance sheet, or T-accounts that consist of assets and liabilities for banks.

Bank liabilities (he right side of the T account sheet)

#1 = demand deposits (DD) or checkable deposits

- cash deposits from the public

- they are liabilities because they belong to depositors 

#2 =owners equity (stock shares) 

-they are values of stocks held by the public ownership of bank shares. 

Key concept for AP concerning liabilities 

-if demand deposits come from someone's cash holdings, then the DD is already part of money supply.

- if the demand deposit comes from the purchase of bonds (by FED) then this creates new cash and therefore creates new money supply (M1)

Bank assets (left side of T account sheet) 

#1) required reserves (RR) 

- these are the percentages of demand deposits that must be held in the vault so that some depositors have access to their money. 

#2) excess reserves (ER) 

- these are the source of new loans. These amounts are applied to the monetary multiplier / reserve multiplier (DD=RR plus ER) 

#3) bank property holdings (buildings and fixtures) 

#4) securities (federal bonds) 

- these are bonds purchased by the bank, or new bonds sold to the bank by the Federal Reserve. These bonds can be purchased from the bank, turned into cash that immediately becomes available as "excess reserves" 

#5) customer loans

-these can be amounts held by banks from precious transactions, owed to the bank by prior customers.

Money creation 

• banks want to create profit. They generate profit by lending the excess reserves and collecting interest. Since each loan will go out into customer's and business' accounts, more loans are created in decreasing amounts (because of reserve requirement) 

A rough estimate of the number of loan amounts created by any first loan is the "money multiplier" 

• The money multiplier - a.k.a Checkable Deposits Multiplier, Reserve multiplier, Loan multiplier 

Formula: 1 / the reserve requirement (ratio)

   - RR = 10% = 1/.1 = Monetary multiplier of 10

• Excess reserves are multiplied by the multiplier to create new loans for the entire banking system and this creates new Money Supply  

Unit 4 - Monetary Policy videos

Part 1

The money market is defined as having three types of money. Commodity money is a currency standing for one thing. Representative money can be explained by things such as gold and silver, which represents a commodity. The third is Fiat money, which is the type that our country now runs by. This is money not backed by metal, and must be accepted through transactions. 

The three functions of money are that it is a medium of exchange, a store of value, and a unit of account. 

Part 2 

The money market is represented as a money market graph, which we can show that if we increase demand, we raise interest rates. So, if we raise demand, we increase the pressure on interest rates. Supply is set by the fed, so when the demand increased, the quantity in money does not. If the money supply shifts to the right, the interest rates are stable. 

Part 3

The Fed's tools of monetary policy are expressed in this segment video through contractionary and expansionary policy. Expansionary can be expressed as easy money, and in this, the RR is decreased as well as the discount rate. They also choose to buy bonds to increase there money supply. This is the opposite in contractionary policy, which is also known as tight money, because the RR increases as well as the discount rate. They choose to sell bonds to decrease this money supply.

RR can be defined as the percentage of a bank's total deposits that must be kept as vault cash or on reserve with the Federal branch. Lowered RR becomes excess reserves.

The discount rate is the rate at which banks borrow money from the Fed.

Part 4

The Loanable Funds Market can be defined as the money available in banks for people to borrow.

The Supply loanable funds comes from the amount of money that people have in banks. They are dependent on savings. So, the more money people save, the more money people will have to make loans. 

In a deficit, the government demands money to spend.

2 ways to demonstrate a change in Loanable Funds 

1) Increase in demand of loanable funds.

2) Decrease supply 

Part 5

The money creation process is defined by how banks create money by making loans. If a banks holds excess reserves, it reduces total money supply. The potential total increase is defined by the Initial Loan x Money Multiplier. 

Part 6

In the money market graph, we can see that the Money supply is controlled by the fed, therefore it is at a set amount. In loanable funds, the equilibrium rate and quantity stay the same. If there is deficit spending, the Money market has the government borrowing money from the people. There is an increase in demand as well as Interest rates. The Fisher Effect is represented, as it is the increase in interest rate, and it must have the same increase in price level. 

Money    (3/3)

3 uses 

1) as a medium of exchange. Using it to determine value. 

2) unit of account. Using it to compare prices. 

3) as store of value. Where you put your money.

3 types

1) Commodity - it has value within itself

      •salt 

      •olive oil

      •gold 

2) Representative- represents something of value.

Ex) IOU 

3) Fiat- it is money because the government says so. Consists of paper currency and coins. 

Currency is money buy not all money is currency. 

6 characteristics

1) Durability- how long it lasts 

2) Portability- you can put it anywhere on your body and take it anywhere.

3) Divisibility - a dollar can be broken down

4) Uniformity- money is the same anywhere you go 

5) Limited supply 

6) Acceptability 

Money supply

The total value of financial assets available in the US economy.

M1 Money

Involves 

•liquid assets - easily converted to cash 

    - coins 

    - currency 

    - checkable deposits or demand        deposits 

    - traveler's checks 

M2 Money

Includes

• M1 money 

• savings account

• money market account 

3 purposes of financial institutions 

1) to store money

2) to save money

3) loan money  

    • for credit cards 

    • for mortgages 

4 ways to save

1) through savings account 

2) through checking account 

3) through market money account 

4) through a certificate of deposit (CD)

Loans

Banks operate on a fractional reserve system. They keep a fraction of the funds and they loan out the rest. 

Interest rates

• principal

The amount of money borrowed

• interest 

   

   - simple interest - paid on the principle 

I=P•R•T / 100

T= I•100 / P•R

P= I•100 / R•T

R= I•100 / P•T

P= Principle

I= Simple interest 

R= Interest rate 

T= Time 

   - compound interest - paid on the principle plus the accumulated interest 

Types of financial institutions 

1) commercial bank 

2) savings and loans institutions 

3) mutual savings banks 

4) credit unions 

5) finance companies 

Investment

Redirecting resources. Consume now for the future. 

Financial assets 

•claims on property and income of borrower 

Financial intermediary 

• institution that channel funds from savers to borrowers 

3 purposes 

1) to share risk 

    -Diversification - spreading out investments to reduce risk. 

2) to provide information 

3) liquidity 

    - returns 

    - the money an investor receives above and beyond the sum of money that was initially invested. 

The higher the risk, the higher the return. 

Bonds you loan

Stocks you own 

Bonds 

Are loans or IOUs that represent debt, that the government or a corporation must repay to an investor. Generally low risk investments

3 components 

1) coupon rate - the interest rate that a bond issuer will pay to a bond holder 

2) maturity - the time at which payment to a bond holder is due. 

3)  par value - the amount that an investor pays to purchase a bond. 

Yield 

The annual rate of return on a bond if the bond were held to maturity. 

  

Unit 3

Aggregate(TOTAL) Demand (AD)

•Shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase price level

Aggregate Demand  (2/11)

•The relationship between the price level and the level of REAL GDP is inverse 

-Three reasons AD is downward sloping

•Real Balances Effect

- When the price level is high households and businesses cannot afford to purchase as much output 

- When the price level is low households and businesses can afford to purchase more output

• Interest Rate Effect 

- A higher price level increases the interest rate which tends to discourage investment 

- A lower price level decreases the interest rate which tends to encourage investment 

•Foreign Purchase Effect

- A higher price level increases the demand for relatively cheaper imports

- A Lower price level increases il the foreign demand for relatively cheaper US exports 

•Shifts in Aggregate Demand

• There are two parts to a shift in AD

- a change in C, Ig, G, and/or Xn (expenditure approach to GDP)

- a multiplier effect that produces a greater change than the original change in the 4 components

•increases in AD= AD➡️

•decreases in AD=⬅️

Consumption 

•Household spending is affected by:

 - consumer wealth 

       •more wealth= more spending(AD shift➡️)

       •less wealth= less spending(AD⬅️)

-Consumer expectations 

     •positive expectations=more spending(AD➡️)

      Negative expectations=less spending(AD⬅️)

-Household indebtedness 

   •less debt=more spending(AD➡️)

   •more debt= less spending(AD⬅️) 

-Taxes

     •less taxes=more spending(AD➡️)

      •more Taxes=less spending⬅️

GROSS DOMESTIC Private investment 

•investment spending is sensitive to

    -the Real Interest Rate 

      •lower real interest rate= more investment 

       •higher real interest= less investment 

-Expected Returns

  •higher expected returns: more investment 

  •lower expected returns: less investment 

  • expected returns are influenced by:

       -expectations of future profitability 

       -technology 

       -degree of excess capacity (existing stock of capital) 

Government Spending 

 - more government spending shift right 

 -less government spending AD shift left

•net exports

   •net exports are sensitive to:

       -Exchange Rates(international value of $)

          •strong $= more imports and fewer exports= AD ⬅️

          •weak $= fewer imports and more exports= (AD➡️)

         -Relative Income

            •Strong Foreign Economies= More exports AD➡️

             •Weak foreign economies= less exports AD(⬅️)

           

UNIT 2

GDP:  total dollar value of all final goods and services produced within a country's borders within a given year.

Only what is produced within the country.
Nike falls on GDP and GNP

What is included in GDP?

C+Ig+G+Xn

C- consumption takes up 67% of economy. Includes final goods and services.

Ig: gross private domestic investment-

1. Factory equipment maintenance
2. New factory equipment
3. Construction of housing
4. Unsold inventory of products built within a year

G: government spending - the government is buying weapons, FBISD buying new schools

Xn: net export- exports-imports (imports not included)

What is not included?
1.Used or second hand goods
2. Intermediate goods- goods and services that are purchased for resale or for further processing or manufacturing.
3. Non market activities- volunteer work, babysit, chores, illegal drug sales
4. Financial transactions- stocks, bonds, real estate. GDP only counts production.
5. Gifts or transfer payments
Public - recipients contribute nothing to the current production
Ex) social security, welfare payments
Private - no output produced, simply transferring funds from one individual to another.
Ex) a scholarship, Christmas gift

GNP- A measure of what its citizens produced and whether they produced these items within its borders.

National income accounting

 Economists collect statistics on production, income, investment, and savings.

Expenditure approach

Adding up the market value of all domestic expenditures made on final goods and services in a single year.

C+Ig+G+Xn = GDP

Income approach

Adding up all the income earned by households and firms in a single year.

Wages- compensation from employees, or salaries
Rents- from tenants to landlord, from lease payments that corporations pay for the use of space.
Interest- money paid by private businesses to the suppliers of loans used to purchase capital. Ex) savings account, corporate bond
Profit-
Can be seen as:
1. Corporate income taxes
2. Dividends
3. Undistributed corporate profits

W+R+I+P+ Statistical Adjustments 

Nominal GDP

Value of output produced in current prices
It can increase from year to year if either output or price increase

Real GDP

value of output produced in base year or constant prices
It is adjusted for inflation

It can increase from year to year only if output increases
Price x quantity
Base year is always the earlier year

Price index- a measure of inflation by tracking changes in a market basket of goods compared with the base year.
Price of market basket of goods in current years/price of market basket goods in base years x 100

Equations: 

Budget = Gov't purchases of goods and services + Gov't transfer payments - Gov't tax and fee collections

Trade = Exports - Imports

GNP = GDP + Net foreign factor income (Use Expenditure Approach to GDP)

Net National Product (NNP) = GNP - Depreciation 

Net Domestic Product (NDP) = GDP - Depreciation 

National Income = GDP - Indirect Buisness Taxes - Depreciation - Net foreign factor payment

or Compensation of employees + Rental Income +Interest Income + Proprietor's income + Corporate profits 

                                       

GDP deflator

 a price index used to adjust from nominal GDP to real GDP.
Nominal GDP/Real GDP x 100
In the base year, GDP deflator is equal to 100. For years after base year, GDP is greater than 100. For years before the base year, GDP deflator is less than 100.

Inflation

 a rise in the general level of prices.
 New GDP deflator-old GDP deflator/ old GDP deflator x 100.

Inflation rate

it measures the percentage increase in the price level over time. It offers a key indicator of the economy's health.

Deflation - a decline in the general price level.
Disinflation - occurs when the inflation rate declines.

Consumer price index (CPI)

 it measures inflation by tracking the yearly price of a fixed basket of consumer goods and services. It indicates changes in price level and cost of living.

Solving inflation problems
1.Finding inflation rate using market basket data
Current year market basket value-base year market basket value / base year market basket value x 100
2. Finding inflation rate using price indexes
Current year price index - base year price index / base year price index x100
3. Estimating inflation using the rule of 70

Rule of 70 

used to calculate the number of years it will take for the price level to double at any given rate of inflation.

Rule of 70 -Years needed to double inflation = 70/ annual inflation rate
4. Determining real wages- real wages= nominal wages/ price level x 100
5. Finding real interest rates
Real interest rate= nominal interest rate- inflation premium
The cost of borrowing or lending money that is adjusted for inflation. Always expressed as a percentage.
Nominal interest rate- unadjusted cost of borrowing or lending money

Causes of inflation

Demand pull inflation- caused by an excess of demand over output that pulls prices upward.
Cost push inflation- caused by a rise in per unit production cost due to increasing resource cost.

Standard for inflation is 2-3% anything over is a problem.

Effects of inflation

Anticipated inflation-
Unanticipated inflation-

Helped by inflation
Borrowers- debt will be repaid with cheaper dollars than those that were loaned out.

Hurt by unanticipated inflation
Fixed income- grant, scholarship
Savers- those who save money.
Lenders/creditors

Unemployment

 the percentage of people who do not have jobs that are in the labor force.
Labor force- number of people in a country that are classified as either employed or unemployed.

Unemployment rate- number of unemployed/ number of unemployed + number of employed x 100
4-5% is ideal unemployment rate

Not in the labor force
1. Kids
2. Military personnel
3. Mentally insane
4. Incarcerated or in prison
5. Retired
6. Stay at home parents
7. Full time students
8. Discouraged workers

Types of unemployment
1. Frictional- people who are"between jobs" . They choose new opportunities, new choices, new lifestyles, new educational levels
2. Structural- technology changing, it is associated with a lack of skills or a declining industry.
3. Seasonal- you are waiting for the right season to go to work. Ex) construction workers, life guards
4. Cyclical - unemployment that occurs due to a swing in the economy. Has to do with the business cycle. Bad for individuals and societies.

Full employment 

occurs when there is no cyclical unemployment present in the economy.
This is when the economy is working at its best potential.

Natural rate of unemployment (NRU)
4-5% rate

Why is it bad?
1. Not enough consumption (GDP)
2. Too much poverty
3. Too much government assistance

Why is unemployment good?
1. There is less pressure to raise wages
2. There are more workers available for future expansions.

Okun's Law

 for every 1% of unemployment above the NRU, causes a 2% decline in real GDP.