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Unit 10 by Mind Map: Unit 10

1. Money (something yo can exchange that you know others will except as payment)

1.1. Wealth (value of all assets combined)

1.1.1. Income (flow of money to you)

2. Borrowing

2.1. Interest rate (price of brining buying power forward in time)

2.1.1. MRT = (1+r) - tradeoff between current and future consumption

2.1.2. interest rate = repayment/principal - 1

2.2. Smoothing - equals diminishing marginal utility (you prefer to spread out spending)

2.2.1. diminishing marginal returns = the value of something declines to more its consumed. Causes smoothing

2.2.1.1. goal is to set slope of feasible frontier (MRT) = slope of indifference curve (MRS) will smooth consumption to make this true

2.3. Pure impatience (consume now vs later, who cares about what it will cost you later)

2.3.1. Discount rate (p) measures a persons impatience, how much they value something now vs later

2.3.1.1. Borrows to make discount rate = interest rate

2.4. Reservation indifference curve = lowest limit of satisfaction you are willing to alter your consumption

2.4.1. Investment + borrowing expands your consumption possibilities

3. Balance Sheet (summarizes what you own and what you owe to others)

3.1. Comprised of assets, liabilities.

3.2. Banks (make money from lending and borrowing money)

3.2.1. net worth is what is owned to shareholders, also called equity.

3.2.2. Base money = money held by people, firms, and banks. liability goes to central bank

3.2.2.1. Bank money = bank deposits created by commercial banks to extend credit to people and firms. Liability goes to commercial banks

3.2.2.1.1. Broad money = sum of bank money and base money that is in the hands of everyone except banks.

3.2.3. Central bank = only bank that can print money. Banker for commercial banks

4. Unit 13 (GDP, business cycle, aggregate economy, economic fluctuations, investment)

4.1. GDP = total value of all final output produced within nations borders in a year. Cannot add in physical output, so is converted to value of output. Result is nominal GDP

4.1.1. real GDP = nominal GDP (t)/price index. Price index = price lever in year (t)/price level in base or reference year.

4.2. Business Cycle - alternating periods of positive and negative growth rates

4.2.1. As output increases, unemployment decreases and vice versa. Higher GDP = usually lower unemployment

4.3. Okun's Law - strong relationship between change in unemployment and GDP growth. GDP grows, unemployment declines. Recession? unemployment rises.

4.3.1. Okun's Coefficient measures strength of relationship between GDP growth and change of unemployment rate. Stronger relationship = higher coefficient, steeper regression line

4.4. National accounts - system used to measure GDP, 3 different ways

4.4.1. 1. Total spending by everyone inside the country. 2 total domestic production (measured in terms of value) 3 total domestic income

4.4.1.1. Include exports, but not imports so that GDP includes value added or consumption of domestic production.

4.4.2. Aggerate Demand = consumption + investment + gov spending + net exports (exports - imports). AD = C+I+G+X-M

4.4.2.1. Y (household income) > AD means aggregate spending is insufficient to fulfill national income. If Y < AD economy is overspending, and inflation occurs. Policies attempt to bring economy to equilibrium.

4.5. Economic fluctuations - all economies fluctuate between good and bad times often linked or caused by economic shocks (ex covid)

4.5.1. Households react to shocks by managing their consumption spending.

4.5.1.1. Self insurance - households that get lucky and get unusually high income will save so when their luck ends they can spend savings. Co-insurance = being helped by family/friends, or gov unemployment beniefits.

4.5.1.1.1. despite income fluctuations during life, you can maintain steady level of consumption by smoothing. (accumulate savings during high income periods, spend savings during low income periods. Level of consumption does not fluctuate as rapidly as income.

4.5.2. Consumption smoothing helps stabilize economy - when consumption fluctuates, aggregate spending does as well, causing Y to not equal AD. When smooth, fluctuations in AD are lessened.

4.5.2.1. Limitations to smoothing: credit constrains and weakness of will

4.5.2.1.1. Access to borrowing means you can smooth consumption, without it what you can buy will be more volatile according with fluctuation of income.

4.6. Investment at firm level depends on their expectations about future demand.

4.6.1. Investment decisions made by looking at capacity utilization (how much production capacity are we using now?) Low demand, therefore low capacity utilization = low investment. Higher demand = high capacity utilization --> more investment, which creates even more demand.

4.6.1.1. Dependence on demand for the product and the expectation for future demand is what makes investment so volatile.

4.6.2. Business confidence high coordinates firms to invest at the same time, and vice versa when confidence is low

4.6.2.1. Coordinating investment makes cycles self reinforcing (either in a good or bad way). Makes investment more volatile than GDP

4.6.2.1.1. While households smooth consumption, investments do not

5. Unit 13 (inflation)

5.1. Inflation = increase in general price level in economy. Much more prominent during extreme economic situations.

5.1.1. Consumer price index (CPI) measures general level of prices that consumers have to pay for goods/services. "cost of living" Inflation is the rate of change of the CPI

5.1.2. GDP deflation is a measure of the level of prices for domestically produced output. Ratio of nominal to real GDP. GDP deflator = nominal GDP in year x/real GDP in year x

6. Unit 14 (AD/multiplier model, How C/I affect GDP

6.1. Multiplier process - gov investment creates income for some people, who then spend more, creating more income at the places they spent their money, and so on.

6.1.1. Multiplier process: Increase in investment raises AD --> Increase in AD creates higher output and income, spending increases --> that further increases demand and income --> new equilibrium reached

6.1.1.1. Opposite force (fall in investment) is exactly the same but reversed. Its also a multiplier process so its the same cycle but a fall in AD, output, income and so on.

6.1.1.1.1. To calculate multiplier (k) use formula change in real gdp(Y)/change in injections (investments)

6.2. Aggregate consumption has 2 parts, autonomous consumption (fixed amount you have to spend no matter what) and everything else which is dependent on your income.

6.2.1. Aggregate demand (AD) = consumption function (C) + investment (I). Market equilibrium is Y=AD=C+I

6.2.1.1. equilibrium is obtained from intersecting the AD line with the 45 degree line. Graph is referred to as Keynesian Cross

6.2.1.1.1. Change in AD also changes Y (income)

6.3. How changes in consumption/investment affect GDP

6.3.1. consumption decisions shift AD curve. When the consumption function changes, it changes as well.

6.3.2. AD is affected by consumption spending ---> one aspect of CS is autonomous consumption --> autonomous consumption is determined by household wealth --> one of the components of HH wealth is target wealth -->households attempt to sustain target wealth by adjusting saving (consumption)

6.3.3. Higher interest rate = more expensive to invest --> lower investment as a result

7. Unit 14 (more complex multiplier model, stabilization, fiscal stimulus, austerity policy, AD& unemployment, gov debt)

7.1. Role of government: Gov spending, consumption, investment. Its the gov's job to stabilize economic fluctuations, but sometimes fails and makes things worse.

7.1.1. With the government present, the gov expenditure acts as autonomous spending and taxes work as a slice out of disposable income. Consumption spending is affected because income (Y) determines consumption (C)

7.2. Imports depends on domestic income: Marginal propensity to import = fraction of each addition unit of income that is spent on imports (imports/income) NOT autonomous spending

7.3. Stabilizing the economy: gov stabilizes by 1 government spending, 2 tax rate, 3 unemployment insurance and 4 fiscal policy

7.3.1. When market failure occurs its the failure of the private sector to provide solutions to problems in the market. Unemployment insurance is a tool for automatic stabilization.

7.3.1.1. paradox of thrift: aggregate attempt to increase savings leads to a fall in aggregate income.

7.3.2. Fiscal stimulus: gov attempts to counteract fall in AD. Cut taxes to encourage more spending or directly increase AD by more gov spending.

7.3.2.1. Budget surplus = more tax revenue than spending, budget deficit = more spending than tax, increases gov debt

7.4. Debt is measured as a ratio of debt over GDP