Economics - Final Revision PDF

Macroeconomics. Final Revision Dr. Gamal Haikal Chapter.4 Ms. Shada Tarek Measuring GDP and Economic Growth....

Macroeconomics. Final Revision Dr. Gamal Haikal Chapter.4 Ms. Shada Tarek Measuring GDP and Economic Growth. The Market Value: Goods and services are valued at their market prices, so we have a total value of output in dollars. Final Goods&Services. Within a Country: Define GDP: "Domestic" A final good (or The market value of the final service) is an item that Only goods and services goods and services produced that are produced is bought by its final within a country in a given within a country count user during a specified time period. time period. as part of that country’s GDP. In a Given Time Period : GDP measures the value of production in a given time period either a quarter of a year—called the quarterly GDP—or a year— called the annual GDP  Distinguish between Final Good and Macroeconomics. Final Revision Intermediate Good: Dr. Gamal Haikal Final Ms. Good Shada contrasts with an intermediate Tarek good (or service), which is an item that is produced by one firm, bought by another firm, and used as a component of a final good or service. For Example: (Bread- Final Good) (Wheat- Intermediate Good) 2. What is the Expenditure approach to calculating GDP? o The Expenditure Approach measures GDP as the sum of consumption expenditure (C), investment (I), government expenditure on goods and services (G), and net exports of goods and services (X – M). o The Expenditures Approach categorises this spending into five categories: consumption, investment, government spending, exports, and imports. GDP = Total Expenditure = Total Income = Total Product (Output) GDP = C+ I+ G+ NX GDP Consumption: All spending by households (Private Consumption) on all final goods and services in a given period in the economy. Note that! Private Consumption excludes the purchase of new homes since it is considered as part of the investment. Investment: spending businesses do in order to produce goods and services; it includes spending on capital goods (tools, equipment) and inventory. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Government Spending: Government entities spend on goods and services such as roads and national defence. Note that! Government Spending does not include transfer payments, such as unemployment benefits, because they are not expenditures on goods and services. Exports: Goods that are produced in one country and then sold within Net Exports: The value of exports minus the value of imports. another country. Imports: goods that are produced in a different country than where they were purchased Problem.1 Using the data in the table calculate: 1. The value of GDP and mention the used approach. 2. The value of Net Exports. 3. The value of National Saving. 1. GDP = C+ I+ G+ NX (X-M) GDP = 5566+ 1234+ 1784+ (957- 1138) GDP = $8403. billion 2. NX = (Exports – Imports) → (957 – 1138) = -$181 billion. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Nominal GDP: The value of goods and services produced during a given year valued at the prices that prevailed in that same year. Includes the effect of price increase "inflation"... Not representative of actual production growth Real GDP: The value of final goods and services produced in a given year when valued at constant prices. Define GDP Deflator: index of current final output prices relative to base year prices. The GDP deflator shows how much a change in GDP relies on changes in the price level. Formula 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁 𝐺𝐺𝐺𝐺𝐺𝐺 GDP Deflatort = 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐺𝐺𝐺𝐺𝐺𝐺 ∗ 100 Define The Economic Growth Rate: The economic growth rate is the percentage change in the quantity of goods and services produced from one year to the next. Economic Growth = (Real GDP Current Period – Real GDP Last)/ Real GDP Last Year Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Unemployment and Inflation The population is divided into two groups: 1. The working-age population—the number of people aged 16 years and older who are not in jail, hospital, or other institution. 2. People too young to work (less than 16 years of age) or in institutional care The working-age population is divided into two groups: those in the labor force and those not in the labor force. People not in the Labor Force: People in jail, hospitals, Home Moms, full-time students or some other form of institutional care. The labor force is the sum of the employed and the unemployed: Employed: a person must have either a full-time job or a part-time job. Unemployed: a person must be available for work and must be in one of three categories: 1. Without work but has made specific efforts to find a job within the previous four weeks. 2. Waiting to be called back to a job from which he or she has been laid off. 3. Waiting to start a new job within 30 days. The business cycle is the periodic but irregular up-and-down movement in production and jobs. The unemployment rate increases in a recession and decreases in an expansion. Fluctuations in labor force participation ratio result from unsuccessful job seekers leaving the labor force during a recession and reentering during an expansion. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek When a recession hits, the number of discouraged workers increases as the labour force decreases since they drop out due to unsuccessful attempts at looking for job. Discouraged workers are workers who have stopped looking for work and left the labor market, as such the official unemployment rate understates true unemployment. Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. The inflation rate is the percentage change in the price level from one year to the next. Consumer Price Index CPI: is a measure of the average of the prices paid by urban consumers for a fixed basket of consumer goods and services. The CPI tells you about the value of the money in your pocket. Essay 4 - The CPI has four biases that lead it to overstate the inflation rate. The biases are: New Goods Bias: New goods are often more expensive than the goods they replace. Quality Change Bias: Sometimes price increases reflect quality improvements (safer cars, improved health care) and should not be counted as part of inflation. Commodity Substitution Bias: Consumers substitute away from goods and services with large relative price increases. Outlet Substitution Bias: When prices rise, people use discount stores more frequently and convenience stores less frequently. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek MONEY Money serves three functions: 1. Medium of exchange: A medium of exchange is any object that is generally accepted in exchange for goods and services 2. Unit of account: unit of account is an agreed measure for stating the prices of goods and services. 3. Store of value: Money can be held and exchanged later for goods and services. Barter is the exchange of goods and services directly for other goods and services “NOT for money”. 4. A depository institution is a firm that accepts deposits from households and firms and uses the deposits to make loans to other households and firms. Such as: Commercial Banks. 5. Depository institutions, such as commercial banks, accept deposits, then keep a fraction of those deposits on reserve and loan out the rest. The amount that a bank is required to keep in reserve is called the required reserves, and the amount that the bank keeps voluntarily that is over and above the required reserves is called excess reserves. 6. Reserves are the cash in a bank’s vault and deposits at Federal Reserve Banks. 7. Required Reserve Ratio is the minimum percentage of deposits that banks are required, by regulation “by CB”, to keep as reserves. 8. Depository institutions make profits from the difference "spread" between the interest rate a banks pay to depositors and the interest rate it receives from loans. 9. The discount rate is the interest rate at which the FED “CB” stand ready to lend reserves to depository institutions “Banks”. 10. The money supply increases when banks make new loans, and a bank makes new loans out of excess reserves. 11. The deposit multiplier is the amount by which an increase in bank reserves is multiplied to calculate the increase in bank deposits. 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑤𝑤𝑤𝑤𝑤𝑤ℎ 𝑡𝑡ℎ𝑒𝑒 𝐶𝐶𝐶𝐶 Required Reserve Ratio = × 100 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 1 The Deposit Multiplier = 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Monetary Policy The term "Monetary Policy" refers to what the nation's central bank does to influence the amount of money in the economy. A central bank conducts monetary policy, set the required reserve ratio and regulates the banking system, but depository banks accept deposits and make loans. Goals / Objectives of Monetary Policy: 1. Full Employment. 2. Price Stability. 3. Sustainable Economic Growth. 4. Stability of Financial Markets and Institutions. Demand for Money Movement along Money Demand Curve Shift in Money Demand Curve Demand for Money is Negatively related to the change in interest Real GDP, Income and Price Level Shift the Money Demand Curve. rate. 1. Real GDP. “Positive Relation” "Money Demand Curve is Downward Sloping" An increase in real GDP increases incomes. Interest Rate causes a Movement along MD Curve. MD Curve shifts to the right. ↑interest rate → ↑opportunity cost of holding money → ↓Demand for ↑Real GDP→↑Income→↑ MD→ MD curve Shifts to the right. real Money → Upward Movement along the Money Demand Curve. A reduction in interest rate increases the quantity of money 2. Price Level. “Positive Relation” demanded. All other things unchanged, the higher the price level, the greater the ↓interest rate → ↓opportunity cost of holding money → ↑Demand for demand for money. MD curve shifts to the right. real money → Downward movement along the Money Demand ↑P → ↑MD → MD curve shifts rightward. Curve. A decrease in price level, decreases the demand for money, and shifts MD curve to the left. ↓P → ↓MD → MD curve sifts leftward. Money Supply An increase in the supply of money shifts the supply of money curve A decrease in the supply of money shifts the supply of money curve to the right and the interest rate falls. to the left and the interest rate rises. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Monetary Policy In Case of Recession. In Case of Expansion. ↓ ↓ Recessionary Output Gap Inflationary Output Gap ↓ ↓ High Unemployment Rate Low Unemployment Rate Unemployment > Natural Rate of Unemployment Unemployment < Natural Rate of Unemployment Actual Real GDP < Potential GDP Actual Real GDP > Potential GDP ↓ ↓ Expansionary MP Contractionary MP ↓ ↓ Central Bank: Central Bank: 1. Buys Bonds through Open Market Operations. 1. Sells Bonds through Open Market Operations. 2. Reduces Required Reserve Ratio. 2. Increases Required Reserve Ratio. 3. Reduces Discount Rate. 3. Increases Discount Rate. ↓ ↓ Increases Money Supply…MS↑ Decreases Money Supply…MS↓ ↓ ↓ Interest Rate Decreases…r↓ Interest Rate Increases…r↑ ↓ ↓ Investment Increases…I↑ Investment Decreases…I↓ ↓ ↓ Aggregate Demand increases…AD↑ Aggregate Demand decreases…AD↓ ↓ ↓ Output ↑ Inflation ↓ Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Fiscal Policy Expansionary Fiscal Policy Contractionary Fiscal Policy ↓ ↓ The use of fiscal policy to expand The use of fiscal policy to contract the “stimulate” the economy by increasing economy by decreasing Aggregate Demand. Aggregate Demand Period Expansionary fiscal policy is used to fix Contractionary fiscal policy is used to fix recession. booms “inflation”. 1. Increase Government Expenditures. 1. Decrease Government Expenditures. (↑G) (↓G) Measures 2. Decrease Taxes. (↓TX) 2. Increase Taxes (↑TX) 3. Increase Transfer Payments. (↑TP) Or 3. Decrease Transfer Payments. (↓TP) Actions 1. Consumer Spending Increases. (↑C) Impacts 1. Consumer Spending Decreases. (↓C) 2. Investment Increases. (↑I) 2. Investment Decreases. (↓I) Effect on 1. Real GDP ↑ 1. Real GDP ↓ the 2. Employment ↑ 2. Employment ↓ Economy 3. Price Level ↑ 3. Price Level ↓ Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Fiscal Policy: The use of Taxes, Government Spending, and Government Transfers to stabilize an economy or to achieve Macroeconomics goals. The Word Fiscal refers to Tax Revenue and Government Spending. Goals / Objectives of Fiscal Policy. 1. Full Employment. 2. Sustained Economic Growth. 3. Price Level Stability. Government Budget & Public Debt. 1. Budget Balance Government Revenues = Government Expenditure 2. Budget Surplus Government Revenues exceed Government Expenditures Revenues > Expenditures 3. Budget Deficit Government Expenditures exceed Government Revenues Expenditures > Revenues When the government expenditures exceed its revenues, there is a budget deficit, Government will borrow to finance the deficit, and the government debt increase. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Essay Questions What does the central bank do to increase the money supply? What does the central bank do to decrease the money supply? “Expansionary Monetary Policy. “Contractionary Monetary Policy. 1. CB buys bonds through open market operation. 1. CB sells bonds through open market operation. 2. CB reduces the discount rate. 2. CB increases the discount rate. 3. CB reduces the required reserve ratio. 3. CB increases the required reserve ratio. What does the government do to stimulate the economy? What does the government do to contract the economy? “decrease price level/ “Expansionary Fiscal Policy. ↓inflation” 1. Increase Government spending. ↑G “contractionary Fiscal Policy. 2. Decrease Taxes. ↓TX 1. Decrease Government spending. ↓G 3. Increase Transfer Payment. ↑TP 2. Increase Taxes. ↑TX 3. Decrease Transfer Payment. ↓TP Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek In 2018, England announced its intention to decrease the government expenditures from 50% to 30%. According to this statement. 1. Define the policy used. Contractionary Fiscal Policy. 2. What is the effect of this policy on inflation and output? The government use contractionary fiscal policy to contract the economy by decreasing aggregate demand, which leads to: Lower output → ↓Real GDP Lower price level → ↓inflation Lower level of employment and higher unemployment Explain the sequence of links connecting an expansionary monetary policy with interest rates, intended investment, aggregate demand, and output. An expansionary monetary policy will lower interest rates, which tends to encourage intended investment, leading to an increase in aggregate demand and output (GDP). Multiple-Choice Questions 1. The functions of money are A. medium of exchange and the ability to buy goods and services. B. medium of exchange, unit of account, and means of payment. C. pricing, contracts, and means of payment. D. medium of exchange, unit of account, and store of value. 2. Barter is A. another type of money. B. printing too much money. C. the exchange of goods and services directly for other goods and services. D. the exchange of goods and services for any type of money. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek 3. Liquidity is the A. speed with which the price of an asset changes as its intrinsic value changes. B. inverse of the velocity of money. C. same as the velocity of money. D. ease with which an asset can be converted into money. 4. Which of the following is a function of money that is most immediately impacted by hyperinflation? A. Medium of exchange. B. Unit of account. C. Bartering. D. Store of value. 5. The discount rate is the interest rate A. that banks charge their best customers. B. that the Fed charges on loans of reserves to commercial banks. C. on interbank lending. D. that bank insurers pay on insured deposits. 6. The opportunity cost of holding money is the A) interest rate. B) price of goods and services. C) level of wage and rental income. D) ease with which an asset can become money. 7. Which of the following is correct? The demand for money A) increases as real GDP increases. B) decreases as the price level increases. C) depends on the quantity of money. D) increases when the interest rate increases. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek 8. The demand for money curve A. is horizontal. B. has a positive slope. C. is vertical. D. has a negative slope. 9. Which of the following is considered a purpose of the federal budget? A. To help the economy achieve full employment. B. To finance the activities of the federal government. C. To promote sustained economic growth. D. All of the above. 10. If the reserve requirement is 10% and a bank has $100,000 in checking deposits, $50,000 in saving deposits, and has made $20,000 in loans to businesses. What is the bank required reserves? a. $17,000 b. $10,000 c. $5,000 d. $15,000 11. A balanced budget occurs when government A. expenditure exceeds revenue. B. revenue exceeds expenditure. C. revenue equals expenditure. D. revenue is expenditure. 12. If the government runs a deficit, the total amount of government debt is A. increasing. B. decreasing. C. constant. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek D. zero. 13. Suppose the only revenue taken in by the government is in the form of income tax, and the tax rate is 10 percent. If aggregate income is $800 billion, and government expenditures are $100 billion then the government budget has A. a deficit of $20 billion. B. a surplus of $20 billion. C. neither a surplus nor a deficit. D. a deficit of $80 billion. 14. An increase in the government ____ reduces the government’s ____. A. budget deficit; debt B. budget surplus; debt C. debt; budget deficit D. None of the above answers is correct. 15. During an expansion, tax revenues ____ and government transfer payments____. A. increase; increase B. increase; decrease C. decrease; increase D. decrease; decrease Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek TRUE or FALSE 1. Money has three functions, medium of exchange, store of value and unit of account. TRUE 2. The most direct way in which money eliminates the need for a double coincidence of wants is through its use as a store of value. False: Medium of Exchange 3. Barter is the exchange rate of goods and services for other goods and services. TRUE 4. Comparing M1 and M2 we know that M2 is approximately equal to M1. FALSE M2 is larger because it contains M1 and other assets. 5. The discount rate is the interest rate at which the commercial banks stand steady to lend reserves to depository institutions. False: The Fed or The CB 6. The CB set the required reserve ratios, which are the minimum percentages of deposits that depository institutions must hold as reserves. TRUE 7. An individual wants the most liquid asset possible will hold money or checkable deposits. False: Money is the most liquid asset 8. Monetary policy is the adjustment of the money market mutual funds to achieve macroeconomic objectives. False: the adjustment of quantity of money in circulation and interest rates by the Fed “CB” 9. An example of Monetary policy is an increase in the quantity of money “Expansionary Monetary Policy” by the Federal Reserves, which increase Aggregate Demand. TRUE 10. If the Fed makes an open market purchase of $2 million, assuming the money multiplier is 4, money supply will increase by $10 million. False: the increase in Money Supply is $8 million = initial deposit × money multiplier = 2 × 4 = 8 11. When the government expenditures exceed its revenues, there is a budget deficit, the government needs to borrow, and the federal government debt increase. TRUE 12. The government fiscal policy denotes the use of government expenditure and taxes. TRUE 13. A decrease in government purchases, and increase in taxes shifts the AD curve rightward. False: when ↓G → AD shifts leftward, and ↑TX → AD shifts leftward. when ↑G → AD shifts rightward, and ↓TX → AD shifts rightward. Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Problems Problem.1 Assets Liabilities and Equities Loans: $25,000 Bonds: $5,000 Deposits: $40,000 Reserves: $10,000 Total Assets: $40,000 Total Liabilities: $40,000 The table gives the initial balance sheet for a bank. Based on the balance sheet, calculate the reserve required ratio. Required Reserve Ratio = (Reserves ÷ Deposits) × 100 Required Reserve Ratio = (10,000 ÷ 40,000) × 100 = 25% Problem.2 If a bank has $100,000 in checking deposits, $50,000 in saving deposits, $22,500 in reserves, and has made $40,000 in loans to businesses. What is the bank required reserves? Required Reserve Ratio = (Reserves ÷ Deposits) × 100 Required Reserve Ratio = (10,000 ÷ 100,000) × 100 = 10% Macroeconomics. Final Revision Dr. Gamal Haikal Ms. Shada Tarek Suppose the only revenue taken in by the government is in the form of income tax, and the tax rate is 10 percent. If aggregate income is $800 billion, and government expenditures are $100 billion: 1. Calculate the government tax revenues. The government tax revenue = (800 * 10%) = $80 billion 2. Identify whether the government runs budget surplus or deficit and its effect on the government debt. Since the government expenditure exceeds the government tax revenues, then the government runs budget deficit, increasing its debt. 3. By how much the government have budget surplus / deficit? The government budget = Taxes – Expenditures = 80 – 100 = $20 billion