Econ 203 Review Session PDF

Summary

This document provides a review session for ECON 203, covering topics like payments to Canada, current and capital accounts, and foreign exchange markets. It explores concepts such as inflow and outflow with respect to capital, and examines the relationship between exchange rates, interest rates, and GDP. This is aimed at undergraduate economics students.

Full Transcript

ECON 203 Review Session Payment to Canada = Export -\> **Receipt** (sale of a product or receipt for Canada)-\> credit (+) Payment from Canada = Import -\> **Payment** (purchase of a product or asset from foreigner) -\> debit (-) **Current Account** (CA)= [Trade account] (payment and receipt of...

ECON 203 Review Session Payment to Canada = Export -\> **Receipt** (sale of a product or receipt for Canada)-\> credit (+) Payment from Canada = Import -\> **Payment** (purchase of a product or asset from foreigner) -\> debit (-) **Current Account** (CA)= [Trade account] (payment and receipt of imports and exporting goods) + [Capital-service account] (net investment income earned from foreign holdings such as dividend, coupons, interest payments) **Capital Account** (KA)= Records transactions in assets including bonds, share of a company, real estate and factory **Purchasing a foreign asset** = purchase of foreign good Government increases in foreign reserves are debit and decreases of foreign reserves are credits **Outflow = Purchasing a foreign asset** = requires a **payment** from Canadians to foreigners, it's a "debit" (-); cases financial capital to leave Canada **Inflow = Selling a Canadian asset** = **receipt** for Canada, it's a "credit" (+); causes financial capital to enter Canada **Balance of payments** CA + KA = 0 **Current Account Balance** = X -- Imports + net foreign investment income If interest Canada goes down = bonds less attractive since the interest on it is low =\> KA goes down =\> \$CAD depreciates **Foreign exchange market** = Appreciation (fall in exchange rate) and Depreciation (rise in exchange rate) If \$CAD goes from 1\$CAD/ 1\$USD to 1.3 CAD/ 1\$USD =\> depreciation **Canada-Euro** = Demand for euros = supply of Canadian dollars; Supply of Euro = Demand for Canadian Dollars **Supply of foreign exchange (Demand for CAD)** = increases if Canadian exports increases , Canadian asset sales (capital inflows) increases and Reserve currency (like savings account): If exchange is above 1.5 = excess supply of foreign exchange (high demand on CAD; pressure for \$CAD to appreciate ![](media/image2.png)Activities that increase foreign currency supply = exports, assets sales (capital inflow) and reserve currency **Demand for foreign exchange (Supply of CAD)** = is negatively sloped; if \$CAD depreciates against Euro; Canadian dollar price rises of European goods rises; Canadian will buy fewer European goods; Amount of foreign exchange is being demanded by Canadians to pay for imported European goods will fall A **depreciation** of \$CAD = **increase the supply** of foreign currencies (more people want to buy Canadian goods A **appreciation** of \$CAD = **increase demand** for foreign currencies (Canadians want to buy foreign goods) **Flexible exchange rate** = when central bank makes no transaction in the foreign-exchange market **Fixed exchange rate (or pegged exchange rate)** = when central bank intervened on the foreign exchange market to "fix" or "peg" the exchange rate at a particular value = capital inflow will \$CAD appreciate the currency of the capital-importing nation. **Exchange rate often respond to changes in the price of import and exports**: A rise in foreign prices of Canadian imports = causes \$CAD to appreciate or depreciate, depending on the elasticity of demand If Canadian demand is **elastic** = if price of foreign of imports increase = Canada will import less =\> demand for foreign currency shift left =\> exchange rate decrease = \$CAD value appreciate If Canadian demand is **inelastic** = if price of foreign of imports increase = Canada will import increase =\> demand for foreign currency shift left =\> exchange rate increase = \$CAD value depreciate Higher inflation = depreciation **Short term capital movement** **Cause of Current Account deficits** (CA = (Saving -- Investment) + (Taxes -Government purchases)) **Purchasing power parity** (e^ppp^ (exchange rate of \$CAD to foreign currency) =P~C~ (price level of Canada) / P~E~ (price level of foreign country)) = price level relation between 2 countries **Neo-mercantilists** = argue, the benefit of international trade [increase in the size of the trade surplus]; the power of the government is related to the size od the trade balance; the country's living standard is related to the size of the trade surplus They believe that a country's gains from trade arise from having exports exceeding imports **Fractionally backed** = banks have many more claims outstanding against them than they have in reserves available to pay those claims; The major problem with a fractionally backed currency was maintaining its convertibility into the precious metal behind it **Type of unemployment**: frictional (due to turnover and job change); structural (mismatch between labor force and characteristic and available jobs); cyclical (business cycle) If cyclical unemployment is positive = means recessionary gap **NAIRU** (U\*) = Natural rate of unemployment, also non-accelerating inflation rate of unemployment also full employment but mean when we at Y\* (potential GDP) **NAIRU = Frictional + structural** **actual unemployment rate (U)** = NAIRU + cyclical Actual unemployment \> NAIRU = Recessionary since more people unemployed Actual unemployment \< NAIRU = inflationary **Output Gaps:** Y\>Y\*, inflationary = wages rise; Y\ Recession - \> Wages go down Prices: changes in wages affect Aggregate Supply (AS), shifting the price level;if wages increase, AS shift left (inflationary) = high prices; if wages decrease, AS shift right (recessionary) **Actual inflation** = [Output-gap inflation + Expectation inflation] + supply shock inflation [Output-gap inflation] (up and down caused by output gap) [ and Expectation inflation]= inflation caused by wages **Expected inflation** = anticipated rate of inflation in the future (also called exceptional effect) **Supply-shock inflation**= other then wages such as increase in price of oil will be bad for Canadian business therefore AS will shift left **Constant inflation** = no output gap effect on wages and no supply shock inflation; Actual inflation = expected inflation **Constant inflation** = maintained though monetary expansion (Money Supply (MS) increases so AD shift right) \[MS increasing = cause [interest rate] to go [down] because bank have [more money] and can afford to loan it a [cheaper interest rate]; AD will go up. People have more to spend\]; AS does not get affected by any Aggregate expenditure (AE), interest, money supply = monetary policy, only affect demand; AS and AD both shift equally to maintain equilibrium Y (if AE goes up= AD will go up) If **monetary expension = MS ↑ = i↓ = AD↑** **Hysteresis** **Inflation targeting =** **Adjustment process** (AS) = prices to adjust in response to output gaps + Tech. / fac. Supplies = constant **Excess demand** = qty demanded \> qty supplied **Excess Supply** = qty supplied \> qty demanded **Overnight interest rate =** rate that bank charges in each (such as CIBC to TD); if Canada reduces its target inflation= overnight interest rate will go down = AD shift right; if higher overnight interest rate = interest of economy will go up **Demand inflation (Positive Demand Shock)** = shift AD t o right and lead to higher price level and Y\>Y\*; positive demand shock when AE function elements increase ( AE = C + I +G + X -IM( IM goes down) **Supply inflation (Negative Supply shock)** = increase price of input If AD positive and AS negative (vise-versa) = Real GDP undetermined but not the price level) If AD and AS negative = decrease in Y but cannot determine price level **Accelerating inflation** = acceleration hypothesis = Y\> Y\*; cause inflation to accelerate; happens when Central bank use monetary policy; example: expansionary policy used during inflation gap **Disinflation =** reduction in rate of inflation**; 3 phases** 1. **Remove monetary policy** (stop expansionary policies and start contractionary polices; slows o stops the shift od AD to the right) 2. **Stagflation** (occurs when slow economic growth, high inflation, and rising unemployment; occurs as AS continues to shift upwards due to inflation expectations, leading to reduction in output and rising prices) 3. **Recovery** (Scenario 1 \[no monetary validation\] = market adjust itself (adjustment process), wages fall slowly, AS shift right and recessionary gap is closed; Scenario 2 \[one time monetary validation\] = Central bank start expansionary policies again to increase MS, shift AD to the right, and recessionary gap is closed) **Cost of Disinflation;** loss of economic activity and rise in unemployment **Sacrifice ratio =** % of Y that is sacrificed for % point of inflation reduction \[sacrifice ratio = (% loss in GDP/decrease inflation) \* 100\] ; We want lower ratio because we want to sacrifice less GDP = cost of disinflation **Fiscal stabilization policy =** **Automatic fiscal stabilizer** **Employment and unemployment** **Unemployment rate** = unemployed/labour force (employed + unemployed) **Avg. duration of unemployment spell** = stock of unemployment (people unemployed at a specific time)/monthly outflow from un employment (people moving out of unemployment and into employment or leaving labor force) **Marketing-clearing =** wage is perfectly flexible; labour market clear quickly; Y return to Y\*; U=U\*; there is no involuntary unemployment (caused by frictional or structural reason and voluntary **Non-marketing-clearing =** wages are sticky; unemployment = involuntary (recession -\> called cyclical unemployment (happen when wage is above market clearing (equilibrium wage)) **Excess supply = above equilibrium and excess demand = below equilibrium** **Reducing Cyclical Unemployment =** Expansionary Monetary **\[in a recession = MS increase; interest go down; AD goes up\]**and fiscal (lower taxes and/or increase government purchase; AD will go up )policies **-(**Increase government spending**;** Decrease taxes**;** Decrease interest rate **or** Increase the money supply) **Reducing Frictional Unemployment=** Decrease benefits of unemployment insurance program**;** Create a national job bank to show available jobs across the country **Reducing Structural Unemployment =** Programs to retrain and relocate individuals **Government Debt and deficits** **Debt** = accumulation of past deficits; **deficits** = annual shortfall between revenues (money from taxes) and disbursements (government spending \[G + i\*D\] **Budget constraint**- government raises money with tax revenue or borrowing; spending includes purchases and interest payments on debt. When gov. annual budget = surplus =\> gov. debt will begin to fall Government Expenditure is financed by income (net tax revenue, T = tax revenue -- transfer payments) and by borrowing =\> Gov. expenditure = T + Borrowing Government Expenditure is divided into purchases of goods and services (G) and interest payments on stock of debts (referred to as debt-service payments)) noted as i\*D =\> Gov. expenditure = i\*D + Borrowing ![](media/image6.png)**Borrowing** (\[Overall\] budget deficit = excess of government expenditure over tax revenue) = (G \[government purchases + i\*D \[debt-service payments\]) -- T\[tax revenue\] **Primary budget deficit** = G - T; also, overall budget deficit -- (i\*D); shows the extent to which T can cover government spending **Budget deficit =** gov. spends too much; change in government debt because the gov. will borrow when it is a deficit and repay debt when it has a surplus; equal to borrowing Government Expenditure is financed by income (net tax revenue, T = tax revenue -- transfer) If borrowing negative = means surplus Any excess of total governmental spending over net tax revenues must be financed by government borrowing **Debt-to-GDP ratio** = total debt/GDP; A lower debt-to-GDP ratio = debt burden compared to the size of economy If "x" = 5% =\> ∆d will go up; if (r -- g) example (3% - 2%) = 1%, meaning government will collect more taxes If "g" increase = next year ∆d will go down; "r" go up = ∆d will go up and the other elements too except for "g" A blue and white box with black text Description automatically generated ![A diagram of a line Description automatically generated](media/image8.png) **Change in budget deficit happen because of**: **Structural Deficit (not get affect by Y) (long term)=**. It persists over time and is not affected by short-term economic fluctuations**;** Stems from permanent changes in government spending or tax policies.; also called cyclically adjust ed deficit **Cyclical Deficit (short term)** = A budget deficit that arises due to economic fluctuations.; Tied to the Business Cyc le (occurs during economic downturns or recessions); Tax revenues decline due to lower incomes and profits during economic downturns; Government expenditures often rise due to social welfare programs and automatic stabilizers; The cyclical deficit tends to diminish as the economy recovers and tax revenues in crease; cyclical deficit= actual deficit -- structural deficit **Effect of government debt;** **Private saving** = Y\* - Tax of transfer -- C **Public Saving** = T -- G **National Saving (NS)** = Private + Public **Crowing out;** is when net exports (NX) and investment goes down due to fiscal policies when government spend more then NS decrease **Long-term burden of government debt**; taxes that will be paid by future generation for current government deficits; could be harmful or beneficial for future generations, depending how the deficits were spend by the current government With capital budgeting, current gov. must classify consumption as investment, consumption benefit current generation and investment benefit future generation In long run, government budget will add to sustained inflation (a lot of inflation) if creation of new money due to continual deficits **Nominal GDP** = current dollar national income (current price goods) ; **real national income** = constant-dollar national income (price of goods in the base year) **Business cycle =** peak (highest point of economy); contraction/recession; through (lowest point); recovery/expansion **GDP deflator (look at everything produced in the economy) =** (GDP~nominal~ / GDP~real~)\* 100 **CPI (consumer price index) =** Avg price of consumer goods CPI = ((CPI old -- CPI new)/CPI new))\*100 Real rate = nominal rate -- inflation (if inflation go up = real inflation go down =\> bad for lenders because making less money **Omission from GDP =** illegal activities not allowed; underground activities; non-market activities; environment damage **National output** **Intermediate goods=** output films that become output for other firms **Final goods =** that do not become inputs for other firms **Value added** = value that is added to a product able the cost of intermediate goods (prevent double counting) **Value added = Sale value -- Cost of intermediate goods** **GDP from expenditure side =** C(consumption) + I (investment) + G(government purchases) + NX (net exports) **GDP from income side =** all income generated **Factor income =** W + I + P (wages + interest + business profits) **Non-factor payments =** indirect taxes (sale taxes and GST, reduce the income) **Subsidies** = negative taxes and increase factor income; decreases indirect tax **Autonomous expenditure** = not affected by income **Induced expenditure** = expenditure rise and fall with income Closed economy = C + I Desired consumption expenditure =\> C = C (autonomous consumption + (MPC(d~D~)) MPC = Marginal propensity to consume MPC = ∆C/∆Y APC (Avg. pro. To consume) = C/∆Y Saving function = -C + MPS(Y~D~) MPC + MPS (marginal propensity to saving) = 1 Y~D~ = C and C = C + MPC(Y~d~) Factore affecting consumption A screenshot of a computer Description automatically generated National income = before taxe; disposable income = after tax ![A close-up of a number Description automatically generated](media/image10.png) Factors affecting investment A blue and white rectangular box with text Description automatically generated ![A graph of a function Description automatically generated with medium confidence](media/image12.png) **Multiplier** = change in autonomous expenditure (AE) will have on the overall GDP; measure horizontal shift in the demand curve If multiplier = 5 and AE increases by 1 =\> GDP will increase by 5 **Multiplier** = 1/(1-z) ; z = slope of AE; if slope of AE increase = higher multiplier =\> more output gap **Simple multiplier** = change in equilibrium GDP **Budget balance** = T -- G A table with arrows and text Description automatically generated ![A screen shot of a computer Description automatically generated](media/image14.png) Fiscal and monetary policy only effect AD **Real GDP per capita** = amount a person earn living in a country; higher real GDP per capita = higher living standards **Overnight Interest Rate** = rate between banks = which can increase the interest of ecnomy If Bank want increase Y =\> reduce target overnight int. rate (expansionary policy) **Money supply =** **M1** moneys supply used by Bank of Canada **M2** currency circulating (mortgage...) **M2+** similar to M2 plus depostis Money =\> Unit of Account, Store of Value, medium of exchange Milling =\> rough edges coins **Debasing** =\> ↑ money in circulation without its value **4 fundamental of growth**= Labour force, Human capital, Physical capital, Technological improvement Fine/Gross Tunning = to persist output gaps The long-time lags in the effectiveness of monetary policy ↑ the difficulty of stabilizing the economy; monetary policy may have a destabilizing effect. Time lags in monetary policy require that decisions regarding a loosening or tightening of monetary policy be forward-looking Gresham's law = "bad" money or debased money drives "good" or unbased money ![A red and black text Description automatically generated with medium confidence](media/image16.png) If bank of Canada buy government securities = increases money supply (vise-versa A yellow and black math equation Description automatically generated ![A blue and white table with white text Description automatically generated](media/image18.png) A diagram of a graph Description automatically generated **Neoclassical growth model** The monetary transmission mechanism explains how changes in the demand for and supply of money impact aggregate demand. It operates in three stages: Changes in the demand for or supply of money alter the equilibrium interest rate in the short; The interest rate change affects desired investment, consumption expenditure, and net exports.; Changes in desired aggregate expenditure lead to shifts in the aggregate demand (AD) curve. ![A table with text and arrows Description automatically generated](media/image20.png)

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