Jason Majewski - Quia



Unit V – Financial Sector (20-25% of AP Macroeconomics exam)

Objectives:

• NCEE Content Standard 11 – Money makes it easier to trade, borrow, save, invest, and compare the value of goods and services.

• NCEE Content Standard 12 – Interest rates, adjusted for inflation, rise and fall to balance the amount saved with the amount borrowed, which affects the allocation of scarce resources between present and future uses.

• NCEE Content Standard 18 – A nation’s overall levels of income, employment, and prices are determined by the interaction of spending and production decision made by all households, firms, government agencies, and others in the economy.

• NCEE Content Standard 19 – Unemployment imposes costs on individuals and nations. Unexpected inflation imposes costs on many people and benefits some others because it arbitrarily redistributes purchasing power. Inflation can reduce the rate of growth of national living standards because individuals and organizations use resources to protect themselves against the uncertainty of future prices.

• NCEE Content Standard 20 – Federal government budgetary (fiscal) policy and the Federal Reserve System’s monetary policy influence the overall levels of employment, output, and prices.

Vocabulary: (Big topics in bold)

Saving (Public vs Private) Investment Personal Investment

Stock Market Bond Market Primary and Secondary Market Stocks: Advantages/Disadvantages Bonds: Advantages/Disadvantages

Diversification Liquidity Bonds Prices

Interest Rates Time Value of Money SEC Risk and Return Loanable Funds Market National Savings Deficits versus Surplus Crowding Out Functions of Money Commodity versus Fiat Money Supply Definitions Functions of FED Federal Reserve Tools Fractional Reserve Banking Open Market Operations Reserve Requirement Excess Reserves Discount Rate Monetary Policy Federal Funds Rate and Target Taylor Rule

Inflation Targeting Theory of Liquidity Preference Nominal versus Real Monetary Neutrality Fisher Effect

Numbers and Formulas:

Benefit Cost Analysis (MB >= MC)

Money Multiplier

Visuals:

Loanable Funds Model

Money Market Model

Aggregate Model

AP Macroeconomics Activity Book (answers to Unit 4 M/C sample questions for Unit 5)

1. A 4. E 7. C 10. D 13. E 16. D 19. B

2. B 5. D 8. B 11. A 14. A 17. C

3. D 6. E 9. D 12. C 15. B 18. D

Unit V Calendar:

|Monday |Tuesday |Wednesday |Thursday |Friday |

|16 |17 |18 |19 |20 |

|Unit 4 Test |Loanable Funds |Bonds |Stocks |Stocks cont. |

| | | | | |

| |Hwk: Read Module 22 and 29 |Hwk: AP Activity 4-5 and | | |

|Hwk: Review Savings and |(p.276-281 only) |Module Practice Problems |Hwk: Literary Project due |Hwk: Read Modules 23-27 |

|Investment Notes | |due Jan. 2 in class |Tomorrow | |

| |Vacation |12/23 – 12/27 |No School | |

|30 |31 |January 1 | 2 |3 |

|No School |No School |No School |Monetary System |FED Tools |

| | | | | |

| | | |Hwk: AP Macro Activities | |

| | | |4-1, |Hwk: AP Macro Activity 4-6 |

| | | |4-3 | |

|6 |7 |8 |9 |10 |

|Tools cont. |Financial Models |Models cont. |Monetary Policy |Policy: SR vs LR |

| | | | | |

|Hwk: Read Module 28 |Hwk: Read Module 31 and AP |Hwk: AP Macro Activity 4-7 |Hwk: Read Modules 29 |Hwk: AP Macro Activity 4-9 |

| |Macro Activity 4-4 | |(p.281-285) and 32 |and Read Modules 20-21 |

AP Macroeconomics Resource Manual (answers to Unit 5 Activities)

Activity 4-5

1. Since the present value projected profits will increase at lower interest rates, businesses will borrow more at lower interest rates to finance the increased number of worthwhile projects.

2. The opportunity cost of savings, spending, increases as more and more spending is foregone.

3. Real interest rate since lenders and borrowers respond to real rates as opposed to nominal rates.

4.

a. The government will need to borrow more to finance the increased spending. The demand for loanable funds will shift to the right causing the real rate to increase.

b. Higher taxes on interest income will cause savers to save less at all real interest rates. Thus, the supply of loanable funds will shift left causing the real rate to increase.

c. As banks with new reserves increase the amount of loans, the supply of loanable funds will increase, causing the real rate to decrease.

d. Both consumers and businesses will not feel confidant to take out more loans which will decrease the demand for loanable funds causing the real rate to decrease.

e. If Chinese consumers spend more, they save less. Since some of Chinese savings is in the United States, the supply loanable funds in the United States will shift to the left (decrease) causing the real rate to increase.

Activity 4-1

2. M 3. U 4. S 5. U 6. M 7. S

8. Credit cards provide a medium of exchange, but they represent a loan and therefore do not serve as a store of value.

9. 1, 2, 4, 3, 5

10A. 1050 B. 3097 C. 5107

11A. Stock and Provide Liquidity B. Loan and Reduce Transaction costs C. Bank Deposit and Reduce Risk D. Bond and Provide Liquidity

Activity 4-3

1a. 100 b. 900 c. 900 d. 90 e. 810 f. 810 g. 81 h. 729

2a. 1000, 1000, 9000 b. less c. more d. less e. less

3a. Loans = 900, Reserves = 100, Deposits = 1000

4a. The money supply will be decreased. Banks must hold more of their deposits as reserves so loans and money creation are decreased.

4b. Deposits decrease; required reserves decrease; excess reserves decrease, and the money supply decreases.

4c. People could hold their loan proceeds as cash; banks could hold excess reserves.

Activity 4-6

1. Sell 2. 10 3. $5 5. 1/0.15 = 6.67 6a. $15,000 6b. $85000 6c. As vault cash, or reserve accounts (deposits at the district federal reserve bank) 7. $566,950

8a. Decrease, Decrease, Increase

8b. Increase, Increase, Decrease

8c. Decrease, Decrease, Increase

8d. Increase, Increase, Decrease

8e. Decrease, Decrease, Increase

8f. Increase, Increase, Decrease

9a. Buy treasury securities, Sell treasury securities

9b. Lower discount rate, Raise discount rate

9c. Lower required reserve ratio, Raise required reserve ratio

Activity 4-4

1. The quantity of money demanded increases as the interest rate falls. The quantity of loans increases. This is because the interest rate is the price of loans and the opportunity cost of holding money.

2. Show an increase of money supply on your money market model. This will cause nominal interest rates to decrease and quantity of money to increase.

3. Show an increase of money demand on your money market model. This will cause nominal interest rates to increase and no change to quantity of money. The quantity of loans decreases because the interest rate (the price of loans) has increased.

Activity 4-7

1a. Expansionary Monetary Policy 1b. Buy 1c. Increase

1d. Nominal interest rates should fall because financial institutions have more funds to lend out because people have sold their treasury securities to the Fed.

1e. Real output should increase. With the decrease in interest rates, the interest rate sensitive components of AD (consumption and investment) will increase, thereby increasing output.

1f. The average price level increases because the increase in demand can be met only if firms have the incentive to produce more. An increasing price level provides this incentive.

2a. Contractionary Monetary Policy 2b. Sell 2c. Decrease

2d. In the short run, nominal interest rates will increase. When the public buy bonds, they pay for them by reducing their demand deposits, decreasing the supply of money, which means the interest rate will increase.

2e. In the short run, real output will decline. As a result of the Fed’s actions, interest rates have increased; therefore, the interest sensitive components of AD (consumption and investment) will decrease and thus, will decrease AD. With a reduced AD, firms will experience an increase in inventories, which in turn leads to a decrease in production. Output decreases.

2f. The price level will fall as firms attempt to clear out inventory by reducing prices; for example, by having a sale.

3a. In the short run, the monetary authorities (the Fed) expand the money supply, which in turn increases the AD curve to AD1. The price level and output increase.

3b. The SRAS will shift to the left, leading to a decrease in output and an increase in price level. Given the Fed’s desire to remain at Y1, the Fed will continue to expand the money supply, shift AD to AD2. With the decrease in SRAS, the economy might be at a point like the intersection of AD2 and SRAS1. Thus, the price level will continue to rise and the economy will experience inflation.

3c. In the short run, both the nominal interest rate and the real interest rate will decline. Consumers and financial intermediaries will not have correctly anticipated the inflation, and both interest rates will decline. As consumers and producers, recognize that the price level is increasing, they will take steps to maintain their real income. Nominal wages will rise, and the nominal and real interest rates will start to rise.

3d. In the long run, the real interest rate will return to its long-run equilibrium, and the nominal interest rate will be the real interest rate plus inflation. Since inflation is increasing, the nominal interest rate will increase as well. Producers and consumers will adjust expectation to match reality.

4. Wages will adjust slowly to changes in prices (inflation) because of wage contracts. Prices adjust slowly because business is slow to change prices to maintain consumer loyalty. Both labor and firms have inaccurate expectations about inflation.

5. In the long run, increases in the money supply translate into an increase in the price level but no long term increase in output. This is known as the neutrality of money. In the short run, nominal and real interest rates decline. In the long run, nominal interest rates follow the Fisher equation and equal the real rate plus the inflation rate. Real interest rates return to their long run level; the rate people require to forgo consumption in the future.

6a. In the short run, the money supply will increase which will decrease interest rates, increase investment and consumption, and increase AD which will increase output (decrease unemployment) and increase the price level.

6b. The price level will increase as AD increases.

6c. Employment increases because output increases. Wages stay the same because of contracts (sticky wages), but real wages fall.

6d. Nominal interest rates fall as the money supply increases. Real interest rates decrease because lower nominal interest rates and higher price level for both tend to decrease real interest rates.

6e. It returns to the full employment level (decreases) because SRAS decreases when workers bargain for higher nominal wages to compensate for the decrease in real wages due to the higher price level.

6f. It is higher as a result of the increase in AD and the decrease in SRAS

6g. Employment returns to the full employment level. Nominal wages are higher as workers require increased nominal wages to keep real wages the same.

6h. The nominal interest rate will increase so that the real interest rates are the same after the price level increases.

Activity 4-9

Year 1 = 3.15, Year 2 = 3.22 Year 3 = 3.64 Year 4 = 3.08 Year 5 = 3.53 Year 6 = 1.43

What you should know at the end of this unit:

• Students recognize that saving means not consuming all current income, and investment refers to the production and purchase of machines, buildings, and equipment that can be used to produce more goods and services in the future.

• The U.S. financial system is made up of many types of financial institutions, such as the bond market, the stock market, banks, and mutual funds. All of these institutions act to direct the resources of households that want to save some of their income into the hands of households and firms that want to borrow.

• The purpose of two major types of financial assets: Stocks and Bonds

• Because savings can earn interest, a sum of money today is more valuable than the same sum of money in the future. A person can compare sums from different times using the concept of present value.

• Risk-averse people can reduce risk by buying insurance, diversifying their holdings, and choosing a portfolio with lower risk and lower return.

• Efficient Market Hypothesis states that financial markets process valuable information rationally, so a stock price always equals the best estimate of the value of the underlying business.

(continue on next page)

• Money serves three functions. As a medium of exchange, it provides the item used to make transactions. As a unit of account, it provides the way in which prices and other economic values are recorded. As a store of value, it provides a way of transferring purchasing power from the present to the future.

• Commodity money, such as gold, is money that has intrinsic value: It would be valued even if it were not used as money. Fiat money, such as paper dollars, is money without intrinsic value: it would be worthless if it were not used as money.

• The Federal Reserve, the central bank of the United States, is responsible for regulating the US Monetary System. The FED chairman is appointed by the President and confirmed by Congress every four years. The chairman is the lead member of the Federal Open Market Committee, which means about every six weeks to consider changes in monetary policy.

• The FED controls the money supply primarily through open-market operations. The purchase of government bonds increases money supply, and the sale of government bonds decreases the money supply. The Fed can also expand the money supply by lowering the reserve requirements or decreasing the discount rate, and it can contract the money supply by raising the reserve requirements or increasing the discount rate.

• Monetary Policy (an increase in the money supply reduces the equilibrium interest rate for any given price level. Because a lower interest rate stimulates the investment spending, the aggregate demand curve shifts to the right and vice versa)

• The Federal Reserve has in recent years set monetary policy by choosing a target for the federal funds rate, a short term interest rate at which banks make loans to one another. As the FED achieves its target, it adjust money supply.

• The overall level of prices in an economy adjusts to bring money supply and money demand into balance. When the central bank increases the supply of money, it causes the price level to rise. Persistent growth in the quantity of money supplied leads to continuing inflation.

• Keynes proposed the theory of liquidity preference to explain the determinants of the interest rate and how the rate will adjust to balance the supply and demand for money.

• An increase in the price level raises money demand and increases the interest rate that brings the money market into equilibrium. Because the interest rate represents the cost of borrowing, a higher interest rate reduces investment and thereby, the quantity of goods and services demanded.

• The principle of money neutrality asserts that changes in the quantity of money influence nominal variables but not real variables. Most economists believe that money neutrality approximately describes the behavior of the economy in the long run.

• A government can pay for some of its spending simply by printing money. When countries rely heavily on this “inflation tax,” the result is hyperinflation.

• According to the Fisher Effect, when the inflation rate rises, the nominal interest rate rises by the same amount, so that the real interest rate remains the same.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download