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Cyclical Unemployment. Recession  unemployment rises  lay-offs increase and new hires decrease Job seekers find it more difficult to find employment  they spend longer time looking for employment. Economic Growth, Productivity, and Living Standards.

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Cyclical Unemployment

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cyclical unemployment
Cyclical Unemployment
  • Recession  unemployment rises  lay-offs increase and new hires decrease
  • Job seekers find it more difficult to find employment  they spend longer time looking for employment
economic growth productivity and living standards
Economic Growth, Productivity, and Living Standards
  • The value of goods available to people today is eight times larger than what people could consume in 1900
  • The wealthiest person in 1900 could not afford many of the things we take for granted today
  • The improvement of living standards economic growth
economic growth productivity and living standards1
Economic Growth, Productivity, and Living Standards
  • In the 19th and 20th centuries economic growth spread to Japan, Latin America
  • Economic growth began over 200 years ago in western Europe and the US
the circular flow model of the economy pg 73
The Circular Flow Model of the Economy (pg.73)
  • Major actors: rectangles= Households, Government, Firms
  • The markets through which the major actors interact= ovals
  • Flow of money and goods/ services= arrows

Households get income by providing factors of production (labor, capital, land) to firms

  • Firms are owned indirectly by households
  • Households provide capital to the firms in exchange for rental payments
  • Households use income to pay taxes, buy goods and services, and save through financial markets
  • Firms receive revenue from selling goods and services.
  • They use this income to buy factors of production that they must hire in order to produce the goods they sell

Government receives taxes from households

  • Government borrows from financial markets
  • Government uses households and financial markets to purchase goods and services

The flow of funds from financial markets to the market for goods and services represented by

    • borrowing by both households and firms
        • which is used to purchase consumer durable goods and capital equipment
what determines how much an economy produces
What determines How Much an Economy Produces?
  • Real GDP per capita=GDP per workers multiplied by the fraction of the population employed.
  • POP: country’s population
  • N: labor force







The average amount of goods and services available for each person to consume relies on the average amount that each worker can produce and the amount of the population that is part of production

the average labor productivity depends on
The Average Labor Productivity depends on…

Physical Capital

Human Capital

The skills that are gained through education, training and experience

Not tangible

People in training must reduce amount of time in productive activities while learning

  • More productive factories: workers with more/better tools, machinery
  • High levels of production: large amounts of capital per workler
Natural Resources

Technological Knowledge

Most important thing for raising average labor productivity

Can include the invention of new products or the improvement of existing ones

  • High standards of living can be because of the trade of natural resources (Saudi Arabia and Kuwait oil)
  • Not necessary for high standards of living
  • Can be replaced by importing raw materials produced elsewhere
The Political and Legal Environment

For example…

After WWII North and South Korea had similar resources but different governments

Presently South Korea has a standard of living like that of most developed countries

North Korea is devastated by poverty and starvation

  • Dysfunctional governmental systems inhibit many countries from modern manufacturing techniques
financial market
Financial Market:

An institution through which someone can deposit money directly to people or companies that wish to borrow money for investment

bond market
Bond Market
  • When a corporation wants to borrow money from the public it can sell bonds
  • The sale of a bond is called a debt finance
  • Date of maturity: the date the bond will be replayed
  • The buyer of a bond lends a company his/her money in return for the amount he gave(the principal) plus interest
bond market1
Bond Market
  • The purchaser of a bond can hold it until the date of maturity or can sell it to someone else
  • As market interest rates change the price at which the bond can be sold will change resulting in changed interest rate
  • The longer the maturity the greater the risk of change but also higher interest rates
  • If a company declares bankruptcy it defaults on its obligation to repay the buyer
stock market
Stock Market
  • Companies can raise funds by issuing and selling shares of stock
  • A share of stock is ownership over a portion of firm
  • Sale of a share of stock is called equity finance
  • If a company is profitable then the stock holders enjoy the benefits through payment of dividends or through an increase in value of their shares
stock market1
Stock Market
  • If a company runs into financial difficulties a bond holder is paid before a stock holder
  • Stock holders face greater risks than bond holders but have higher potential for high returns
  • A buyer of stocks can sell shares in an organized stock exchange
  • The trade of stock on a stock exchange does not affect a company
financial intermediaries a third party who acts as a link between 2 others
Financial Intermediariesa third party who acts as a link between 2 others


  • When businesses that are too small for Bonds/stocks need to borrow money they turn to a bank
  • Most banks depositors are fully insured so they have little risk
  • The value of deposits does not change with banks success
  • They provide checking accounts which facilitate purchases of goods and services by providing checking accounts
financial intermediaries a third party who acts as a link between 2 others1
Financial Intermediariesa third party who acts as a link between 2 others

Mutual Funds

Allow people with small amounts of money to purchase a portfolio of bonds and stocks

Higher diversification: if one company doesn’t do well another backs it up

Provides access to professional money managers b/c they put the mutual fund together

saving and investment in aggregate
Saving and Investment in Aggregate
  • The equality of income:
  • Y=C+I+G+NX
  • Y: income
  • C: consumption expenditures
  • I: investment
  • G: government purchases
  • NX: net exports

The relationship between income and expenditures can be represented with S=I

  • In the expression above it is possible to +or – taxes , T, from the left side to get: S=Y-C-G=(Y-C-T)+(T-G)
  • If T-G is positive then the government runs a budget surplus
  • If T-G is negative the government runs a budget deficit
  • When the government runs a deficit
international capital flows
International Capital Flows
  • In an open economy domestic savings do not have to equal domestic investment because of the international lending
  • Net capital outflow=purchase of foreign capital outflow by domestic residents minus the purchase of domestic assets by foreigners
  • Foreign direct investment: a company/ individual acquires assets in a foreign country that they will manage actively

The amount of net capital outflows must exactly equal net exports

  • The equality of income and expenditures for an open economy:
  • Y=C+I+G+NX can be rearranged into:
  • Y-C-G=S=I+NX shows that exports=net capital outflow so we can replace NX with NCO
  • S=I+NCO
  • This means that domestic savings is equal to domestic investments plus net capital flow
how financial markets coordinate saving and investment decisions in a closed economy
How Financial Markets Coordinate Saving and Investment Decisions(in a closed economy)
  • In the financial market the supply of savings and the demand for savings are stabilized by the adjustment of interest rates
  • People invest money because to the possibility of buying more in the future
  • The interest rate must be greater than inflation
  • The original interest rate minus inflation= real interest rate

The lower the real interest rate the larger the number of investments a business will pursue

  • Interest rate below the equilibrium level: borrowers wouldn’t attract enough savers
  • Competition to find the funds would then drive up the real interest rate
  • Interest rate above the equilibrium level:
  • An excess supply of funds and competition between lenders would cause real interest rate to fall
how various events affect equilibrium
How Various events affect equilibrium
  • New technology raises the productivity of capital 
  • The demand for funds results in businesses wanting to borrow more money at every interest rate
  • Rising interest rates more savings and investments
how various events affect equilibrium1
How Various events affect equilibrium
  • Increase in government deficit/reduction in government saving/borrowing more
  • Supply of saving in the economy is reduced at every interest rate
  • Interest rates are higher, total amount of saving and investment in the economy is lower
  • Government deficits reducing private investments=crowding out

The effect of a government tax credit on encouraging savings/the effects when government reduces the tax rate on interest income earned on saving accounts :

  • Interest rates fall while saving and investments both increase

medium of exchange (an item buyers can use to purchase with, explains why people hold on $ when it earns no interest)

unit of account (way of expressing pieces of things)

store value (an item that people can use to transfer purchasing power)


Wealth=different stores of value in an economy

  • Liquidity -distinguishes different assets that make up wealth

-measure of ease with which an asset can be converted into the economy’s medium of exchange

-(ex. Currency, checking accounts, most stocks/bonds, shares of mutual funds.)

federal reserve system
Federal Reserve System
  • Central Bank
  • Created to oversee banking system + regulate supply money
  • Created in 1913
  • Consists of 12 regional banks owned by commercial banks
  • Red Reserve board of Washington D.C. run by 7 governors appointed by President (14 yr terms)
12 regional banks
12 Regional Banks
  • Overseeing commercial banks in region
  • Facilitating transactions by clearing checks
  • Make loans to banks
  • Act as a lender/last resort to a bank in trouble to maintain stability of banking system
federal open market committee fomc
Federal Open Market Committee (FOMC)
  • In charge of money supply(controlling quantity of money in economy)
  • Made of 7 governors of the Fed+5 regional bank presidents
  • President of NY Fed always a member
  • Meet every 6 weeks in Washington
roles of fomc
Roles of FOMC
  • Determine if change in Money Policy necessary
  • If so, achieve goals through open market operations
  • Fed wants ↑money supply buy US gov. Bonds (from banks/public)
  • Fed wants ↓money supply Sell bonds
banks open market operations
Banks: open market operations
  • Banks earn profit by lending depositors money to people wanting to borrow funds
  • Must keep some reserves to be able to pay back depositor
  • By holding onto fraction of depositors’ reserves banks able to create money
  • Borrowers have more assets but also more wealth
  • Fractional reserves make economy more liquid but doesn’t increase wealth
let s get technical
Let’s get technical
  • Money banking sector creates from each dollar of reserves is the money multiplier (reciprocal reserve ratio)
  • When banks change reserve ratio they hold they alter stock of money in the economy
  • Amount of currency + reserves=monetary base (high powered $)
how does this effect the money supply
How does this effect the money supply?

M= $ Fed provided

C = $ Public chooses to hold

R = banks hold this fraction of each dollar of deposits as reserves

C+(m-c/R)= (R*C+M-C/R)= (M+(R-1)*C/R)


Smaller C or R is larger money supply will be

what else can the fed to influence supply of money
What else can the Fed to influence supply of money?
  • Reserve requirement – Fed set for banks
  • Discount rate- interest rate the Fed charges on loans made by banks
  • (related to federal funds rate which is the rate charged to banks to lend $ to other banks)
  • Higher rate= less banks borrowing reserves

(reduces supply of $)

bank problems
Bank Problems
  • Public wants to hold more currency  bank runs

(rush of withdrawals)

  • Even when bank is solvent (assets > liabilities) banks don’t have enough $
  • Banks forced to close
  • Fed bail out
money inflation
Money + Inflation
  • Prices risen every year since 1960s
  • (biggest decline 1929-2933 fell 25%)
  • Prices rise and people forced to pay more for same good$ worth less
how does this affect our
How does this affect our $?
  • Value moneyinteraction of supply + demand
  • Because of fractional reserves, Fed can choose supply of money
  • Demand $ how much people wish to hold $


volume of transactions take place

any trends
Any trends?
  • Value $ ↑  price levels ↓
  • Injections of more $↑ demand for goods
  • ↑demand + fixed supply of goods = prices ↑
  • This will continue until prices will = supply
  • ↑ in supply of $ = proportional increase in price level
neutrality of
Neutrality of $
  • Neutrality of Moneychanges in quantity of $ = no effect of real quantities of economy
  • This leads to the quantity equation
  • V=(P*Y) / M

V=velocity of money ( average # of times dollar used in a year)

Y= real GDP

P=Price level

M=Dollars in circulation

equation shows
Equation shows
  • Any increase in $ will be reflected by

1.) a fall in the velocity of $

2.) increase in real GDP

3.) increase in price level

why worry about inflation
Why worry about inflation?
  • Reduces the value of $
  • Distorts prices
  • Confusion of true value of goods/services