Final Exam Study Guide PDF

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Final Exam Study Guide - summary of everything on the final exam, mostly macroeconomic topics, but some microeconomics as well...

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Business 201 Final Exam: Lectures 12-18 Lecture 12: Imperfect Competition (Monopolistic Competition & Oligopoly) - Oligopoly: few firms w/ similar or identical products o Duopoly: 2 firms make an agreement to act as a monopoly together to split at max profit  Each thinks to go above until a certain point called the Nash equilibrium  But they are better off cooperating… due to self-interest each firm only wants to maximize their own profit  When firms individually choose their production to maximize profit after an agreed amount there is  Higher quantity and lower price than in a monopoly  Lower quantity higher price than in a competitive market  Dominant strategy: best choice regardless of the others strategy o Public policy:  Predatory pricing: prices so low that it drives competitors out of business  Tying 2 products together (to force firms out of business) - Monopolistic: many firms w/ distinct products o Maximize profit so inefficient quality is produced o Downward sloping demand curve  product differentiation o Profit  + in short run  P > ATC  Area between demand and ATC at the optimal Q  Optimal quantity where MC = MR  0 in the long run (like in competitive markets)  Area between demand and MC  Higher P than in a competitive market (P > MC) and lower Q than in a competitive market  In a competitive market P = MC  To maintain monopoly profits, it is better if there is a lack of cooperation among oligopolists because the quantity produced is closer to the efficient quantity and a lower price - Advertising o Good  Allows consumers to make more informed choices  Competition: informs customers of price thus reducing producer market power and new firms can enter knowing that consumers will know about the product o Bad  Not always informative, tries to convince consumers products are more different than they really are o Can signal quality b/c the more money spent on advertising means the product is better (more revenue so easy to spend a lot on advertising) o Brand names

Lecture 13: Finance - Stocks & bonds: the higher the risk  the higher the return - Bonds: IOU (capped) with… o Maturity (fixed time) o Coupon (amount paid/year) o Principal (size of loan) o Value of bond = each cash flow summed up - Time value of money = $ * return o Return = 1 + % (return = 5% then the return is 1.05) o After N years $ * (return)^N o Future value: amount of money in the future that an amount of money today will yield (relates future to present value)  FV = PV * (1 + r/100)^N (r = annual interest rate) o Present value: amount today that would be needed to produce that future sumdiscounts back at interest rate (relates present to future value)  PV = FV / (1 + r/100)^N o In order to compare prices we need to get them in the same point of time - Stocks: unlimited payoff potential o Riskier than bonds o Maturity is infinite o Dividend o Capital gain - Risk aversion: concave down due to law of diminishing marginal utility o The utility gain from winning $ is less than the utility from losing $  The magnitude from the loss > magnitude from the win - Insurance: premiums set high b/c people who need it will buy it (low risk people do not buy it) o Adverse selection: high-risk person benefits more from insurance o Moral hazard: people are less careful - Reduce risk by diversification o The larger the # of stocks  the lower the risk  Replacing a single risk with a large number of smaller, unrelated risks  Want negatively correlated stocks o Eliminates firm-specific risk: uncertainty associated with specific companies o Cannot eliminate market-risk: uncertainty associated with the entire economy (recession  low stock returns) - Trade-off between risk & aversion: the increased proportion of stocks in a portfolio, the increased expected return and the greater risk - Deciding which stocks to buy o Compare the stock price to the value of that share of the company (fundamental analysis)  If price < value buy the stock it will make a profit b/c it is undervalued o Also buy stocks randomly

Lecture 14: GDP & Inflation - GDP measures total income (selling something) and total expenditure (buying something) o Every transaction has buyer & seller o The market value of all (except illegal goods or those never entering the market) final (not intermediate) goods and services produced (currently, not already produced goods sold used) within a country in a specific period of time o Formula: Y = C + I + G + NX where Y = GDP  C= consumption: spending by households on goods/services  I = investment: spending on capital equipment, inventories, and structures  G = government purchases: spending on goods/services by local, state, and federal government  NX = net exports = exports – imports: goods/services produced domestically (exports) and sold abroad minus goods/services produced abroad and sold domestically (imports) o Nominal GDP: production of goods and services valued at current prices o Real GDP: production of goods and services at constant prices  Accounts for inflation by setting the price level  Recession: 2 consecutive quarters of declining real GDP  Prices remain the same o Ignores the (1) underground economy, (2) leisure, (3) goods produced at home, (4) quality of environment, (5) volunteer work, (6) distribution of income b/c GDP/capita focuses on the average person BUT it has a strong correlation w/ measure of standard of living - Measuring the cost of living: CPI (Consumer Price Index) o Measure of the overall cost of the goods/services by a typical consumer  Fix the “basket”  Find the prices  Compute the baskets cost  Choose a base year (where CPI = 100) and compute CPI in other years  CPI = (price of basket in current year / price of basket in base year) * 100  Inflation rate = ((CPI in year 2 – CPI in year 1) / CPI in year 1) * 100  Measures % change in price index from the previous period  Measure how quickly prices change o Quantity remains the same - Problems with measuring the CPI o Substitution bias: consumers substitute toward goods that become relatively cheaper & basket needs to adjust accordingly (law of demand) o Introduction of new goods: as more goods come into the market, consumers have more choices so each $ is worth more o Unmeasured quality change: if the quality of a good rises  cost of living decreases (not reflected) - Interest rates o Nominal interest rate: w/o adjustment for inflation o Real interest rate: interest rates adjusted for inflation

o Real interest rate = nominal interest rate – inflation rate o Prices have risen over time  inflation reduces purchasing power of each $ Lecture 15: Labor Markets - Demand for labor o Marginal product of labor (MPL) = Q / L o Value of marginal product of labor (VMPL) = P * MPL o Marginal profit (MP) = VMPL – W (where w is wage)  Hire where this is still + o The more people hired the larger the output but follows diminishing marginal product (marginal product of an input declines as the quantity of input increases… each individual worker produces less as the workers increase) o Curve  VMPL  Rely on factors of production (land, labor, capital)  Derived demand for factors of production because it is dependent on the decision to supply a good in another market o Ability, human capital, effort, chance & beauty - What causes the labor demand curve to shift? (D = P * MPL) o We cannot control the Price but we can control MPL  Output price: increase in the price of the good raises the value of marginal product of each worker  increases demand for workers  Decrease in the price of the good drops the value of marginal product of each worker  decreases demand for workers  Technological change (MPL)  Shift to the right: labor-augmenting devices that assist workers o MPL increases  Shift to the left: labor-saving devices that rival workers o MPL decreases  Availability of other factors of production o Fall in supply reduces marginal product o Rise in supply increases marginal product - Supply of Labor o Trade off b/w work & leisure o Shifts in the supply curve include (1) changes in taste (2) changes in alternative opportunities (3) immigration o Dependent on wage and incentives - Wages o Minimum wage > Equilibrium wage  surplus where supply exceeds demand o Maximum wage < Equilibrium wage  shortage where demand exceeds supply o Wage adjusts to balance supply & demand for labor (wage = VMPL) o Above equilibrium wages  Minimum-wage laws raise wages above equilibrium level  Union is a type of cartel (members strike) where employees in these get paid 10-20% more  Efficiency wages

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A firm pays high wages to increase worker productivity: (1) reduce worker turnover, (2) increase worker effort, (3) increase worker health, (4) raise quality of workers who apply for jobs

o More educated people earn more money (higher capital)  Productivity enhancing & revealing Unemployment o Labor force = number of employed + number of unemployed  Unemployed that would like to have a job o Unemployment rate = (number of unemployed / labor force) * 100 o Labor- force participation rate = (labor force / adult population) * 100 o Persistent unemployment  Frictional: unemployment that results b/c it takes time for workers to find a job suiting tastes & skills  Structural: b/c shortage of jobs  Government can help match to jobs, offer training programs & unemployment insurance Businesses which care only about profit are at an advantage over those who discriminate o Competitive markets reduce discrimination overtime unless customers have discriminatory preferences Economic mobility is the movement of people between income classes o Hard work, education & luck  more $

Sectoral shifts? Political philosophies?

Lecture 16: Money and prices in the long-run - Money: most liquid asset o Medium of exchange: buyers give to sellers when they want to purchase goods/services o Unit of account: price comparison allows for informed choices to maximize utility o Store of value: transfer purchasing power from present to future o Commodity money has an intrinsic value while fiat money has none o Money demand = how much wealth people want in liquid form - Federal Reserve system o Regulates the banking system: lends to banks, acts as lender for troubled banks to maintain stability in the banking system o Controls quantity of money in the economy  Monetary, open-market conditions: buy/sell US government bonds - Balance sheet o Assets: owned by the bank  Reserves, loans, securities o Liabilities: owed by the bank  Deposits, debt, bank capital (owners’ equity)  Bank capital (owners’ equity): resources a bank obtains from issuing equity to its owners’ o Equity = Assets – Liabilities o Reserve ratio: fraction of deposits that banks hold as reserves  In other words, how much banks must hold against their deposits  R = (reserves / deposits) * 100  The higher the reserve ratio the less banks lend out and the smaller the money multiplier o Money multiplier: amount of money the banking system generates with each dollar of reserves  MM = 1/R o Leverage: use of borrowed money for investment  Leverage ratio is the ratio of assets to bank capital  LR = (assets / bank capital)  Homework 6, 2b(iv) o Total money supply = deposits * money multiplier - The Fed can control the quantity of reserves by o Buying government bonds  increases money supply o Selling government bonds  decreases money supply o Decreasing reserve ratio  increases money supply o Increasing reserve ratio  decreases money supply - Value of money = 1/P (where P is price)

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o When the value of money is low  people demand more to buy their normal amount of goods o When supply increases everyone has more money so there is a decrease in the value of money and an increase in the price level o When supply decreases everyone has less money so there is an increase in the value of money and a decrease in the price level o On graph  what is actually shown is what happens to the value of money, what happens to price level is actually opposite of what is shown on graph Velocity of money, V: the rate at which money changes hands o V = (P * Y) / M = nominal GDP / quantity of money  P = price level, Y = quantity of output, M = money supply  Derive to M * V =P * Y  Velocity is stable over time  Output is not determined by money supply but by factors of production  M and P are directly related Increasing money rapidly  high rate of inflation b/c price level also increases For spending power to grow in the real world o Inflation rate < Interest rate Costs of inflation (italicized are also costs of deflation) o Shoe-leather costs: resources wasted when inflation encourages people to reduce their money holdings o Menu costs: costs of changing prices (deciding, printing, advertising) o Relative-price variability: misallocation of resources o Taxes: capital gains & interest income are over-taxed o Arbitrary redistribution of wealth o Confusion/inconvenience

Lecture 17: Aggregate Supply & Demand (Slide #5?) - In the short-run  follow micro supply and demand o Y-axis: price level (CPI)  As price level decreases  demand increases o X-axis: quantity of output (real GDP) - Demand curve slopes downward - Micro vs. Macro o Micro: the substitution effect o Macro (AD)  Consumption: wealth effect  When the price level decreases, consumers are wealthier so they consume more  Investment: interest rate effect  When price level decreases, households need less money and save more, this drives down interest rates and increases investment  Net exports: exchange-rate effect  When price level in US goes down, interest rates do too  Demand for US dollar and assets falls  US dollar goes down in value vs other currencies  Foreign goods become relatively more expensive compared to US goods  So… as currency falls, net exports increase b/c imports decrease and exports increase - A cut in personal income tax increases households take-home pay - When the Fed increases the money supply  the interest rate is lowered  there is an increase in AD (investment spending?) GO UP o Take more money out b/c they can pay less - When the Fed decreases the money supply  the interest rate is higher  there is a decrease in AD (investment spending?) - AS curve slopes upwards in the short-run o As price level increase  supply increases o Why?  Sticky wage theory: wages do not change at a high frequency  Sticky price theory: prices do not change at a high frequency  Do not want to incur menu costs  Misperceptions theory: firms mistake price level changes as their price changing relative to other firms - The long run AS curve is vertical o AS curve = total quantity of goods that firms produce at any given price level o An economy’s real GDP depends on its supplies of labor, capital, natural resources and technology to turn real goods into services

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 Not affected by price level  vertical line o Long-run level of production = natural rate of output  Always move back to the natural rate of output Phillips curve: short-run trade-off b/w inflation & unemployment (Know this graph!!) o High inflation  low unemployment o Low inflation  high unemployment o In the short run:  An increase in AD   higher output so lower unemployment   higher price level so higher inflation  A decrease in AD   lower output so higher unemployment   lower price level so lower inflation o In the long run: (AS curve is vertical)  An increase in AD   a higher price level so higher inflation  Output and unemployment remain at their natural rates  A decrease in AD   a lower price level so lower inflation  Output and unemployment remain at their natural rates  Low inflation & low unemployment are possible in the long run o Shifts in the Phillips curve  Inflation & unemployment can move in the same direction if AS changes  In short run?  AS increases  Lower inflation, higher output and higher employment o Caused by (1) increase in immigration (2) discovery of new natural resources (3) more educated workers (4) technological innovation

Lecture 18: Trade - Trade makes everyone better off o Open-economy interacts freely with other companies and allows trade (closed economies do not) o Allows companies to specialize in what they produce best  Consumers get a better price and larger variety of goods o Deciding on trade  Create a production possibilities frontier  produce where utility is at max (indifference curve touching)  Trading allows producers to end up at points above their production possibilities frontier  Absolute advantage: the ability to produce a good using fewer inputs than another producer  Time (labor), money spent on inputs  Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer (determines trade)  One person cannot have both comparative and absolute advantage in production of 2 or more goods because then what is the point of trading?  For both parties to gain from trade, the exchange rate (price) must lie between their opportunity costs o Gains come from specialization, trade comes from comparative advantage  When each person specializes in producing the good for which they have comparative advantage for, total production in the economy rises o Allows for an (1) increase in total production, (2) increase in consumption, (3) increased variety of goods, (4) lower costs through economies of scale, (5) increased competition from foreign producers, (6) enhanced flow of ideas/technology, (7) strengthens political ties - Export: world price > price w/o trade o Because cheaper so more profit? - Import: world price < price w/o trade - When a country exports the price in the domestic market = world price (which is above) o Domestic consumer surplus decreases b/c they pay a higher price and there are less consumers (some drop out of the market due to the price)  Area above price and below the demand curve o Domestic producer surplus increases b/c producers are selling for a higher price and a larger quantity is sold  Comes from domestic sales and exports  Area below price and above the supply curve o Total surplus increases b/c producer surplus increases by a larger amount than consumer surplus decreases by

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When a country imports the price in the domestic market = world price (which is below) o Domestic consumer surplus increases o Domestic producer surplus decreases o Total surplus increases b/c consumer surplus increases by a larger amount than producer surplus decreases by Arguments for restricting trade: (1) protecting domestic jobs, (2) national security, (3) protecting infant industries, (4) preventing unfair competition, (5) threat of trade restrictions as a bargaining chip with trading partners Tariff: restricted trade o Tax on goods produced abroad and sold domestically o #1 - When importing  Domestic consumer surplus increases  Domestic producer surplus decreases  Total surplus increases o #2 - With a tariff  world price rises  Domestic consumer surplus decreases  Domestic producer surplus increases  Loss in total surplus  Government revenue from tariff  Deadweight loss b/c kind of tax Net exports (trade balance) = exports – imports o Trade surplus: exports > imports o Trade deficit: imports > exports o Net exports increase when imports decrease and exports increase o Net exports decrease when imports increase and exports decrease Exchange rates o Nominal exchange rate: the rate at which a person can trade the currency of one country for the currency of another o Real exchange rate: the rate at which a person can trade the goods/services of one country for the goods/services of another o Measured by the amount of foreign currency that can be bought (nominal)  Appreciation: increase in value of a currency  Depreciation: decrease in value of a currency o Purchasing power parity (PPP)  Law of one price: goods should sell for the same price in all locations  Real exchange rate should be 1:1  Arbitrage: taking advantage of the mispricing of exchange rates  Can be done until exchange rate is 1:1 o Adjusts to this ...