International Trade and Macroeconomics

Posted on Dec 3, 2024 in Economy

Item 10 International Trade (Chapter 13)

1. Comparative Advantage and International Trade

Imports are goods and services purchased from other countries.

Exports are goods and services sold to other countries.

A country has comparative advantage in producing a good if the opportunity cost of that country to produce those goods is less than the cost of other countries.

When countries specialize in producing those goods in which they have comparative advantage and exchange them for other goods, will increase the global production of all goods.

Specialization and trade gains from trade arise.

Determinants of comparative advantage

International trade occurs because countries have comparative advantage in producing a bien.Estas comparative advantages arise from three main reasons:

• Differences in climate in general, climatic differences are a major reason for international trade. Part of the trade is due to the difference in seasons between the northern and southern hemispheres.
• Differences in factor endowments to the combination of productive factors that are available to countries is different, and these combinations are an important source of relative comparative advantage.

The Heckscher-Ohlin model shows the relationship between comparative advantage and the availability of a productive factor.

A key concept in the model is the intensity of use of a productive factor.

The intensity of use of a production factor measures how productive factor is used in greater proportion in relation to other factors of production. Producers use different% of inputs in the production of different goods.

According to the Heckscher-Ohlin model, a country will have comparative advantage in producing a good when used intensively to produce factors that are abundant in this economy, ie, factors that abound in that country.

Explanation: the opportunity cost of a given productive factor is low in those countries where this factor is abundant. Therefore, it is also small, the opportunity cost of producing goods in which an abundant factor used intensively.

The fact that much of international trade due to differences in endowments of productive factors helps explain another phenomenon: the international specialization of production is oftenincomplete. That is, a country often kept some own production of goods it imports.

• Differences in technology cause of the technological differences are not clear. Sometimes it seems they are based on knowledge acquired from experience in other, are the result of a series of technological innovations taking place in one country but not in others. Often comparative advantage due to this factor is transient. However, the short term, the technology gap is the main cause of comparative advantage.

2. Supply, demand and international trade

Simple models of comparative advantage are useful for understanding the root causes of international trade. But to analyze the effects of international trade in more detail and to understand the protectionist policies, it is useful to use the model of supply and demand.

The effects of imports

In the absence of trade, the domestic price is P _A, which is the price at which the curve of the domestic supply and domestic demand curve intersect. The quantity produced and consumed in the economy is Q _A.

The domestic demand curve shows that way depends on the price of the property the amount demanded by the inhabitants of a country property.

When we introduce international trade need to distinguish between purchases of goods made by consumers of home and buying it rather than do consumers in other countries.

The domestic supply curve shows that way depends on the price of those goods the quantity supplied by producers in a country of a well.

When we introduce international trade need to distinguish between the supply of domestic producers and international supply, ie the offer that comes from outside.

It defines the situation of autarky as one in which a country does not trade with the outside.

In situation of autarky, the market equilibrium would be determined by the intersection of supply and demand curves National (A).

If the market opens on imports, a price is set internationally.

The international price of goods is the price at which you can buy that property abroad.

If the international price is lower than its domestic price, importers find it profitable to buy abroad and sell in their own country.

The imported product that increases the supply of product on the market, driving down prices in that market.

It will continue to import until the domestic price to fall and equals the international price.

As imports brought down the domestic price of the product, the consumer surplus increases, while the surplus of producers decreases.

Consumers gain a surplus equal to area X + Z. Producers lose surplus equal to area X. Therefore, total surplus increases in the area Z.

Thanks to international trade consumers gain and producers lose, but consumers gain is greater than the loss of producers.

This result is consistent with the notion that there are gains from international trade.

The fact that international trade gives rise, in general, winners and losers is crucial to understand the barriers to trade.

The effects of exports

The international price P _I which can be sold abroad, is higher than the price that would prevail in the domestic market in autarky P _A.

The largest international price makes it profitable for exporters to buy at home and sell abroad. Purchases of the product at home cause the domestic price rises to match the international price. Consequently, the domestic consumer demand decreases and supply increases the domestic producers.

Like imports, exports lead to an increase in the total surplus of exporting countries, but also create winners and losers.

Consumer surplus in the absence of trade is the sum of the areas W and X, while the producer is the Y. As a result of trade, consumer surplus decreases to W and the producer increases to X + Y + Z.

Therefore, the surplus of the economy as a whole, increases in the number Z:

International trade and factor markets

The effects of international trade on consumers and producers in a particular industry is a good approach to many issues but it is not adequate to understand the effects of international trade on income distribution in the long run, since factors moving production of some industries.

Sometimes what is important to analyze is how trade affects thefactor prices.

The Heckscher-Ohlin model suggests how international trade affects the prices of production factors in one country compared to the situation of autarky, international trade tends to increase prices in the country’s abundant factors and reducing the prices of scarce factors.

We assume that in a country industries are of two types: export industries that produce goods and services sold abroad and industries that compete with imports, domestically produced goods and services are also imported. Compared to the situation of autarky, international trade leads to increased production of export industries and a decline in production in industries that compete with imports. Indirectly, the demand of productive factors used by the companies and reduces the demand for inputs used by industries that compete with imports. In addition, the Heckscher-Ohlin model suggests that a country tends to export those goods that are intensive in their abundant production factors and to import those goods that are intensive in scarce factors.

Therefore, international trade tends to increase demand for productive factors that are abundant in the country discussed in comparison with other countries. Consequently, the abundant factor price increases and the prices of scarce factors tend to decrease.

3. The effects of trade barriers

In an economy is free trade when the State did not try either reduce or increase the quantities of exports and imports which occur spontaneously as a result of supply and demand.

Despite the argument of economists favor free trade, many states use taxes and other restrictions to limit imports. Less frequently subsidies for export promotion.

Policies that limit imports, usually with the objective of protecting international competition domestic producers in industries that compete with imports, known as protectionist policies and trade barriers.
The most common are tariffs and quotas or import quotas.

The effects of a tariff

A tariff is a type of indirect taxes on imports.

A tariff increases both the price received by domestic producers as the price paid by domestic consumers.

A tariff, therefore, increases the domestic price, and in comparison with the situation in which there is free trade, increased domestic production and domestic consumption decreases.

As for the surplus, the effects produced are threefold. First, because the domestic price is higher, increases the producer surplus (area A). Secondly, since the domestic price is higher, consumer surplus decreases (- (A + B + C + D)). Finally, the tariff provides revenue for the state (area C). In short, producers gain, consumers lose and the state wins, with the loss of consumers greater than the sum of the profits of producers and State.

There is a deadweight loss to society as a whole, which is equal to the loss in total surplus (area B + D). Fees create inefficiencies due to two causes: first, certain exchanges are beneficial to both parties performed (area D), and second, inefficient production implies that economic resources are wasted (area B).

The effects of an import quota

The import share is defined as the maximum amount of goods that can be imported legally.

The quotas on imports, in general, are managed by a license or permit: No way are issued permits, and each permit allows its owner the annual import of a given quantity of a commodity.

In this case, unlike tariffs, the revenue it generates are for license holders, not the state.

4. The political economy of trade barriers

Arguments for trade barriers

The defenders of tariffs and quotas on imports used several arguments. The most common are national security, employment creation and protection of infant industries.

The national security argument is based on the risk that international disputes before the external supply of goods may be disrupted, and consequently, a country should protect the production of strategic goods in order to be self sufficient in such items.

The argument job creation points to the new jobs created in industries that compete with imports due to trade barriers. Economists suggest that these positions are offset by jobs lost in other sectors.

The argument for infant industry protection, often used in newly industrializing countries, maintains that new industries need trade barriers over a period of time to consolidate.

The policy of trade barriers

In fact, many trade barriers have little to do with the above arguments, if not that they reflect the political influence of producers of goods that compete with imports.

Thus, the existence of trade barriers is common because the groups representing industries competing with imports are smaller, are more united, and therefore are more influential than consumer groups.

International Trade Agreements and World Trade Organization

When a country trade barriers harm applies to two groups: domestic consumers and export industries abroad. This means that countries interested in the protectionist policies implemented by other countries.

So sign international trade agreements, treaties that a country pledges to reduce their barriers to exports from other countries (less protectionist policies), obtaining in exchange the promise that other countries do the same with the country’s exports . Currently, the majority of world trade is governed by such agreements.

There are global agreements, involving almost all countries, supervised by the World Trade Organization (WTO), which plays two roles: it provides the framework for complex negotiations taking place to create a large international trade agreement On the other hand, arbitrates disputes between member countries.

Item 11 Macroeconomics: an overview (Ch. 14)

1. Microeconomics and Macroeconomics

Microeconomics focuses on studying how individuals make decisions and analyze business and the consequences of those decisions.

However Macroeconomics examines the aggregate behavior of the economy, ie how the actions of all individuals and firms interact to produce a particular level of economic performance for the entire economy.

Macroeconomic questions can not answer, “adding” micro-economic responses.

We analyze the three main points on the macroeconomy differs from microeconomics.

Macroeconomics: the total is more than the sum of the parts

A very important aspect that differentiates the macroeconomics of microeconomics is that all individual actions combine to produce a result that is greater than the sum of individual actions.

Eg “paradox of thrift.”

An important aspect in macroeconomics in the short term (several years, but usually <10 years), the combined effect of individual actions can produce very different consequences for each of the individual decision makers, often provided these consequences are bad.

Macroeconomic Policies

Economists believe that, contrary to what occurs in microeconomics, macroeconomics governments should play a more active role, especially to address short-term fluctuations and adverse events occurring in the economy.

This widely held view that the government must intervene at the macroeconomic level comes from the Great Depression of 1930, event in world economic history. In this context, we developed the toolkit of modern macroeconomics: fiscal policy (control of public spending and taxes) and monetary policy (control of interest rates and the amount of money in circulation), both now days are used to manage the macroeconomic performance.

Economic aggregates

A distinctive feature of modern macroeconomics is that both in theory and in policy implementation, focusing on economic aggregates, which are economic indicators that add data from different markets for goods, services, jobs and assets (real that serve as “reserve” value, eg: Cash). Using aggregate nature, we will study the economic cycle and how fiscal and monetary policy can be used to properly manage the business cycle.

2. The economic cycle

The succession in the short term, falls and booms in the economy known as the economic cycle.

A depression is a decline in economic activity (fall) very deep and long.

Recessions are periods of low activity (less protracted declines) in production employment decline.

The expansions or recoveries are periods of increased economic activity in the rising production and employment.

To know what occurs during an economic cycle and find ways to control it, we should concentrate on three issues: the effects of recessions and expansions on unemployment, its effect on aggregate output and the potential role of economic policies.

Employment and unemployment

Like depression, the recession leads to a rise in unemployment, lower production, lower incomes and lower living standards.

To understand unemployment and its relation to the negative consequences of a recession, we must understand how to structure the workforce.

Employment is the total number of people working at any given time.

Unemployment is the total number of people actively seeking employment but at a given moment can not find work.

The working population of a country is the sum of employment and unemployment.

The active population “official” does not include those who are of working age but not actively seeking employment (discouraged workers).

The statistics do not collect data on underemployment, which is that people make during a recession, which charged lower wages due to production cuts, reductions in working time, lower paying jobs or all at once.

The unemployment rate is the number of unemployed for the workforce as a percentage.

Unemployment rate =

The unemployment rate is a good indicator of the conditions of work. If high, indicates that the market is very active and difficult to find employment. If low, indicating a very active market in which it is easy to find employment.

In general, during recessions, unemployment rises and low during expansions.

The aggregate production

During the economic cycle, the unemployment rate and output move in opposite directions.

The aggregate production is the total of final goods and services produced in an economy in a given period, which generally is the year.

Excluded goods and services produced for use in the production of other goods and services (intermediate goods).

Gross Domestic Product (GDP) is the quantity which is most often used to measure the aggregate output.

Aggregate output falls during recessions and increases during expansions.

Control the economic cycle

The economic measures that are established with the aim of reducing the severity of recessions or to curb excessively strong expansion called stabilization policies.

They are based on two main instruments:

– Monetary policy to try to stabilize the economy by changing the amount of money in circulation, interest rates or both.

– Fiscal policy aims at stabilizing the economy through tax changes, changes in public spending, or both.

These policies fail to completely eliminate fluctuations, ie at the end of the economic cycle softens, but does not disappear.

3. Inflation and deflation

In macroeconomics, it is important the difference between nominal and real.

A nominal scale is a quantity which is uncorrected for the changes that have seen prices over time.

A real magnitude is a magnitude that it has been adjusted for price changes.

Normally, one speaks of wages in real terms because real wages is a more accurate indicator of real change in the purchasing power of employees: it expresses the extent wages have grown faster than the growth of prices of goods and services purchased with those wages.

The aggregate price level is the general level of prices of final goods and services in an economy, that is, the price level of aggregate output.

When this level rises, we say that there is inflation in the economy.

When this low level, we say that there is deflation in the economy.

Two quantities are used to measure the aggregate price level: GDP deflator and the consumer price index or CPI.

Unlike the growing trend in aggregate output, which is a positive feature, the regular increase in prices is not necessarily a feature of an efficient economy, nor positive.

Inflation and deflation can cause problems in the economy, but less noticeable than those caused by depression.

The desirable objective is to achieve price stability, a situation in which the general price level changes very slowly.

The annual change in the general price level, expressed in%, is called the rate of inflation (% negative is a case of deflation).

Unit 12 Assess macroeconomics (Chapter 15)

• National accounts

National accounts estimates the existing cash flows (private consumption, public spending, sales of the producers, the formation of fixed capital investment and other) among the different economic sectors.

The circular flow diagram, revised and expanded

The basic principle is that incoming cash flows of each market or sector are equal to outflows that market or sector.

In the markets for goods and services, households (families) make private consumption, ie buying goods and services to domestic enterprises and the rest of the world (imported goods). Households also own production factors (labor, land , physical capital and financial capital.) sell homes using these factors to enterprises and in return receive wages, dividends, interest payments and leases. For most households, wages accounted for the bulk of their income, but also receive additional revenue because, indirectly, are the owners of physical capital used by businesses in the form of:

• or shares in the company capital.
• Obligations or bonds, representing debt, ie loans granted to companies whose pay is the interest it generates.

Finally, households receive income from the fact that yield to firms (through leasing) use of their land or their property.

In short, households receive income in the form of wages, dividends, interest and leasing through market factors.

Goods and services do not absorb all the income of households by two reasons:

• have to relinquish part of rent to the state through taxes.
• devote a private savings, which is usually directed toward the financial markets, where individuals and financial institutions buy and sell stocks and bonds and borrow money.

On the other hand, some households receive transfers (or subsidies) which are payments made by the State to individuals without the state received in return or any goods or services.

The household disposable income to spend on consumption or savings income will be available to households after paying taxes and transfers received.

Financial markets are markets banking, stocks and bonds, that channel private savings and the funds raised abroad to investment spending, public debt and borrowing abroad.

The state returns to households in the form of transfers of the money it collects in taxes. But most of the collection, along with government bonds (sum of money the state borrows in financial markets), uses it to purchase goods and services.

Public spending on goods and services is the total purchases made by government.

The rest of the world participates in the economy of a country in three ways:

• Exports: goods and services sold to other countries.
• Imports: goods and services purchased from other countries
• Transactions with other countries in financial markets: loans from abroad and selling shares or borrowing abroad and buying shares.

The national accounting takes into account the investment spending, which is the sum devoted to the purchase of productive physical capital, ie machinery, construction of buildings or changes in inventory stocks.

Gross domestic product

The final goods and services are goods and services sold to the end user of that good or service.

The intermediate goods and services that a company buys another, are used for the production of final goods and services.

Gross domestic product or GDP is the total value of all final goods and services produced by an economy over a specific period, usually the year.

Aggregate spending is total spending on final goods and services produced in the internal market of the country, and is equal to the sum of private consumption, investment spending, government spending on goods and services, and the difference between exports and imports .

Calculate GDP

There are three methods for calculating GDP:

> Calculate GDP as the value of production of final goods and services

It consists of adding the value of all final goods and services produced in the economy, a calculation that excludes the value of the goods and intermediate goods.

No intermediate products are considered, because otherwise we would be counting two or more times the same product. To avoid this, use the value added, which is the difference between the value of sales of a producer and the value of what it buys from other producers.

>

Calculate GDP as spending on final goods and services produced in the internal market

It would get the sum of the aggregate expenditure on goods and services produced in the domestic market.

Also with this method must avoid counting the same good two or more times, which got by counting only the value of sales to final consumers, ie households, companies when they purchase capital goods, the State and foreign buyers. Excludes sales of materials and supplies for production that few other companies make.

Thus, the calculation of GDP can be represented as follows:

GDP = C + I + G + X – IM

where C = private consumption

I = sales of investment goods to other companies

G = government spending on goods and services

X = exports

IM = imports

>

Calculate GDP as factor income paid by businesses in the economy

The last way to calculate GDP is by adding all income paid by the companies of the economy to factors of production, ie, wages paid for the work received, interest paid to those who lent their savings to businesses and the State, leases paid to those who paid their land or their property to companies and dividends paid to shareholders, who own the physical capital of the company.

Net exports are the difference between the value of exports and the value of imports.

The GDP is mainly used to measure the size of an economy and provides a scale with which to compare the behavior of an economy year after year or with which to compare the performance of a country in another country.

Be careful with comparisons over time and that over the years, the increase of the value of GDP comes from increases in prices of goods and services rather than increases in production. To measure actual changes in aggregate output is a modified version of GDP adjusted for price changes is called real GDP.

2. Real GDP and aggregate output

For real GDP is to calculate which part of the variation in GDP due to a change in aggregate production and how to price changes.

Calculate the real GDP

Real GDP is the total value of final goods and services produced in the economy for a year, calculated as if prices had not changed with respect to a given year is called base.

Nominal GDP is the total value of final goods and services produced in the economy for a year, calculated using prices of the year when output is generated.

A technical detail: the dollars ‘chained’

The economists who designed the national accounts have adopted a method for calculating real GDP called “Chain – linking” (linking) that splits the difference between using as a basis for calculating a few years or more.

Do not measure real GDP

The GDP is a quantity that measures the aggregate output of a country. If all other variables are equal, a country with more population will have a higher GDP simply because there are more people who work and consume. Thus, to compare the GDP of several countries but we want to eliminate the effect caused by the size of the population, we use the GDP per capita (GDP divided by the number of inhabitants), which equals the average GDP per person.

The real per capita GDP is a measure of average per capita aggregate output of an economy, ie what is possible. It is not a sufficient magnitude to measure the welfare of a population, or is itself a proper goal of economic policy, because it takes into account how a country uses this production to improve living standards, and does not reflect other important issues involved in the standard of living. A country with a high GDP can afford a good health, good education and, in general, a good standard of living. But a high GDP does not automatically or necessarily a high standard of living.

3. The unemployment rate

Understanding unemployment

The unemployment rate tells us how easy or difficult it is to find a job in the current economic times.

When low, almost all job seekers find it. When high, it is difficult to find employment.

Not to be taken literally, and to some extent may overstate the difficulty they may experience some people in your job search or on the contrary, underestimate.

It is important to note that the unemployment rate varies significantly from one population group to another.

Thus, the unemployment rate should be interpreted as an indicator of the labor market, not as a literal measure the% of people can not find work.

There is a close relationship between the unemployment rate and the rate of real GDP growth.

Growth and unemployment

In general, there is an inverse relationship between economic growth and unemployment.

When growth is above average, the unemployment rate falls. When growth is below average, the unemployment rate grows.

This relationship helps us understand why recessions (periods of low real GDP) are difficult, for cause unemployment and therefore problems for many families.

4. The price indices and aggregate price level

Both inflation and deflation can cause problems in an economy. Therefore we must have some indexes to help us quantify the changes that occur in the general price level of an economy over time.

The aggregate price level appears to be a good measure of general price level of final goods and services.

In an economy where you produce many different goods and services, we will use a price indexto represent them.

The shopping baskets and price indices

To measure the average changes in prices of consumer goods and services is estimated that an average consumer would spend on your shopping cart, that is, a typical set of goods and services purchased before prices increase.

A hypothetical basket, which is used to measure changes in the general price level, is the name, shopping cart.

It uses the same method to measure changes in the general price level, ie it quantifies the variations in the cost of purchasing a representative basket.

Simplification also do not have to track the cost of the basket in a given year: normalizes the measure of aggregate price level to be equal to 100 in a given base year.

A price index measures the cost of purchasing a representative basket in a given year, in which the cost has been normalized (= 100) for the year was chosen as the base year.

The price indices are also used to measure inflation.

The inflation rate is the percentage change in price index in a given year, usually the consumer price index.

The inflation rate between year 1 and year 2 is calculated as follows:

The consumer price index

The price index that is used most often in the consumer price index.

The consumer price index (CPI) estimates the cost of the basket of a typical urban family and tries to reflect how the cost of purchases varies with time.

The calculation is done through surveys, estimating the market prices of a basket of the consumption of a typical family of 4 living in a typical city.

The main component of the basket is housing, which includes all costs of owning or renting a home, heating and electricity incluidas.Después, spending on transportation and food.

In poor countries the composition varies, being the heaviest component of food.

Other price indicators

Two other price indices that are frequently used to measure price changes in the overall economy.

à Producer Price Index (PPI): quantifies the changes in the prices of goods and services purchased by producers.

Because the producers of raw materials prices rise relatively quickly when they perceive a change in the overall demand for their goods, the PPI response to inflationary or deflationary pressures more rapidly than the CPI and, consequently, the PPI is usually considered one of the first signs of changes in the rate of inflation.

à GDP deflator: for a given year is 100 times the ratio of nominal GDP relative to real GDP for that year calculated in the prices of a given base year.

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Item 13 The supply and demand (Ch. 16)

1. Aggregate supply

The relationship between the fall of real GDP and the price drop is not the result of chance. The economy runs along the aggregate supply curve, which shows the relationship between aggregate price level (overall level of prices of final goods and services in the economy) and aggregate production, which is the amount total final goods and services that producers are willing to offer.

The aggregate supply curve of short-term

There is a short term relationship between the aggregate price level of aggregate output, ie that an increase in aggregate price level causes an increase in aggregate output (if the other variables constant), and vice versa.

To understand this relationship is to consider the question arises as a producer: Is it profitable to produce one unit of a good? Depend on whether the price the producer receives for each unit produced is less or greater than cost of production of that unit.

There comes a time when many of the costs that producers have to bear the costs are fixed and can not be changed in a period of time. One of the main causes of this rigidity are the wages paid to workers, called nominal wages, and are set by contracts signed before or informally agreed. Not tend to decrease during periods of recession or increase in periods of economic boom.

But if these periods are lengthened much, nominal wages do not remain rigid, but will vary depending on economic circumstances, what distinguishes the short term.

The aggregate supply curve in the short term shows the direct relationship between the aggregate price level and aggregate output in the short term, which is the time period in which much of the production costs can be considered fixed cost .

When the general price level falls, aggregate output falls short term. Since many of the production costs are fixed costs in the short term, the unit production cost falls into the same proportion as the fall in unit price. Thus, the unit profit and short-term decreases the producer reduces production.

When the general price level increases, the aggregate production increases in the short term. Since many of the production costs are fixed costs in the short term, the unit cost of production does not increase in proportion to the increase in unit price. Therefore, the benefit amounts and short-term unit the producer increases production.

The curve of the short-run aggregate supply is upward sloping.

The downward movement in the aggregate supply curve corresponds to short-term deflation and falling aggregate output.

Shifts in aggregate supply curve in the short term

SARS Aggregate short run supply curve

A leftward shift of the aggregate supply curve in the short term indicates a decrease in aggregate supply in the short term. The aggregate supply decreases as producers reduce aggregate output are willing to bid for any given price level.

A rightward shift of the aggregate supply curve in the short term indicates an increase in aggregate supply in the short term. The aggregate supply increases when the producers raise the amount of aggregate production are willing to bid for any given price level.

Farmers make production decisions based on the unit production profit they want to achieve. The aggregate supply curve in the short term shows the relationship between the aggregate price level and aggregate output: because some production costs are fixed in the short term, a change in the aggregate price level affects the profit per unit product and therefore causes a variation in aggregate output. In addition to the aggregate price level, other factors that may influence the profit per unit and, therefore, changes agregadazo production of these other factors that cause shifts in the aggregate supply curve in the short term.

The main factors that can influence unit profit (causing shifts in the aggregate supply curve in the short term) are:

• Changes in raw material prices

The aggregate supply curve does not incorporate the influence of raw material prices because they are not a final good, so are not included in calculating the aggregate price level.

Raw materials represent a major production cost, so that changes in raw material prices have a strong impact on production costs.

They can undergo large changes in price due to supply shocks.

• Variations of nominal wage

Although they tend to remain constant, nominal wages may vary when contracts expire or informal agreements are renegotiated.

An increase in nominal wages is an increase in production costs and shift the aggregate supply curve in the short term to the left. A decline would cause a shift to the left.

• Productivity changes

Increased productivity means that workers can produce more units with the same amount of inputs.

Increased productivity increases profits for producers and shifts the aggregate supply in the short term to the right.

Lower productivity, increases the unit cost of production, and both the benefits and decrease supply, causing a leftward shift of the aggregate supply curve in the short term.

The aggregate supply curve long term

Unlike the short term, long term both nominal wages and the aggregate price level are elastic. This significantly alters the relationship between the aggregate price level and aggregate supply in the long term.

In the long term, ie, when all prices are completely elastic, inflation and deflation have the same effect that if you change all prices in the same proportion. As a result, variations in aggregate price level does not affect aggregate output that long-term supply. This is possible because the level of aggregate long-term prices will be accompanied by proportional changes in the prices of factors of production, including wages.

The aggregate supply curve shows the long-term relationship between aggregate price level and aggregate output is ofertaría if all prices, including nominal wages were completely elastic. It is vertical because the aggregate price level does not affect the long-run aggregate production.

The point of intersection between the x-axis and the aggregate supply curve represents long-term potential output, ie, the level of real GDP would be achieved if all prices, including wages, were completely elastic.

However, in the real world GDP is almost always either above or below potential output

From short to long term

The economy is almost always in the aggregate supply curve in the short term (this production has a lower or higher than potential output) and not in the aggregate supply curve over time.

The economy is always in one of two possible states with respect to the curve of the short-run aggregate supply and aggregate supply curve over time. Either you are in both curves at the same time (graphically corresponds to the intersection of two curves), or is only in the aggregate supply curve in the short term.

If the economy is only in the aggregate supply curve the short term, this curve will move up to the point where the curve matches the long term, ie until the point where aggregate output matches with potential.

It is only possible to aggregate output exceeds potential output when nominal wages are not adjusted to the upward trend. Until we readjust the producers have great benefits and reach high levels of production. In these circumstances, the unemployment rate is low and workers are scarce, so that nominal wages will increase over time, gradually shifting to the left the aggregate supply curve in the short term.

It is only possible to aggregate output is below potential output when nominal wages are not adjusted downward. Until they are adjusted, the producers have low profits and low levels of production. In these circumstances, the unemployment rate is high and workers abound, so that nominal wages will decline over time, gradually shifting to the right the aggregate supply curve in the short term.

2. Aggregate demand

The aggregate demand curve shows the relationship between aggregate price level and quantity of aggregate output demanded by households, businesses, government and the rest of the world.

The aggregate demand curve is downward sloping, ie the relationship between the aggregate price level and aggregate production quantity demanded is inverse. If all other variables constant, an increase in the aggregate price level reduces the quantity demanded and vice versa, a decrease in the aggregate price level increases the quantity demanded.

Why is the slope of the aggregate demand curve is negative?

The equation for calculating national income was:

GDP = C + I + G + X – IM

If we measure these variables at constant currencies, is desirven base year prices, then C + I + G + X – IM is the amount of final goods and services produced within the economy that are demanded in a given period.

G depends on the state, but the rest are private-sector decisions.

Why an increase in the aggregate price level leads to a decrease of final goods and services demanded by households? There are two main reasons for this:

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The wealth effect of a change in aggregate prices is the effect that a change in the aggregate price level has on the purchasing power of consumer assets. Thus, consumption (C) decreases as the aggregate price level increases, causing the aggregate demand curve has a negative slope.

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The interest rate effect of a change in aggregate prices is the effect on consumption and investment, a variation of the aggregate price level which modifies the purchasing power of consumers and businesses money.

An increase in the aggregate price level reduces the purchasing power for a given amount of money, so for the same basket, people need a greater amount of money. In response, people trying to increase their amount of money through greater borrowing or by selling other assets such as bonds, reducing the funds available to lend to other borrowers, causing a rise in interest rates.

An increase in interest rates, reducing investment and raising the cost of borrowing. It also reduces consumption, since households save a larger share of income at their disposal. Therefore, an increase in the price level depresses aggregate investment (I) and consumption (C), through its effect on the purchasing power of money. This causes the aggregate demand curve has negative slope.

Note: The rate of interest is the price, calculated as a% of the amount borrowed, the lender charges the borrower for the use he makes of his savings during the period of one year.

The displacement of the aggregate demand curve

Aggregate Demand AD à

An increase in aggregate demand at any aggregate price level, a shift of the aggregate demand curve to the right.

A decrease in aggregate demand at any aggregate price level, causing a shift in aggregate demand curve to the left.

The factors that cause shifts in the aggregate demand curve are:

• Changes in expectations

Both consumption and investment depend to some extent on the future expectations with consumers. They base their spending not only on current income but also in the future. Firms base their investment not only in current conditions, but also in sales expected in the future.

If you are optimistic, spending increases, if pessimistic, spending decreases.

• Variations in wealth

The consumption depends to some extent the value of assets held by households.

When the real value of these assets increases, purchasing power, causing an increase in aggregate demand.

When the value of household assets decreases, the reduced purchasing power and aggregate demand with it.

• Variations in the amount of physical capital

Part of the cost of investment firms is to increase its physical capital. Spending incentives depend to some extent already have much physical capital, if all other variables constant, the higher the physical capital stock less the additional investment

Macroeconomic policies and demand

State intervention can change aggregate demand and thus influence the improvement of the economy when circumstances require. Fiscal policy and monetary policy are the two main tools that the State has to influence aggregate demand.

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Fiscal policy

Is the use of taxes and government spending to stabilize the economy. Generally, states respond to recessions by increasing public spending, a cut in tax rates or both at once. Often facing inflation measures the opposite direction: decreasing public spending and increase tax rates.

An increase in government expenditure (G), which is a component of aggregate demand, shifts the aggregate demand curve to the right, while a decrease in the shift to the left.

The changes in tax rates affect the economy indirectly through its effect on disposable income.

A low rate allowing consumers to keep more of what they earn, thereby increasing disposable income. This in turn increases consumption and shifts the demand curve to the right.

An increase in the tax rate, reduces the disposable income of consumers and in turn consumption, causing a shift of the aggregate demand curve to the left.

? Monetary policy

Monetary policy uses the changes in the volume of money or interest rates to stabilize the economy.

When you increase the amount of money in circulation (because it puts the government through the Central Bank), people handle a larger amount of money and are willing to pay more. This makes the interest rates for any price level decrease and increase investment and consumption. Therefore, the increased volume of money shifts the aggregate demand curve to the right.

A reduction in the amount of money has the opposite effect: people have less money than available before, borrow more and pay less. This raises interest rates, reduced corporate investment and consumption, shifting the aggregate demand curve to the left.

3. The multiplier

The multiplier we use to determine the magnitude of the rightward shift of the aggregate demand curve.

Assuming a constant aggregate price level and a fixed interest rate, you tend to think that the shift taking place is the same as the investment was made. This would be true if the process would stop at this point, but not, if that increased investment leads to increased production, thereby increasing disposable income in households, and therefore consumption, which induces firms to increase production again and so on. We can say that there are multiple sequences increases in aggregate output.

If you add it all up, what is the magnitude of the total effect on aggregate output? To answer, we introduce the concept of marginal propensity to consume (MPC), which is the increase of consumption as disposable income increases by one unit of currency.

When consumption varies due to an increase or a decrease in disposable income, PMC is also defined as the change in consumption divided by the change in disposable income.

The additional disposable income that consumers do not spend is devoted to saving.

The marginal propensity to save (WFP)
is the fraction of the monetary unit of additional disposable income devoted to saving, ie 1-PMC.

The displacement of the aggregate demand curve may be due to autonomous changes in any component of aggregate expenditure.

An autonomous change in aggregate spending is an initial change in the level of desired spending by businesses, households and government to a GDP basis.

The multiplier is the ratio of real GDP growth, self-induced change in expenditure, and the autonomous change in expenditure. In the event that no trade or taxes that represents the equation would be:

Where ?GAA an autonomous change in aggregate spending and ?Y the change in real GDP.

The multiplier depends on the marginal propensity to consume (MPC), so that the larger PMC, the greater the leverage and less disposable income “will be lost” in each sequence of expansion.

4. The model of aggregate supply-aggregate demand

The model of aggregate supply-aggregate demand analysis jointly studying economic fluctuations curves aggregate supply and demand.

Balancing short-term macroeconomic

The economy achieved macroeconomic balance in the short term (E _SR) where the aggregate production to supply equals the total quantity demanded by households, businesses, government and the rest of the world.

The short-run equilibrium aggregate price level is the aggregate price level at the point of short-term macroeconomic equilibrium.

The short-run equilibrium aggregate output is the amount of aggregate output at the point of short-term macroeconomic equilibrium.

If the aggregate price level is above its equilibrium level of aggregate supply exceeds aggregate demand, so that there is a decline in the aggregate price level which brings it closer to its equilibrium level.

If the aggregate price level is below its equilibrium level of aggregate supply is less than aggregate demand, so that there is an increase in the aggregate price level which brings it closer to its equilibrium level.

The short-run equilibrium aggregate output and the short-run equilibrium aggregate price level can be affected by shifts in aggregate supply curve in the short term and the aggregate demand curve.

Shifts in aggregate supply curve in the short term

A supply disruption is the imbalance caused by an event that shifts the aggregate supply curve in the short term. It may be a variation in commodity prices, nominal wages or productivity.

A negative supply shock raises production costs and reduces the amount of goods that producers are willing to bid at any aggregate price level, causing a leftward shift of the aggregate supply curve in the short term.

Stagflation is the combination of declining inflation and aggregate output, seen in panel (a). Stagflation is a complicated situation: an aggregate production leads to decreasing unemployment and at the same time the price increase reduces purchasing power workers.

A positive supply shock reduces production costs and increases the offer to any aggregate price level, causing a rightward shift of the aggregate supply curve in the short term.

The hallmark of supply shocks, both negative and positive, which makes the aggregate price level and aggregate output move in opposite directions.

Shifts in aggregate demand. Short-term effects

A demand shock is the event that shifts the aggregate demand in the short term, as it might be a change in expectations, wealth, physical capital stock or the result of fiscal and monetary policies.

A negative demand shock shifts to the left of the aggregate demand curve in the short term to the left. The economy moves down along the aggregate supply curve in the short term, and registers a movement that causes the production and the level of equilibrium prices are lower.

A positive demand shock shifts the demand curve to the right. There is an upward movement along the aggregate supply curve in the short term, raising the level of production and equilibrium prices.

In contrast to supply shocks, demand in aggregate output and aggregate price level move in the same direction.

Long-term macroeconomic equilibrium

We assume that enough time has passed so that the economy is also in the aggregate supply curve of long-term (LRAS). E _LR is the point of intersection of the three curves (SARS LRAS and AD), so that balance of aggregate output, Y _E is equal to potential output, and _P.

It says there are long-term macroeconomic equilibrium when the point of macroeconomic equilibrium in the short term lies in the aggregate supply curve over time.

There are demand shocks that make the economy ceases to be in long-run equilibrium.

Effects of a negative demand shock in the short and long term

If there is a sudden deterioration in the expectations of consumers and businesses, aggregate demand falls and the aggregate demand curve shifts to the left. As a result, decrease the aggregate price level of balance and equilibrium aggregate output, and the economy is projected to be in the short term. Aggregate output in this new short-run equilibrium is below potential output. When this happens the economy is facing arecession, which carries a high unemployment rate. Faced with high unemployment, in the end, nominal wages, the same way as other sticky prices tend to diminish and ultimately increases production. So a recession causes the aggregate supply curve in the short term moves gradually to the right. At the end of all this, the economy returns to be at the point of macroeconomic equilibrium, returns to achieve the same aggregate production, but with a lower aggregate price level, reflecting a fall in the aggregate price level in the long term. Eventually, the economy is able to be corrected, to regulate themselves, in the long term.

Effects of a positive demand shock in the short and long term

Suppose there is an increase in aggregate demand and aggregate demand curve shifts to the right. As a result, increase the aggregate price level and aggregate output balance, and the economy would be about short-run equilibrium. Aggregate output in this new short-run equilibrium is higher than potential output and unemployment is low in order to obtain this high level of aggregate output. When this happens, the economy faces an inflationary gap.
Faced with low unemployment, in the end, nominal wages, the same way as other sticky prices, rise. So an inflationary gap causes the aggregate supply curve in the short term to gradually left, as producers reduce production in response to higher nominal wages. At the end of all this, the economy returns to be at the point of long-term macroeconomic equilibrium, again reaches the same potential output or aggregate, but with a higher aggregate price level, reflecting an increase in the aggregate price level long term. Again, the economy has long-term self-regulated.

Therefore, demand shocks affect aggregate output in the short term but long term, since the economy is self-regulating.

5. Macroeconomic Policies

In the long run the economy is self-regulating, but this process can take several years. In particular, if aggregate output is below potential output the economy can go through a long period of low production and high unemployment added before returning to normal.

Thus, governments should not wait for the economy to self-regulate but should apply monetary and fiscal policies to bring the economy back to potential output following a shift in aggregate demand curve.

They are called stabilization policies.

Policies to cope with demand shocks

Faced with a negative demand shock, ie a fall in aggregate demand, if acted upon quickly monetary and fiscal policies can shift the curve back to your site. If policies could anticipate the movements of the aggregate demand curve, one could avoid the period of low production and falling prices. It is desirable that policies act in this sense for two reasons: to avoid high unemployment and achieve price stability, ie avoiding deflation.

This does not mean you should always act to counter a decline in aggregate demand, as some of the policies used to boost aggregate demand, can have long-term costs, such as the crowding-out effect on private investment.

Not clear which should offset the positive demand shocks, because although inflation is a bad thing in this situation reduces unemployment and increases production. Still, there are also counter the positive demand shocks.

Policies to deal with supply shocks

Unlike what happens with the aggregate demand curve, there are no simple policy shift the aggregate supply curve in the short term. Therefore, the response to a supply crisis can not simply be trying to shift back the supply curve to its original position.

The use of fiscal or monetary policies to shift the aggregate demand curve in response to disruption of supply is not adequate because two situations occur simultaneously negative (a decrease in aggregate output and an increase in aggregate price level) and make the aggregate demand curve move helps solve one of the two problems, but aggravating the other at the same time. If aggregate demand increases, production increases, but also inflation. By reducing aggregate demand, puts a brake on inflation, but it causes a further decline of production.

Item 14 The supply and demand (Ch. 17)

1. Fiscal policy: the basics

The current states raise and spend important amounts of money.

Taxes, government spending on goods and services, transfers and government bonds

Flows within the State in the form of tax revenues and public borrowing, and come out in public expenditure on goods and services and transfers to households.

Taxes are compulsory payments that are made to the State. Most of the tax revenues comprise: income tax of individuals, the business profit taxes and Social Security contributions. The remainder consists of property taxes, sales taxes and other sources of income.

There are two types of public spending:

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Purchase of goods and services

Are defense, health, education, social security, police, firefighters, construction and maintenance of public roads …

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Transfers

Subsidies are paid by the State to households without an exchange for goods and services of any kind.

In Western countries, transfers represent an important part of the state budget.

The public budget and total expenditure

If we recall the basic equation of national accounts:

GDP = C + I + G + X – IM

The state directly controls public spending on goods and services (G).

But this is not the only effect of fiscal policy on aggregate expenditure of the entire economy. Through changes in taxes and transfers, also influences consumption (C) and in some cases, investment (I). Why? Because both a tax increase or a decrease in transfers reduce the disposable income of families, and if the other variables remain constant, a decrease in disposable income causes a decrease in consumption. Conversely, both a reduction of taxes and transfers increased disposable incomes increase, and if the other variables remain constant, an increase in disposable income leads to increased consumption.

The state’s ability to modify the investment is much more complex. The basic idea is that there are taxes on profits of enterprises and that changes in the rules determining the amount to be paid by a company can change the incentives that have the company for investment expenses.

The state can use changes in taxes and transfers to move the aggregate demand curve.

Expansionary fiscal policy and contractionary

The State may want to shift the aggregate demand curve because he wants to end a recession (aggregate output below potential output) or to end an inflationary gap (aggregate output exceeds potential output).

In a recession we have the following situation:

Aggregate output in the initial equilibrium point is below potential output. What I would like the state is to increase aggregate demand, shifting the aggregate demand curve to the right (AD _2), equal to potential output.

It is called expansionary fiscal policy to fiscal policy that increases aggregate demand and usually takes one of three ways:

? An increase in public spending in goods and services.

? A reduction of taxes.

? An increase in transfers.

During an inflationary gap we find:

Aggregate output in the initial equilibrium point is above potential output. Economic policy makers often try to curb inflation by eliminating the inflationary gap, for which fiscal policy will have to reduce aggregate demand, shifting the aggregate demand curve to the left (AD _2), which reduces production equals aggregate and potential output.

Contractionary fiscal policy is called fiscal policy reduces aggregate demand. In practice is achieved in three ways:

? A decrease in government spending for goods and services.

? An increase in taxes.

? A decrease in the transfers.

Warning: The delays in fiscal policy

Many economists are in favor of stabilization policies and argue that overly active when the state exceeds its attempts to stabilize the economy, be it through fiscal or monetary policy may increase the volatility of the economy.

In the case of tax policy reason for caution is that there are significant lags in their implementation.

Because of these delays, attempts to get out of a recession by increasing government spending can lead to long recession in the meantime you are finished naturally and the economy has entered into an inflationary phase, where an expansionary fiscal policy during a period Inflation will make things worse instead of achieving its objective.

2. Fiscal policy and the multiplier

You need to know not only where you are going to shift the aggregate demand curve, but also as to be shifted in response to a certain extent.

The multiplier effect of increased public spending on goods and services

When you decide to make a public spending on goods and services, this spending will cause a spillover effect, since such spending will start a chain reaction in the overall economy.

Companies that produce goods and services purchased by the State paid cash flows which in turn will flow to households as wages, dividends, interests and leases. The increase in household disposable income will lead to increased consumption, and this, an incentive for companies to increase their production, which in turn will further increase in disposable income, increasing consumption and so on.

Thus, an increase in public spending on goods and services (G) will cause a multiplier effect represented:

An increase in government spending shifts the aggregate demand curve to the right, increasing the GDP, which causes an increase in disposable income, which leads to consumption, which in turn generates a further increase of GDP, again causes an increase in consumption, and so on indefinitely.

The multiplier effect of a change in transfers and taxes

Generally, a variation of the transfer of taxes causes a minor shift of the aggregate demand curve that generated by a variation of the same amount of public spending on goods and services.

In general, a dollar for transfer will increase the GDP by MPC / (1-MPC) units, a multiplier less than the increases in public spending in goods and services, which is 1 / (1-MPC).

If what is produced is a tax cut, it is the same as in the case of transfers, the overall effect is less than that caused by an increase of equal volume of public spending on goods and services. Why? For households engaged in saving a portion of the tax cut.

Economists say it also influences social group who is the beneficiary of tax cuts or increased transfers. For example: the unemployed tend to have more PMC than those with greater purchasing power, since the latter are “enough” money to save when there is an increase of disposable income. If this is true, a dollar for unemployment benefits in aggregate demand increases more than a drive to raise money left for tax cuts on dividends.

How taxes affect the multiplier

Taxes which are talked about lump-sum taxes, which are those imposed on households which is independent of the income of these households. A lump-sum tax is one that does not vary with changes in real GDP.

Taxes are very rare. Most tax revenues is by proportional taxes, which are those taxes that directly depend on the level of real GDP. By increasing the real GDP, the amount of tax increases and also to reduce real GDP, the amount of tax decreases.

The proportional tax change the size of the multiplier.

The taxes are a part of real GDP growth that occurs in each sequence of the multiplier process, because most taxes are directly dependent on real GDP. Consequently, by including in the model tax, disposable income increases by an amount well below the monetary unit.

As the most proportional and non-tax lump sum, when real GDP increases, many of the sources of state revenues automatically increase (income tax, sales tax, tax on company profits).

This automatic increase in tax collection results in a reduction of the magnitude of the multiplier. The fact that the State receives part of the increases in real GDP in taxes, it means that each of the stages of this process increased consumption multiplier is less than it might have been if there was no effect of taxes . Consequently, the multiplier is reduced.

Many economists believe that this diminution of the tax multiplier is positive cause. As tax revenues decline when real GDP falls, the effects of negative demand shocks are lower than the absence of the effect of taxes. The fall in tax revenue reduces the negative effect of the initial fall in aggregate demand.

By reducing the amount that households pay in taxes, lower auto recovery caused by the decrease in real GDP acts in the same manner as if it would automatically launch an expansionary fiscal policy to curb the recession. Also when the economy grows the State automatically increase tax revenues, ie, sets in motion a contractionary fiscal policy.

Automatic stabilizers are called public spending and tax rules that have the effect of expansionary fiscal policy when the economy contracts and restrictive when the economy expands.

The rules governing tax collections are the most important automatic stabilizers, but not unique. Some transfers also act as stabilizers, which increase when the economy contracts and drop when the economy is expanding. These variations of the transfers tend to reduce the size of the multiplier, because the total variation in disposable income given that causes a change in real GDP is lower.

There are fiscal policies that do not result from the outriggers. These are called discretionary fiscal policies, fiscal policies are those which result from a series of deliberate steps agreed by those responsible for economic policy and standards.

3. The fiscal balance

The fiscal balance as a criterion of fiscal policy

The fiscal balance is the difference in a given year, between government revenue (ie tax revenue) and spending on both goods and services and transfers.

Budget balance = T – G – TR

where T is the value of tax revenue, G government spending on goods and services and TR value of the transfers.

The budget surplus is the positive difference between tax revenues and public spending, ie, when tax revenues exceed the expenditures.

The budget deficit is the shortfall between tax revenues and public spending, that is, when government spending exceeds the taxes collected.

If the other variables remain constant, the expansionary fiscal policy reduces the budget balance.

If the other variables remain constant, contractionary fiscal policy increases the budget balance.

One might assume that changes in the balance could be used to measure fiscal policy, but this approach can be misleading for two reasons:

• Two different modifications of fiscal policy, still having the same effect on the budget balance can have very different effects on aggregate demand.
• Often the balance changes are the consequence and not the cause of fluctuations in the economy.

The economic cycle and the budget balance and cyclically adjusted

The budget deficit tends to periods of economic recession, but these deficits tend to decrease or even become surplus in periods of expansion.

The relationship between the economic cycle and the balance becomes even more evident if we compare the balance with the rate of unemployment. Almost always the deficit increases when the unemployment rate rises and falls when it falls.

That ratio reflects the discretionary fiscal policies by the government, if not reflecting the action of the stabilizers: tax revenue increases and some transfers to fall (such as unemployment benefits) in times of economic expansion . Conversely, tax revenue tends to decline and certain transfers to increase when the economy contracts. Thus, the budget tends to the deficit during recessions and to the surplus during expansions, although the government has taken no action.

The effects of the economic cycle on the budgetary balance is temporary, since both recessions and inflationary gaps tend to disappear over time.

To isolate the effect of the economic cycle of the effects of other factors which many countries consider the budget balance would be if there were no periods of recession or inflationary gaps.

The adjusted budget balance comes from the cycle calculation of what the balance if the real GDP would be exactly the potential production. This calculation takes into account the extra tax revenue that would raise state and transfers that would be saved if you eliminate the recession or, in the case to eliminate the inflationary gap, tax revenue would be lost and extra transfer should be done.

Does the budget be balanced?

Most economists believe that the budget would be balanced on average, that is, that would be permitted to have deficits in bad years and surpluses in good times. Do not believe the State should be obligated each year to reach equilibrium, because this would weaken the role of automatic stabilizers of taxes and transfers.

The trend to lower tax revenues and transfers to increase when the economy contracts helps to limit the severity of recessions. However, declining revenues and increases in transfers to push the budget deficit. If the State was obliged to maintain a balanced budget, to address the deficit should establish contractionary fiscal policies tend to aggravate the recession.

4. The long-term consequences of fiscal policy

No study of fiscal policy would be complete without taking into account the long-term implications of surpluses and budget deficits.

Deficit, surplus and debt

When a state spends more than it receives through tax collection, that is, when you have deficits, almost always borrow extra funds. And if the States have chronic deficit just accumulating a huge debt.

The public debt is government debt owned by individuals and private institutions.

The problems caused by a growing public debt

When the chronic deficit state has two concerns:

• When the state borrows in financial markets competing with private enterprises, which had planned to ask the funds to finance its investment. Consequently, the interest rate increases and companies invest less than they would have spent if the rate had not risen.

This negative effect of budget deficit on private investment is called “expulsion effect”.
When the deficit caused by this effect, the annual increase in private physical capital of the economy is lower than would have been if the budget would have been in balance or surplus.

• The current deficit, increasing debt, putting pressure on future budgets. Governments have to pay their debts, including interest on debt. If all other factors being equal, one State to pay large sums in interest will have to raise even more taxes or spend less than you would not have to pay. They could borrow to pay interest, but further endeudarían. If a debt unpaid, could lead to economic and financial chaos, undermining general confidence in the state and deposited in the economy.

The deficit and debt in practice

To assess the ability of states to pay the debt often used the debt ratio to GDP, which measures debt as% of GDP. This indicator is used in preference to the volume of debt, because the GDP, to measure the size of the entire economy, it is a good indicator of potential tax revenue that can reach a country. If the debt grows more slowly than GDP, the burden of paying that debt is actually decreasing in relation to the potential tax revenue.

The ratio of debt to GDP may decrease with the debt increase in absolute terms, if the GDP grows faster than the debt.

A state that chronically large deficits will generate a ratio of debt to GDP increased if the debt grows faster than GDP.

Implicit Liabilities

Implicit liabilities are future spending commitments accepted by the States that are really debt, but are not covered by regular debt statistics.

An example of these implicit liabilities are some transfers such as pensions.

These liabilities implicit concern to experts in taxation, it is anticipated that expenditure will increase significantly in coming decades.

One reason for this increase is the demographic, because in the coming decades workers currently listed and coming generation of “baby boomers” are retiring and those who pass will receive pensions, which The number of pensioners will increase substantially from the number of workers paying into Social Security.

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Theme 15 Money, Central Banks and Monetary Policy (cap.18)

1. The meaning of money

The economic definition of money does not cover all forms of wealth.

What is money?

Money is any asset that can be easily used to purchase goods and services.

An asset is liquid if it can become quickly and with little loss of value in cash. The money is in cash, which is the liquid by definition, and other highly liquid assets.

Cash held by the public are banknotes and coins in the hands of citizens and is considered money.

They are also money the deposits, which are bank accounts against which the public can write checks.

The money supply is the total value of financial assets that are considered money.

Money plays a crucial role in generating gains from trade, as it makes possible indirect trade.

Money solves the problems that could generate the exchange when there is no “double coincidence of needs” (the two parties can make an exchange in case one wants what the other offers). With money individuals can change what have money and change the money for what they want to purchase.

Functions of money

Money serves three main functions:

• Method of payment:

  
  

A means of payment is an asset that individuals use to exchange it for goods and services and not for consumption.

• Store of value:

  
  

A store of value is a means of preserving purchasing power over time.

Money is not the only store of value, any asset that maintains its purchasing power over time it is.

• Unit of account:

  
  

A unit of account is a measure used to determine prices and economic calculations.

Types of money

For thousands of years, has been usedcommodity money: a good, even though you have other uses, is used as means of payment.

Has also been used token money backed by commodity, which is a means of payment without inherent value whose value is guaranteed by the issuing bank at any time that can be redeemed for goods.

The current coins are not any of these types, its value comes from the fact is accepted as payment widespread, a fact which is legal as it comes from a decree issued by the country in question.

In this type of currency is called fiat money is a means of payment whose value derives solely from their legal status as such payment.

Measuring the money supply

A monetary aggregate is an aggregate measure of money supply.

There are three monetary aggregates (M1, M2, M3) which differ in the degree they restrict the definition of money.

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M1:

only takes into account the public’s cash, travelers checks and deposits.

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M2:

consider other assets as well as money (quasi-money assets), financial assets that can not be used directly as payment but can be converted easily into cash or deposits. Eg savings accounts.

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M3:

M2 added to a group less liquid assets, which are somewhat more difficult to turn into cash or deposits. Eg deposits with an early termination penalty.

2. The role of the banks money

What do banks

A financial institution is a financial intermediary providing liquid financial assets in the form of deposits to lenders and use those funds to finance the needs, less liquid, investment or investment spending of borrowers.

A financial intermediary is an entity that transforms the funds it receives a large number of individuals in financial assets.

A bank deposit is a contract between the depositor and the bank whereby the bank is obligated to repay the depositor’s total cash in the time of his request.

Banks are able to create liquidity, because they need to maintain liquid assets in the form of all funds deposited, except in anbanking panic in which all depositors want to withdraw their funds at a time. Most of the funds of the depositors have invested in less liquid assets, such as mortgages and corporate loans. Not provide all the funds they receive because they have to be able to attend any depositor who wishes to withdraw funds.

Banks have assets in the form of cash in the safes or deposit account with the Central Bank of the nation.

They are called cash reserve requirement that banks hold in the vaults and deposits with the Central Bank. As there are in private hands, not part of the cash held by the public.

An asset is a right that you will receive income in the future.

An obligation is a commitment to make a payment in the future.

The reserve ratio is the% of bank deposits that the bank holds as reserves. Central banks set a minimum ratio of cash that banks must meet in order to deal with banking panics.

The banking panics

If all depositors decide to withdraw their funds at once, the bank would not have enough cash or deposits with the Central Bank to respond to their customers.

Thus, any effort by the bank to get cash compelled to sell their assets cheap and inevitably fails to return all deposits.

That all depositors want to withdraw their money from the bank can come simply caused by concerns about the financial health of a bank.

A banking panic is one in which a large number of depositors of a bank trying to withdraw their funds due to fears that the entity will fail.

Moreover, these situations have historically been contagious, spreading to other entities such as a chain reaction.

To address this situation, governments have established regulations that protect bank depositors and try to avoid panic situations.

Banking regulation

Most developed countries have established a system which aims to protect depositors and the overall economy of bank failures.

This system has three main features:

• Escrow

It states that the depositors of a bank may recover their funds if the bank is unable to return to a ceiling per account.

This eliminates the main trigger in the banking panics.

• Regulatory Capital

Given this security that the government could be situations of indifference of depositors about where to enter your savings or a more risky financial behavior by banks.

To avoid this, the laws require the bankers who have assets worth considerably more than the value of bank deposits, so that even if some debtors are insolvent, losses will be charged on the assets of the bank and not against public assets.

Regulatory capital is called the excess of assets relative to bank deposits and other liabilities.

• Statutory reserves

Another way to reduce the risk of occurrence of banking panics is the requirement that banks maintain a reserve requirement higher than that maintained in the absence of a legal requirement.

Reservations regulations are legal requirements that the central banks of nations imposed on commercial banks by establishing a minimum reserve requirement.

How banks create money

If there were no banks, the amount of cash in public hands would be equal to the money supply.

But their existence affects the money supply in two ways:

– Removing a certain amount of lawful money of the movement (in the vaults, not part of the money supply).

– Making money by offering their customers deposits, so that money supply is greater than the volume of legal money. Entities may provide excess reserves (or sobreencaje), ie, the amount of deposits in excess of minimum reserves. So that, the money you deposit (minus the required reserve ratio), can be loaned to another person, creating money, new deposits and increase the monetary supply.

3. The Federal Reserve System

The nation’s Central Bank is responsible for ensuring that banks maintain an adequate level of reserves and implement monetary policy.

In the U.S. Federal Reserve is called.

In our case (Europe) is the European Central Bank (ECB).

The Federal Reserve: Central Bank of the United States

The Central Bank is the institution that oversees and regulates the banking system and controls the monetary base.

Examples of Central Banks are the Federal Reserve, the Bank of England, Bank of Japan, the European Central Bank (Central Bank common EU 16 countries: Germany, France, Italy, Spain, Belgium, Holland, Luxembourg, Ireland , Portugal, Austria, Finland, Greece, Slovenia, Cyprus, Malta and Slovakia).

The Federal Reserve is composed of two bodies: the Board of Governors and the 12 regional banks of the Federal Reserve. Headquartered in Washington DC

NY Federal Reserve plays a special role. It is the carrier of open market operations, the main tool of monetary policy.

The functions of the Central Bank. Statutory reserves and discount rate

The central banks have at their disposal three tools: the statutory reserves, the discount rate and, most important, open market operations.

In the banking panics, the Central Bank required a minimum reserve requirement, which if not reached in the allotted time, may punish the bank in question.

The bank to achieve this minimum can borrow additional reserves to other banks. The banks lend money to each other in the interbank market, which is a financial market that allows for loans to those financial institutions whose stocks do not reach the legal minimum. Usually the deadlines are very short (1 day) and the borrowers are banks with excess reserves. The interest rate on the interbank market is fixed by the law of supply and demand, but influenced by the Central Bank, and plays a key role in the current monetary policy.

The bank can also borrow from the Central Bank. The interest rate which central banks lend to banks is called the discount rate.
It is usually higher than the interbank market, to deter institutions use this option.

In practice, the tool used: open market operations to (OMA).

Open market operations

The Central Bank has assets and liabilities. The assets are public debt, which has (is an asset to him because the BC is not a public body and a liability to the State). His liability is comprised of cash held by the public and bank reserves (which are in the vaults of the entities and deposited by them in BC).

An open market operation is the sale of public debt held by the Central Bank.

When buying debt that banks pay an additional deposit that amount in the accounts of those banks, increasing their reserves.

When you sell debt to banks, charging the amount to their accounts, reducing their reserves.

The funds to buy public debt by the Central Bank is created with a point in the general ledger accounts (as the current currency is fiat and is not supported by any good). So central banks can create extra reserves in its sole discretion .

The change in bank reserves caused by open market operations does not directly affect the money supply. However, begin the process of money creation. Following the increase in reserves in the banks, they provide additional reserves, thus increasing the money supply.

A sale of government debt, has the opposite effect: decrease bank reserves, banks reduced the volume of loans and money supply is reduced.

When the Central Bank buys government debt, the interest rate falls because there is an increase in bank reserves, so that banks can lend more. An increase in the provision of loans, lowers the price of loans, which is precisely the type of interest.

When the Central Bank sells debt, the interest rate increases because there is a decrease in bank reserves, so that banks can pay less. A decrease in the supply of loans increases the price of loans, ie the rate of interest.

Central Bank (ECB)

He is in charge and responsible for monetary policy for 16 countries, including those who are currently part of the euro zone: Germany, France, Italy, Spain, Belgium, Holland, Luxembourg, Ireland, Portugal, Austria, Finland, Greece, Slovenia Cyprus, Malta and Slovakia. The EU has 25 countries, so not all have adopted the same currency either unwilling to do that (UK) or because they have not fulfilled the required criteria.

For euro area countries, the interest rate periodically deciding member of the ECB Governing Council is one and the same for all of them, but all member countries take part in the decision on interest rates.

How are decisions on the interest rate in the euro area?

The Governing Council to vary the interest rate in order to achieve the objective entrusted to the ECB, which is to achieve price stability in the euro area. For stability in prices means an increase in annual inflation less, but close to 2% in the medium term.

4. Monetary policy and aggregate demand

We’ll see how the monetary policy, ie changes in the money supply, interest rates, or both can serve the same function.

The expansionary and contractionary monetary policy

The Central Bank sets the interbank interest rate target, which is the level at which you want to keep the interbank interest rate.

The central bank adjusts the money supply by buying government debt until the initial interest rate on the interbank market rate reaches the target. In turn, changes in interest, modify the aggregate demand.

If all other variables constant, a fall in interest rate causes an increase in investment and consumption and, consequently, an increase in aggregate demand.

If all other variables constant, a rise in interest rate causes a fall in investment and consumption and, consequently, a decrease in aggregate demand.

Therefore, monetary policy, like fiscal policy, can be used to end a recession or close an inflationary gap.

Expansionary monetary policy to fix a recession

The economy is in recession, in which aggregate output is below potential output.

An expansionary monetary policy lowers the interest rate, which shifts the aggregate demand curve to the right (DA ₂₎ and eliminates the differential between the aggregate production and potential.

Monetary policy is expansionary monetary policy that increases aggregate demand.

Contractionary monetary policy to correct the inflationary gap

The economy faces an excess demand and aggregate output is above potential output.

A contractionary monetary policy increases the interest rate, which shifts the aggregate demand curve to the left (DA ₂₎ and eliminates the differential between the aggregate production and potential.

Contractionary monetary policy or rigid is that monetary policy reduces aggregate demand.

Monetary policy and multiplies dor

In the figure we see a shift in aggregate demand to the right by a fall in the interest rate. For any level of aggregate demand increases prices. To calculate the increase in aggregate demand, we must know how much the real GDP after the fall of the interest rate.

An expansionary policy lowers the interest rate induces an initial growth of investment, ?I.Este initial real GDP growth translates into an increase in disposable income, which in turn induces an increase in consumption C, which turn raises the disposable income (real GDP growth) and so on. At the end of the process the aggregate demand curve shifts to the right to an extent that is a multiple of the initial increase in I. In each sequence, is less than the increase in the previous sequence, because of the increase is “escape” to the savings, because the marginal propensity to save (WFP) is positive.

The total increase in real GDP is a figure multiple of the initial increase in investment: