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CFA Level 1 > Economics > Flashcards

Economics Flashcards

1
Q

Own Price Elasticity

A

Measure of the responsiveness of the quantity demanded to change in a price. Negative if an increase in price decreases quantity demanded

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2
Q

Elastic

A

When quantity demanded is very responsive to a change in price (absolute value of elasticity > 1)

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3
Q

Inelastic

A

When quantity demanded is not very responsive to change in price (absolute value of elasticity < 1)

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4
Q

Perfectly Elastic

A

At any higher price, quantity demanded decreases to zero. Elasticity = infinity (horizontal line). When one or more goods are very good substitutes

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5
Q

Perfectly Inelastic

A

A change in price has no effect on quantity demanded. Elasticity = 0 (vertical line). Few or no good substitutes for a good

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6
Q

Portion of Income

A

The larger the proportion of income spent on a good, the more elastic an individual’s demand for that good

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7
Q

Time

A

Elasticity of demand tends to be greater the longer the time period since the price change

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8
Q

Inelastic Range

A

Lower part of the demand curve, where percentage change in quantity demanded is smaller than the percentage change in price. Total revenue will increase when price increases (percentage decrease in quantity demanded will be less than the percentage increase in price)

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9
Q

Elastic Range

A

Upper part of the demand curve, where percentage change in quantity demanded is greater than the percentage change in price. Total revenue will decrease when price increases (percentage decrease in quantity demanded will be greater than the percentage increase in price)

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10
Q

Unitary Elasticity

A

A 1% increase in price leads to a 1% decrease in quantity demanded (-1 elasticity). Point of greatest total revenue. Price increase moves into elastic region, price decrease moves into inelastic region

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11
Q

Income Elasticity

A

The sensitivity of quantity demanded to a change in income. Ratio of the percentage change in quantity demanded to the percentage change in income

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12
Q

Normal Goods

A

The sign of income elasticity is positive (an increase in income leads to an increase in quantity of goods demanded) –> positive income effect

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13
Q

Inferior Goods

A

Sign of income elasticity is negative (an increase in income leads to a decrease in quantity demanded) –> negative income effect

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14
Q

Cross Price Elasticity

A

The ratio of the percentage change in the quantity demanded of a good to the percentage change in the price of a related good

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15
Q

Substitutes

A

When an increase in the price of a related good increases the demand for a good (an increase in the price of one will lead consumers to purchase more of the other) –> cross price elasticity is positive (price of one is up, quantity of the other is up)

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16
Q

Complements

A

When an increase in price of a related good decreases demand for a good (an increase in the price of one leads consumers to purchase less of the other as well) –> cross price elasticity is negative

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17
Q

Substitution Effect

A

Always acts to increase the consumption of a good that has fallen in price

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18
Q

Income Effect

A

Can either increase or decrease consumption of a good that has fallen in price (total expenditure on the original bundle of goods falls as result of substitution effect)

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19
Q

Giffen Good

A

Inferior good for which the negative income effect outweighs the positive substitution effect when price falls (demand rises when price rises, and demand falls when price falls) –> bread, rice, wheat (few substitutes, substantial portion of buyer’s income)

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20
Q

Veblen Good

A

A higher price makes the good more desirable. Consumer gets utility from being seen to consume a good that has high status (luxury goods). This is not an inferior good. Both substitution and income effects of price increase decrease consumption

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21
Q

Factors of Production

A

Resources a firm uses to generate output
Land: where facilities are located
Labor: all workers (unskilled to management)
Capital: manufacturing facilities, equipment, machinery
Materials: raw materials and manufactured inputs

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22
Q

Production Function

A

Quantity of output that a firm can produce as a function of the amounts of capital and labor employed

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23
Q

Diminishing Marginal Productivity

A

The quantity of labor for which the additional output for each additional worker begins to decline (diminishing marginal returns)

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24
Q

Short Run

A

The time period over which some factors of production are fixed (capital) –> If total revenue is greater than total variable cost, and price is greater than average variable costs, firm can stay open in the short run. If average revenue is less than average variable costs, shut down

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25
Q

Long Run

A

All factors of production are variable (leases can expire, sell equipment) –> firm can avoid short run fixed costs by shutting down. If price is below average minimum total cost, shut down

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26
Q

Perfect Competition

A

Many firms produce identical products, and competition forces them all to sell at the market price. price = marginal revenue = average revenue (price taker). Perfectly elastic demand curves
Barriers to Entry: very low
Substitutes: very good
Nature of Competition: price only
Pricing Power: none (supply and demand determine)

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27
Q

Short Run Shutdown Point

A

If average revenue is less than average variable cost in the short run, shut down. If average revenue is greater than average variable cost, can still operate even with losses

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28
Q

Long Run Shutdown Point

A

Firm should shut down if average revenue is less than average total cost

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29
Q

Breakeven Point

A

Average revenue is equal to average total cost (total revenue = total cost)

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30
Q

Price Searcher Firms

A

Downward sloping demand curve, marginal revenue does not equal price (imperfect competition)

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31
Q

Long Run Average Total Cost Curve

A

Drawn for many different plant sizes or scales of operation. Each point along the curve represents minimum ATC for a given plant size or scale of operations

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32
Q

Minimum Efficient Scale

A

Average total costs first decrease (economies of scale) with larger scale and eventually increase (diseconomies of scale). Lowest point is scale or plant size where average total cost of production is at a minimum

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33
Q

Monopoly

A 
Only one firm is producing a product with no close substitutes. Chooses the price at which it sells. Patents, copyrights, control resources (supported by the government)
Barriers to Entry: very high
Substitutes: none
Nature of Competition: advertising
Pricing Power: significant
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34
Q

Monopolistic Competition

A

Many independent sellers and differentiated products (products not identical). Downward sloping demand curve.
Barriers to Entry: low
Substitutes: good but differentiated
Nature of Competition: price, marketing, quality
Pricing Power: some (each firm has relatively small market share, no one can control the price). Too many firms for collusion –> price searchers
Maximize Profit: MR = MC (that’s where you find Q and also P on demand curve)

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35
Q

Oligopoly

A

Few firms that compete in a variety of ways (interdependent). Very large firms respond to actions of the others
Barriers to Entry: high
Substitutes: very good or differentiated
Nature of Competition: price, marketing features, quality
Pricing Power: some to significant

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36
Q

Natural Monopoly

A

Single firm supplies entire market demand for product. The average cost of production is falling over the relevant range of consumer demand. Having two or more producers would result in significantly higher cost of production and be detrimental to consumers

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37
Q

Network Effects

A

Synergies. Make it very difficult to compete with a company once it has reached a critical level of market penetration (has a moat). Changes in technology and consumer taste threaten

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38
Q

Marginal Revenue

A

Increase in total revenue from selling one more unit of a good or service. Maximize profit by selling quantity for which MR = marginal cost

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39
Q

Shutdown Point

A

If the firm is only just covering its variable costs (P = AVC)

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40
Q

Long Run Equilibrium Output

A

MR = MC = ATC for perfectly competitive firms (where ATC is minimized)

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41
Q

Short Run Supply Curve

A

MC line above the AVC curve

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42
Q

Short Run Market Supply Curve

A

Horizontal sum (add up quantities of all firms at each price) of the MC curves for all firms in a given industry (upward sloping to the right)

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43
Q

Markup

A

In monopolistic competition, P > MC (price slightly higher than perfect competition)

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44
Q

Excess Capacity

A

ATC is not at a minimum for quantity produced, suggesting inefficient scale of production

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45
Q

Product Innovation

A

Firms that bring new and innovative products to the market are confronted with less-elastic demand curves, enabling them to increase price. Optimal amount of innovation is when MC addtl. innov = MR addtl. innov

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46
Q

Kinked Demand Curve

A

An increase in a firm’s product price will not be followed by its competitors, but a decrease in price will (more elastic, flatter, above a given price than below). Gap in MR curve (MC passes through)

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47
Q

Cournot Model

A

Model considers a duopoly, where both firms have identical and constant marginal costs of production. Each firm knows the quantity supplied by the other firm in the previous period and assumes that this is what it will supply in the next period. Subtract Q from linear market demand curve to construct own demand and MR curve to determine profit maximizing Q. Quantities will change each period until they are equal

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48
Q

Nash Equilibrium

A

Reached when the choices of all firms are such that there is no other choice that makes any firm better off (increases profits or decreases losses)

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49
Q

Prisoner’s Dilemma

A

Prisoner A confesses, B remains silent: A freed, B 10 yrs
Prisoner B confesses, A remains silent: B freed, A 10 yrs
Both silent: 6 months each
Both confess: 2 years each
Equilibrium is that both confess

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50
Q

Collusion

A

Nash equilibrium is to undercut the agreement to have two firms raise prices (going lower). Collusive agreements more successful when there are fewer firms, products more similar, cost structures more similar, purchases small and frequent, retaliation for cheating certain and severe, less competition from outside firms to the cartel

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51
Q

Dominant Firm Model

A

Single firm that has a significantly large market share because of its greater scale and lower cost structure. Market price determined by this firm, other firms take this price as a given

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52
Q

Price Discrimination

A

If a monopoly’s customers cannot resell the product to each other for a lower price, maximize profits by charging different prices to different customers for same product or service

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53
Q

Deadweight Loss

A

Quantity produced by a monopolist reduces the sum of consumer and producer surplus by an amount represented by empty triangles under demand curve. Monopoly is inefficient compared to perfect competition because of this reduction, but price discrimination reduces this inefficiency

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54
Q

Rent Seeking

A

When producers spend time and resources to try to establish a monopoly

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55
Q

Average Cost Pricing

A

Forces monopolist to reduce price to where ATC intersects the market demand curve. Increases output and decreases price, increases social welfare, normal profit (price = ATC)

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56
Q

Marginal Cost Pricing

A

Forces monopolist to reduce price to the point where firm’s MC curve intersects the market demand curve. Increases output and reduces price, but causes monopolist to incur a loss because price is below ATC (requires a government subsidy)

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57
Q

N-firm Concentration Ratio

A

The sum or the percentage market shares of the largest N firms in a market (relatively insensitive to mergers of two firms with large market shares)

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58
Q

Herfindahl-Hirschman Index (HHI)

A

Sum of the squares of of the market shares of the largest firms in the market

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59
Q

GDP

A

Total market value of the goods and services produced in a country within a certain time period (size of the nation’s economy). Includes only purchases of newly produced goods and services

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60
Q

Final Goods

A

Goods and services that will not be resold or used in the production of other goods and services (input goods’ value included in final prices)

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61
Q

Expenditure Approach

A 
GDP calculated by summing the amounts spent on goods and services produced during the period --> value of final output method
-Consumption
-Investment
-Government Spending
-Exports/Imports (Net Exports)
C + I + G + (X - M)
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62
Q

Income Approach

A

GDP calculated by summing the amounts earned by households and companies during the period (wage income, interest income, business profits) –> sum of value added method
National Income + Capital Consumption Allowance + Statistical Discrepancy

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63
Q

Nominal GDP

A

GDP as described under the expenditures approach (inflation will increase nominal GDP)

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64
Q

Real GDP

A

Measures the output of the economy using the prices from a base year, removing the effect of changes in prices so that inflation is not counted as economic growth

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65
Q

GDP Deflator

A

Price index that can be used to convert nominal GDP into real GDP, taking out the effects of changes in the overall price level. Based on the current mix of goods and services, using prices at the beginning and end of the period

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66
Q

Per Capita Real GDP

A

Real GDP divided by population (measure of economic well-being of a country’s residents)

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67
Q

Capital Consumption Allowance

A

Measures the depreciation of physical capital from the production of goods and services over a period. The amount that would have to be reinvested to maintain the productivity of physical capital from one period to the next

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68
Q

Statistical Discrepancy

A

Adjustment for the difference between GDP measured under the income approach and the expenditure approach

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69
Q

National Income

A

Sum of the income received by all factors of production that go into the creation of final output
+Compensation of employees (wages and benefits)
+Corp and govt. profits before taxes
+Interest Income
+Unincorporated business net income
+Rent
+Indirect business taxes - subsidies

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70
Q

Personal Income

A 
Measure of the pretax income received by households and is one determinant of consumer purchasing power and consumption (includes all income that households receive)
\+National Income
\+Transfer Payments to households
-Indirect Business Taxes
-Corporate Income Taxes
-Undistributed Corporate Profits
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71
Q

Personal Disposable Income

A

Personal income after taxes. Measures the amount that households have available to either save or spend on goods and services

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72
Q

Total Income

A

+Consumption Spending
+Household and Business Savings
+Net Taxes (Taxes - Transfer payments received)

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73
Q

Fiscal Balance

A

Difference between government spending and tax receipts (G - T)

  • Negative value is budget surplus, positive value is budget deficit
  • Government deficit is financed by trade deficit or excess of private saving over private investments
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74
Q

Trade Balance

A 
Net exports (X -M)
-Positive value is trade surplus, negative value is trade deficit
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75
Q

Consumption

A

Function of disposable income. Increase in personal income or decrease in taxes increase consumption and saving

  • Marginal Propensity to Consume: portion of additional income spent on consumption
  • Marginal Propensity to Save: proportion saved (MPC + MPS = 100%)
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76
Q

Investment

A

Function of expected profitability and the cost of financing (depends on the overall level of economic output)

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77
Q

Government Purchases

A

Tax revenue to the government, therefore fiscal balance

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78
Q

Net Exports

A

Function of domestic disposable incomes (imports), foreign disposable incomes (exports), relative prices of goods in foreign and domestic markets

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79
Q

IS Curve

A

Income-savings. Negative relationship between real interest rates and real income for equilibrium in the goods market. Points on the curve are combinations of real interest rates and income consistent with equilibrium in goods market

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80
Q

LM Curve

A

Liquidity-money. Positive relationship between real interest rates and income consistent with equilibrium in the money market (increase in money supply shifts curve downward)

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81
Q

Real Money Supply

A

M/P constant. Increase in real interest rates must be accompanied by an increase in income for equilibrium.

  • M is nominal money supply
  • P is price level
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82
Q

Aggregate Demand Curve

A

Relationship between the quantity of real output demanded (real income) and price level. Slopes down because higher price levels reduce wealth, increase real rates, and make domestic goods more expensive

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83
Q

Aggregate Supply Curve

A

Relationship between price level and the quantity of real GDP supplied when all other factors are kept constant (amount of output firms will produce at different price levels)

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84
Q

Very Short Run Aggregate Supply Curve (VSRAS)

A

Firms will adjust output without changing price by adjusting labor hours and intensity of use of plant and equipment (perfectly elastic curve)

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85
Q

Short Run Aggregate Supply Curve (SRAS)

A

Slopes upward because some input prices will change as production is increased or decreased. Output prices will change proportionally to price level, some input prices are sticky. Total level of output willing to supply at different price levels

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86
Q

Long Run Aggregate Supply Curve (LRAS)

A

All input costs can vary. Wages and other inputs change proportionally to the price level, so price level has no long run effect on aggregate supply (Potential GDP or Full Employment GDP) –> perfectly inelastic

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87
Q

Increase in Agg Demand

A

Increase in aggregate demand (quantity of goods and services demanded is greater at any given price level)

  • Increase in Consumer Wealth (C increases)
  • Business Expectations (I increases)
  • Consumer expectations of future income (C increases)
  • High capacity utilization (I increases)
  • Expansionary monetary policy (C and I increase)
  • Expansionary fiscal policy (C and G could increase with tax cut or spending increase)
  • Exchange Rates (net X increases)
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88
Q

Shifts in Short Run Agg Supply Curve

A

Quantity supplied at each price level increases.

  • Labor Productivity: output per hour worked (decreases unit costs to producers, increases output)
  • Input Prices: decrease in wages or prices of other inputs increases production
  • Expectations of future output prices
  • Taxes and govt. subsidies: decrease in taxes, increase subsidies decrease cost of production and increase output
  • Exchange Rates: appreciation in currency decreases cost of imports (reduces production costs for inputs)
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89
Q

Shifts in Long Run Agg Supply Curve

A

Affect the real output that an economy can produce at full employment.

  • Increase in supply and quality of labor
  • Increase in supply of natural resources
  • Increase in stock of physical capital
  • Technology
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90
Q

Recessionary Gap

A

Decrease in aggregate demand results in lower real output and lower price level. Real GDP is less than full employment potential (period of declining GDP and risking unemployment)

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91
Q

Fiscal Policy

A

Increasing (expansionary) government spending or decreasing taxes –> stabilize aggregate demand

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92
Q

Monetary Policy

A

Central bank’s actions that affect the quantity of money and credit in an economy in order to influence economic activity

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93
Q

Inflationary Gap

A

Increase in aggregate demand from its previous level causes upward pressure on the price level. Competition among producers for workers, raw materials and energy shifts curve back to full-employment GDP (higher price)

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94
Q

Stagflation

A

Declining economic output and higher prices (stagnant economy with inflation) –> decrease in SRAS (shift left) caused by increase in prices of input (lower GDP, higher price). Subsequent decrease in input prices will increase demand returns to full employment at higher price

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95
Q

AD and AS Increase Same Time

A

Real GDP increases, but price level depends on magnitude of changes (price effects in opposite directions)

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96
Q

AD and AS Decrease Same Time

A

Real GDP decreases, effect on price level depends on magnitude of changes (price moves in opposite directions)

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97
Q

AD Increases, AS Decreases Same Time

A

Price level increases, effect on real GDP depends on relative magnitudes

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98
Q

AD Decreases, AS Increases Same Time

A

Price level decreases, effect on real GDP depends on relative magnitudes

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99
Q

Economic Growth

A

Labor supply, human capital, physical capital stock, technology, natural resources

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100
Q

Labor Supply

A

Number of people over the age of 16 who are either working or available for work but currently unemployed. Affected by population growth, net immigration

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101
Q

Human Capital

A

Education and skill level of a country’s labor force

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102
Q

Physical Capital Stock

A

High rate of investment (increases labor productivity and potential GDP)

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103
Q

Technology

A

Improvements in technology increase productivity and potential GDP

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104
Q

Natural Resources

A

Raw materials. May be renewable (forests) or non-renewable (coal). Countries with large amounts can achieve greater rates of economic growth

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105
Q

Sustainable Rate of Economic Growth

A

Growth in potential GDP (growth in labor force and growth in labor productivity). Rate of increase in economy’s productive capacity

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106
Q

Production Function

A

Describes the relationship of output to the size of the labor force, capital stock and productivity. Function of the amounts of labor and capital that are available and their productivity, which depends on level of technology

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107
Q

Total Factor Productivity

A

Quantifies the amount of output growth that is not explained by increases in the size of labor force and capital (inferred)

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108
Q

Capital Deepening Investment

A

Increasing physical capital per worker over time (will not sustain long term growth)

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109
Q

Solow (Neoclassical) Model

A

Contributions of capital, labor and technology to economic growth

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110
Q

Business Cycle

A

Fluctuations in economic activity. Real GDP and rate of unemployment are variables (do not occur at regular intervals)

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111
Q

Expansion

A

Real GDP increases. Growth in most sectors, increasing employment, consumer spending and business spending. Two consecutive quarters of real GDP growth

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112
Q

Peak

A

Real GDP stops increasing, starts decreasing. Rates of increase in spending, investment and employment slow but remain positive, while inflation accelerates (before decrease)

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113
Q

Contraction/Recession

A

Real GDP decreases. Declines in most sectors, inflation decreasing. Two consecutive quarters of declining real GDP

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114
Q

Trough

A

Real GDP stops decreasing, starts increasing. The economy then begins a new expansion (recovery), and economic growth becomes positive again, inflation is moderate, employment growth doesn’t increase until later

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115
Q

Inventory-Sales Ratio

A

When an expansion is reaching its peak, sales growth begins to slow and unsold inventories accumulate. This ratio will increase. When reaching its trough, inventories will become depleted more quickly and sales growth accelerates (ratio decreases)

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116
Q

Mortgage Rates

A

Low interest rates increase home buying and construction, high rates reduce

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117
Q

Housing Costs Relative to Income

A

When incomes are cyclically high relative to home costs (mortgage financing costs), home buying and construction tend to increase. When home prices are rising faster than incomes, housing activity can decrease (late cycle)

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118
Q

Speculative Activity

A

Rising home prices can lead purchases based on expectations of further gains. Higher prices lead to more construction and excess building, resulting in falling prices and decreased housing activity

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119
Q

Demographic Factors

A

Proportion of population in 25 - 40 segment is positively related to activity in the housing sector

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120
Q

Neoclassical School

A

Shifts in both aggregate demand and aggregate supply are primarily driven by changes in technology over time. Economy has a strong tendency toward full employment equilibrium. Business cycles result from temporary deviations from long run equilibrium

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121
Q

Keynesian School

A

Shifts in aggregate demand due to changes in expectations primary cause of business cycles. Fluctuations due to swings in the level of optimism of those who run businesses (overinvest and overproduce when too optimistic). Wages are downward sticky (decrease in wages unable to increase short-run aggregate supply and move from recession back to full employment). Increase aggregate demand through monetary policy or fiscal policy

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122
Q

New Keynesian School

A

Prices of productive inputs rather than labor are also downward sticky

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123
Q

Monetarist School

A

Variations in aggregate demand that cause business cycles are due to variations in the rate of growth of the money supply, likely from inappropriate decisions by monetary authorities. Recessions caused by external shocks or inappropriate decreases in money supply. Central bank follow policy of steady and predictable increases in money supply

124
Q

Austrian School

A

Business cycles caused by government intervention in the economy. Policymakers forcing interest rates down to artificially low levels, firms invest too much capital in the long term compared to actual consumer demand

125
Q

New Classical School

A

Real Business Cycle theory. Emphasizes effect of real economic variables such as changes in technology and external shocks, as opposed to monetary variables, as the cause of business cycles. Policymakers should not try to counteract business cycles because expansions and contractions are efficient market responses to real external shocks (individuals and firms maximize expected utility)

126
Q

Frictional Unemployment

A

Time lag necessary to match employees who seek work with employers needing their skills

127
Q

Structural Unemployment

A

Long run changes in the economy that eliminate some jobs while generating others for which unemployed workers are not qualified

128
Q

Cyclical Unemployment

A

Changes in the general level of economic activity. Positive when economy is operating at less than full capacity, negative when expansion leads to employment temporarily over full employment

129
Q

Underemployed

A

Employed part time but would prefer to work full time or is employed at a low paying job despite being qualified for a significantly higher paying one

130
Q

Participation Ratio

A

Percentage of working age population who are wither employed or actively seeing employment. Increases when economy expands

131
Q

Discouraged Workers

A

Those who are available for work but are neither employed nor actively seeking employment

132
Q

Unemployed

A

A person who is not working but is actively seeking work. Discouraged workers become unemployed once they start looking for jobs, which can temporarily increase unemployment rates

133
Q

Productivity

A

Output per hour worked. Declines early in contractions as firms try to keep employees on despite producing less. Increases early in expansions as firms try to produce more output but are not yet ready to hire new workers

134
Q

Inflation

A

Persistent increase in the price level over time (prices of almost all goods and services are increasing). Erodes purchasing power of a currency. Favors borrowers at the expense of lenders (principal is returned is worth less than when borrowed)

135
Q

Hyperinflation

A

Inflation that accelerates out of control. Can destroy a country’s monetary system and bring about social and political upheavals

136
Q

Inflation Rate

A

Percentage increase in the price level, typically compared to the prior year

137
Q

Disinflation

A

An inflation rate that is decreasing over time but remains greater than zero

138
Q

Deflation

A

Persistently decreasing price level (negative inflation). Deep recessions (consumers delay purchases, decreasing revenues)

139
Q

Price Index

A

Measures the average price for a defined basket of goods and services (Consumer Price Index)

140
Q

CPI

A

Represents the purchasing patterns of a typical urban household. Compares cost of CPI basket today with cost of basket in earlier base period

141
Q

Price Index for Personal Consumption Expenditures

A

Index is created by surveying businesses rather than consumers

142
Q

Producer Price Index (PPI)/Wholesale Price Index (WPI)

A

Observe for different stages of processing to watch for emerging price pressure. Widespread increases for producers’ goods may be passed along to consumers

143
Q

Headline Inflation

A

Price indexes for all goods

144
Q

Core Inflation

A

Price indexes that exclude food and energy (food and energy prices more volatile than most other goods)

145
Q

Laspeyres Index

A

Price index calculated using a constant basket of goods and services. Biased upward as a measure of the cost of living (New Goods, Quality Changes, Substitution)

146
Q

New Goods

A

Older products are often replaced by newer, but initially more expensive, products. New goods periodically added, older goods they replace are reduced in weight

147
Q

Quality Changes

A

Price of a product increases because product has improved, price increase not due to inflation, but still captured by index

148
Q

Substitution

A

Even in inflation free economy prices of goods relative to each other change all the time. When two goods are substitutes, consumers increase purchases of relatively cheaper one

149
Q

Hedonic Pricing

A

Used to adjust a price index for product quality. Address bias from substitution using a chained index

150
Q

Fisher Index

A

Geometric mean of a Laspeyres index

151
Q

Paasche Index

A

Uses current consumption weights, prices from the base period, and prices in the current period

152
Q

Cost Push Inflation

A

Results from a decrease in aggregate supply, caused by an increase in the real price of an important factor of production (wage pressure)

153
Q

Demand Pull Inflation

A

Results from an increase in aggregate demand (increase in the money supply, increased government spending). Increase in GDP not sustainable, unemployment falls, upward pressure on real wages, price keeps increasing

154
Q

Natural Rate of Unemployment (NARU)

A

Some segments of the economy may have trouble finding enough qualified workers even during contraction, so rate can be higher than rate associated with absence of cyclical unemployment

155
Q

Unit Labor Costs

A

Ratio of total labor compensation per hour to output units per hour

156
Q

Expected Inflation

A

If workers expect inflation to increase, they will increase their wage demands accordingly (difference in yield between inflation indexed bonds and treasuries)

157
Q

Leading Indicator

A

Change direction before peaks or troughs in the business cycle (consumer expectations, weekly hours in manufacturing, manufacturers’ new orders for consumer goods, building permits for new houses)

158
Q

Coincident Indicators

A

Change direction at roughly the same time as peaks or troughs (employees on nonfarm payrolls, real personal income, manufacturing and trade sales)

159
Q

Lagging Indicators

A

Don’t tend to change direction until after the expansions or contractions are already underway (average duration of unemployment, inventory sales ratio, change in unit labor costs, change in CPI, prime lending rate, commercial and industrial loans)

160
Q

Budget Surplus

A

Government tax revenues exceed expenditures

161
Q

Budget Deficit

A

Government expenditures exceed tax revenues

162
Q

Expansionary Monetary Ploicy

A

Easy, accommodative. Central bank increases the quantity of money and credit in an economy

163
Q

Contractionary Monetary Policy

A

Restrictive, tight. Central bank is reducing quantity of money and credit in an economy

164
Q

Money

A

Generally accepted medium of exchange (accepted as payment for goods and services)

165
Q

Unit of Account

A

Prices of all goods and services are expressed in units of money

166
Q

Store of Value

A

Money received for work or goods can now be saved to purchase goods later

167
Q

Narrow Money

A

The amount of notes (currency) and coins in circulation in an economy plus balances in checkable bank deposits

168
Q

Broad Money

A

Narrow money plus any amount available in liquid assets

169
Q

M1

A

Narrowest measure of money supply, most liquid (currency in circulation, overnight deposits, travelers checks)

170
Q

M2

A

M1 plus savings accounts, time deposits under $100k, balances in retail money market mutual funds (deposits agreed maturity up to 2 years, redeemable at notice up to 3 months)

171
Q

M3

A

M1 and M2 plus repurchase agreements, money market fund shares, debt securities with maturity up to 2 years

172
Q

Promissory Notes

A

Promise by the bank to return money on demand by the depositor (also a medium of exchange)

173
Q

Fractional Reserve Banking

A

A bank holds a proportion of deposits in reserve. The portion that is not required (excess reserves) to be held can be loaned out (process of lending, spending and depositing)

174
Q

Quantity Theory of Money

A

Quantity of money is some proportion of total spending in an economy

175
Q

Velocity

A

Average number of times per year each unit of money is used to buy goods or services

176
Q

Money Neutrality

A

Real variables (real GDP, velocity) are not affected by monetary variables (money supply and prices)

177
Q

Demand for Money

A

Amount of wealth that households and firms in an economy choose to hold in the form of money

178
Q

Transaction Demand

A

Money held to meet the need for undertaking transactions

179
Q

Precautionary Demand

A

Money held for unforeseen future needs (higher for large firms, increases with the size of the economy)

180
Q

Speculative Demand

A

Money that is available to take advantage of investment opportunities that arise in the future (inversely related to returns available in the market)

181
Q

Supply of Money

A

Determined by the central bank, independent of the interest rate (perfectly inelastic)

182
Q

Short Term Interest Rates

A

Determined by the equilibrium between money supply and money demand. If interest rate is above equilibrium rate, there is an excess supply of money, and securities will be purchased to reduce these balances. If interest rate is below equilibrium, excess demand for money, securities will be sold to increase money holdings

183
Q

Fisher Effect

A

The nominal interest rate is simply the sum of the real interest rate and the expected inflation. Real rates are relatively stable, changes in rates driven by changes in inflation

184
Q

Central Bank

A
  • Central banks have sole authority to supply money. Money is legal tender. Fiat money is not backed by any tangible asset
  • Banker to the government and other banks
  • Regulator and supervisor of payments system (impose risk taking standards, reserve requirements, clearing system)
  • Lender of last resort. Print money to supply banks in shortages
  • Holder of gold and foreign exchange reserves
  • Conductor of monetary policy (control inflation to promote price stability)
  • Full employment, stable exchange rates, moderate long term interest rates
185
Q

Menu Costs

A

Cost to businesses of constantly having to change their prices (result of high inflation)

186
Q

Shoe Leather Costs

A

Costs to individuals of making frequent trips to the bank so as to minimize their holdings of cash that are depreciating in value due to inflation

187
Q

Pegging

A

Countries choose a target level for the exchange rate of their currency with that of another country (USD)

188
Q

Perfectly Anticipated Inflation

A

Expected inflation and actual inflation match. Price of all goods and wages could be indexed to this rate to increase incrementally each month

189
Q

Unanticipated Inflation

A

Inflation that is higher or lower than expected inflation. Higher, borrowers gain at the expense of lenders. Lower, benefit lenders at the expense of borrowers. Volatile inflation means lenders require higher interest rates to compensate for uncertainty (reduces business investment). Supple and demand info becomes less reliable

190
Q

Policy Rate

A

Banks can borrow funds from the Fed if they have temporary shortfalls in reserves

191
Q

Discount Rate

A

Rate at which banks can borrow reserves from the Fed

192
Q

Repurchase Agreement

A

Central bank purchases securities from banks that, in turn, agree to repurchase the securities at a higher price in the future

193
Q

Federal Funds Rate

A

Rate that banks charge each other on overnight loans of reserves

194
Q

Reserve Requirements

A

Fed increases reserve requirement, decreases funds available for lending and the money supply, which increases interest rates (and vice versa)

195
Q

Open Market Conditions

A

Buying and selling securities by the central bank. When the central bank buys, cash replaces securities in investor accounts, banks have excess reserves, more funds available for lending, money supply increases, interest rates decrease

196
Q

Monetary Transmission Mechanism

A

Ways in which a change in monetary policy, specifically policy rate, affects the price level and inflation

  • short term lending rates increase in line with increase in policy rate (decrease agg demand)
  • asset prices in general decrease as discount rates applied to future expected cash flows increase (decrease in value of household’s assets decreases consumption)
  • consumers and businesses decrease consumption from expectations of future economic growth decrease
  • increase in interest rates attract foreign investment in debt, appreciation of domestic currency increases foreign currency prices and reduces exports
197
Q

Independence

A

Central bank must be free from political interference

198
Q

Operational Independence

A

Central bank is allowed to independently determine the policy rate

199
Q

Target Independence

A

Central bank also defines how inflation is computed, sets target inflation level and determines horizon over which target is to be achieved

200
Q

Inflation Reports

A

Central banks periodically disclose the state of the economic environment to increase transparency. Periodically report their views on economic indicators and other factors in setting rate policy

201
Q

Interest Rate Targeting

A

Increasing the money supply when specific interest rates rose above the target band and decreasing the money supply when rates fell below the target band

202
Q

Exchange Rate Targeting

A

Developing countries target a foreign exchange rate between their currency and another (USD) rather than targeting inflation. Value of domestic currency falls, use reserves to purchase their domestic currency (reduce money supply, increase interest rates)

203
Q

Real Trend Rate

A

Long term sustainable real growth rate (must be estimated). Changes over time as structural conditions of the economy change

204
Q

Neutral Interest Rate

A

Growth rate of the money supply that neither increases nor decreases the economic growth rate

205
Q

Bond Market Vigilantes

A

Money supply growth seen as inflationary, higher expected future asset prices will make long term bonds less attractive and increase long term interest rates

206
Q

Liquidity Trap

A

Demand for money becomes very elastic and individuals willingly hold more money even without a decrease in short term rates (economy experiencing deflation even though monetary policy has been expansionary)

207
Q

Quantitative Easing

A

Central bank buys assets (Treasuries, mortgages) to encourage bank lending and reduce longer term interest rates to generate excess reserves. Purchased securities with credit risk to improve bank balance sheets

208
Q

Discretionary Fiscal Policy

A

Spending and taxing decisions of a national government that are intended to stabilize the economy

209
Q

Automatic Stabilizers

A

Built in fiscal devices triggered by the state of the economy (tax receipts, unemployment insurance payments)

210
Q

Transfer Payments

A

Entitlement programs. Redistribute wealth by taxing some and making payments to others (Social Security, unemployment) –> Spending Tool

211
Q

Current Spending

A

Government purchases of goods and services on an ongoing and routine basis

212
Q

Capital Spending

A

Government spending on infrastructure (boost future productivity of the economy)

213
Q

Direct Taxes

A

Levied on income or wealth (income taxes, wealth taxes, estate taxes, etc.). Progressive taxes (income and wealth) generate revenue for income redistribution –> Revenue Tool

214
Q

Indirect Taxes

A

Levied on goods and services (sales, VAT, excise). Can be used to reduce consumption of goods and services (alcohol, tobacco, gambling)

215
Q

Horizontal Equality

A

People in similar situations should pay similar taxes

216
Q

Vertical Equality

A

Richer people should pay more in taxes

217
Q

Multiplier Effect

A

Those whose incomes increase from govt spending will increase their spending, which increases incomes and spending of others

218
Q

Fiscal Multiplier

A

Determines the potential increase in aggregate demand resulting from an increase in government spending

219
Q

Ricardian Equivalence

A

If taxpayers reduce current consumption and increase current savings by just enough to repay the principal and interest on the debt the govt issued to fund the increased deficit, no effect on aggregate demand

220
Q

Debt Ratio

A

Ratio of aggregate debt to GDP. Will increase over time if the real interest rate on govt’s debt is higher than the real growth rate of the economy (keeping tax rates constant)

221
Q

Crowding Out Effect

A

Government borrowing causes interest rates to increase and is taking place instead of private sector borrowing

222
Q

Recognition Lag

A

Discretionary fiscal policy decisions made by political process, and it may take policymakers time to recognize the nature and extent of economic problems

223
Q

Action Lag

A

Time govt takes to discuss, vote on and enact fiscal policy changes

224
Q

Impact Lag

A

Time between enactment of fiscal policy changes and when impact of the changes on the economy actually takes place

225
Q

Structural Budget Deficit

A

Cyclically adjusted. Deficit that would occur based on current policies if the economy were at full employment

226
Q

Imports

A

Goods and services that firms, individuals and governments purchase from producers in other countries

227
Q

Exports

A

Goods and services that firms, individuals and governments from other countries purchase from domestic producers

228
Q

Autarky

A

Closed economy. Country that does not trade with other countries

229
Q

Free Trade

A

Government places no restrictions or charges on import and export activity

230
Q

Trade Protection

A

Government places restrictions, limits or charges on exports or imports

231
Q

World Price

A

Price of a good or service in world markets for those to whom trade is not restricted

232
Q

Domestic Price

A

Price of good or service in the domestic country, may be equal to the world price if free trade is permitted

233
Q

Net Exports

A

Value of a country’s exports minus the value of its imports over the same period

234
Q

Trade Surplus

A

Net exports are positive. Value of goods and services a country exports greater than the value of goods and services it imports

235
Q

Trade Deficit

A

Net exports are negative. Value of goods and services a country exports less than the value of goods and services it imports

236
Q

Terms of Trade

A

Ratio of an index of the prices of a country’s exports to an index of the prices of its imports expressed relative to base value of 100

237
Q

Foreign Direct Investment

A

Ownership of productive resources (land, factories, natural resources) in a foreign country

238
Q

Multinational Corporation

A

Firm that has made foreign direct investment in one or more foreign countries, operating production facilities and subsidiaries in foreign countries

239
Q

Gross National Product

A

Total value of goods and services produced by the labor and capital of a country’s citizens

240
Q

Absolute Advantage

A

Can produce a good at a lower resource cost than another country

241
Q

Comparative Advantage

A

Has a lower opportunity cost in the production of that good, expressed as the amount of another good that could have been produced instead

242
Q

Production Possibility Frontier

A

Country specializes and increases production of an export good, increasing costs will increase opportunity cost of the good. Shows all combinations of two goods an economy can produce

243
Q

Ricardian Model of Trade

A

Only one factor of production (labor). Source of differences in production costs is difference in labor productivity dure to differences in thecnology

244
Q

Hecksher-Olin Model

A

Two factors of production (capital and labor). Source of comparative advantage is differences in relative amounts of each factor. The country with more capital will specialize in the capital intensive good and trade for the less capital intensive good. Good that the country imports will fall in price and good that a country exports will rise in price

245
Q

Infant Industry

A

Protection from foreign competition is given to new industries to give them an opportunity to grow to an internationally competitive scale

246
Q

National Security

A

Even if imports are cheaper, might be in country’s best interest to protect producers of goods crucial to country’s national defense

247
Q

Dumping

A

Preventing foreign imports at less than their cost of production

248
Q

Tariffs

A

Taxes on imported good collected by the government. Increases the domestic price, decreases quantity imported, increases quantity supplied domestically

249
Q

Quotas

A

Limits on the amount of imports allowed over some period. Domestic producers gain, domestic consumers lose

250
Q

Export Subsidies

A

Government payments to firms that export goods

251
Q

Minimum Domestic Content

A

Requirement that some percentage of product content must be from the domestic country

252
Q

Voluntary Export Restraint

A

Country voluntarily restricts amount of a good that can be exported (avoid tariffs or quotas)

253
Q

Quota Rents

A

Domestic govt doesn’t charge for import licenses, amount gained by foreign exporters who receive import licenses

254
Q

Deadweight Loss

A

Amount of lost welfare from the imposition of the quota or tariff

255
Q

Voluntary Export Restraint

A

Voluntary agreement by a government to limit the quantity of a good that can be exported (protect domestic producers)

256
Q

Export Subsidies

A

Payments by a government to its country’s exporters. Benefit exporters of the good, but increase prices and reduce consumer surplus in exporting country

257
Q

Capital Restrictions

A

Flow of financial capital across borders. Outright prohibition of investment in domestic country by foreigners, prohibition of or taxes on income earned on foreign investments by domestic citizens, etc. Decrease economic welfare

  • Reduce volatility of domestic asset prices
  • Maintain fixed exchange rates
  • Keep domestic interest rates low
  • Protect strategic industries
258
Q

Free Trade Areas

A

All barriers to import and export of goods and services among member countries are removed (NAFTA)

259
Q

Customs Union

A
  • Barriers to import and export of goods and services among member countries removed
  • countries adopt a common set of trade restrictions with non-members
260
Q

Common Market

A
  • Barriers to import and export of goods and services among member countries removed
  • countries adopt a common set of trade restrictions with non-members
  • barriers to movement of labor and capital goods among member countries removed
261
Q

Economic Union

A
  • Barriers to import and export of goods and services among member countries removed
  • countries adopt a common set of trade restrictions with non-members
  • barriers to movement of labor and capital goods among member countries removed
  • member countries establish common institutions and economic policy for the union (EU)
262
Q

Monetary Union

A

-Barriers to import and export of goods and services among member countries removed
-countries adopt a common set of trade restrictions with non-members
-barriers to movement of labor and capital goods among member countries removed
-member countries establish common institutions and economic policy for the union
-member countries adopt a single currency (eurozone)
Individual countries give up ability to set monetary policy, they all participate in determining monetary policy

263
Q

Balance of Payments

A

Adjustment for changes in foreign debt to the domestic country and domestic debt to foreign countries must balance each other

264
Q

Current Account

A

Measures the flows of goods and services (merchandise and services, income receipts, unilateral transfers)

265
Q

Capital Account

A

Capital transfers and the acquisition and disposal of non-produced, non-financial assets

266
Q

Financial Account

A

Records investment flows (govt owned assets abroad, foreign owned assets in the country)

267
Q

Merchandise and Services

A

Raw materials and manufactured goods bought, sold or given away. Tourism, transportation, business and engineering services, fees from patents and copyrights

268
Q

Income Receipts

A

Foreign income from dividends on stock holdings and interest on debt securities

269
Q

Unilateral Transfers

A

One way transfers of assets (money received from those working abroad), direct foreign aid (donor nation account debited)

270
Q

Capital Transfers

A

Debt forgiveness and goods and financial assets migrants bring when they come or take with them when they leave. Gift and inheritance taxes, death duties

271
Q

Non-financial Assets

A

Rights to natural resources, patents, copyrights, trademarks, franchises, leases

272
Q

Govt. Owned Assets Abroad

A

Gold, foreign currencies, foreign securities, reserve position in IMF, credits and long term assets, direct foreign investment, claims against foreign banks

273
Q

Foreign Owned Assets in the Country

A

Domestic government and corporate securities, direct investment in domestic country, domestic currency, domestic liabilities to foreigners reported by domestic banks

274
Q

Current Account Deficit

A

Imports more than exports. Net surplus in capital and financial accounts

275
Q

World Bank

A

Source of financial and technical assistance to developing countries around the world. Low interest loans, interest free credits, grants

  • International Bank for Reconstruction and Development (IBRD)
  • International Development Association (IDA)
276
Q

World Trade Organization

A

Ensure that trade flows as smoothly, predictably and freely as possible. Interprets agreements and commitments

277
Q

Exchange Rate

A

Price or cost of units of one currency in terms of another (Price Currency in terms of Base Currency)

278
Q

Direct Quote

A

From point of view of an investor in the price currency country

279
Q

Indirect Quote

A

Point of view of the investor in the base currency country

280
Q

Nominal Exchange Rate

A

Exchange rate at a point in time

281
Q

Real Exchange Rate

A

Cost of purchasing same unit of goods based on new (current) exchange rate and relative changes in the price levels of both countries

282
Q

Spot Exchange Rate

A

Currency exchange rate for immediate delivery (exchange of currencies takes place 2 days after the trade)

283
Q

Forward Exchange Rate

A

Currency exchange rate for an exchange to be done in the future (30 days, 60 days, 90 days, 1 year). Agreement to exchange specific amount of one currency for specific amount of another

284
Q

Forward Currency Contract

A

Reduces or eliminates foreign exchange risk associated with currency transactions

285
Q

Hedging

A

Firm takes a position in the foreign exchange market to reduce an existing risk

286
Q

Speculative

A

Transaction in the foreign exchange market increases currency risk

287
Q

Sell Side

A

Primary dealers in currencies and originators of forward foreign exchange contracts

288
Q

Buy Side

A

Many buyers of foreign currencies and forward contracts

289
Q

Real Money Accounts

A

Mutual funds, pension funds, insurance companies and other institutional accounts not using derivatives

290
Q

Leveraged Accounts

A

Firms using derivatives (hedge funds), firms that trade for their own accounts

291
Q

Cross Rate

A

Exchange rate between two currencies implied by their exchange rates with a common third currency (when there is no active FX market in the currency pair)

292
Q

Interest Rate Parity

A

Percentage difference between forward and spot exchange rates is approximately equal to difference between two countries’ interest rates (no arbitrage relation)

293
Q

Forward Discount/Forward Premium

A

Calculated relative to the spot exchange rate. Percentage difference between the forward price and the spot price (for the base currency)

294
Q

Formal Dollarization

A

Country can use the currency of another country. cannot have its own monetary policy or create currency

295
Q

Currency Board Arrangement

A

Explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate

296
Q

Conventional Fixed Peg Arrangement

A

Country pegs its currency within margins of +-1% versus another currency or basket that includes currencies of major trading or financial partners

  • Direct Intervention: maintain exchange rates within band by buying or selling foreign currencies in forex market
  • Indirect Intervention: change interest rate policy, regulation of forex transactions
297
Q

Target Zone

A

Pegged exchange rates within horizontal band permit fluctuations in currency valuation relative to another currency (wider band than conventional)

298
Q

Passive Crawling Peg

A

Exchange rate is adjusted periodically to adjust for higher inflation versus the currency used in the peg

299
Q

Active Crawling Peg

A

Series of exchange rate adjustments over time is announced and implemented. Can influence inflation expectations

300
Q

Crawling Bands

A

Width of the bands that identify permissible exchange rates is increased over time. Transition from a fixed peg to a floating peg

301
Q

Managed Floating Exchange Rates

A

Monetary authority attempts to influence the exchange rate in response to specific indicators such as BOP, inflation rates, employment, No target exchange rate or predetermined exchange rate path

302
Q

Independently Floating

A

Exchange rate is market determined, foreign exchange market intervention is used only to slow the rate of change and reduce short-term fluctuations

303
Q

Elasticities Approach

A

Impact of exchange rate changes on the total value of imports and on the total value of exports (import or export demand is elastic)

304
Q

Absorption Approach

A

View the effects of a change in exchange rates on capital flows rather than on goods flows

305
Q

Marshall-Lerner Condition

A

The condition in which a depreciation of the domestic currency will decrease a trade deficit

306
Q

J-Curve

A

The short-term increase in the deficit resulting from initial currency depreciation, followed by a decrease when the Marshall-Lerner condition is met

CFA Level 1 (7 decks)

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