To socialize
spread an individual’s cost/value to the society at large
Karl Marx
founder of socialism, “from each, according to his ability, to each, according to his need”
Original rational of socialism
firms have more power than individuals, so they exploit workers, fairness by eliminating the class system
Modern rational of socialism
must socialize individual decisions by state force in order to counter nature’s socializing effects- externalities- some costs spill over to others
Externalities
polluting firm imposes costs on people but doesn’t pay those costs
______ decision makers _____ for others based on their own assessments of _____ & ______
Authoritarian, choose, values, costs
State’s response that won’t maintain socialist order
Allow individual choice
State response that will maintain socialist order
The use of force and threat
Fascism
State does not take title of property, but orders the use of that property and the individual in any way it wishes- no title but threat of force
Eminent Domain
when property is taken for state use (roads), but the owner is compensated- now used for commercial buildings- spreading private costs
Civil forfeiture
When a person is suspected of a crime and that person’s property is seized because it is automatically suspected as having contributed to the crime
In socialism, who gets what, who does what, and which stuff is produced?
Authorities decide
In a market society, who gets what?
People get based on the value of their production (income), and based on the value of goods and services
In a market society, who does what?
Individuals choose based of tastes.
In a market society, which stuff is produced?
The things people demand.
In capitalist view,
society’s best interest is promoted by individuals with property rights making voluntary decisions
Incentive problem of socialism
Socialism divorces production from consumption, which takes the incentive to voluntarily serve
Money
anything that is generally acceptable in making exchanges
Barter
trading without the use of widely accepted means of exchange (money)
Double coincidence of wants
to exchange with barter there must exist both mutual wants
What is a commodity?
money that has other uses
What is fiat money?
Money that doesn’t have any other use- by law
Commodities that evolved into money
labor- original mean of exchange, cigarettes in jails, salt, sugar, copper, gold
3 functions of money
medium of exchange, unit of account, store of value
A medium of exchange happens when a good is _____/_____ for exchange.
acceptable, convenient
Unit of account
each unit is worth the same
Store of value
Retains value over time
M1 is the sum of:
paper currency held outside banks plus checking account balances plus traveler’s checks
Monetary policy
The Fed uses the money supply to affect the economy
The federal Open Market Committee
conducts monetary policy
3 tools of monetary policy
Open Market Reservations, Required reserve ratio, Discount rate
Open Market reservations
buying and selling US government bonds from individuals
When more bonds are bought the money supply ____.
Increases
When bonds are sold, the money supply _____.
Decreases
Required Reserve Ratio
Percent of deposits banks can lend out
With a _____ reserve ratio, banks can lend ____.
lowered, more
Which tool of the Fed is seen as dangerous:
Required reserve ratio
Discount rate
when a bank borrows from the fed, it pays an interest rate
The Fed prefers to use which tool?
Open Market Operations
The value of the dollar in the domestic economy depends on
how many and which goods and services it will buy
Consumer Price Index (CPI)
Measures prices of 200 goods that a typical consumer buys- most cited price measure
Formula of CPI
cost in market in focal period/ cost in base period
Inflation % formula
CPInew/CPIold - 1
Equation of Exchange
shows the relationship between prices and the money supply (MV=PQ)
Simple Quantity Theory
begins with equation of exchange, has 2 observations, assumes that output & velocity are constant- M & P are proportionally related
2 Observations of the Simple Quantity Theory
output is limited, velocity is limited
Monetarism
Friedman, begins with equation of exchange then softens the assumptions of the simple quantity theory
Assumptions of Monetarism
velocity is predictable and stable, economy has a potential that it tends to move toward
If all prices in economy double, should you produce more/less/same?
Same
Unanticipated inflation
your wealth increases, the seller’s wealth decreases (buyers gain, lenders lose)
Nominal interest rate
real rate plus expected inflation, the rate that is advertised
Real interest rate
how much inflation actually is
Helicopter Drop results
At the beginning, production increases but after time, output is same and prices have risen proportionally.
Secured loans
loan with an asset backing (a house)
Unsecured loans
not backed (credit card)
Uneven inflation
some prices rise faster than others- can’t tell about value of goods, services, and resources
Result of uneven inflation
Stagflation- (inefficiency, unemployment)
A Bubble is formed when…
created money accumulates in some places (housing)
Monetizing the debt
the Fed can assist government in borrowing
Inflationary tax
government is the biggest borrower, so they like inflation- outstanding bonds are easier to pay off
Gold standard historically
with the gold standard, the inflation can’t really change- 0% inflation. After the Fed went off the gold standard, inflation rose to 4%.
Direct finance
a borrower who deals directly with the lender, saver directly to borrower
Maturity
date the payment will be made to the lender
Face value
the value paid at maturity
Zero coupon bond
US government bonds and some corporate bonds- NO INTEREST
Coupon rate
interest rate quoted on bond
Indirect finance
when individuals and businesses use middle men such as banks for borrowing and lending
Financial intermediaries, such as banks,:
1) Spread the risk of non-payment
2) develop comparative advantages in credit evaluation and collection
3) divide denominations of loans
4) Match up time preferences
Usury law
puts a ceiling on rates
When the Fed is active…
Supply increases and there is a social loss`
When people are optimistic…
demand increases, causing a rise in the interest rate and equilibrium moves right
Indirect crowding out
when an increase in government spending is financed through borrowing, private spending decreases due to rising interest rates
Super crowding out
Less output occurs when the government spends more but with the threat of force (marijunana or gambling in GA)
Direct crowding out
When the government spends more, private markets spend less because their ability to spend is taxed away
Leveraged buyout
an extreme example of a financial transaction that creates value- where a firm borrows in order to purchase another firm, then immediately sells the firm in whole or in parts—good for economy- resources move to those who can better use them
Insolvent bankruptcy
a firm whose value is negative (owes more than it owns)—Shred it and sell it
Illiquid bankruptcy
Cannot pay it’s immediate obligations- not enough cash to pay current debts (hostess twinkies, GM)
Absolute priority rule
courts are supposed to follow this, by which the creditors are ranked with regard to how long ago the company became indebted to them, that every penny is paid to the senior debt before any less senior debt is paid
Community Reinvestment Act
Instructed banks to make loans to poor people
Nonconforming laws
Directed the FMs to purchase loans that banks made to risky borrowers who could not meet the old standards
The US poverty rate is about
a. 7%
b. 16%
c. 24%
d. 36%
B
- If the required reserve ratio is .25 and the Fed sells $100 B in government bonds, then throughout the banking system, then the money supply
a. rises by $25 B
b. falls by $25 B
c. rises by $400 B
d. falls by $400 B
C
- Which is not an assumption of monetarism?
a. the equation of exchange holds
b. velocity is a stable function of a few variables
c. eventually output is at its potential
d. all of the above are assumptions of monetarism
e. none of the above is an assumption of monetarism
D
- In the helicopter drop story
a. in the short run an increase in the money supply can increase output
b. in the short run an increase in the money supply cannot increase output
c. in the long run an increase in the money supply increases prices proportionally
d. a and c
e. b and c
D
- With unanticipated inflation
a. those with significant long term contracts to pay for goods or services see their wealth rise
b. those with significant long term contracts to pay for goods or services see their wealth fall
c. those with long term contracts to pay for goods or services are not affected
d. the outcome is uncertain, either a or b could happen
A
- If people become more optimistic about the growth of their future incomes then
a. interest rates fall
b. interest rates rise
c. the supply of loanable funds falls
d. the supply of loanable funds rises
B
- Bastiat says that Ariste’s savings
a. kills jobs
b. is another way of spending
c. deprives the poor since he is not giving to charity
d. is short-sighted
B
- In the 1990s and the 2000s, Fannie Mae did not care if homeowners defaulted on mortgage loans because
a. every time a loan defaulted, the U. S. government compensated the lender
b. with higher housing prices, foreclosed homes could be sold for more than the debt
c. they were a government agency that used tax dollars to finance their daily operations
d. the loans were really just paper instruments that did not have a real value
B