Micro and Macro Economics

Economic Rent – Surplus of input over next highest bidder for unique good, person, or service
Demand Elasticity – (% Change in qty demanded) / (% Change in price)

Supply Elasticity - (% Change in qty supplied) / (% Change in price)

• Horizontal lines with lowest slope are most elastic

Elasticity of 1 or greater = Elastic

Elasticity between 0 and 1 = inelastic (0 being perfectly inelastic)

Increase in Demand and Supply

• Increases output
• Indeterminate change in price

Increase in Demand and decrease in Supply

• Increases market price
• Indeterminable effect on output

Indifference Curves - cannot intersect, are sloped negatively, and are convex to the origin.
Graphs combos of products that would yield consumer equal utility.

Budget Constraint Lines – Shift with income increases to the right (Note: indifference curves
DO NOT shift with increse in income)
Normal Profit = profit necessary to motivate investors to enter and remain in an industry; in
other words, the cost of resources (total return on investment) from an economic perspective. i.e.
– the required rate of return!

Economic Profit = Total revenue (-) Total costs (including opportunity costs!)

Economic Costs = Sum of all implicit and explicit costs

Net Income -> always greater than economic profit since doesn’t consider opportunity costs

Relationship- Normal profit is an implicit cost used to calculate economic profit; economic profit
is the excess return after normal profit is considered

Concentration Ratio = % of total market sales due to the four largest producers.
• High ratios indicate a monopoly

Cartels = oligopoly form, main goal is to limit output and thus increase prices

Monopoly Profit maximization point -> MR = MC, unless price falls below AVC (production
ceases completely in this case)

Pure Competition -> Price = Marginal Revenue = Marginal Costs

Monopolistic Competition -> large number of sellers, differentiated products, relatively easy
entry and exit, considerable non-price competition, and some price controls
MACROECONOMICS

GDP = Value of all goods and services produced within a country

• Output (Income & Cost) Approach The sum of wages, interest, rent, profits, depreciation, and indirect business
taxes.
• Input (Expenditure) Approach The sum of consumption, investment, government expenditures, and net
exports.

GNP = Value of all goods services produced by a country (not necessarily w/in its borders)

NDP = GDP (-) depreciation

National Income = NDP plus a country's net income earned abroad less indirect business taxes

Personal Income =
National income
(+) Transfer Payments
(+) S.S. Distributions
(-) Undistributed Corp profits
(-) Corp income taxes
(-) S.S. Contributions
Personal Income

Disposable Income = Personal Income (-) Personal Income taxes

Classic Economic Theory -> Unemployment does not exist in long-run due to wage
adjustments. Full employment is equilibrium. Flexible interest rates allow self-correcting for
saving vs. investing.

Keneysian Economics (assumptions)

• Downward Price Inflexibility Price flexibility doesn't ensure full employment because wage rates are not
lowered readily.
• Savings vs. Investment Understanding changes in levels of income is dependent on distinguishing between
savings and investment functions.
• Equilibrium Full employment is not necessarily an attribute of equilibrium.

Production Possibility Frontier

Shift to the right– increase in output due to more resources or tech

Inflation – Prices of goods will increase

Investment Categories
1. Residential Construction
2. Inventories
3. PP&E (less depreciation, a.k.a. “capital consumption allowance”)

The multiplier effect is that any increase in autonomous investment, consumption, or

government spending results in a multiplied increase in national income.
• Same money being spent multiple times, based on marginal propensity to save
• Multipliter coefficient = (1 / MPS)
• Change in National Income due to change in spending is (1 / MPS) x spending change

Supply-Side Economics – Tax cuts will stimulate economy by increasing aggregate demand and
investment. Tax revenues will maintain constant due to increased activity. Does not believe
increase in money supply leads to inflation.

Discount Rate – Rate charged to banks by the Fed for loans

Prime Rate – Rate banks charge to their best customers
Federal Funds Rate – Rate banks charge to each other for overnight lending
Reserve Ratio – Example: a 10% ratio
• $1m increase in reserve = $10m increase in demand deposits
• $1m increase in demand deposits requires $100K increase in reserves

Fed purchasing U.S. Govt Debt -> Increases money supply, expansionary policy (effectively
lowers interest rates)

Fed Sale of Govt Debt -> Decreases money supply by removing money from circulation
(effectively raises interest rates)

Unemployment Types
• Frictional – Naturally occurs when people are switching jobs. Keneysian
economics assumes this to be true.
• Structural – i.e. there are too many engineers and too few accountants
o Mismatches can occur in terms of skills, occupations, industries, or
geographic locations.
• Cyclical – Aggregate demand is lower than aggregate labor supply in economic
downtimes

Taxes
• Direct Direct taxes include sales taxes, income taxes, and the property taxes that property owners pay. For
example, income taxes are paid by (or withheld from) an entity directly.
• Indirect Indirect taxes are hidden in forgone income or compliance costs. Although the employer's share of
Social Security and unemployment taxes are paid by employers, this is an indirect tax on employees; employers base
the decision to hire employees on the whole compensation cost, including what is required to be paid in Social
Security taxes.
• Proportional Entities pay the same proportion regardless of income (or wealth).
• Progressive Entities with higher income (or wealth) pay more tax as a proportion of income (or wealth) than
entities with low income (or wealth).
• Regressive Entities with higher income (or wealth) pay less tax as a proportion of income (or wealth) than
entities with low income (or wealth).

Federal Budget Deficit = The excess of federal government spending over revenues in one year
Transfer Payments – Redistribute wealth and aggregate demand among private sector

Classic Economic Model

• Equilibrium @ full employment
• Self-regulating MKT
• Unsold INV = decrease in prices
• All savings invested due to flexible interest rates
• Competition btw workers eliminates unemployment
• Planned saving/investing depends entirely on interest rates

Keynesian Model
• Unemployment can exist @ equilibrium
• Govt is responsible for correcting a recession
• Consumer’s saving habits based on income
• Investing -> Profit Expectations are most important in determining

Consumption & Savings (disposable income, ‘DI’, either spent or saved)

• As DI increases, consumption increases, but not as much as income increases
• As DI decreases, consumption decreases, but not as much as income decreases

Marginal Propensity to Consume (MPC)

• = change in consumption spending / change in disposable after-tax income
• 0 < MPC <1

Marginal Propensity to Save

• Change in planned saving to change in DI
• MPC + MPS = 1

Multiplier Effect (k)

• Relationship between a change in aggregate expenditure and the resulting larger change
in national output or income
• Explains why: A small change in investment can have a much larger impact on gross
domestic product
• k = 1 / MPS = 1 / (1 – MPC)
• The larger the MPC, the larger the multiplier, and vice versa

Money Supply
M1 Money Stock
• Most liquid def of money includes currency, traveler’s checks, and demand deposits
• Currency = paper money and coins

M2 Money Stock = Sum of M1 +……

• Savings deposits
• CD’s
 • Money Market funds
M3 Money Stock = Sum of M2 +……
• Large negotiable CD’s
• Eurodollars: US dollars deposited in foreign banks and outside US jurisdiction

Money Multiplier = (1 / Reserve Ratio)

Fed Implications on Money Supply

• Purchase of securities on open MKT -> EXPANSION of MS
• Increases excess reserves
• Sale of securities on open MKT -> CONTRACTION of MS
• Decreases excess reserves

Excess Reserves = bank reserves over legally established required reserves

Low Reserve Req -> during recession

High Reserve Req -> during full employment, decreases banks ability to inc MS

Discount Rate = Rate at which banks borrow from the Fed

• Used to replenish reserves
• Low discount rate = Fed want to encourage expansion of MS

Prime Rate = Rate which individuals and firms w/best collateral can borrow from commercial
banks

INTERNATIONAL MONEY

Absolute Advantage = produce a good using fewer total resources than other producers
Comparative Advantage = produce at lower opportunity cost than other producers face. TIP:
look at output per each unit of input and divide outputs
• Only 1 country (in 2 country economy) can have comparative advantage for a good
• Should specialized and produce the comparative advantage item exclusively

Managed Float = hybrid of fixed/floating exchange rate (limited govt intervention)

Forward Exchange Markets

• Spot = rate paid now
• Forward = future contract
• Premium: Forward rate > Spot; MKT expects currency’s value to increase
• Discount: Forward < Spot; MKT expects currency to decline in value

Interest Rates
• Premium: If domestic rate > foreign rates, forward sells @ premium (DFP)
• Discount: If domestic rate < foreign rates, forward sells @ discount (FDD)
Balance of Payments (sum of…)
Current Account = Imports (dr.) less exports (cr.), of goods AND services
Net interest & divs (paid = export [cr]; rec = import [dr.]
Net unilateral transfers (paid = export [cr])
Balance of Trade = Imports (dr.) – Exports (cr.), excludes services
• ***excludes services***
Capital Account
• Results from the exchange of fixed or financial assets

Import Quota = Limit on imports (quantity)

Tariff = Tax on imports (protects domestic producers, hurts domestic consumers)

Subsidies = govt pays domestic producers to export overseas

• Increases effective price that domestic producers receive

Options
Buying Options = Hedges your receivable
Selling Options = Does not hedge receivable