Shalom's AP Econ Blog

Balance Sheet: summarizes the financial position of the bank at a certain time Assets = Liabilities How do banks create money? Banks create money by lending out deposits Fractional Reserve Banking System: the bank holds a fraction of the total money supply in reserves as currency                       Where do the loans come from? Loans come from people who make deposits.          Money Market: the market where the fed and the users of money interact thus determining the nominal interest rate. Money demand comes from households, firms, the government, and foreign sector.  Money supply is determined only by the federal reserve because the fed has a monopoly over the supply of money, and for this reason the MS curve is vertical  MS is also vertical because it is independent of the interest rate  OMO: the Fed can buy or sell bonds to the bank or the pu...

Fiscal Policy: changes in the expenditures or tax revenues of the federal government. Two Tools of Fiscal Policy Taxes - government can either increase or decrease Spending - government can increase or decrease If the government increases taxes, they must decrease spending. If the government increases spending, they must decrease taxes.  Fiscal policy is enacted to promote our national economic goals: full employment, price stability, economic growth Deficits, Surpluses, and Debt Balanced budget: revenues = expenditures Budget deficit: revenues < expenditures Budget surplus: revenues > expenditures Government debt: sum of all deficits - sum of all surpluses  Government must borrow money when it runs into a budget deficit  Individuals Corporations Financial institutions Foreign entities or foreign governments Two Options for Fiscal Policy Discretionary Fiscal Policy Expansionary Fiscal Policy - think deficit ...

The Spending Multiplier Effect  an initial change in spending (C, IG, G, XN) causes a larger change in aggregate spending, or Aggregate Demand (AD).  multiplier = change in AD/change in spending change in AD/change in C, IG, G, or XN) why this happens: expenditures and income flow continuously which sets off a sending increase in the economy the spending multiplier can be calculated from the MPC or the MPS  multiplier = 1/1-MPC or 1/MPS multipliers are positive when there is an increase in spending and negative when there is a decrease The Tax Multiplier  when the government taxes, the multiplier works in reverse because now money is leaving the circular flow the tax multiplier is always negative  -MPC/1-MPC or MPC/MPS if there is a tax cut, then the multiplier is positive because there is now more money in the circular flow

Disposable Income: income after taxes or net income With disposable income, households can either - Consume (spend money on goods and services) - Save (not spend money on goods and services) Consumption Household spending The ability to consume is constrained by (the amount of disposable income, the propensity to save)  Do households consume of DI = 0? Yes. (autonomous consumption, dissaving) Saving Household is not spending The ability to save is constrained by (the amount of disposable income, the propensity to consume) Do households save DI = 0? No.  Formulas:  APC = Average Propensity to Consume, APS = Average Propensity to Save MPC = Marginal Propensity to Consume APC + APS = 1 1 - APC = APS 1 - APS = APC APC > 1 = Dissaving -APS = Dissaving MPC + MPS = 1 MPC = 1 - MPS MPS = 1 - MPC  MPC = change in consumption/change in DI (% of every extra dollar earned that is spent) the fraction of any change ...

Investment: Money spend or expenditures on things like new plants (factories), capital equipment (machinery), technology (hardware + software), new homes, and inventories (goods sold by producers) Expected Rates of Return How do businesses make investment decisions?  - Cost / Benefit Analysis How does business determine the benefits?  - The expected rate of return How does business count the cost?  - Interest costs How does business determine the amount of investment they undertake?  - Compare the expected rate of return to interest cost - If expected return > interest cost. then invest - If expected return < interest cost, then do not Real vs. Nominal Interest Rate What's the difference?  - Nominal is the observable rate of interest while real subtracts out inflation (π%) and is only known x post facto. Formula: r% = i% - π% What determines the cost of an investment decision? - The real interest rate (r%) ...