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Unemployment:
➔ Who are classified/identified as employed, unemployed, not in the labor
force, marginally attached to the labor force, and discouraged workers by
the statistical agencies?
◆ Employed : Individuals who have a job and are working for pay. ◆ Unemployed: Individuals without a job who are actively seeking employment. ◆ Not in the Labor Force : Individuals who are not employed and not actively seeking employment, such as retirees, students, and homemakers. ◆ Marginally Attached to the Labor Force : Individuals who are not actively seeking employment but have looked for a job in the past and are available for work. ◆ Discouraged Workers: Individuals who have stopped actively seeking employment because they believe there are no jobs available for them.
➔ Be sure to know how to calculate the following labor market statistics
using the available data: labor force, unemployment rate, civilian
noninstitutional population (adult population), labor-force participation rate,
and employment-population ratio.
◆ Labor Force (LF) ● The labor force includes all individuals who are employed or actively seeking employment ○ Formula: LF = E +U (where E is the number of employed individuals, and U is the number of unemployed individuals) ◆ Unemployment Rate (UR) ● The unemployment rate measures the percentage of the labor force that is unemployed ○ Formula: UR = U/LF x 100 (where U is the number of unemployed individuals, and LF is the labor force) ◆ Civilian Noninstitutional Population (CNP or Adult population) ● This represents the total number of people who are of working age and not in the military or institutionalized ● It includes both the employed and the unemployed ○ Employed + Unemployed + Not in the Labor force ◆ Labor Force Participation Rate: (LFPR) ● The labor force participation rate measures the percentage of the working-age population that is either employed or actively seeking employment ○ FormulaL LFPR = LF/CNP x 100 (where LF is the labor force, and CNP is the civilian noninstitutional population ◆ Employment-Population Ratio (EPR)
● The employment-population ratio measures the percentage of the working-age population is employed ○ Formula: EPR = E/CNP x 100 (where E is the number of employed individuals, and CNP is the civilian noninstitutional population)
➔ Be prepared to identify the changes in the labor market statistics after a
person’s labor market status changes.
◆ Entering Employment ● If a person moves from being unemployed to employed, it will: ○ Increase the number of employed individuals (E) ○ Decrease the number of unemployed individuals (U) ○ Increase the labor force (LF) ○ Potentially increase the employment-population ratio (EPR) ○ Potentially increase the labor force participation rate (LFRP) if the person was previously not in the labor force ◆ Becoming Unemployed: ● If a person transitions from employment to unemployment, it will:
○ Decrease the number of employed individuals (E)
○ Increase the number of unemployed individuals ( U ).
○ Increase the labor force ( LF ).
○ Potentially decrease the employment-population ratio
( EPR ).
○ Potentially increase the labor force participation rate
(LFPR).
◆ Entering/Exiting the Labor Force: ● If a person enters the labor force (e.g., a student graduating and seeking employment) or exits the labor force (e.g., retirement), it will:
○ Impact the civilian noninstitutional population ( CNP ).
○ Impact the labor force participation rate ( LFPR ).
○ Potentially impact the employment-population ratio ( EPR ).
◆ Changing from Not in the Labor Force to Unemployed: ● If a person who was not in the labor force starts actively seeking employment, it will:
○ Increase the labor force ( LF ).
○ Increase the number of unemployed individuals ( U ).
○ Potentially increase the unemployment rate ( UR ).
● Causes: It can result from technological changes, shifts in consumer demand, globalization, or changes in the structure of industries. ● Duration: Structural unemployment tends to be more persistent and can require longer-term policy solutions, such as retraining programs or education initiatives. ● Example: Workers in declining industries (e.g., traditional manufacturing) facing unemployment due to automation and a shift towards more technologically advanced industries
➔ What is the common argument about the role of unemployment insurance
(UI) in frictional unemployment? What does the evidence say?
● Positive Impact on Job Search: Proponents argue that UI can facilitate a more efficient job search process. By providing financial support to individuals while they search for suitable employment, UI allows workers to take the time necessary to find a job that is a better match for their skills and preferences. ● Reducing Pressure to Accept Inappropriate Jobs : UI may reduce the pressure on unemployed individuals to accept the first available job out of desperation. This can lead to better job matches, where individuals are more likely to find positions that align with their qualifications and career goals. ● Evidence: Mixed Findings on Duration of Unemployment: Research findings on the impact of UI on the duration of unemployment are mixed. Some studies suggest that UI may lead to longer unemployment spells, while others find little to no effect. Enhanced Job Matching: There is evidence that individuals receiving UI benefits may take longer to find a new job, but when they do, the job matches tend to be more suitable. This supports the idea that UI allows for better job matching. Moderate Impact on Overall Unemployment Rates: The overall impact of UI on the total unemployment rate is considered relatively modest, as frictional unemployment is only one component of the total unemployment.
➔ What are the benefits of UI?
◆ economic Stability: UI helps provide financial stability for individuals and families during periods of unemployment, reducing the risk of poverty and supporting overall economic stability.
◆ Consumer Spending: UI benefits can help maintain consumer spending, which is crucial for economic growth. Unemployed individuals receiving benefits are more likely to continue spending on essential goods and services. ◆ Social Stability: By mitigating the financial hardships associated with unemployment, UI contributes to social stability and helps prevent adverse consequences, such as homelessness and increased stress on social services. ◆ Job Search Quality: UI allows individuals to take the time needed for a more thorough and thoughtful job search, potentially leading to better job matches and increased productivity in the long run.
➔ Why do many economists think that minimum wage laws and unions cause
structural unemployment? Does the evidence support their claims?
◆ Minimum Wage Laws: ● Argument: Impact on Low-Skilled Workers - Critics argue that setting minimum wages above the market equilibrium can lead to unemployment, especially among low-skilled workers. When the minimum wage exceeds the value of their labor, employers may be reluctant to hire or retain them, leading to job losses. ● Argument: Reduced Entry-Level Opportunities - Some economists suggest that higher minimum wages may deter employers from hiring entry-level workers or those with limited skills and experience. This can hinder these individuals' ability to enter the workforce and gain valuable work experience. ● Argument: Automation and Outsourcing - Employers may respond to higher labor costs by investing in automation or outsourcing jobs to locations with lower labor costs, potentially leading to job displacement. ● Evidence on Minimum Wage: ○ Mixed Findings - Research on the impact of minimum wage laws is mixed. Some studies find little to no adverse employment effects, while others report negative effects, especially for low-skilled workers and certain industries. ○ Differences Across Industries and Regions - The impact of minimum wage increases can vary across industries and regions. In some cases, businesses may adapt without significant job losses, while in others, the effects may be more pronounced.
to job losses, as firms may be able to absorb the higher costs by reducing other expenses or improving worker productivity. ◆ Labor Market Dynamics : The labor market is dynamic, and various adjustments can occur in response to minimum wage changes, such as changes in prices, productivity, and the distribution of wages within a firm.
➔ What are efficiency wages and why would firms willingly pay their workers
higher wages than the market-clearing wages?
◆ Worker Productivity: Higher wages can motivate workers to be more productive, leading to increased efficiency and quality of work. Workers may feel more committed to their jobs when they are paid well. ◆ Reduced Turnover Costs : Paying higher wages can reduce turnover costs for firms by improving employee morale and reducing the likelihood of workers leaving for other opportunities. This can result in cost savings associated with recruitment, training, and disruptions in production. ◆ Worker Health and Morale : Higher wages can contribute to better worker health and morale, leading to lower absenteeism and higher job satisfaction. This, in turn, can enhance productivity. ◆ Firm Reputation: Paying higher wages may enhance a firm's reputation as an employer of choice, attracting high-quality workers. This can be particularly important in industries where skilled and motivated workers are crucial.
➔ What other reasons could be given to explain the lack of a sufficient
number of jobs (i.e., natural unemployment) in a capitalist economy?
◆ Mismatch of Skills: There may be a mismatch between the skills demanded by employers and the skills possessed by job seekers. This structural unemployment can result from changes in technology, shifts in consumer preferences, or inadequate training opportunities. ◆ Cyclical Unemployment: Economic downturns can lead to cyclical unemployment, where overall demand for goods and services decreases, and businesses reduce their workforce. This type of unemployment is generally temporary and related to fluctuations in the business cycle. ◆ Geographic Mobility Issues: Unemployment can arise if workers are unable or unwilling to relocate to areas with job opportunities. Geographic immobility can result from housing market constraints, family considerations, or other factors. ◆ Automation and Technological Changes : Advances in technology and automation can displace certain jobs, leading to unemployment in specific industries. Workers may need to acquire new skills to adapt to changing job requirements.
◆ Discouragement and Hidden Unemployment: Some individuals may become discouraged and drop out of the labor force altogether, leading to hidden unemployment that is not captured in official unemployment statistics.
Monetary System
➔ Define money and explain its functions.
◆ Money: a Medium of exchange that is widely accepted in transactions involving goods, services, or settlement of debts. It serves as a unit of account, a store of value, and a standard of deferred payment ◆ Functions of money: ● Medium of Exchange: Money facilitates the buying and selling of goods and services by serving as a common medium that everyone accepts in exchange for goods and services. ● Unit of Account: Money provides a common measure for valuing goods and services. Prices are expressed in terms of the monetary unit, making it easier to compare and measure value. ● Store of Value: Money allows individuals to store wealth in a convenient form. Unlike perishable goods, money can be held for future use or investment. ● Standard of Deferred Payment: Money enables agreements to be made for future payments. Contracts and loans can be denominated in money terms, providing a standard for future transactions.
➔ What is the difference between assets and liabilities? Give examples for
each.
◆ Assets: Assets are resources with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide future benefit. Examples include cash, stocks, real estate, and intellectual property. ◆ Liabilities: Liabilities are obligations or debts that an entity owes to others. They represent claims against an entity's assets. Examples include loans, mortgages, and accounts payable. ➔ What is money stock? ◆ Money stock: refers to the total amount of money circulating in an economy at a particular point in time. It includes various forms of money, such as currency, demand deposits, and other liquid assets
➔ How do economists measure the money stock in a typical economy?
influence the amount of money banks can create through the lending process. ➔ How does the Fed (the central bank in the US) influence the money supply? Specifically, explain a) how the Fed uses open-market operations to influence the money supply and b) how the Fed uses the interest rate on reserves to influence the money supply (a policy tool that it has started using since October 2008). ◆ The Fed influences the money supply and implements monetary policy through various tools ● Open market operations: ○ Definition: Open-market operations involve the buying or selling of government securities (such as Treasury bonds) in the open market. These operations influence the reserves in the banking system and, consequently, the money supply. ○ Buying Securities: ● If the Fed wants to increase the money supply, it buys government securities from banks and other financial institutions. ■ Adding Reserves: ● When the Fed purchases securities, it credits the sellers' bank accounts, increasing their reserves. Banks, in turn, have more money to lend, leading to an increase in the money supply. ■ Selling Securities: ● Conversely, if the Fed wants to decrease the money supply, it sells government securities to banks. This reduces the reserves of the buying banks, limiting their ability to lend and, thus, decreasing the money supply. ● b) Interest Rate on Reserves: ■ Definition: The Fed pays interest on reserves held by banks at the central bank. By adjusting this interest rate, the Fed can influence banks' decisions to hold excess reserves or lend in the open market. ■ Higher Interest Rate: ○ If the Fed raises the interest rate on reserves, banks are more inclined to keep excess reserves with the central bank rather than lending them in the market. This can reduce the money supply. ● Lower Interest Rate:
● Conversely, if the Fed lowers the interest rate on reserves, banks may prefer to lend in the market to earn higher returns, leading to an increase in the money supply. ➔ What is the federal funds rate (FFR)? How does the Fed influence the FFR? ◆ Definition: The federal funds rate is the interest rate at which banks lend to each other overnight in the federal funds market. It serves as a benchmark for many other interest rates in the economy ◆ Influence on FFR: ● The Fed influences the federal funds rate through its open-market operations. If the Fed wants to lower the federal funds rate, it buys securities, injecting money into the banking system. This increased supply of reserves lowers the interest rate at which banks lend to each other. ● Conversely, if the Fed wants to raise the federal funds rate, it sells securities, reducing the supply of reserves and causing the interest rate to rise. ➔ Explain why the Fed cannot fully control the money supply. ◆ Demand for Money: ● The Fed cannot fully control the demand for money, which is influenced by factors such as consumer preferences, economic conditions, and global events. ◆ Velocity of Money: ● The speed at which money circulates, known as the velocity of money, is beyond the Fed's direct control. Changes in the velocity of money can impact the effectiveness of monetary policy. ◆ Global Factors: ● Global economic conditions, exchange rates, and international capital flows can affect the money supply, and these factors are not directly controlled by the Fed. ◆ Financial Innovation: ● Financial innovations and changes in the structure of the financial system can also influence the effectiveness of traditional monetary policy tools. ➔ What is the difference between the liquidity and (in)solvency risk? ◆ liquidity Risk: ● Definition: Liquidity risk refers to the possibility that a financial institution may not have enough liquid assets (assets that can be quickly converted to cash) to meet its short-term obligations.
Insurance National Bank of Santa Clara. This is currently the biggest bank run in history. ➔ What is the leverage ratio? Why does it matter? ◆ Definition: The leverage ratio is a measure of a bank's capital adequacy and financial stability. It is calculated by dividing a bank's capital by its total assets. The leverage ratio is expressed as a percentage and provides insight into the proportion of a bank's assets that are funded by its capital, rather than by deposits or borrowed money. ◆ Formula: Leverage ratio = Tier 1 capital / Average Total Consolidated Assets ◆ WHy does this matter? ● Financial Stability: A higher leverage ratio indicates that a bank has more capital relative to its total assets, which can enhance its financial stability. This means the bank has a better buffer to absorb losses without jeopardizing its solvency. ● Risk Management: The leverage ratio serves as a risk management tool by limiting the degree to which a bank can rely on borrowed funds. It helps prevent excessive risk-taking and encourages banks to maintain a more conservative capital structure. ● Comparative Analysis: Investors, regulators, and the public use the leverage ratio to compare the financial health and risk profiles of different banks. It provides a standardized measure that can be applied across the industry.
➔ Why are banks considered to be important for the normal functioning of
the economies?
◆ intermediation Role: Banks act as intermediaries between savers and borrowers. They gather funds from depositors and channel them to borrowers, facilitating the efficient allocation of capital in the economy. ◆ Payment Services: Banks provide payment services that enable the smooth functioning of transactions within the economy. This includes facilitating electronic transfers, issuing checks, and providing credit and debit card services. ◆ Credit Creation: Through the fractional-reserve banking system, banks create credit by lending out a portion of the deposits they receive. This process supports economic growth by providing businesses and individuals with the funds needed for investment and consumption. ◆ Risk Management: Banks play a crucial role in managing and diversifying risks in the economy. They offer a variety of financial products, such as insurance and derivatives, to help businesses and individuals mitigate
risks associated with fluctuations in interest rates, currency values, and commodity prices. ◆ Monetary Policy Transmission: Central banks use banks as intermediaries to implement monetary policy. By influencing interest rates and the money supply, central banks can regulate economic conditions and control inflation. ◆ Financial Stability: Banks contribute to financial stability by providing a secure place for individuals and businesses to hold their money. The presence of a well-regulated banking sector helps maintain public confidence in the financial system. ◆ Economic Growth: Access to credit and financial services from banks supports entrepreneurship, innovation, and investment, fostering economic growth and development.
Open-Economy Macroeconomics: Basic Concepts
➔ Define net exports and net capital outflow. What is the relationship between these two variables? ◆ Net Exports (NX) ● Represents the difference between a country’s exports and imports of goods and services ● Calculated as follows: ○ NX = Exports - Imports ◆ If a country exports more than it imports, it has a trade surplus, and if it imports more than it exports, it has a trade deficit ◆ Net Capital Outflow (NCO) ● Measures a country’s total capital outflow minus its total capital inflow. It reflects the net flow of a country's financial capital to the rest of the world. ● The formula ○ NCO = CapitalOutflow - CapitalINFlow ◆ Positive net capital outflow indicates that a country is investing more in foreign assets that foreigners are investing in the country;s assets, while negative net capital outflow suggests the opposite ◆ The relationship between the both of them ● There is a relationship between net exports and net capital outflow, and it is described by the saving-investment identity. The identity states that a country's net exports (NX) is equal to its net capital outflow (NCO).
● Definition: FPI involves the purchase of financial assets (such as stocks or bonds) in a foreign country, without obtaining a significant degree of control over the company or assets in which the investment is made. ● Impact on NCO : FPI also contributes to net capital outflow, but it is considered more short-term and can be more easily liquidated compared to FDI. ➔ What factors influence net exports and net capital outflow? ◆ interest Rates: ● Impact on NCO: Higher interest rates in a country can attract foreign capital seeking better returns, leading to an increase in net capital outflow. ◆ Economic Growth Rates: ● Impact on Net Exports: Higher economic growth in a country often leads to increased consumption and, potentially, increased imports. ● Impact on NCO: Economic growth can also influence the level of investment, affecting net capital outflow. ◆ Exchange Rates: ● Impact on Net Exports: The exchange rate between two currencies affects the competitiveness of a country's goods and services in international markets. ● Impact on NCO: Exchange rate movements can influence the attractiveness of foreign assets, impacting net capital outflow. ◆ Government Policies: ● Impact on Net Exports: Trade policies, such as tariffs and subsidies, can affect a country's net exports. ● Impact on NCO: Government policies on taxation, regulation, and incentives can influence both foreign direct and portfolio investments. ◆ Consumer and Business Confidence: ● Impact on Net Exports: Confidence levels influence spending patterns, affecting imports and exports. ● Impact on NCO: Confidence also plays a role in investment decisions, influencing net capital outflow. ◆ Political Stability and Risk: ● Impact on Net Exports: Political stability affects a country's attractiveness for trade partners. ● Impact on NCO: Investors often seek stable environments, so political stability can influence net capital outflow.
◆ Global Economic Conditions: ● Impact on Net Exports: The overall state of the global economy can affect demand for a country's exports. ● Impact on NCO: Global economic conditions, including interest rates and investor sentiment, can influence net capital outflow.
➔ Define nominal (e) and real exchange rates (eP/P∗).
◆ Nominal Exchange Rate (e) ● The nominal exchange rate, denoted as e , is the rate at which one country's currency can be exchanged for another country's currency. It represents the relative value of two currencies and is expressed as the amount of foreign currency one unit of the domestic currency can buy. The formula for the nominal exchange rate is: ○ E = Foreign Currency / Domestic Currency ◆ Real Exchange rates ● The real exchange rate, denoted as e p/p* takes into account the relative price levels between two countries.
➔ What do the depreciation and appreciation of a currency mean?
◆ Depreciation: ● Definition: Depreciation of a currency occurs when its value decreases relative to other currencies in the foreign exchange market. ● Implications: A depreciating currency means that more of the domestic currency is needed to buy one unit of foreign currency. It can make a country's exports more competitive but may lead to higher import costs. ◆ Appreciation: ● Definition: Appreciation of a currency occurs when its value increases relative to other currencies. ● Implications: An appreciating currency means that less of the domestic currency is needed to buy one unit of foreign currency. While this can make imports cheaper, it may make a country's exports less competitive.
➔ Why is the real exchange rate an important variable in open-economy
macroeconomics?
◆ international Competitiveness: ● The real exchange rate influences a country's competitiveness in international trade. A lower real exchange rate makes a country's
○ Exports become more competitive for foreign consumers. ● Impact on Trade Balance: ○ May lead to an improvement in the trade balance as exports become more competitive. ● Inflation and Purchasing Power: ○ Can contribute to higher domestic inflation as imported goods become more expensive. ○ May reduce the purchasing power of domestic consumers. ◆ Capital Flows: ● Appreciation: ○ Can attract foreign investment seeking higher returns. ○ May lead to capital outflows as domestic assets become less attractive. ● Depreciation: ○ May attract foreign investment looking for opportunities in a more competitive environment. ○ Can lead to capital inflows as domestic assets become more attractive.
➔ How are the nominal exchange rates determined according to the theory
of purchasing-power parity (e = P∗/P)?
◆ The theory of Purchasing Power Parity (PPP) is an economic theory
that attempts to explain the determination of nominal exchange
rates based on relative price levels between two counties
● Formula is
○ E = P*/ P
➔ What is the role of arbitrage in the theory?
◆ Arbitrage plays a crucial role in the theory of Purchasing Power Parity. The
idea is that if identical goods can be bought and sold in different markets and there are no transportation costs or other barriers to trade, then arbitrage should ensure that prices, when expressed in a common currency, are equalized. Here's how arbitrage works in the context of PPP: Arbitrage Opportunity: ● If a good is cheaper in one country than in another, traders can buy the good in the cheaper country, sell it in the more expensive country, and make a profit. Currency Exchange and Nominal Exchange Rates: ● Arbitrage activities will lead to an increased demand for the currency of the cheaper country, causing its value to rise in
the foreign exchange market. Conversely, the currency of the more expensive country will depreciate. Restoration of Equilibrium: ● As currencies adjust, the price differential for the same good across countries narrows, and the arbitrage opportunity diminishes until prices are equalized when expressed in a common currency.
➔ What are the limitations of arbitrage and hence the theory?
◆ transaction Costs: ● Real-world transactions involve costs, such as transportation, taxes, and other fees, that are not considered in the theory. These costs can erode potential profits from arbitrage. ◆ Imperfect Competition: ● The assumption of perfect competition and identical goods may not hold in reality. Differences in product quality, brand preferences, and market structures can impact prices. ◆ Barriers to Trade: ● The theory assumes no barriers to trade, but in reality, countries may have tariffs, quotas, or other restrictions that impede the free flow of goods.
➔ What happens to the currency of an economy if the economy has a higher
inflation rate than the rest of the world in the long run?
◆ If an economy experiences a higher inflation rate than the rest of the world
in the long run, the currency of that economy is likely to depreciate. ◆ purchasing Power Erosion: ● Higher inflation erodes the purchasing power of the domestic currency. Prices of goods and services rise faster in the higher inflation country compared to countries with lower inflation. ◆ Impact on Nominal Exchange Rates: ● As the purchasing power of the domestic currency declines, the nominal exchange rate is likely to adjust. The currency of the country with higher inflation will depreciate relative to currencies of countries with lower inflation.
➔ Be sure to understand that net capital outflow (NCO) is the difference
between capital outflow (CO) and capital inflow (CI). That is, NCO = CO −
CI. Be prepared to identify the impact of specific international transactions
on net capital outflow.
◆ Trade Surplus (Exports > Imports):
