ME Cheat Sheet for Final Owners of assets that People who want to buy assets that

Unemployment types increase in value with are rapidly increasing in price.

1. Frictional  Short-term. It ever exists in dynamic economy. E.g. inflation.
graduated student seeking job Politicians gaining support Politicians losing popular support
2. Structural  Long-term. When there is big change in economy. because of their position because of their inability to control
3. Cyclical  Up and down with business cycle. E.g. recession on inflation. inflation.
Employment & unemployment statistics How can we hedge inflation risk?  Linked Bond
* Labor force  all above age of 16  Employed + Unemployed Can we forecast inflation rate?  Yes, by seeing price (implied
(means actively seeking jobs) yield) of inflation Linked Bond etc.
* Not in labor force  prisoners, under 16, retired seniors, people How to measure the level of production???
who are not seeking for a job though they are in eligible age 1. GDP 2. Nominal GDP 3. Real GDP – adjusted by inflation
* Participation rate  Labor force / Adult population 4. GDP per capita
* Unemployment rate  Unemployed / Labor force Inflation  general rise in the price level. It reduces the purchasing
Criticism to unemployment statistics power of money.
* Classified as employment A measure of inflation
- Did any work, even just for one hour - Worked without pay for Consumer Price Index (CPI)
family-business - Away from job due to illness, labor-management CPI =
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑏𝑎𝑠𝑘𝑒𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑎𝑛𝑑 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑎𝑟𝑡𝑖𝑐𝑢𝑙𝑎𝑟 𝑦𝑒𝑎𝑟
∗ 100
dispute, or personal reasons - NGO (if with salary or contract) 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑏𝑎𝑠𝑘𝑒𝑡𝑠 𝑖𝑛 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟
* Discouraged workers are not counted as unemployed.
𝐶𝑃𝐼 𝑖𝑛 𝑌𝑒𝑎𝑟 𝑡−𝐶𝑃𝐼 𝑖𝑛 𝑌𝑒𝑎𝑟 𝑡−1
* Regional differences in unemployment Inflation rate in year t = ∗ 100
𝐶𝑃𝐼 𝑖𝑛 𝑌𝑒𝑎𝑟 𝑡−1
* Types of jobs held by the unemployed
- No distinction between full-time and part-time - Involuntary part-
time workers are counted as full-time
* Underemployment: people who have skills accept unskilled jobs
* People who pretend to search a job but no intention to work are
counted as unemployed
CPI2 = 100
Full employment
*Natural rate of unemployment  occurs when cyclical is 𝑃3 110−100
CPI3 = ∗ 𝐶𝑃𝐼2 i= ∗ 100
eliminated but that includes frictional and structural. 𝑃2 100
Economic cost of unemployment
* GDP gap  actual GDP – potential GDP = 550/500 * 100 = =10%
* Potential GDP is GDP if the economy has only fractional and 110
structural
* OKUN’s Law: every 1% of cyclical unemploy = 2% GDP gap. Real rate of interest
Why does unemployment occur? (1 + rnominal) = (1 + rreal) (1 + i)  Nominal = Real + Inflation
* Price of labor force is INELASTIC *** inflation premium is required return.
* Employee usually layoff rather than cut wages. Inflation Vs Interest rate
Remedy to structural unemployment Borrowers gain benefits  People who save or lend money would
* Vocational training * Support for job hunting be hurt.
* Liquid job market  job changeability Wealthy (who has many assets) become wealthier  People who
* Regulation  subsidy when hiring handicapped people are planning to buy assets would be hurt.
Remedy to cyclical unemployment Flexible income receiver: cost of living adjustments (COLAs) and
* Fiscal policy (decided by Government) social security recipients
- Government expenditure e.g. construction projects  creates jobs Causes of inflationary pressure
- Lower tax rate  people spend more * Demand-pull inflation (demand shift right  price up)
* Monetary policy (decided by Central Bank) - excess spending relative to output - CB issues much money
- Lower the interest rate * Cost-push inflation (supply shift left  price up)
- Stimulate the investment - due to a rise in per-unit cost - supply shocks
- Create employment * Role of expectations (demand shift right  price up)
Unemployment VS Inflation - buyer’s fear of future high price - seller expects high cost
Inflation terminologies
* Hyperinflation: Extraordinary rapid inflation (cause of excessive
money creation)
Remedy to (Hyper) Inflation
Fiscal policy Monetary policy
- Decrease government - Increase the reserve requirement
expenditure - Increase the discount rate
- Decrease transfer - Central bank or federal bank
payment (FAB) sells securities to bank and
- Increase tax dealers on the open market
Production
Measure of production
*** Gross Domestic Product (GDP)
1. Nominal GDP 2. Real GDP 3. GDP per capita
Low unemploy > high labor demand > owners pay more > inflation
GDP  the market value of all final goods and services produced
High unemploy > high labor supply > owner bargain > no inflation
within a country in a given period of time regardless of nationality
Winners and losers from inflation
(whether production is owned by a local company of foreign
Winners Losers
company).
People with after-tax People on fixed income or working
GNP (Gross National Product)  outputs from citizens and
income rising faster than under contracts with wages
companies of a particular nation regardless of location (inside or
the rate of inflation. increases below the inflation rate.
outside of the original country).
Borrowers paying back Savers and lenders earning interest
loans at an interest rate less rates below the inflation rate.
than the inflation rate.
Expenditure approach
GDP = C + I + G + Ex – Im
C: people’s consumption I: businesses’ investment
G: government expenditure Ex: export Im: import
GDP = $245 + $27 + $33 + $72 + $11 = $388.
Income approach
GDP = COE + GOS + GMI + TP&M – SP&M
COE: Compensation of employee (salary, wages, employer
contribution to social) GOS: Gross operating surplus (profits,
surplus due to owners of incorporate business) GMI: Gross mixed
income (profits for unincorporated business) TP&M: Taxes on
production and imports SP&M: Subsidies on production and exports
GDP = $223 + $14 + $13 + $33 + $56 + $18 + $27 -$4 + $8 = $388
Labor and productivity
Real GDP = hours of work x labor productivity
How to increase GDP – Institutional structures of growth
*Strong property rights * Patents and copyrights
*Literacy and widespread education
*Efficient financial institutions * Free trade
How to increase GDP – Saving and investment
*Investment (which increases GDP)
*How to finance?
-Saving (Reduce consumption Now)
-Borrowing (Reduce consumption in the future)
*Need credible banks and financial institutions
Pros and cons of GDP
Pros
* Higher GDP/capita tend to have higher quality of life
* Higher level of education, medical services, clean water etc.
* Higher GDP countries tend to have Lower criminal rate, better
atmosphere
Cons
* Only the products/services traded are included
- Production by household is not included
* Increment of productivity is not incorporated
- Increment of productivity & reduction in working hour
* Environmental improvement is not incorporated
* Disaster might push up the GDP (while people’s life would be
suffered)
* Underground economy includes productive activities not included
in GDP
- Nonmarket productive activities
- Unreported work
- Swapped services
Business cycle
recovery, peak, recession, and trough…
Total (aggregate) spending is the combined household, business,
government, and foreign sector spending in the economy for new
goods and services.

GDP terminologies
*Net foreign factor income (NFFI): the aggregate amount that a
country’s citizens and companies earn abroad minus the aggregate
amount that foreign citizens and overseas companies earn in that
country.
*Transfer payment: welfare, social security, and subsidy. !!!Not
included in GDP as it is just a transfer.
*Social security contributions: used for future contingent social
benefit such as unemployment.
*Proprietors’ income: the excess of revenue over explicit production
cost of owner-operated businesses and includes payments for labor,
capital, land, and entrepreneurship.
Real GDP
*Adjusted nominal GDP to eliminate inflation.
*Real GDP measures actual (real) production and shows how actual
production, without prices increases (or decreases), has changed.
𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃𝑡
Real GDPt = ∗ 100
𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 𝑡

Step 1.
i = P2/P1 x i1
= 18000/16000 x 100 = 112.5
Step 2.
𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃𝑡
Real GDP = ∗ 𝑖1
𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 1
= 1080000/112.5 x 100
= 960000
GDP per capita
Real GDP earned by individual. Increase GDP per capita  increase
productivity. GDP per capita = real GDP / no. of population
 Fed buys bonds from commercial bank  Lending Capacity,
If… sells  Lending Capacity
Federal Funds Rate: commercial banks lend money each other

Monetary Policy
Advantages: Rapid implementation compared to fiscal policy,
largely removed from politics
Disadvantages: Lending/ borrowing relationship must exist;
Federal Reserve cannot force the loan-making process
Interest rates increase as money supply is tightened; businesses may
Leakages Injections raise prices to pay for borrowing costs
Household saving Household spending from borrowing Comparative advantage: more efficiently use resource, lower
Business saving Household spending from transfer opportunity cost
payments Free Trade: Goods and services can be exported and imported by
Household taxes Business investment spending anyone in any country with no restriction
Business taxes Government purchases of goods and Protectionism: The philosophy that it is in the best interest of a
services country to restrict free trade.
Import expenditure Export expenditure Tariff: A tax on import - Consumption, Production, Imports,
Fiscal policy Tariff Revenue
Unemployment due to decline Demand-pull inflation from Quota: limits the no. or value of goods that can be imported or
spending can be solved by: too much spending can be exported Consumption, Production, Imports
solved by: Embargo: restricts commerce or exchange with a specified country
-increase gov purchase -decrease gov purchase or the exchange of specific goods.
-increase transfer payment -decrease transfer payment Trade Subsidies: A government payment to the domestic producer
-decrease tax - increase tax of an exported good
Multiplier effect Dumping: Selling a product in a foreign market below cost or below
* The (larger) change in total output and total income of an economy its price in its own domestic market
that is a result of non-income determined spending change is called Exchange Rates: the no. of units of a nation’s currency = one unit
the “multiplier effect”. of another nation’s currency. fixed or flexible
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑛𝑜𝑛𝑖𝑛𝑐𝑜𝑚𝑒 𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑠𝑝𝑒𝑛𝑑𝑖𝑛𝑔 Fixed Ex Rates: Use of reserves, Trade policies, Distorted trade,
Favoritism, Restricted choice, Black Market
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑎𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 𝑛𝑜𝑡 𝑠𝑝𝑒𝑛𝑡
Flexible Ex Rates: determined by the forces of demand and supply,
= 𝑇𝑜𝑡𝑎𝑙 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑜𝑢𝑡𝑝𝑢𝑡 𝑎𝑛𝑑 𝑖𝑛𝑐𝑜𝑚𝑒
Foreign exchange markets
Multiplier =  Real GDP / MPC, GDP = Multiplier x MPC,
Factors that shift demand/supply: Changes in tastes for particular
Multiplier = 1/MPS or 1/(1-MPC)
foreign products, economic conditions, Policies of foreign
Effect = DI x Multiplier //Disposable Income = GDP
governments and banks, Relative income, Relative price-level,
Average Propensity Consume/Saving:APC = C / DI, APS = S / DI
Purchasing-power-parity theory, Relative interest rates, Relative
Marginal Propensity Saving/Saving: MPC = C / DI , MPS = S
expected returns on assets, Speculation.
/ DI , MPC + MPS = 1
a nation’s money: Exports cost less to foreign buyers, Imports cost
Functions of Money more to domestic buyers
*Medium of Transaction
a nation’s money: Exports cost more to foreign buyers, Imports
*Measure of Value
cost less to domestic buyers
*Method for Storing Wealth and Delaying Payments
Money Supply: Total Amount of Money in an Economy
M1: coins, and paper money in circulation, checks, most demand
deposits
M2: M1, savings, small denomination time deposit accounts, money
market deposit accounts, financial instruments.
M3: M2, $100,000+ time deposit accounts (certified deposits, CDs),
financial instruments
Velocity: is the average money supply turned over in a year, relative
to GDP, Velocity = GDP / Money Supply
Demand for Money: Total Money Demand (Dm) = Transaction
Demand (Dt) + Asset Demand (Da)
Money Supply and Activity: M × V = P × Q, Not Full Employment:
M  Q, Full Employment: M  P, M  Q
Money Creation TA.
Reserve Ratio = Required Reserves / Demand Deposit Liabilities CPI = (XXX / 200) * 100 =
Excess Reserves or New Money Created = Actual Reserve –
Required Reserve Inflation up = Money purchase power down
Money Multiplier = 1 / Required Reserve Ratio
Labor force = Total popul – under 16 – not in labor force
Total Change in Money Supply = Initial Change in Excess Reserve Unemp rate = unemp / labor force
x Money Multiplier
Interest Rate: determined by the demand and the supply of funds Growth rate = (New-Old) / Old
available for loans,
excess reserves  interest rates and loans amount  money Explain how an increase in your nominal income and a decrease in your real
supply and spending, if… excess reserves  … income…. Answer: If a person’s nominal income increases by 10 percent
while the cost of living increases by 15 percent, then her real income has
Tools of Monetary Policy decreased from 100 to 95.65 (= 110/115). Alternatively expressed, her real
1. Reserve Requirement: the amount (percent) of reserves a income has decreased by 4.35 percent (= 100 95.65). Generally, whenever
financial depository institution must keep the cost of living increases faster than my nominal income, real income
2. Discount rate: interest rate that Central Bank lend money to decreases.
commercial banks (+/- money supply)
3. Open market operations: buying and selling of securities,
primarily Treasury securities
Explain how hyperinflation might lead to a severe decline in total output…
Answer: With inflation running into the double, triple, quadruple, or even
greater number of digits per year, it makes little sense to save. The only
sensible thing to do with money is to spend it before its value is cut in half
within a month, a week, or a day. Everyone trying to spend as fast as possible
will speed the inflationary spiral and cause people to spend more and more
time trying to figure out what goods are most likely to go up fastest in price.
More and more people will turn away from productive activity, because
wages and salaries are not keeping up with inflation. Instead, they will spend
their time speculating, transferring goods already in existence and producing
nothing. Eventually, money may become worthless. No one will work for
money. Production falls for this reason and also because investment in
productive capital practically ceases. Unemployment soars. A massive
depression is at hand.

Okun’s law problem… Actual emp – Natural emp= Cyclical  Cyclical x 2 Bolivia: Globalization, Sovereignty, or Democracy Case
The output foregone = potential GDP x (cyc x 2) Decrease Why Hyperinflation? interest on Bolivia’s debt increased in 1980,
Government spending increases, Government was force to finance (printing
(a)Int rec: on bond (I) Income received by the bondholder for the services money), Tax revenue fell with lags in tax collection, vicious cycle continues.
derived by the corporation for the loan of money. How Lozada / Sachs plan work? Exchange rate policy (float system),
(b)Social sec: rec: (E) A transfer payment from taxpayers for which no cutting fiscal deficit, Liberalizing prices and interest (opening foreign trade),
service is rendered. promise social cost would be addressed in the future, Washington consensus
(c)Family business unpaid (E). Nonmarket production. Why Success? Population was ready to change, political consensus (pact for
(d)Income of dentist (I). Payment for a final service. democracy), globalization with free capital markets
(e)Monthly allowance (E). A private transfer payment; simply a transfer of Global Economy? Golden straightjacket – economic grows, politics shrinks
income from one private individual to another has no market transaction.
(f)Resell (E). The production of the car had already been counted at the time
of the initial sale.
(g)Sales of new book (I). It is a new good produced for final consumption.
(h)Inc: leisure with no deduction (E). The effect of the decline will be
counted, but the change in the workweek itself is not the production of a final
good or service or a payment for work done.
(i)Inc: in biz inventory (I). could occur as a result of increased production.
(j)Stock purchase (E). the transfer of ownership of existing financial assets.

Inc by +6/MPSaving = 24 B dec by -350/MPSaving = 1.75B

Gov cut back on def spending  dec: output and employment

Fed runs large defit while full emp  Inc price
Transfer pay for poverty cut from gov budget  dec: output and emp
Politicial promise to lower tax & inc spending  inc output and emp
Disaster relif prog:  inc output and emp

Reserve acc + Vault = actual reserve

Money create (or) Expand = FED spending x 1/R

Money multiplier can be weakened by actions such as converting some

portion of deposits to cash

Movement from S to S’ – Inc in excess -both excess & int fall

Crowding out results from an increase in int rate due to gov borrowing…

with specialization according to the principle of comparative advantage the

same amount of resources can produce as much oil, but more men's suits can
be produced than before specialization.

If MPC is .70, the multiplier is 1/0.3. A tax cut of $30 billion will result in
initial increase in consumption of $21 billion (.70 x $30 billion). This initial
increase in spending will ultimately result in an increase in consumption
spending of $70 billion ($21billion×(1/0.3) because of the multiplier process.
In contrast, an initial increase in government spending of $30 billion will
ultimately increase consumer spending by $100 billion (1/0.3 x $30) because
none of the initial increase is siphoned off as savings as would be the case
with a $30 billion tax cut.
A decrease in the dollar price of Mexican pesos makes Mexican goods less
expensive to U.S. buyers and leads to an increase in the quantity of pesos
demanded by holders of U.S. dollars.
If nations were on a system of floating exchange rates and the demand for a
country's exported products fell dramatically, there would be: a decrease for
that country's money by foreigners.
Country Risk Analysis and Managing Crises: Tower Associates
Domestic Benchmark: inflation or real GDP growth = 8% +/- 3%
(Developing), 3% +/- 1% (Developed)
International Benchmark: Foreign exchange or Bal of payment = +/- 6%
(Developing), +/-3% (Developed)
Domestic Economy: Inflation or recession, International Economy:
Budget surplus or deficit
Monetary Policy: Interest rate, money supply, Fiscal Policy: Tax, public
investment
Financial / Foreign Exchange Crisis: stock market index, real interest rate,
real exchange rates, real estate price
Liquidity Risk: money supply, domestic credit expansion. Foreign Debt
crisis: foreign debt service ratio = debt service pay / export earning, no of
months covered by reserve (reserves / (imports / 12)) > 3 is adequate, else
dangerous

The public debt was $125 billion. (+$25 billion +$0 −$25 billion −$50
billion −$75 billion)… 3.1% ($125 billion/$4000 billion x 100 = 3.1%).

MPC = (C2-C1)/((DI2-DI1) = … % APS = S/DI

Trans demand + Asset demand = Total

Trans = 2000 x 20% Asset = 800-400 So 5%