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Helicopter TourWhat Microeconomics?
Microeconomics covers:– Price determination via quantities supplied and demanded
Laws of demand
– Opportunity costs and sunk costs
– Theory of the firm Monopolies, Oligopolies, and perfect competition Cost benefit analysis/profit maximization
– Theory of the consumer Utility functions, budget constraints, utility maximization
– Specialization, efficiency, comparative advantage
– Examples
Helicopter TourWhat is Macroeconomics?
Macroeconomics covers:
– Fiscal policy http://www.wtfnoway.com/ and http://www.usdebtclock.org/
– Monetary policy
– National Income Accounting GNP, GDP
– Interest rate determination
– Exchange rate determination
– Business Cycles
– Inflation
Financial IntermediariesWhat are they?
Lenders1) Households2) Business3) Governments4) Foreigners
Financial Markets1) Brokers2) Dealers3) Investment bankers4) Exchanges
Borrowers1) Households2) Business3) Governments4) Foreigners
Financial Intermediaries1) Banks2) Mutual funds3) Insurance companies4) Pension funds5) Finance companies
Financial MarketsSome puzzles
1. Why are banks and other financial intermediaries the primary sources of external financing for business, rather than stocks and bonds?
2. Why is the financial system among the most heavily regulated sectors of the economy?
3. Why do only large and well-established firms have access to the securities markets?
4. Why is collateral a prevalent feature of debt contracts?
Financial Intermediaries Why do we need them?
1. Information costs
– Adverse selection
– Moral hazard
2. Transaction costs
– Explicit Financial
– Implicit
Asymmetric InformationAdverse selection
1. Asymmetric information problem occurs before the transaction– Securities markets
– Banks
– Question: Will the asymmetric information problem be more or less of a problem as interest rates rise?
2. Dealing with adverse selection– Private production and sale of information
– Government regulation
– Intermediation
– Collateral
Asymmetric InformationMoral hazard
1. Asymmetric information problem occurs after the transaction
– Debt markets
– Equity markets
principle-agent problem
2. Dealing with moral hazard
– Intermediation
– Debt contracts
Trading CostsAnother surplus story
1. Start with a perfect financial market
– I is the amount of borrowing for investment
– S is the amount of savings
– rpm and qpm are the perfect market interest rate and level of investment
2. What happens to total surplus?
Trading CostsAnother surplus story
Quantities of Investment and Saving
Interest rate
Spm
Ipm
rpm
qpm
Investors Surplus
Savers Surplus
rs,nb
ri,nb
Cost of Trading
Investors Surplus
Savers Surplus
Cost of Trading
Investors Surplus
Savers Surplus
ri,b
ri,b
Ii,b
Si,b
qbqnb
Si,nb
Ii,nb
Dead Weight Loss
Financial Intermediaries What they provide
Services Supplied by Financial Intermediaries
Reduce information costs Reduce transaction costs
Reduce search costs Denomination intermediation
Credit valuation Maturity intermediation
Price discovery Provide payments system
Monitoring Diversify risk and Hedge risk
Gross National Product What does it measure?
1. GNP is:
– the value of all final goods and services produced and sold
– a measure of a country’s output
– is the sum of four components
Consumption
Investment
Government expenditures
Current account balance
Gross National Product What does it measure?
1. GNP Y – Individual’s use income to either consume or save while the
government taxes and redistributes wealth – GNP measures only the final sale of products
I.E., the price of a computer to the consumer goes into GNP but the price IBM pays for RAM does not. Why?
2. GNP does not account for – Depreciation– Unilateral transfers
Pension payments to retired U.S. citizens abroad Relief funds
– Tax wedge: Price people pay - Price producers receive
Gross National Product What does it mis-measure?
1. Value of leisure
2. Value of government production
3. The illegal economy
– Cash transactions
– Drugs
– Household production
4. Increases in output of goods/services can either be a good or bad thing
GNP vs. GDP What’s the difference?
1. GDP = GNP – (income domestic residents earn on wealth held in other countries – payments to foreign owners of domestic wealth)
2. GDP doesn’t correct for domestic output produced by foreign owned capital
3. Are they correlated?
Three Price indexes Measuring Inflation
GNP deflator
– Ratio of nominal GNP in a given year to real GNP
– Measure of inflation between the period from which the base prices used in real GNP are taken, to the current period
GNP measured in current prices
GNP deflatorGNP measured in base year prices
Three Price indexes Measuring Inflation
Consumer price index (CPI)
– Cost of representative fixed bundle of goods
– Prices are of finished or retail goods and services
– Problems? Intertemporal changes in tastes and goods International differences in tastes and goods Should we include Food and Energy
GNP deflator vs. CPI
– Deflator measures wider group of goods than does the CPI – CPI uses fixed basket, deflator uses things produced in a year – The CPI includes imports, deflator only measures U.S. goods
–
Three Price indexes Measuring Inflation
Producer price index (PPI)
– Measures the cost of a given basket of raw materials and semi-finished goods
– Constructed from prices at the level of the first significant commercial transaction
– Often viewed as a predictor of business cycles
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