I.    Microeconomics and Macroeconomics

A.   Definition of microeconomics:

B.   Definition of macroeconomics:

II.   The Economy’s Production, Income and Expenditure

A.   To judge whether or not an economy is doing well, it is useful to look at Gross Domestic Product (GDP).

1.   GDP measures the total production in the economy.

2.   GDP measures the total income of everyone in the economy.

2.   GDP measures total expenditure on an economy’s output of goods and services.

B.   For an economy as a whole, total income must equal total expenditure.

a.   Households buy goods and services from firms; firms use this money to pay for resources purchased from households.

b.   In the simple economy described by this circular-flow diagram, calculating GDP could be done by adding up the total purchases of households or summing total income earned by households.

III. The Measurement of Gross Domestic Product

A.   Definition of gross domestic product (GDP): the market value of all final goods and services produced within a country in a given period of time.

B.   “GDP Is the Market Value . . .”

C.   “. . . Of All . . .”

D.   “. . . Final . . .”

E.   “. . . Goods and Services . . .”

F.   “. . . Produced . . .”

G.   “. . . Within a Country . . .”

H.   “. . . in a Given Period of Time.”

IV.  The Components of GDP

A.   GDP (Y ) can be divided into four components: consumption (C ), investment (I ), government purchases (G ), and net exports (NX ).

B.   Definition of consumption:

C.   Definition of investment:

1.   housing

D.   Definition of government purchases:

   Transfer payments are not included as part of the government purchases component of GDP.

.   Definition of net exports:

V.   Real Versus Nominal GDP

A.   There are two possible reasons for total spending to rise from one year to the next.

1.   The economy may be producing a larger output of goods and services.

2.   Goods and services could be selling at higher prices.

B.   When studying GDP over time, economists would like to know if output has changed (not prices).

C.   Thus, economists measure real GDP by valuing output using a fixed set of prices.

   Definition of nominal GDP:

  Definition of real GDP:

E.   Because real GDP is unaffected by changes in prices over time, changes in real GDP reflect changes in the amount of goods and services produced.

      VI.  Is GDP a Good Measure of Economic Well-Being?

A.   GDP measures both an economy’s total income and its total expenditure on goods and services.

B.   GDP per person tells us the income and expenditure level of the average person in the economy.

C.   GDP, however, may not be a very good measure of the economic well-being of an individual.

1.   GDP omits important factors in the quality of life including leisure, the quality of the environment, and the value of goods produced but not sold in formal markets.

2.   GDP also says nothing about the distribution of income.

3.   However, a higher GDP does help us achieve a good life. Nations with larger GDP generally have better education and better health care.

I.    The Meaning of Money

A.   Definition of money:

B.   The Functions of Money

1.   Money serves three functions in our economy.

a.   Definition of medium of exchange:

b.   Definition of unit of account:

c.    Definition of store of value:

2.   Definition of liquidity:

a.   Money is the most liquid asset available.

b.   Other assets (such as stocks, bonds, and real estate) vary in their liquidity.

c.    When people decide in what forms to hold their wealth, they must balance the liquidity of each possible asset against the asset’s usefulness as a store of value.

C.   The Kinds of Money

1.   Definition of commodity money:

2.   Definition of fiat money:

3.   IDefinition of bank notes:

D.   Money in the U.S. Economy

1.   The quantity of money circulating in the United States is sometimes called the money stock.

2.   Included in the measure of the money supply are currency, demand deposits, and other monetary assets.

a.   Definition of currency:

b.   Definition of demand deposits:

a.   Credit cards are not a form of money; when a person uses a credit card, he or she is simply deferring payment for the item.

b.   Because using a debit card is like writing a check, the account balances that lie behind debit cards are included in the measures of money.

II.   The Federal Reserve System

A.   Definition of Federal Reserve (Fed):

B.   Definition of central bank:

C.   The Fed’s Organization 

1.   The Fed was created in 1913 after a series of bank failures.

2.   The Fed is run by a Board of Governors with 7 members who serve 14-year terms.

a.   The Board of Governors has a chairman who is appointed for a four-year term.

b.   The current chairman is...

3.   The Federal Reserve System is made up of 12 regional Federal Reserve Banks located in major cities around the country.

4.   One job performed by the Fed is the regulation of banks to ensure the health of the nation’s banking system.

a.   The Fed monitors each bank's financial condition and facilitates bank transactions by clearing checks.

b.   The Fed also makes loans to banks when they want (or need) to borrow.

5.   The second job of the Fed is to control the quantity of money available in the economy.

a.   Definition of money supply:

b.   Definition of monetary policy:

D.   The Federal Open Market Committee

1.   The Federal Open Market Committee (FOMC) consists of the 7 members of the Board of Governors and 5 of the 12 regional Federal Reserve District Bank presidents.

2.   The primary way in which the Fed increases or decreases the supply of money is through open market operations (which involve the purchase or sale of U.S. government bonds).

a.   If the Fed wants to increase the supply of money, it creates dollars and uses them to purchase government bonds from the public through the nation's bond markets.

b.   If the Fed wants to lower the supply of money, it sells government bonds from its portfolio to the public. Money is then taken out of the hands of the public and the supply of money falls.

III. Banks and the Money Supply

a.   Definition of reserves:

   The financial position of the bank can be described with a T-account:

B.   Money Creation with Fractional-Reserve Banking

1.   Definition of fractional-reserve banking:

2.   Definition of reserve ratio: 

   Definition of money multiplier:

D.   The Fed’s Tools of Monetary Control

1.   Definition of open market operations:

a.   If the Fed wants to increase the supply of money, it creates dollars and uses them to purchase government bonds from the public in the nation's bond markets.

b.   If the Fed wants to lower the supply of money, it sells government bonds from its portfolio to the public in the nation's bond markets. Money is then taken out of the hands of the public and the supply of money falls.

2.   Definition of reserve requirements: r

3.   Definition of discount rate:

a.   When a bank cannot meet its reserve requirements, it may borrow reserves from the Fed.

b.   A higher discount rate discourages banks from borrowing from the Fed and likely encourages banks to hold onto larger amounts of reserves. This in turn lowers the money supply.

c.    A lower discount rate encourages banks to lend their reserves (and borrow from the Fed). This will increase the money supply.