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Managerial Economics (Macro) Dr. Timothy Simin 2011 [email protected] Helicopter Tour What 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 [email protected] 2 Helicopter Tour What 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 [email protected] 3 Financial Intermediaries What are they? Financial Markets 1) Brokers 2) Dealers 3) Investment bankers 4) Exchanges Borrowers 1) Households 2) Business 3) Governments 4) Foreigners Lenders 1) Households 2) Business 3) Governments 4) Foreigners Financial Intermediaries 1) Banks 2) Mutual funds 3) Insurance companies 4) Pension funds 5) Finance companies [email protected] 4 Financial Markets Some 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? [email protected] 5 Financial Intermediaries Why do we need them? 1. Information costs – Adverse selection – Moral hazard 2. Transaction costs – Explicit Financial – Implicit [email protected] 6 Asymmetric Information Adverse 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 [email protected] 7 Asymmetric Information Moral hazard 1. Asymmetric information problem occurs after the transaction – Debt markets – Equity markets principle-agent problem 2. Dealing with moral hazard – Intermediation – Debt contracts [email protected] 8 Trading Costs Another 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? [email protected] 9 Trading Costs Another surplus story Interest rate Si,nb Investors Surplus Dead Weight Loss ri,nb ri,b Si,b Cost of Cost of Trading Trading Spm rpm Ipm ri,b Ii,b rs,nb Ii,nb Savers Surplus Savers Surplus qnb qb qpm Quantities of Investment and Saving [email protected] 10 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 [email protected] 11 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 [email protected] 12 Gross National Product Break down [email protected] 13 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 [email protected] 14 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 [email protected] 15 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? [email protected] 16 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 deflator GNP measured in base year prices [email protected] 17 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 – [email protected] 18 Three Price indexes Measuring Inflation Producer price index (PPI) – Measures the cost of a given basket of raw materials and semifinished goods – Constructed from prices at the level of the first significant commercial transaction – Often viewed as a predictor of business cycles [email protected] 19