Company Presentation

1
Introduction to Macro and Micro Economics
Dr. Khaled Fouad Sherif Chief Financial
Officer The World Bank Group
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What is Economics?

• The social science that studies how agents
  allocate scarce resources amongst alternatives to
  meet unlimited human wants
• Fundamental Economic Problem Resource allocation
• Conflicting goals of unlimited wants and resource
  scarcity implies need to make choices regarding
  allocation
• Three basic questions
• What and how much to produce
• How to produce
• How to distribute goods and services amongst
  individuals and groups

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Approaches to Economics

• Positive Economics
• Examines how decisions are made and the
  consequences of such decisions
• Descriptive process exploring the process of
  decision making and its impacts
• Normative Economics
• Examines how resources should be allocated
• Prescriptive process analyzing what should be done

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Allocation of Resources

• Process occurs at many levels
• Consumers
• Firms
• Government
• Market System
• Allocation decisions impact natural environment
• Want decisions to be based upon incentives that
  reflect true value to society
• Unfortunately decision makers due not consider
  true value in choices
• Need for policy intervention to overcome such
  market failure

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Contemporary (Neoclassical) Economics

• Macroeconomics Aggregated analysis
• John Maynard Keynes in 1936 and 1940
• Choices of government
• Monetary Policy - Federal Reserve
• Fiscal Policy Taxes and Spending
• Macroeconomic targets
• Income Levels
• Inflation
• Employment

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Contemporary (Neoclassical) Economics

• Microeconomics Disaggregated analysis
• Adam Smiths Wealth of Nations in 1776
• Choices of consumers (households) and producers
  (firms)
• Two types of Markets
• Factor Markets Consumers sell inputs used in
  production to firms
• Product Markets Firms sell final output to
  consumers
• Three types of analysis
• Partial Equilibrium Focus on single factor or
  good
• Multi-Market Interrelationships amongst key
  fundamental markets
• General Equilibrium Economy as a whole

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Basic Economic Model (Paradigm)

• Households provide factors of production to firms
• Capital, Labor, Natural Resources, and
  Entrepreneurship
• Firms make payments for factors of production to
  households
• Interest, Wages, Rents, Profits
• Households demand (purchase) goods and services
  from firms
• Firms produce goods and services by transforming
  inputs into output
• Firms receive payments for goods and services
  from households
• Payments received represent the value of the
  factors used in production process

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Economic Theory of Value

• Value is reflected in prices determined through
  interaction of supply and demand
• Supply (demand) reflects trade-offs firms
  (consumers) make when producing (buying) goods
  and services
• Abundance implies lower prices
• Scarcity implies higher prices
• Conceptually market forces reflect true value
  to society, but there are reasons why markets may
  fail
• Externalities
• Public Goods
• Property Rights

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Introduction and Review
1. What is microeconomics how are economic
models constructed? 2. Buyers, Sellers, Markets
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Whats the difference between Microeconomics
Macroeconomics?

• Microeconomics examines small economic units, the
  components of the economy.
• For example individuals, households, firms,
  industries
• Macroeconomics looks at aggregates.
• For example national output, overall price
  level, aggregate unemployment

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Questions relevant to all economies,
market-oriented or not

• What goods services should be produced and how
  much?
• How should the goods services be produced?
• Who gets the goods services?
• How do changes in the production distribution
  mixes take place?

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In a market economy, these questions are handled
by the market.

• What how much to produce
• Determined by demand supply conditions,
  individual choices, pursuit of profit.
• How to produce
• Determined by technology resource costs.
• Distribution
• Based on ability willingness to pay the price.
• What if consumer wants or technology change?
• Those changes alter demand supply, which
  changes prices, profits, consequently output
  levels distribution.

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The Circular Flow
Product Markets
money to pay for goods services
goods services
Households Resource Owners
Firms
labor other resources
resource payments such as wages, rents, interest
Resource or Factor Markets
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The Market Supply and Demand
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What is the law of demand?

• The lower the price of a good, the larger the
  quantity consumers will buy.
• So the demand curve slopes downward from left to
  right.

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What is the difference between demand quantity
demanded?

• Demand is the entire curve that shows the
  relation between price quantity purchased.
• Quantity demanded is one particular quantity on
  the demand curve.

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Example Apple Market
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What factors change demand (that is, shift the
entire curve)?

• Consumer income
• Prices of substitutes and complements
• Tastes
• Consumer expectations

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Example Apple Market
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What makes the quantity demanded of apples change?

• In other words, what causes a movement along the
  demand curve for apples?
• A change in the price of apples.
• Thats it, only a change in the price of apples.

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Example Apple Market
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What is the law of supply?

• The higher the price of a good, the larger the
  quantity firms will be willing to produce and
  sell.
• So the supply curve slopes upward from left to
  right.

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What is the difference between supply quantity
supplied?

• Supply is the entire curve that shows the
  relation between price quantity provided.
• Quantity supplied is one particular quantity on
  the supply curve.

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Example Apple Market
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What factors change supply (that is, shift the
entire curve)?

• Technology
• Prices of inputs (for example land, labor,
  machinery, raw materials)
• Weather (in the case of agriculture)

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Example Apple Market
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What makes the quantity supplied of apples change?

• What causes a movement along the supply curve for
  apples?
• Just a change in the price of apples.

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Example Apple Market
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What is equilibrium?

• It is a state of balance, where there is no
  tendency for things to change.

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Equilibrium occurs where the quantity demanded
equals the quantity supplied, which is at the
intersection of the supply and demand curves.
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Example Apple Market
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Example Cigarette Market

• Suppose that the surgeon general comes out with
  stronger health warnings.
• That will reduce the demand for cigarettes.
• Simultaneously, there is a year of bad weather.
• That decreases the supply of cigarettes.

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Elasticity
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Elasticity measures

• What are they?
• Responsiveness measures
• Why introduce them?
• Demand and supply responsiveness clearly matters
  for lots of market analyses.
• Why not just look at slope?
• Want to compare across markets inter market
• Want to compare within markets intra market
• slope can be misleading
• want a unit free measure

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Why Economists Use Elasticity

• An elasticity is a unit-free measure.
• By comparing markets using elasticities it does
  not matter how we measure the price or the
  quantity in the two markets.
• Elasticities allow economists to quantify the
  differences among markets without standardizing
  the units of measurement.

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What is an Elasticity?

• Measurement of the percentage change in one
  variable that results from a 1 change in another
  variable.
• Can come up with many elasticities.
• We will introduce four.
• three from the demand function
• one from the supply function

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2 VIP Elasticities

• Price elasticity of demand how sensitive is the
  quantity demanded to a change in the price of the
  good.
• Price elasticity of supply how sensitive is the
  quantity supplied to a change in the price of the
  good.
• Often referred to as own price elasticities.

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Examples of Own Price Demand Elasticities

• When the price of gasoline rises by 1 the
  quantity demanded falls by 0.2, so gasoline
  demand is not very price sensitive.
• Price elasticity of demand is -0.2 .
• When the price of gold jewelry rises by 1 the
  quantity demanded falls by 2.6, so jewelry
  demand is very price sensitive.
• Price elasticity of demand is -2.6 .

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Examples of Own PriceSupply Elasticities

• When the price of DaVinci paintings increases by
  1 the quantity supplied doesnt change at all,
  so the quantity supplied of DaVinci paintings is
  completely insensitive to the price.
• Price elasticity of supply is 0.
• When the price of beef increases by 1 the
  quantity supplied increases by 5, so beef supply
  is very price sensitive.
• Price elasticity of supply is 5.

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Examples of Unit-free Comparisons

• Gasoline and jewelry
• It doesnt matter that gas is sold by the gallon
  for about 1.09 and gold is sold by the ounce for
  about 290.
• We compare the demand elasticities of -0.2 (gas)
  and -2.6 (gold jewelry).
• Gold jewelry demand is more price sensitive.

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Examples of Unit-free Comparisons

• Paintings and meat
• It doesnt matter that classical paintings are
  sold by the canvas for millions of dollars each
  while beef is sold by the pound for about 1.50.
• We compare the supply elasticities of 0
  (classical paintings) and 5 (beef).
• Beef supply is more price sensitive.

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Inelastic Economic Relations

• When an elasticity is small (between 0 and 1 in
  absolute value), we call the relation that it
  describes inelastic.
• Inelastic demand means that the quantity demanded
  is not very sensitive to the price.
• Inelastic supply means that the quantity supplied
  is not very sensitive to the price.

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Elastic Economic Relations

• When an elasticity is large (greater than 1 in
  absolute value), we call the relation that it
  describes elastic.
• Elastic demand means that the quantity demanded
  is sensitive to the price.
• Elastic supply means that the quantity supplied
  is sensitive to the price.

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Size of Price Elasticities
Unit elastic
Inelastic
Elastic

• Unit elastic own price elasticity equal to 1

• Inelastic own price elasticity less than 1

• Elastic own price elasticity greater than 1

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General Formula for own price elasticity of demand

• P Current price of good X
• XD Quantity demanded at that price
• DP Small change in the current price
• DXD Resulting change in quantity demanded

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Note

• The own price elasticity of demand is always
  negative.
• Economists usually refer to the own price
  elasticity of demand by its absolute value
  (ignore the negative sign).
• So, even though the formula says that the own
  price elasticity of demand is negative, we would
  say the elasticity of demand is 1.5 in the first
  example and 0.67 in the second.

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Supply Elasticities

• The price elasticity of supply is always
  positive.
• Economists refer to the price elasticity of
  supply by its actual value.
• Exactly the same type of point and arc formulas
  are used to compute and estimate supply
  elasticities as for demand elasticities.

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Some Technical Definitions For Extreme Elasticity
Values

• Economists use the terms perfectly elastic and
  perfectly inelastic to describe extreme values
  of price elasticities.
• Perfectly elastic means the quantity (demanded or
  supplied) is as price sensitive as possible.
• Perfectly inelastic means that the quantity
  (demanded or supplied) has no price sensitivity
  at all.

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Perfectly Elastic Demand

• We say that demand is perfectly elastic when a 1
  change in the price would result in an infinite
  change in quantity demanded.

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Perfectly Inelastic Demand

• We say that demand is perfectly inelastic when a
  1 change in the price would result in no change
  in quantity demanded.

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Perfectly Elastic Supply

• We say that supply is perfectly elastic when a 1
  change in the price would result in an infinite
  change in quantity supplied.

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Perfectly Inelastic Supply

• We say that supply is perfectly inelastic when a
  1 change in the price would result in no change
  in quantity supplied.

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Determinants of elasticity

• What is a major determinant of the own price
  elasticity of demand?
• Availability of substitutes in consumption.
• What is a major determinant of the own price
  elasticity of supply?
• Availability of alternatives in production.

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Reminders

• Value of own price elasticity usually changes
  along a demand curve
• There are many interesting intra elasticity
  applications
• Can also compare elasticities across markets
• There are interesting inter elasticity questions

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Using Demand Elasticity Total Expenditures

• Do the total expenditures on a product go up or
  down when the price increases?
• The price increase means more spent for each
  unit.
• But, quantity demanded declines as price rises.
• So, we must measure the measure the price
  elasticity of demand to answer the question.

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Bridge Toll Example

• Current toll for the George Washington Bridge is
  2.00/trip.
• Suppose the quantity demanded at 2.00/trip is
  100,000 trips/hour.
• If the price elasticity of demand for bridge
  trips is 2.0, what is the effect of a 10 toll
  increase?

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Bridge Toll Elastic Demand

• Price elasticity of demand 2.0
• Toll increase of 10 implies a 20 decline in the
  quantity demanded.
• Trips fall to 80,000/hour.
• Total expenditure falls to 176,000/hour (
  80,000 x 2.20).
• 176,000 lt 200,000, the revenue from a 2.00
  toll.

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Bridge Toll Example, Part 2

• Now suppose the elasticity of demand for bridge
  trips is 0.5.
• How would the number of trips and the expenditure
  on tolls be affected by a 10 increase in the
  toll?

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Bridge Toll Inelastic Demand

• Price elasticity of demand 0.5
• Toll increase of 10 implies a 5 decline in the
  quantity demanded.
• Trips fall to 95,000/hour.
• Total expenditure rises to 209,000/hour (
  95,000 x 2.20).
• 209,000 gt 200,000, the revenue from a 2.00
  toll.

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Elasticity and Total Expenditures

• A price increase will increase total expenditures
  if, and only if, the price elasticity of demand
  is less than 1 in absolute value (between -1 and
  zero)
• Inelastic demand
• A price reduction will increase total
  expenditures if, and only if, the price
  elasticity of demand is greater than 1 in
  absolute value (less than -1).
• Elastic demand

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Elasticity and Total Expenditure (Graph)

• At the point M, the demand curve is unit elastic.
  M is the midpoint of this linear demand curve
• Above M, demand is elastic, so total expenditure
  falls as the price rises
• Below M, demand is inelastic. so total
  expenditure falls as price falls.
• Total expenditure is maximized at the point M,
  where the elasticity 1.

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Two real world examples

• Gas taxes in Washington DC
• Vanity plates in Virginia

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Other Price Elasticities Cross- Price Elasticity
of Demand

• Elasticity of demand with respect to the price of
  a complementary good (cross-price elasticity)
• This elasticity is negative because as the price
  of a complementary good rises, the quantity
  demanded of the good itself falls.
• Example software is complementary with computers.
  When the price of software rises the quantity
  demanded of computers falls.
• Cross-price elasticity quantifies this effect.

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Other Price Elasticities Cross Price Elasticity
of Demand

• Elasticity of demand with respect to the price of
  a substitute good (also a cross-price elasticity)
• This elasticity is positive because as the price
  of a substitute good rises, the quantity demanded
  of the good itself rises.
• Example soccer is a substitute for basketball.
  When the price of soccer tickets rises the
  quantity demanded of basketball tickets rises.
• Cross-price elasticity quantifies this effect.

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Other Elasticities Income Elasticity of Demand

• The elasticity of demand with respect to a
  consumers income is called the income
  elasticity.
• When the income elasticity of demand is positive
  (normal good), consumers increase their purchases
  of the good as their incomes rise (e.g.
  automobiles, clothing).
• When the income elasticity of demand is greater
  than 1 (luxury good), consumers increase their
  purchases of the good more than proportionate to
  the income increase (e.g. ski vacations).
• When the income elasticity of demand is negative
  (inferior good), consumers reduce their purchases
  of the good as their incomes rise (e.g. potatoes).

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Introduction to Macroeconomics
70
Introduction to Macroeconomics

• Microeconomics examines the behavior of
  individual decision-making unitsbusiness firms
  and households.
• Macroeconomics deals with the economy as a whole
  it examines the behavior of economic aggregates
  such as aggregate income, consumption,
  investment, and the overall level of prices.
• Aggregate behavior refers to the behavior of all
  households and firms together.

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Introduction to Macroeconomics

• Microeconomists generally conclude that markets
  work well. Macroeconomists, however, observe
  that some important prices often seem sticky.
• Sticky prices are prices that do not always
  adjust rapidly to maintain the equality between
  quantity supplied and quantity demanded.

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Introduction to Macroeconomics

• Macroeconomists often reflect on the
  microeconomic principles underlying macroeconomic
  analysis, or the microeconomic foundations of
  macroeconomics.

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The Roots of Macroeconomics

• The Great Depression was a period of severe
  economic contraction and high unemployment that
  began in 1929 and continued throughout the 1930s.

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The Roots of Macroeconomics

• Classical economists applied microeconomic
  models, or market clearing models, to
  economy-wide problems.
• However, simple classical models failed to
  explain the prolonged existence of high
  unemployment during the Great Depression. This
  provided the impetus for the development of
  macroeconomics.

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The Roots of Macroeconomics

• In 1936, John Maynard Keynes published The
  General Theory of Employment, Interest, and
  Money.
• Keynes believed governments could intervene in
  the economy and affect the level of output and
  employment.
• During periods of low private demand, the
  government can stimulate aggregate demand to lift
  the economy out of recession.

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Recent Macroeconomic History

• Fine-tuning was the phrase used by Walter Heller
  to refer to the governments role in regulating
  inflation and unemployment.
• The use of Keynesian policy to fine-tune the
  economy in the 1960s, led to disillusionment in
  the 1970s and early 1980s.

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Recent Macroeconomic History

• Stagflation occurs when the overall price level
  rises rapidly (inflation) during periods of
  recession or high and persistent unemployment
  (stagnation).

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Macroeconomic Concerns

• Three of the major concerns of macroeconomics
  are
• Inflation
• Output growth
• Unemployment

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Inflation and Deflation

• Inflation is an increase in the overall price
  level.
• Hyperinflation is a period of very rapid
  increases in the overall price level.
  Hyperinflations are rare, but have been used to
  study the costs and consequences of even moderate
  inflation.
• Deflation is a decrease in the overall price
  level. Prolonged periods of deflation can be just
  as damaging for the economy as sustained
  inflation.

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Output GrowthShort Run and Long Run

• The business cycle is the cycle of short-term ups
  and downs in the economy.
• The main measure of how an economy is doing is
  aggregate output
• Aggregate output is the total quantity of goods
  and services produced in an economy in a given
  period.

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Output GrowthShort Run and Long Run

• A recession is a period during which aggregate
  output declines. Two consecutive quarters of
  decrease in output signal a recession.
• A prolonged and deep recession becomes a
  depression.
• Policy makers attempt not only to smooth
  fluctuations in output during a business cycle
  but also to increase the growth rate of output in
  the long-run.

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Unemployment

• The unemployment rate is the percentage of the
  labor force that is unemployed.
• The unemployment rate is a key indicator of the
  economys health.
• The existence of unemployment seems to imply that
  the aggregate labor market is not in equilibrium.
  Why do labor markets not clear when other
  markets do?

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Government in the Macroeconomy

• There are three kinds of policy that the
  government has used to influence the
  macroeconomy
• Fiscal policy
• Monetary policy
• Growth or supply-side policies

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Government in the Macroeconomy

• Fiscal policy refers to government policies
  concerning taxes and spending.
• Monetary policy consists of tools used by the
  Federal Reserve to control the quantity of money
  in the economy.
• Growth policies are government policies that
  focus on stimulating aggregate supply instead of
  aggregate demand.

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The Components ofthe Macroeconomy

• The circular flow diagram shows the income
  received and payments made by each sector of the
  economy.

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The Components ofthe Macroeconomy

• Everyones expenditure is someone elses receipt.
  Every transaction must have two sides.

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The Components ofthe Macroeconomy

• Transfer payments are payments made by the
  government to people who do not supply goods,
  services, or labor in exchange for these payments.

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The Three Market Arenas

• Households, firms, the government, and the rest
  of the world all interact in three different
  market arenas
• Goods-and-services market
• Labor market
• Money (financial) market

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The Three Market Arenas

• Households and the government purchase goods and
  services (demand) from firms in the goods-and
  services market, and firms supply to the goods
  and services market.
• In the labor market, firms and government
  purchase (demand) labor from households (supply).
• The total supply of labor in the economy depends
  on the sum of decisions made by households.

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The Three Market Arenas

• In the money marketsometimes called the
  financial markethouseholds purchase stocks and
  bonds from firms.
• Households supply funds to this market in the
  expectation of earning income, and also demand
  (borrow) funds from this market.
• Firms, government, and the rest of the world also
  engage in borrowing and lending, coordinated by
  financial institutions.

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Financial Instruments

• Treasury bonds, notes, and bills are promissory
  notes issued by the federal government when it
  borrows money.
• Corporate bonds are promissory notes issued by
  corporations when they borrow money.

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Financial Instruments

• Shares of stock are financial instruments that
  give to the holder a share in the firms
  ownership and therefore the right to share in the
  firms profits.
• Dividends are the portion of a corporations
  profits that the firm pays out each period to its
  shareholders.

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The Methodology of Macroeconomics

• Connections to microeconomics
• Macroeconomic behavior is the sum of all the
  microeconomic decisions made by individual
  households and firms. We cannot understand the
  former without some knowledge of the factors that
  influence the latter.

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Aggregate Supply andAggregate Demand

• Aggregate demand is the total demand for goods
  and services in an economy.

• Aggregate supply is the total supply of goods and
  services in an economy.

• Aggregate supply and demand curves are more
  complex than simple market supply and demand
  curves.

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Expansion and ContractionThe Business Cycle

• An expansion, or boom, is the period in the
  business cycle from a trough up to a peak, during
  which output and employment rise.

• A contraction, recession, or slump is the period
  in the business cycle from a peak down to a
  trough, during which output and employment fall.

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Fiscal Policy The Basics
97
How big is the Government?

• To see how big of a role the government plays in
  the economy we need to see what percentage of the
  GDP is represented by the government sector
• United States Government plays a smaller role
  compared to other countries
• But it still plays a big role!

98
Fiscal Policy The Basics
99
Remember the Flow!

• Funds flow into the government in the form of
• Taxes
• Borrowing
• Funds flow out
• Spending (purchases)
• Transfer payment

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An Expanded Circular-Flow Diagram The Flows of
Money Throughthe Economy
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Sources of Tax Revenue in theUnited States, 2004
102
Government Spending in theUnited States, 2004
Social insurance programs are government programs
intended to protect families against economic
hardship.
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The Government Budget and Total Spending

• Fiscal policy is the use of taxes, government
  transfers, or government purchases of goods and
  services to shift the aggregate demand curve.

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Change a Variable

• Change a variable
• Shift the Curve

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Government Budget Total Spending

• Government directly controls one of the variables
  in GDP
• GDP C I X - IM

G
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Consumer Spending and Taxes

• Taxes affect Consumer spending
• Disposable Income Total Income Transfer
  payment - Taxes
• A fall in the Disposable Income leads to a fall
  in Consumption
• An Increase in the Disposable Income leads to an
  increase in Consumption

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Why?

• Why would the government want to shift the
  Aggregate demand curve?

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Expansionary Fiscal PolicyExpansionary Fiscal
Policy Can Close a Recessionary Gap
Expansionary fiscal policy increases aggregate
demand.
Recessionary gap
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Why?

• Why would the government want to shift the
  Aggregate demand curve inward and shrink
  everyones income?

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Contractionary Fiscal PolicyContractionary
Fiscal Policy Can Eliminate an Inflationary Gap
Contractionary fiscal policy decreases aggregate
demand.
Inflationary gap
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Lags in Fiscal Policy

• In the case of fiscal policy, there is an
  important reason for caution there are
  significant lags in its use.
• Realize the recessionary/inflationary gap by
  collecting and analyzing economic data ? takes
  time
• Government develops an action plan? takes time
• Implementation of the action plan ? takes time

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Monetary Policy

• The Basics of Money, Interest, and Banking

113
Money Definition

• Simple Definition An article of faith that
  guides transactions

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Money Definition

• Formal Definition Money is anything that meets
  the following four criteria
• Debt Settlement (accepted to pay off loan)
• Medium of Exchange (accepted to buy goods and
  services)
• Store of Value (can be held for future purchases)
• Unit of Account (can be used to compare prices
  and calculate opportunity costs)

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Money Measures

• Whether the Fed chooses to observe it or not,
  there are still two (technically three) primary
  measures of money
• M1 Currency Notes Checking accounts
• Highly Liquid
• M2 M1 Savings Accounts Money Market Mutual
  Funds (which are similar to Savings Accounts)
  Short-Term, Small CDs.
• Less Liquid
• M3 M2 Long Term Time Deposits
• Not Very Liquid not as important

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Money FYI

• Most Money is book entry
• Monetary Base or High Powered Money is currency
  notes, coins, and reserves.
• Called High Powered because its the money
  directly controlled by the government!

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Interest Rates Definition

• The Cost/Price of Money
• Long Term Interest Rates Price (in terms of what
  you give up) to acquire funds for major
  investment
• Short Term Interest Rates Primarily is the price
  (in terms of what you give up) to hold money in
  pocket or spend it.

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Interest Rates Types

• There are numerous rates. Most important are
  probably
• Prime Loan Rate (S.T.)
• Fed Funds Rate (S.T.)
• Mortgage Loan Rate (L.T.)
• Though rates vary, all rates tend to move
  together

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Banking Definition

• Entity that transfers money from savers to
  investors (often called financial intermediaries)
• Dont confuse economic investing with financial
  investing!
• Banks are in business, not as a public service,
  but to make money
• Primarily through interest profits (iloan
  iborrow/deposit)
• This helps to explain why bond market is so
  influential

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Banks and Bonds

• Government Bonds are perfect substitutes for
  loans
• ibond iloan,
• bank indifferent
• ibond gt iloan,
• bank buys bond, rather than lend
• ibond lt iloan,
• bank lends, rather than buy bond

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Banks and Bonds

• This is why the market for T-bonds (govt bonds
  with maturities 10 years or more) influences the
  market for Long-Term Loans (Mortgages).
• In contrast, the markets for T-notes (govt bonds
  with maturities of typically 2 to 10 years) and
  T-bills (govt bonds with maturities of 3 months,
  6 months, and 1 year) influence Short-Term Loans
  (buildup inventory, cover business expenses until
  customers pay, credit card debt).

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Running a Bank

• On a given day, a typical bank can and will
  engage in any of these transactions
• Receive deposits from savers
• Give loans to investors
• Borrow money from other banks (through the
  Federal Funds market)
• Lend money to other banks (through the Federal
  Funds market)
• Borrow money directly from its district Federal
  Reserve Bank (through a Discount Loan)

124
Running a Bank

• When you deposit 100 dollars at a bank, what
  happens?
• Bank would love to lend all 100, but if it has
  checking accounts, then, by law, it must maintain
  some as reserve (either as vault cash or as a
  deposit at district Federal Reserve bank).
• Currently, 0 for first 7 million of deposits
  3 for 7 million to 48 million and 10 for all
  deposits above 48 million.

125
Running a Bank

• Lets assume a required reserve ratio of 10.
• Therefore, our bank
• Lends 70 to private households
• Has 30 in reserves at end of day
• What to do?
• Keep 10
• Lend other 20 overnight to another bank (who
  might have engaged in more lending that day).
• Your bank gains interest, other bank keeps Fed
  off its back!