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•GDP: Spending Y = C + I + G + NX Money MV = PY
•Circular flow Spending—Output—Income
•Measuring GDP and Price Indexes•Unemployment Rate
•Laborforce•Natural rate
•Interest rate: nominal and real•Consumption function
C = C0 + mpc x Yd
•Aggregate Demand: C + I + G + NX•Shifts
•Aggregate Supply: Short-run—Long-run•AD—AS Equilibrium
•Automatic adjustment via price•Keynesian intervention
•Fiscal Policy•Money
•Functions•Money creation in banking system
•Monetary Policy•Tools•Effects
•Phillips Curve•Inflation—Unemployment Tradeoff ?•Expectations and “natural rate”
•Economic Growth•Factor growth—investment•Technology
Macro - ReviewMacro - Review
GDP = C + I + G + NXGDP = C + I + G + NX
MV = P Y (= $GDP)MV = P Y (= $GDP)
Circular Flow
GDP: Real and Nominal• Gross Domestic Product (GDP): Gross Domestic Product (GDP): the market
value of all final goods and services produced within a country during a year.
GDP = C + I + G + Ex – Im GDP = C + I + G + Ex – Im
= C + I + G + NX= C + I + G + NX• Real GDPReal GDP adjusts for inflation
$GDP = P x Q $ GDP = GDP Deflator x Real GDP$ GDP = GDP Deflator x Real GDP
Real GDP = Q = $GDP/P = Nominal GDP divided by
(deflated by) the GDP Price Deflator
Price Indexes (Base Year = 100)Price Indexes (Base Year = 100)• Consumer Price Index (CPI)Consumer Price Index (CPI)
– cost over time of a typical bundle of goods and services purchased by households.
CPI = Cost of Typical Market Basket CPI = Cost of Typical Market Basket NowNow
divided bydivided by
Cost of the Same Basket in Base YearCost of the Same Basket in Base Year
Inflation Rate = {Change in CPI} Inflation Rate = {Change in CPI} ÷ {Initial CPI}÷ {Initial CPI}
• GDP Price Deflator (GDP Price Index)GDP Price Deflator (GDP Price Index)– measures average prices over time of all
goods and services included in GDP.
2006 2007
Quantity Price Quantity Price
Cars
Computers
Oranges
10
4
1,000
$2,000
$1,000
$1
12
6
1,000
$3,000
$500
$1
$GDP in 2006 = $GDP in 2007 =
% Growth =
2006 Base Prices
GDP in 2006|2006= GDP in 2007|2006=
% Growth =
P in 2006|2006 = P in 2007|2006=
2007Base Prices
GDP in 2006|2007= GDP in 2007|2007=
% Growth =
P in 2006|2007 = P in 2007|2007=
2006 – 2007 Average Price Base
GDP in 2006|avg P= GDP in 2007|avg P=
% Growth =
P in 2006|avg P = P in 2007|avg P=
UnemploymentUnemployment
Rate ofUnemployment
= number unemployednumber in the Labor Force
Unemployment rate: % of Unemployment rate: % of labor forcelabor force not working. not working.
• Unemployed persons: not working and looking• Labor force: Employed + unemployed
noninstitutionalized persons 16+ years of age• Underemployed workers are treated as employed• Discouraged workers are not in the labor force
• “Natural” or normal rate of unemployment (NAIRU)(NAIRU)Seasonal UnemploymentFrictional Unemployment: searching for jobsStructural Unemployment: Imperfect match between employee skills and requirements of available jobs.• Cyclical Unemployment : Results from business cycle
Interest Rates: Nominal and RealInterest Rates: Nominal and Real
• Nominal Interest Rate (i): the interest rate observed in the market.
• Real Interest Rate (r): the nominal rate adjusted for inflation ().
r = i - r = i - • Low real interest rates spur business
investment spending (the II in C + II + G + NX)
Consumption Function
C = C0 + mpc * Yd
C0 = Autonomous Consumption
mpc = Marginal Propensity to Consume
mpc+mps = 1 [what’s not consumed is saved]
Yd = Disposable Income
Aggregate Demand Curve
AD = C + I + G + NX
Factors that Shift AD
• Consumption– Income– Wealth– Interest Rates– Expectations/Confidence– Demographics– Taxes
• Investment– Interest Rates– Technology– Cost of Capital Goods– Capacity Utilization– Expectations/Confidence
AD = C + I + G + NXAD = C + I + G + NX
Government Spending Net Exports
– Domestic & Foreign Income
– Domestic & Foreign Prices
– Exchange Rates– Government Policy
Aggregate Supply: Short – Run & Long – Run
Aggregate Demand and
Supply Equilibrium:
Short-run and long-run responses to increase in aggregate demand
::
AutomaticAdjustment
viaPrice Change
Macroeconomic ViewpointsLaissez - Faire
ClassicalMonetaristNew Classical
Activist/InterventionistKeynesianNew Keynesian
Demand-Side Policy: Greater
Spending Means Higher Prices
Real GDP
Pri
ce
Le
ve
l
(c) Aggregate Demand and Supply in the classical range of AS curve. (Prices rise without significant improvements in output and employment.)
AD1
AD
Y?
Fiscal Policy: Some Definitions• Fiscal policy: government spending and
taxing– Demand-side policies– Supply-side policies:
• Discretionary Fiscal Policy:• Automatic Stabilizers:
– Progressive taxes– Unemployment insurance– Welfare payments / other transfer payments
Functions of Money
• Medium of exchange
• Unit of account
–Standard of Deferred Payment
• Store of value
Multiple Creation of Bank Deposits M1Fractional Reserve Banking System: r = .1
Deposit expansion multiplier = 1/r(when banks lend all excess reserves and public redeposits proceeds of loans into the banking system no leakages)
The Fed’s Policy Tools
1) Reserve Requirements
2) Discount rate
“primary credit rate”
3) Open market operations
• Manage the public’s expectations
Inflation Targeting?
How Money Supply Changes Affect GDP
Aggregate Demand and Supply Phillips Curve
Expectations and the Phillips Curve
• Starting at (1): 5% unemployment and 3% inflation. People believe inflation will continue at 3% Curve I.
• Then Fed hypes inflation to 6% unemployment falls to 3% (Point 2 on Curve I).
• Expectations adjust to 6% inflation Wage demands up Economy moves to point (3) Unemployment returns to 5%.
• If expectations adjust instantly, e.g., anticipating Fed’s policy, economy moves directly from (1) to (3).
Economic Growth• Economic growth: an increase in Real GDP.• Small changes in rates of growth
Big changes over many years • Per Capita Real GDP: real GDP divided by
population.
Determinants of Economic Growth• Size and quality of the labor force• Capital• Land/Natural Resources … are not a necessary
condition for economic growth … they can be acquired through trade.
• Technology