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經濟學講義(下)
Chapter 23 Measuring a Nation’s Income
Macroeconomis： Y, un-E, P(Π), I, X, IM...
I. The Economy’s Income and Expenditure
For an economy as a whole, income must equal expenditure
i.e. GDP can be measured by adding up either by the total expenditure of household
or total income(wages, rent, and profit)paid by firms(p.509 figure 1)
II. The Measuement of GDP
1. Definition
(1)GDP＝the market value of all final goods and services produced within a country in a
given period of time
(2)cf. GNP (p.513 FYI)
(3)Ranking(2008)：U.S., Japan, China, Germany
(4)GDP/person：Taiwan：17,507(2008)；U.S.：$47,42；Singapore：37,597；
HK：$30,863；Korea：19,109；China：$3,267
(5)Legal market and final goods and services(not including black market; also not
including most items produced and consumed at home)
p.520 In the News Table
(6)reported quarterly(already multiplied by 4 to give an annual rate) and yearly
(7)seasonally adjusted(or not)(in general, the data are seasonally adjusted)
(8)Green GDP(GNP)
GNP; NNP; NI; PI; DPI(p.513 FYI) (Macroeconomics course)
2. Component of GDP(expenditure side)
GDP(Y)≡C＋I＋G＋NX
NX＝EX-IM
(1)Consumption：durable goods and nondurable goods(not include purchase of new house)
(2)Investment：include inventory and household purchases of new housing
(3)Government purchases：(recently called as government consumption expenditure and
gross investment)；
do not include transfer payment(which do not add to the economy’s production)
(4)Net export：Export－Import
*p.515 Table 1(Component of U.S. GDP, 2007)
Y＝C(70.33％)＋I(15.43％)＋G(19.37％)＋NX(－5.13％)
X(12.04％)－IM(17.17％)；
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Taiwan(2007)
Y＝C(58.9％)＋I(21.5％)＋G(12.1％)＋NX(＋7.5％)； X(73.48％)－IM(65.99％)
III. Nominal GDP vs. Real GDP
1. Nominal GDP：the production of goods and services valued at current prices.
Real GDP：the production of goods and services valued at constant(base year) prices.
(ex. P.516 Table 2)
*Real GDP(growth rate) is more meaningful.
2.GDP deflator：GDP deflator＝(Nominal GDP/Real GDP)*100
(ex. P.516 Table 2； 2009 cf. 2008 Price level increases 71％)
3. Case Study p.519 figure 2：U.S. real GDP
Economic boom, recession(two consecutive quarters of falling real GDP), depression
III. Is GDP a Good Measure of Economic Well-being？
GDP(or GDP/person) a better life？
1. Leisure is not included in GDP
If everyone work on weekend＝＞GDP↑ but better-off?
2. GDP excludes the quality of the environment
Production↑ but pollution↑, better-off? (Green GDP)
3. GDP says nothing about income distribution
GDP(10 very rich& 90 poor)＝GDP(90 rich& 10 poor)＝＞Gini coefficient
4. GDP neglects underground economy
5. Case Study p.523. Table 3
GDP/person is positively related with the citizen’s standard of living.
6. Case Study p. 524(FYI)
Large GDP means more medals in Olympic Games.
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Chapter 24 Measuring the Cost of Living
Inflation, Deflation？ Price Index：CPI, WPI(PPI), GDP deflator …
I. The Consumer Price Index
U.S. Bureau of Labor Statistics(BLS) publishes CPI every month.
CPI：a measure of overall cost of the goods and services bought by a typical consumer.
How the consumer Price Index is Calculated？(see p.531.Table 1 steps)
(1)Fix the basket：choose the goods and the weights(p.533 figure 1)
(7,000 families, 8 major groups：more than 200 categories)
(2)Find the prices
(3)Compute the basket’s cost
(4)Choose a base year and compute the index
CPI＝(price of basket of goods and services/price of basket in base year)*100
(5)Calculate the inflation rate
inflation rate＝(CPI in year 2－CPI in year 1)/ CPI in year 1*100
Π＝ΔP/P or (dP/dt/P)
(6)PPI (initially called as WPI from 1902 to 1978)
PPI：a measure of overall cost of the goods and services bought by firms.
Over 10,000 PPIs for individual products and groups of products are released each month.
TAIWAN
CPI：主計處 (95 年基期＝100) ：7 大類、424 項；每月 5 日公布
食物(26.08％)、衣著(4.17％)、居住(27.95％)、交通(14.04％)、醫藥保健(4.74％)、
教養娛樂(17.15％)、雜項(5.87％)。
WPI：主計處 (95 年基期＝100) ：4 大類、575 項 (權數：1000)；每月 5 日公布
農林漁牧業產品(27.147)、土石及礦產品(57.590)、製造業產品(890.987)、
水電燃氣(24.276)
II. Problems in Measuring the Cost of Living
CPI is not a perfect measure of the cost of living, some problems below：
(1)substitution bias
Consumers will substitute toward goods that are cheaper, but if CPI is computed with
the (old) fixed basket of goods, then CPI will overstate the cost of living.
(ex. In year 2, pears becomes cheaper than apples, consumer will buy more pears and
less apples, yet the CPI(year 2) still uses a fixed basket(more apples than pears,
thus will get a larger increase in cost of living).
(2)introduction of new goods
When a new good is introduced, consumers have more option to choose while keeping
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the same level of well-being, but initially, the new good is not computed in CPI(but later
on will be). So the level of cost is over-estimated.
(ex. VCR vs. movie theater, maybe at same expense but more satisfaction(at home))
(3)unmeasured quality change
ex. Computer with same price before, but more powerful.
(p.534 In the News, BLS tries to adjust it.(ex. TV with same price but more function,
BLS tries to adjust the TV price down))；but too subjective？
III. GDP Deflator vs. CPI
Both are representative price of the economy and usually move together(p.537 figure 2),
But there are differences：
(1)GDP Deflator reflects the prices of all goods and services produced domestically.
CPI reflects the prices of all goods and services bought by consumers.
ex1. If the price of airplane produced by Boeing and sold to Air Force rises, then GDP
Deflator rises, but CPI does not rise.(the airplane is not bought by general onsumers)
ex 2. Price of Volvo car in U.S. rises, CPI rises but not GDP Deflator(Volvo is not
produced in U.S.)
(2)The basket of goods and services in GDP deflator changes automatically over
time(because it measures the price of currently produced goods and services toward
base year), but CPI use the fixed basket(and adjust not quite often)
IV. Correcting Economic Variables for the effects of Inflation
1.Dollar values at different time
ex. U.S.：best-selling movie：Titanic
vs. adjusted after inflation：Gone with the wind (p.539.FYI)
*Indexation
The automatic correction of a dollar amount for the effects of inflation by law of contract.
ex1. COLA(cost-of-living index allowance) provision：indexation of the wage to CPI.
ex2. Income tax brackets adjusted by CPI
ex3. Index bond
2.Nominal Interest rate vs. Real Interest rate
Real Interest rate＝nominal interest－Inflation rate
(During inflationary time, it is worthwhile to borrow the money)
(p.541 figure 3)
negative real interest rate：bad for depositors or lenders
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Chapter 25 Production and Growth
Long- run determinants of the level and growth of real GDP.
(p.551 Table 1：Real GDP and growth rate of different countries)
I. Productivity：Its Role and Determinants
1. Why productivity is so important？
Productivity：the quantity of goods and services produced from each unit of labor input.
Like Robinson Crusoe, a nation’s can enjoy a high standard of living only it can
produce a large quantity of good and services.
2. How productivity is determined？
(1) physical capital per worker
(2) human capital per worker：education is important
(3) natural resources per worker： renewables vs. non renewables
(4) technology knowledge：Coca-Cola and Kentucky Fired Chicken have secret recipes.
p.557 FYI
Y＝A*F(L, K, H, N)
A：technology；N：natural resources
constant returns to scale xY＝A*F(xL, xK, xH, xN)
increasing returns to scale xY＞A*F(xL, xK, xH, xN)
diminishing returns to scale xY＜A*F(xL, xK, xH, xN)
Case Study(p.558)
Are natural resources a limit to growth？ Not necessarily, because of technology progress.
II. Economic Growth and Public Policy
The government should adopt policy to promote economic growth：
1. Saving and Investment
(1)One way to raise future productivity is to invest more current resources in the
production of capital. So encourage saving and investment is one way that the
government can encourage a country’s long-term growth.
(2)But as capital accumulates, diminishing returns may probably happen.(p.560 figure 1)
(3)catch-up effect：the property whereby countries that start off poor tend to grow more
rapidly than countries that start off rich.
2. Investment from broad
(1)FDI(foreign direct investment)：long-term and stable, more welcomed.
(2)foreign portfolio investment：(buy stock, bond…)short-term and less stable,
(hot money is not so welcomed especially)
3. Education
(1)Education is investment in human capital and hence good for country’s long-term
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growth.
(2)Less-developed countries often face brain drain(emigration of may of the most hghly
educated workers to rich countries) situation.
4. Health and Nutrition
5. Property Rights and Political Stability
6. Free Trade
Outward-oriented policies will be better than inward-oriented policies.
7. Research and Development
R&D should be encouraged, and patent system should be established.
8. Population
Good or bad？
(1)Stretching natural resources？
Malthus：an ever-increasing population would continually strain society ability to
provide for itself.
But growth in human ingenuityhas offset the effects of a larger population.
(2)Diluting the Capital？
High population growth reduces GDP per worker because rapid growth in the numbers
of workers forces the capital to be spread more thinly, and thus is harmful.
(3)Promoting Technology Progress？
World population growth has been an engine of technological progress and economic
prosperity？
Conclusion
Policymakers who want to encourage growth in standards of living must aim to increase
their nation’s productive ability by encouraging rapid accumulation of the factors of
production and ensuring that these factors are employed as effectively as possible.
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Chapter 26 Saving, Investment, and the Financial System
How the system works：(1)Financial institutions；(2)Relationship between financial
system and saving & investment；(3)Supply and demand for funds in financial systems.
I. Financial Institutions
1. Financial Markets
(1)Bond market：IOU (debt finance)
term：the length of time until the bond matures；perpetual bond：no maturity
(in general, long term bond has higher interest)
credit risk： default？ credit rating；junk bond
tax treatment：(in U.S. interest on municipal bond is nontaxable, but not other bond)
(2)Stock market(equity finance)
No maturity in theory；Stock exchange(NYSE, NASDAQ…)；stock index(Dow Jones..)
(3)Others： Derivative(futures, option,…)； Foreign exchange market….
2. Financial Intermediaries
(1)Banks
(2)Mutual fund：”Don’t put all your eggs in one basket”…；Index fund
(3)Others：credit union, pension fund, insurance co.…
II. Saving and Investments in the National Income Accounts
Y≡C＋I＋G＋NX
In closed economy NX＝0,
1. Y＝C＋I＋G＝＞Y－C－G((national )saving)＝I or S＝I(saving equal investment)
2. S＝Y－C－I－G＝(Y－T－C)＋(T－G)＝private saving＋public saving
(budget surplus＝T－G＞0；budget deficit＝T－G＜0
Case Study (p.592 figure 5 The U.S. Government Debt)
III. The Market for Loanable Funds
1. Supply and Demand for Loanable Fund
Supply of Loanable Fund：private saving(buy bond(directly), deposit in the
bank(indirectly)…)＋government saving
Demand for Loanable Fund：investment
p.585 Figure 1 S(r)＝I(r)
r：real interest rate
2. Government Policy
(1)tax on interest income
p.587 figure 2 ex. Tax incentive＝＞S(r) shift right＝＞r↓＝＞new equilibrium
(2)investment incentive
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Investment tax credit↑＝＞I(r)↑＝＞ r↑＝＞new equilibrium
(3)government deficit(surplus)
government deficit＝＞public saving↓＝＞S(r) shift left
＝＞r↑＝＞investment is crowing out＝＞new equilibrium
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Chapter 28 Unemployment
long run (This chapter)：natural rate of unemployment(natural does not mean desirable)
short run(ch.35)：cyclical unemployment
I. Identifying Unemployment
1.How is unemployment measured？
U.S Dept . of Labor ：BLS(Bureau of Labor Statistics) 60,000 household regular survey
BLS 3 categories(adult i.e. 16 and older)：
labor force(employed, unemployed)、not in labor force
(1)Labor force＝employed＋unemployed
(2)Employed：p.615…
(3)Unemployed：not employed, available for work and tried to find employment during
the previous 4 week.
(4)Not in labor force：adult not (1)&(2), includes full-time students, homemakers, retirees.
* unemployment rate＝(number of unemployed/labor force)*100
*labor force participation rate＝(labor force/adult population)*100
(p.615 figure 1 U.S. data & p.616 Table 1)
*natural rate of unemployment：the normal un-E rate that the economy experience, and
around which the un-E rate fluctuates.
*cyclical unemployment：the deviation of un-E from its natural rate(p.617 figure 2)
Case Study：Labor force Participation of Men and Women(p.620 figure 3)
*Different measures of unemployment rate(p.619 Table 2)
台灣：主計處
樣本戶約 20,000 戶，包括年滿 15 歲人口約 6 萬人
(1)民間勞動力：指在資料標準週內年滿 15 歲可以工作之民間人口，包括就
業者及失業者。
(2)就業者：指在資料標準週內年滿 15 歲從事有酬工作者，或從事十五小時
以上之無酬家屬工作者。
(3)失業者：指在資料標準週內年滿 15 歲同時具有下列條件者：無工作；
隨時可以工作；正在尋找工作或已找工作在等待結果。此外，尚包
括等待恢復工作者及找到職業而未開始工作亦無報酬者。
(4)非勞動力：指在資料標準週內，年滿 15 歲不屬於勞動力之民間人口，包
括因就學、料理家務、高齡、身心障礙、想工作而未找工作及其他原
因等而未工作亦未找工作者。
*失業率：失業者占勞動力之比率。
*勞動力參與率：勞動力占 15 歲以上民間人口之比率。
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II. Why are there always some people unemployed？
1. Frictional unemployment (short term un-E)
Un-E that results because it takes time for workers to search for the jobs that best suit
their tastes and skills.(short term)
(p.623-626 explanation：Job Search)
2.
Structural unemployment(long term un-E)
Un-E that results because the number of jobs available in some labor markets is
insufficient to provide a job for everyone who wants one.
(because wage is set above the equilibrium when labor demand and supply is equal)
(p627-634 explanation：minimum wage laws, unions, and efficiency wages))
III. Further Explanation of Reasons of Unemployment
1. Frictional unemployment： Job Search
Job Search：the process by which workers find appropriate jobs given their tastes and
skills.
(1)Why is frictional un-E inevitable？
Frictional un-E is often the result of changes in the demand for labor among different
firms(because consumers tastes buy differently＝＞product of firm＝＞labor demand)
Different regions produce different goods
Ex. Oil price↓＝＞Texas oil-producing firms lay-off workers, but Michigan(Detroit
cars producers hire more workers)(sector shifts)
Information between job candidates and job vacancies disseminate not smoothly
Restructure of industry
*The churning of labor force is normal in a well-functioning and dynamic market
economy, but the result is some amount of frictional un-E.
(2)Government Policy
Government-run employment agencies, public training program
But critics：can government do better than enterprise？
(3) unemployment insurance
Most states in U.S., the worker can have about 50％ of former wage for 26weeks.(But
the unemployed who quit the job(himself), fired for cause or just enter the labor force,
are not eligible)
*Empirical result shows that receiving unemployment insurance benefits reduces the
search effort of the unemployed.(which is good or not is unsure however)
2. Structural unemployment：
(1) Minimum-wage laws
p.628 figure 4
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Minimum-wage laws matter most for the least skilled and least experienced members
of labor force such as teenagers.
(2) union and collective bargaining(Insider-outsider theory)
When a union raises the wage above the equilibrium, labor supply↑& labor demand
↓(like figure 4)＝＞those remained employed(insiders) are better-off, but those who
were previously employed and now are unemployed(outsiders) are worse-off.
Good or bad？
(3) efficiency wages theory
efficiency wages：above-equilibrium wages paid by firms to increase worker
productivity.
Reasons for firm to pay wage above equilibrium：
worker health：wage higher＝＞worker health↑
＝＞productivity↑(esp. developing countries)
worker turnover：wage higher＝＞turnover rate↓＝＞hiring and training cost↓
worker quality：wage higher＝＞attract better worker to apply for job.
worker effort：wage higher＝＞worker has incentive to work harder to keep the job
Case Study：1914 Ford motors raise wage to $5/day＝＞productivity↑
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Chapter 29 The Monetary System
I. The Meaning of Money
1. The Function of Money
(1)medium of exchange
(2)unit of account
(3)store of money
Money is the most liquid asset.
(liquidity：the ease with which an asset can be converted into the economy’s medium of
exchange.)
2. The Kinds of Money
(1)commodity money
Gold. Silver…(cigarette in the prison)
(2)fiat money(paper money)
fiat money：money without intrinsic value that is used as money because of government
decree
legal tender
2. Money in the US Economy
M1：p.646 figure 1) ； M1a, M1b
M2：
(p.647 FYI ：credit card are excluded from the definition of Money
台灣：(中央銀行)
M1A=通貨淨額（社會大眾手中持有的通貨）+企業及個人與非營利團體存在銀
行與基層金融機構之支票存款及活期存款
M1B＝M1A＋個人與非營利團體存在銀行與基層金融機構之活期儲蓄存款
M2＝M1B＋準貨幣(Quasi-money)
準貨幣：可無條件立即按等價兌換成狹義貨幣的貨幣性資產，包括企業及個人
在貨幣機構之定期性存款與外匯存款，中華郵政公司儲匯處吸收之郵
政儲金總數，企業及個人持有貨幣機構之附買回交易餘額，外國人持
有之新台幣存款，以及貨幣市場共同基金。
II. The Federal Reserve System
1. The Federal Reserve(Fed)
1913 established, 7 governors (of board), 14-year terms to ensure independence.
Chairman of FED：2nd powerful man, Bernake now
The Federal Reserve System：Fed Board＋12 regional Fed banks.
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Two jobs：
(1)Regulate banks and ensure the health of the banking system
“Bank’s bank”：lender of last resort
(2)Control the money supply
2. The Federal Open Market Committee(FOMC)
U.S. monetary policy is made by FOMC(meets about every 6 weeks)
FOMC committee：12 members( 7 governors of Board＋5/12 regional bank presidents)
III. Banks and the Money Supply
1. Bank Reserve
Reserve ratio：the fraction of deposits that banks hold as reserves.
U .S. Reserve Requirements
Requirement
Percentage of
liabilities
Effective date
$0 to $10.3 million2
0
1-01-2009
More than $10.3 million to $44.4 million3
3
1-01-2009
More than $44.4 million
10
1-01-2009
Nonpersonal time deposits
0
12-27-1990
Eurocurrency liabilities
0
12-27-1990
Type of liability
Net transaction accounts 1
*Total transaction accounts consists of demand deposits, automatic transfer service (ATS) accounts,
NOW accounts, share draft accounts, telephone or preauthorized transfer accounts, ineligible bankers
acceptances, and obligations issued by affiliates maturing in seven days or less.Net transaction
accounts are total transaction accounts less amounts due from other depository institutions and less
cash items in the process of collection.
台灣：(占存款％)(甲戶 45％不計息)；乙戶(55％計息)
法定
準備率
(最高)
支票
存款
25
活期 儲蓄存 定期
存款 款(活期) 存款
25
15
15
97.9.18
10.75 9.775
5.5
儲蓄存
款(定期)
15
5
4
13
其他各種負 其他各種負
信託資金
債(外匯存款) 債(其他項目)
20
25
25
0.1250
0
15.125
2. Money Creation with Reserve Banking
(1)100％-Reserve- Banking
p.650 Table：currency↓$100, but demand deposit↑$100＝＞money supply unchanged
So, if banks hold all deposits in reserve, banks do not influence money supply.
(2) Fractional Reserve Banking
p.651-652 Table
$100＋$100(1－10％)＋$100(1-10％)(1-10%)＋…
＝$100【1＋((1－10％)＋(1-10％) (1-10%)＋…】
＝$100【1/(1－(1－10％)】
＝$100＊(1/10％)＝$1,000
＝$100＊(1/reserve ratio)
Money multiplier＝1/reserve ratio(the reciprocal of reserve ratio)
i.e. currency↓$100, but demand deposit↑$1,000(bank create $1,000 money)
3. The Fed’s Tools of Monetary Control
(1)Open-Market operations
Fed buy government bond＝＞money supply↑
Fed sell government bond＝＞money supply↓
*Great flexibility and used most often.
(2)Reserve Requirement
From above, reserve ratio↓(↑)＝＞money multiplier↑(↓)
*Rarely used because it will disrupt the business of banking.
(3)The Discount Rate
Strictly speaking, this is “rediscount rate”
rediscount rate：the interest rate on the loans that the Fed makes to banks
rediscount rate↑(↓)＝＞Fed discourages(encourages)banks from borrowing from Fed
＝＞bank’s reserve↓(↑)
＝＞money supply↓(↑)
＜p.654.FYI＞
4. Problems in Computing the Money Supply
(1)Fed can not control the amount of money that households choose to hold as deposit
＝＞bank reserves can not be controlled＝＞money supply can not be controlled
(2)Fed can not the amount that banks choose to lend
＝＞money supply can not be controlled
Case Study
Bank Run
*Even if the bank is solvent(assets exceed liabilities), it will not have enough cash on
hand to allow all depositors immediate access to all of their money.(Faith)
FDIC：federal Deposit Insurance Corporation($100,000＝＞$250,000 till 2009/12)
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*The Federal Funds Rate( p.657)
Federal Funds Rate：the short term interest rate that banks charge one another for loans
*overnight(most liquid), 1 week, 2 weeks, …several months
*The rates are determined by the market, but Fed has set a target goal rate in recent years.
＝＞Federal Funds Rate↓(↑)
＝＞Fed will use the open market operation to induce interest↓(↑)
＝＞loose(tight) monetary policy
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Chapter 30 Money and Inflation
I. The Classical (Quantity)Theory of Inflation
The Velocity and the Quantity Equation
Equation pf Exchange(Fisher), Cambridge Equation…
(1) Equation pf Exchange(p.671)
M＊V＝P＊Y V：velocity of money(V＝(P＊Y)/M
(V is determined by the economic system and is quite stable p.671 figure 3)
*nominal variables vs. real variables(p.667)
nominal variables：variables measured in monetary terms
real variables：variables measured in physical units
ch.24 real Interest rate＝nominal interest－Inflation rate
real wage＝nominal wage adjusted for Inflation rate(w＝W/P)
P＊Y(nominal income)；Y(real income)
(2)The Classical Dichotomy and Monetary Neutrality
According to Classical Dichotomy, changes in the supply of money only affect nominal
variables but not real variables(Monetary Neutrality). (p.669)
From MV＝PY, V is relatively stable over time(can be viewed as constant)
M↑＝＞(PY)↑ proportionately
Y is determined by factor supplies(K, L, natural resources, technology…)
＝＞P↑ proportionately in the long run(Monetary is Neutral)
*But money can affect real variables in the short run(one year or two, later inch.34).
(3)The Graphic Explanation(p.667. figure 1)
Money Demand：Money is used only as medium of exchange in classical theory
P↑【(1/P)：value of money↓】＝＞money demand↑(need more money to trade)
Money：given(determined by Fed)
p.667 figure 1；p.668 figure 2(Money↑＝＞P↑)
Case Study： Money and Prices during Hyperinflations(p.673 figure 4)
Hyperinflation：inflation rate＞50％/month or ＞100times/year
The growth of inflation is almost the same as the growth of money.
Inflation tax：government raises revenue by printing money.(The inflation tax is like on
everyone who holds money because the money is not so valuable as before.)
Fisher effect：real interest rate＝nominal interest rate－(expected) inflation rate
Fisher effect holds in the long run because expected＝actual inflation rate,
But does not hold in the short run because expected≠actual inflation rate.(p.677 figure 5)
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II. The Cost of Inflation
1. Inflation vs. Deflation
Inflation：the continuing increase in the overall level of prices
Deflation：the continuing decrease in the overall level of price
2. The Cost of inflation
(1)A Fall in Purchasing Power？The Inflation Fallacy？？？
(If nominal income keeps pace with rising inflation), inflation does not reduce people’s
real purchasing power.
(2)Cost of Inflation
 Shoeleather Cost
Inflation＝＞money holding↓＝＞go to bank often＝＞waste of time and effort
 Menu Cost
Cost of changing cost, printing catalogs, advertising….
 Relative-Price Variability and the Misallocation of Resources
When inflation distorts relative prices, consumer decisions are distorted, and markets are
less able to allocate resources to their best use.
Inflation-induced Tax Distortions
Ex1. Capital Gains tax
Inflation＝＞House P↑＝＞sell house＝＞capital gains＝＞tax
Ex2. Tax on interest
Tax on nominal interest＝＞discourage saving
The tax system need to be indexed.
(ex. 1997 U.S. Inflation-Indexed Bond)
Confusion and Inconvenience
Redistribution of Wealth(from Unexpected inflation)
Lender vs. borrower、retired…
*3. The Problem of Deflation
(1) Case Study(p.682)
The Wizard of OZ and the Free-Silver Debate
1880-1896 U.S. Deflation＝＞real value of debt↑＝＞harm on farmer, gain by bank
To increase money supply, should the silver(other than gold) be used as money？
(2) Problem of Deflation
17
Chapter 3 Interdependence and the Gains from Trade
I. A Parable for the modern Economy
1. No Trade(p.51 Figure 1)
2 people(farmer, rancher)
2 goods(potato, meat)
＝＞Individual Possibility Curve
Why the curve is a straight line？ (assume opportunity cost is constant)
＝＞IF NO TRADE(Autarky Economy), Production=Consumption
＝＞farmer：A(4,16)
rancher：B(12,24)
(Why A or B？need Utility Function (later))
2. With trade(Specialization and Trade) (p.53 Figure 2)
Farmer specializes in producing potato 32 oz
Rancher specializes in producing meat 18 oz, potato 12oz
＝＞Trade term of trade：15 oz potatoes＝ 5 oz meat
＝＞farmer (5,17) (from A to A*, better off)
rancher：(13,27) (from B to B*, better off)
( term of trade=? ；why A*, B*)
II. Comparative Advantage: The driving Force of Specialization
1. Absolute Advantage vs. Comparative Advantage
Adam Smith：Absolute Advantage
Ex. rancher 48 meat＞farmer 32 meat
rancher 24 meat＞farmer 8 meat
David Ricardo：Comparative Advantage
Comparative Advantage：the ability to produce a good at a lower opportunity cost than
any other producer.
Ex. P.55 Table 1
Rancher has the comparative advantage in producing meat
(Rancher：to produce 1 meat he has to give up 2 potatoes
Farmer：to produce 1 meat he has to give up 4 potatoes)
Farmer has the comparative advantage in producing potato
(Farmer：to produce 1 potato he has to give up 1/4 potato
Rancher：to produce 1 potato he has to give up1/2 potatoes)
2. Comparative advantage and Trade
*The gains from specialization and trade are based not on absolute advantage but on
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comparative advantage.
*When each person specializes in producing the good for which he or she has a
comparative advantage, total production in the economy rises.
*This increase in the size of the economic pie can be used to make everyone better off.
(ex. Farmer produce 32 potatoes , Rancher produce 18 meat, 12 potatoes
Trade：farmer 15 potato vs. rancher 5 meat
＝＞total production (18 meat, 44 potatoes)＞(16 meat, 40 potatoes) (no specialized)
＝＞both share the pie：farmer(5,17)trade＞farmer (4,16)no trade
Both
Rancher(13,27)trade＞Rancher(12,24)no trade better off )
Question:
(1)How is the term of trade determined？
(2)How they share the pie？
Can be found answer in International Economics(Trade)
3. Application of Comparative advantage
(1) Tiger Woods：good at both golf and mowing the lawn
But if he specializes in playing golf(and make money), then hire someone(Forrest
Gump) to mown his lawn(at a little higher wage)
＝＞Wood and Gump both better off.
(2)Same reason that U.S. should trade with other countries.
19
Chapter 31 Open-Economy Macroeconomics：Basic Concepts
I. The International Flows of Goods and Capital
1. The Flow of Goods and Services
Export, import, net export, trade balance, trade surplus(deficit), balanced trade
Case Study(p.693 figure1)：The increasing openness of the U.S. Economy(Big Deficit)
NAFTA, GATT, WTO,…
Ch.23 U.S. GDP, 2007
Y＝C(70.33％)＋I(15.43％)＋G(19.37％)＋NX(－5.13％)；X(12.04％)－IM(17.17％)
Taiwan(2007)
Y＝C(58.9％)＋I(21.5％)＋G(12.1％)＋NX(＋7.5％)； X(73.48％)－IM(65.99％)
2. The Flow of Financial Resources
Flow of capital has two forms：
(1)foreign direct investment(FDI)
(2)foreign portfolio investment
Net capital flow(NCO)＝Purchase of foreign assets by domestic residents
－Purchase of domestic assets by foreigners
3. The Equality of Net Exports and Net Capital Outflow(p.697)
*Net capital outflow(NCO)≡Net export(NX)
Why”≡”？
Sell computer to Japan＝＞export(出口＋)
＝＞receive Yen
＝＞usages：(1)hold Yen in cash(acquire foreign asset)
(2)buy Japanese bond(acquire foreign asset)
(3)buy Japanese good(Import－)
(4)deposit in bank or change into US. dollars
(bank acquire foreign asset)
U.S. deficit(Net Export＜0≡Net capital outflow＜0)＝＞financed by capital inflow
4. Saving, Investment, and Their Relationship to the International Flows
Y＝C＋I＋G＋NX
＝＞Y－C－G＝I＋NX ；S＝Y－C－G
＝＞S＝I＋NX
；NX＝NCO
＝＞S＝I＋NCO (Saving＝Domestic Investment＋Net Capital Outflow)
When S＜I＝＞NCO＜0(net capital inflow)：(NX＜0)(export＜import)
S＞I＝＞NCO＞0(net capital outflow)：(NX＞0)(export＞import)
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*p.700 Table 1
Case Study(p.701 figure 2)
After 1990, U.S. S＜I＝＞NCO＜0(net capital inflow)
II. The Prices for International Transactions：Real and Nominal Exchange Rates
1. Nominal Exchange Rate
(Nominal) Exchange Rate：the rate at which a person can trade the currency of one
country for the another.
(e＝NTD/USD＝NTS35/US$1＝35)
Appreciation：e↓(NTS35/US$1＝35＝＞NTS34/US$1＝34)
Depreciation：e↑(NTS35/US$1＝34＝＞NTS34/US$1＝35)
2. Real Exchange Rate
Real exchange rate＝e＊(Pd/Pf) (Pf is P* in textbook)
Ex. Rice in US $100, e＝80；Rice in Japan 16,000yen＝＞real e＝80*100/16,000＝0.5
*real exchange is the key determinant of export(import)
In the above case, if buy rice in US, cost＝$8,000 yen But buy in Japan 16,000＝＞export
III. Exchange Rate Determination：Purchasing-Power Parity
1. Purchasing-Power Parity(PPP) ：e(nominal exchange rate)＝Pf/ Pd) (p.706)
In the case above, buy rice in US(Pd↑) and export to Japan and sell(Pf↓)
＝＞(Pd/Pf) ↑＝＞….＝＞until e＊ Pd＝Pf or real exchange rate＝1
e＊Pd＝Pf＝＞Law of one Price(p.707：A good must sell for the same price in all
locations.(Or there will be arbitrage)
Purchasing-Power Parity(PPP)：a unit of currency should be able to buy the same
quantity of goods in all countries.(in the long run)
1/P(a dollar can buy 1/P units of goods domestically)
＝(e＊1)/ Pf(a dollar can be converted into e units foreign currency and can buy
e*/ Pf units of good abroad)
Case Study(p.710 figure 3 Hyperinflation in Germany during 1923-25))
From PPP above e＝Pf/ Pd
If G prints more money＝＞ Pd↑＝＞e↓
2. Limitation of PPP
PPP may not hold because：
(1) many goods are not easily traded(arbitrage is difficult)
(2) even traded good are not always perfect substitutes(ex. US vs. Japanese cars)
*So PPP is not a perfect theory of exchange rate determination, nevertheless, when (real)
exchange rate drifts from the level predicted by PPP, people have greater incentive to
move good across national borders.
21
Case Study(p.711 The Hamburger Standard)
Big Mac Index, Wii Index…
…………………………………………………………………………………….
Why Net Capital Outflow(NCO)=Net Export(NX) ？
Net Export=Export－Import
Net Capital Outflow= Purchase of foreign assets by domestic residents
－Purchase of domestic assets by foreign residents
Example 1, buy foreign stock＝capital outflow； foreign portfolio investment
Example 2, investment abroad＝capital outflow； foreign direct investment(FDI)
If U.S. sell good to Japan for 10,000 yen, U.S. (net) export↑ 10, 000 yen
(1) If keep the yen＝a domestic resident acquired the foreign asset(Japanese currency)
＝＞(net) capital Outflow 10, 000↑ yen＝(net) export↑ 10, 000 yen
(2)Use yen to buy Japanese stock＝＞(net) capital Outflow 10, 000↑ yen＝(net) export
↑ 10, 000 yen
(3)use yen to buy Japanese good＝＞Import↑10, 000 yen
＝＞Net Export＝0＝Net Capital Outflow
(4)go to bank & convert yen to U.S. dollar＝＞bank gets yen＝＞…As above
＝Net Capital Outflow
Summary
(1)When a country has trade surplus(NX＞0) ＜＝＞ Capital is outflow (NCO＞0)
(2)When a country has trade deficit(NX＜0) ＜＝＞ Capital is inflow (NCO＜0)
Ex. Us trade deficit towards China＜＝＞China buy lots U.S. Bond
22
Chapter 32 A Macroeconomic Theory of the Open Economy
In previous papers, we discuss“closed economy”, now we have the“open”economy
(the outflow(inflow) of capital and export(import) of good…). In the open economy, how
the (real) interest rate, exchange rate are determined？How the government policies affect
the outcome？…
(In this chapter, assume P is fixed(hence real nominal interest equals real exchange rate
and also Y is given(determined by factors of production and technology) )
I. Supply and Demand for Loanable Funds and for Foreign Currency Exchange
1. Supply and Demand for Loanable Funds in Open Economy
(1) Supply and Demand for Loanable Funds in closed Economy
Ch. 26 p.585 Figure 1 S(r)＝I(r)
r：real interest rate, S’＞0, I’＜0
(2) Supply and Demand for Loanable Funds in open Economy
Supply of Loanable Funds：National Saving S(r), S’＞0
Demand for Loanable Funds：I(r) ＋NCO(r)
 If NCO＞0(＜0)＝＞demand for loanable fund ↑(↓)
 NCO’＜0(If domestic real r high＝＞capital outflow(inflow) decrease(increase))
Equilibrium：p.717 figure 1 S(r)＝I(r) ＋NCO(r) r：real interest rate NCO’＜0
2. Supply and Demand for Foreign Currency Exchange
(1)Demand for Foreign Currency Exchange
Net export＝Export－Import
＝supply of Yen－demand for Yen
＝Demand for USD －Supply of USD
＝Demand for dollars(net export)
 Export(to Japan)：supply of Yen
if e↓(USD depreciate)＝＞Export↑＝＞Supply of Yen↑＝＞Demand for USD↑
 Import(from Japan)：demand for Yen
if e↓(USD depreciate)＝＞Import↓＝＞demand for Yen↓＝＞Supply of USD↓
＝＞e↓(USD depreciate)＝＞(net) Demand for USD↑
(2) Supply for Foreign Currency Exchange
Assume NCO(r)(capital outflow－capital inflow) is affected by r, not by e？？
Capital outflow(sell USD, buy Yen)：USD supply, Yen demand
Capital inflow(sell Yen, buy USD)：USD demand, Yen supply
Supply of US dollars(from NCO(r)) is vertical in figure 2 NCO’(r)＜0
(3) Equilibrium in Foreign Exchange Market
(p.719 figure 2)
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II. Equilibrium in the Open Economy
Simultaneous equilibrium in two markets(p.722 figure 4)
Figure 4(a)The market for loanable fund(same as p.717 figure 1)
4(c)The market for foreign currency exchange(same as p.719 figure 2)
＋4(b) Net capital outflow NCO’(r)＜0(NCO is negatively correlated with real r)
＝＞real r & real e are determined
III. How Policies and Events affect an Open Economy
1. Government Budget Deficits(p.725 figure 5)
Government deficit↑＝＞public saving↓＝＞supply of loanable fund shift left
＝＞r↑(and crowd out private I)
＝＞(r↑＝＞capital outflow less, inflow more to earn higher r)
＝＞net capital outflow↓
＝＞supply of dollars↓(shift left because sell USD( buy Yen)↓
＝＞e↑(USD appreciate)＝＞net export↓
G Deficit↑＝＞(real ) r↑＝＞(I↓)＝＞e↑(USD appreciate) ＝＞net export↓
2. Trade Policy(p.729 figure 6)
Tariff, import quota, voluntary export restrictions(in fact involuntary)…
＝＞net export↑(import↓)
＝＞supply of Yen↑(demand of USD↑because covert Yen to USD)
＝＞USD demand curve shift right(figure 6(c))
＝＞ USD appreciate(e↑)
＝＞NCO(r) does not change (NCO depends on r, not e) (figure 6(b))
＝＞NX does not change(e↑＝＞net export↓ offset net export↑initially)
＝＞trade balance does not change(but specific industry or good will be affected)
3. Political Instability and Capital Flight(p.731 figure 7)
Mexico Political Instability
＝＞Capital Flight out of Mexico(NCO shift right：figure 7(b))
＝＞Demand for Loanable Funds：I(r) ＋NCO(r)↑)(D shift right：figure 7(a))
&
＝＞sell Mexican assets and covert to USD
＝＞supply of pesos↑(S shift right：figure 7(c))
＝＞peso depreciate(e↓)
Case Study
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Chapter 33 Aggregate Demand and Aggregate Supply
Ch.33-35 discuss “short-run “economic fluctuations(recession, un-E, …)：ch.33 set
【aggregate demand and supply model】 to analyze short run fluctuations, ch.34 discuss
government policies(financial and monetary policies), ch.35 discuss the trade-off between
inflation and unemployment.
Recession
I. Three Key Facts about Economic Fluctuations
1. Economic Fluctuations(Business Cycle)s are Irregular and Unpredictable.
2. Most Macroecnomic Quantities Fluctuate Together
Y, C, I, un-E homes sales…
*C is quite stable, but I is more volatile(p.742 sec.2)
3. As Output Falls, Unemployment Rises.(p.740 figure 1)
II. Aggregate Demand and Supply Model
Classical theory：MV＝PY；Money is neutral(M↑＝＞(PY)↑＝＞P↑) describe the
world in the long run, but not in the short run.(why Y, un-E …fluctuate)
New model to explain how real and nominal variables interact：Aggregate Demand and
Supply Model
1. Aggregate Demand Curve
aggregate demand：(C＋I＋G＋(X－IM)) at different P levels(in the whole economy)
(1) Consumption
Wealth effect：P↓＝＞real wealth(wealth/P)↑＝＞C↑
(2) Investment
Interest-Rate effect：P↓＝＞money demand↓＝＞interest↓＝＞I↑
(3) G is exogenous
(4) Net Export(X－IM)
Exchange-Rate effect：P↓＝＞interest↓＝＞capital outflow
＝＞sell dollars buy Euro＝＞USD depreciate＝＞net export↑
Summary：When P↓＝＞aggregate demand↑(downward sloping)
Shift of Aggregate Demand Curve：
(1) Consumption： tax cut, stock market↓,
(2) Investment：firm expectation
Tax credit, Money supply↑…
(3) G
(4) Net Export
【Summary p.752 Table 1】
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2. Aggregate Supply Curve
(1)Long Run Aggregate Supply Curve
Why is Long Run Aggregate Supply Curve vertical？
p.753 figure 4
In the long run, the quantity of output supplied depends on the economy’s quantity of
labor, capital, natural resources and technology, and does not depend on the overall price
level, so the long run aggregate supply is vertical.
(ch. 25 Y＝A*F(L, K, H, N)
A：technology；N：natural resources)
Shift of Long Run Aggregate Supply Curve
K, H, A, free trade, ….
Long Run Growth and Inflation(p.756 figure 5)
In the long run, technology↑＝＞AS shift right
Also Fed Money↑＝＞AD shift right
＝＞P↑&Y↑
(2)Short Run Aggregate Supply Curve
The quantity of output supplied deviates from its long run, or natural level when the
actual price level in the economy deviates from the price level that people expected to
prevail. That is, when the price level in the economy rises above the level that people
expected, output rises above its natural rate, and when the price level falls below the
expected level, output falls below its natural rate.
Why is Short Run Aggregate Supply Curve upward sloping？
A)The Sticky-Wage theory
If P↑but nominal wages are based on the expected prices and hence sticky(contract
bounded )＝＞(W/P↑)↓＝＞cost of firm↓＝＞produce more(output↑)
B)The Sticky-Price theory
If money↑unexpected＝＞P↑(general price↑unexpected)＝＞menu cost
＝＞some firm’s price does not adjust↑＝＞sales↑＝＞produce more(output↑)
C)The Misperception theory
If P↑(general price↑)＝＞some suppliers misperceive that the prices of their
products↑relative to other products(in fact all prices↑and relative price does not
change)＝＞produce more(output↑)
In Summary：
Quantity supplied＝Q(natural rate output)＋a(actual P－expected P)
In the SR, actual P≠expected P＝＞SR Aggregate Supply Curve is upward sloping
In the LR, actual P＝expected P＝＞Quantity supplied＝Q(natural rate output)
＝＞LR Aggregate Supply Curve is vertical
Shift of Short Run Aggregate Supply Curve
A) K, L, natural resources, technology change＝＞ SR Aggregate Supply Curve shift
26
B) expected price↑(↓)＝＞W↑(contract bargained)＝＞firm cost↑＝＞produce less
＝＞SR Aggregate Supply Curve shift left(right).
【Summary p.761 Table 2】
III. Causes of Economic Fluctuations
p.762 figure 7 Long Run Equilibrium
When the economy reaches the long run equilibrium, the expected price level will have
adjusted to equal actual price level. As a result, the SR aggregate supply curve cross the
LR vertical supply curve(at point A).
1. Contraction of Aggregate Demand
Financial crisis＝＞aggregate demand↓(AD1＝＞AD2)(A→B)
＝＞P↓&Y↓(P1→P2 & Y1→Y2)
At first, people are surprised, but over time they will realize the reality and
expectations catch up with this new reality( P↓&Y↓)
＝＞W↓…＝＞firm cost↓
＝＞aggregate supply curve shift right(AS1＝＞AS2)(B→C)
＝＞P↓&Y↑(P2→P3& Y2→Y3)
＝＞Y is restored(p.762 figure 8)
Therefore, in the LR shifts in aggregate demand affect only P but not output.
*What can government do？
(1)Do nothing, and the economy will restore to original Y but may long and painful.
(2)Increase aggregate demand(Money↑, G↑…), move AD2 back to AD1, shorten the
painful period.(because of「election」, or「in the long run, we are all dead」)
But who will pay the bill？(p.763 figure 8) & (p.770 FYI Keynes)
Case study p.766 figure 9
(1) Great Depression(1929-1933)：real GDP↓27％, un-E↑25％, P↓22％,
stock prices↓90％. (War saves it？)
(2) Recession of 2001 (after dot-com bubble & 911 attack.
Fed increase money supply, but now the financial crisis！
2. Adverse Shift of Aggregate Supply(p.768 figure 10)
Bad weather, oil crisis＝＞cost of production↑＝＞firms reduce production
＝＞aggregate supply curve shift left(AS1＝＞AS2)
＝＞P↑&Y↓& Y1→Y2)(Stagflation)
＝＞expectation pf P↑
＝＞W↑＝＞AS shift further( P↑further)(wage-price spiral)
Later, Y↓＝＞W↓＝＞(W↓/P↑) ↓
＝＞cost of firm↓ and profitable
＝＞firm increase output(Y↑)＝＞Y is restored(p.768 figure 10)
27
*What can government do？
(1)Do nothing, and the economy will restore to original Y but may long and painful.
(2)Increase aggregate demand(Money↑, G↑…), move AD2 back to AD1, shorten the
＝＞Y is restored but P↑(P2→P3)(Government policy accommodate the shift of AS)
But who will buy the bill？(p.769 figure 11)
Case study p.770
Oil and Economy：Oil Crisis 1973-1975；1978-1981
Now(2007 2nd half-now)：Financial Crisis：擴大內需
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Chapter 34 The Influence of Monetary and Fiscal Policy on Aggregate Demand
Discuss how monetary and fiscal policies affect aggregate demand and hence
macroeconomic variables in the SR.
I. How monetary policy influences aggregate demand
In ch.33, aggregate demand curve is downward sloping because of wealth effect, interest
rate effect and exchange effect, in U.S., the most important effect is interest rate effect, so
we focus the monetary policy here.
1. The Theory of Liquidity Preference(Equilibrium in the Money Market)
Theory of Liquidity Preference：Keynes’s theory that the interest rate adjusts to bring
money supply and money demand into balance. (p.780 Figure 1)
e
(Assume π is constant in the SR and hence interest rate applies both to nominal and real)
(1)Money supply：Fed control it(exogenous)；vertical in figure 1
(2)Money demand：negatively related with interest rate(downward sloped in figure 1)
Interest rate r is the opportunity cost of holding money
＝＞r↑＝＞reduce money holding(to buy bond…)
(3)Equilibrium in money market
If r1(r2)＝＞money demand＜(＞)money supply
＝＞people buy bond(or deposit in the bank)（people hold more money）
＝＞lenders(making the money) lower r↓（↑）(until money demand＝money supply)
Question？？？
Ch.32 r：loanable fund market(LR)
Now r：money market(SR)
2. The Downward Slope of the Aggregate Demand Curve (p.783 figure 2)
P↑(P1＝＞P2)＝＞money demand↑(because transaction↑)
＝＞r↑(figure 2(a))(r1＝＞r2)
＝＞I↓(Y demanded ↓)(Y1＝＞Y2)
＝＞aggregate demand curve is downward sloping
3. How monetary policy influences aggregate demand
(1)Changes in the Money Supply(p.784 figure 3)
Money supply↑＝＞r↓(interest rate must fall to induce people to hold more money)
＝＞I↑(Y demanded ↑)
＝＞aggregate demand shift right(AD1＝＞AD2)
p.784-785. When the Fed increase money supply, ……
29
(2)The Role of Interest rate Targets in Fed Policy
Because money supply is hard to measure and control, so Fed may try to control interest
rate instead to replace the changes of money supply
＝＞Fed set the target rate of Fed Fund Rate & FOMC buy(sell) bond to change money
supply(if Fed want r↓(↑)＝＞buy bond(sell) through open market operation)
So, monetary policy(either by changing money supply or interest rate) will influence
aggregate demand！
Case Study：Why FED watches the stock market closely？
If stock market down(boom)↓(↑)
＝＞people wealth↓(↑)＝＞C↓(↑)& I↓(↑)＝＞aggregate demand↓(↑)
＝＞to stabilize aggregate demand and hence to stabilize P and Y
＝＞Fed announces r↓(↑)＝＞stock market↑(↓) ＝＞aggregate demand↑(↓)
II. How fiscal policy influences aggregate demand
Fiscal policy：government spending(directly)；taxation(indirectly)
1. Changes in Government Spending
(1) The Multiplier Effect
Multiplier Effect：p.788
G↑＝＞multiplier＝1/(1-MPC)
MPC：marginal propensity to consume
0＜MPC＜1 If MPC is greater＞multiplier effect is larger.
(2) Other Applications of the Multiplier Effect
The multiplier effect can apply to other aspects：(p.790 A small initial change in
consumption, investment, government purchases, or net exports can end up having a
larger effect on aggregate demand and, therefore, the economy’s production of goods
and services)
(3) The Crowding Effect(p.791)
Crowding Effect：
The offset in aggregate demand that results when expansionary fiscal policy raises the
interest rate and thereby reduces (private)investing spending
G↑＝＞aggregate demand↑(p.791 figure 5(b) AD1＞AD2)
＝＞income of people↑(multiplier effect)＝＞people buy more
＝＞money demand↑＝＞r↑(p.791 figure 5(a) r1＝＞r2)
＝＞I↓＝＞aggregate demand↓(p.791 figure 5(b) AD2＝＞AD3)
SO, G↑ crowd out private I↓
2. Changes in Taxes
Cut tax ＝＞people disposable income↑
＝＞C↑(and save part of it)
30
(Effect of tax cut＜G↑)
＝＞Y↑(multiplier effect) & Y↓(crowding effect)
*Tax cut is permanent＝＞MPC higher＝＞multiplier effect is greater
Tax cut is temporary＝＞MPC smaller＝＞multiplier effect is smaller
FYI(p.793)
How Fiscal Policy Might Affect Aggregate Supply？
Supply Side Economics：
Tax cut＝＞more incentive to work＝＞aggregate supply↑
(1980 ‘s Reagan, Laffer curve)
III. Using Policy to Stabilize the Economy
1. The Case for Active Stabilization Policy
U.S. 1946 Employment Act：”It is the continuing policy and responsibility of the federal
government to…promote full employment and production.”
Two implications：
(1) Government should avoid being a cause of economic fluctuations.(Therefore, large
and sudden changes in monetary and fiscal policy should be avoided.)
*(2) Government should respond to changes in the private economy to stabilize aggregate
demand(and the economy).
Keynes： People have “animal spirits”, and aggregate demand fluctuates because of
largely irrational waves of pessimism and optimism. And also these changes in
attitudes are, to some extent, self-fulfilling.
＝＞The government should and can adjust its monetary and fiscal policy (in response
to these waves of pessimism and optimism) and stabilize the economy.
2. The Case against Active Stabilization Policy
*The government should not and cannot use the monetary and fiscal policy to stabilize
the economy. (Policy should be set to achieve long run goals such as rapid economic
growth and low inflation, and the economy should be left to deal with short run
fluctuations on its own)
Reasons：government policy has time lags.
(1)Monetary policy：it needs about 6 month for monetary policy to have effect.
(2)Fiscal policy：has direct effect on economy, but has the lag of political process.
So, government policies may end up as the causes of rather than the cures for
economic fluctuation.
3. Automatic Stabilizers
Automatic Stabilizers：Changes in fiscal policy that (automatically)stimulate aggregate
demand when the economy goes into a recession without
policymakers having to take any deliberate action.
Examples:
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(1)Tax system
If recession＝＞government tax revenue↓(like tax cut)
＝＞aggregate demand↑(automatically)
(2) Government spending
If recession＝＞welfare payments paid to people↑(unemployed insurance…)
＝＞aggregate demand↑(automatically)
*But these automatic stabilizers are not sufficiently strong to prevent recessions completely
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Chapter 35 Short Run Trade-off between Inflation and Unemployment
Misery index：inflation rate(π)＋unemployment rate(un-E rate)
Previous：LR P is determined by money supply, and un-E is determined by minimum wage
laws, labor union, efficient wages…(Ch. 28), so the two are unrelated.
This chapter：Trade-off between the two
I. Phillips Curve
1. Origins of the Phillips Curve( SR negative association betweenπ & un-E rate)
Phillips Curve：1958 U.K. data(1861-1957) (also Samuelson and Solow(1960)
Negative association betweenπ & un-E rate(p.803 figure 1)
2. Aggregate demand, supply and SR Phillips Curve
Why trade-off？(p.804 figure 2)
Ch.34 AD↑(figure 2(a) A→B))＝＞P↑& Y↑(un-E↓)(figure 2(b) A→B))
II. Shifts in the Phillips Curve：The Role of Expectations
1. The long-run Phillips Curve(LR π& un-E rate are not negatively correlated)
Friedman(1968) & 【Phelps later(based on Classical Economics)】
p.805 “ The monetary authority controls nominal quantities…. It cannot uses its
control over nominal quantities to peg a real quantity-real r, un-E, real Y…”
＝＞LR Phillips Curve is vertical(p.806 figure 3 M↑＝＞un-E(&Y) does not change)
2. Aggregate demand, supply and LR Phillips Curve
Why LR Phillips Curve is vertical？(p.807 figure 4)
Because LR Aggregate Supply Curve is vertical(ch.30 Money is neutral in the LR,
MV＝PY, M↑＝＞P↑ proportionately(figure 4(a)) but Y is not affected(figure 4(b))
* Natural un-E： Natural does not mean desirable
3. Reconciling SR and LR Phillips Curve
(1) Short-run and Long-run Phillips Curve(p.810 figure 5)
Friedman & Phelps view can be expressed as follows：(a＞0)
e
un-E＝Natural rate of un-E－a【Actual Inflation(π)－Expected Inflation(π )】
e
In the SR, π is given,
G↑＝＞AD↑＝＞P↑＆Y↑＝＞un-E↓(as p.804 figure 2) (πe has not adjusted)
e
＝＞(π＞π )＝＞un-E＜Natural rate of un-E (A→B)
e
In the LR, because P↑＝＞π ↑＝π＝＞un-E ＝Natural rate of un-E (B→C)
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Explanation：
e
In the SR, P↑＝＞(W/P↑)↓(π has not adjusted＝＞ W does not change)
＝＞cost of firm↓＝＞produce and hire more＝＞Y↑& un-E↓
e
In the LR, π ↑＝π＝＞W↑＝＞(W↑/P↑)＝＞cost of firm↑
＝＞produce and hire less＝＞Y↓& un-E↑＝＞back to original point
*When expected inflation rate changes, short run Phillips Curve shifts(as p.810 figure 5)
(2) Experiment for the Natural Rate Hypothesis(p.811 figure 6 &p.812 figure 7)
Natural Rate Hypothesis：
Unemployment rate will eventually returns to its normal or natural rate regardless of the
rate of inflation.(i.e. LR Phillips curve is vertical)【even though it can deviate from
natural rate in the short run】
In the SR：1961-1968 U.S. data
Inflation rate and un-E rate are negatively correlated.(p.811 figure 6)
In the LR：1961-1973 U.S. data
Inflation rate and un-E rate are not negatively correlated(p.812 figure 7)
III. Shifts in the Phillips Curve：The Role of Supply Shocks(p.814 figure 8)
1. Supply Shock
1974 oil price↑＝＞cost of firm↑＝＞aggregate supply curve shift left(AS1→AS2)
＝＞P↑ & Y↓(stagflation)(A→B)(figure 8(a))
2. Shift of Phillips Curve(figure 8(b))
e
Because of supply shock＝＞P↑＝＞π↑＝＞π ↑
＝＞ Phillips Curve shift right(PC1→PC2) (figure (b))
(1)Initial：Inflation rate and un-E rate trade-off is at A
(2)After shock：Inflation rate and un-E rate trade-off is at B
U.S. experiences：(p.814 figure 9) (supply shocks in 1973-1975 & 1978-1981)
Trade-off between Inflation rate and un-E rate has moved from A→B in figure 9.
3. Whether the Supply shock is temporary or permanent？
(1) If people think the shock is temporary
e
＝＞π will not adjust＝＞Phillips curve move back to original position
(2) If people think the shock is permanent
e
＝＞π ↑＝＞Phillips curve stay at PC2(＝＞government faces a higher trade-off)
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4. Government Policies
(1)G fight against inflation
AD↓＝＞P↓ but un-E↑furthe
(2)G fight against un-E
G↑＝＞un-E↓but P↑further
IV. The Cost of Reducing Inflation
In Oct. 1979, because of Oil shock, Paul Volcker pursued the disinflation policy：
1. The Sacrifice Ratio
【Sacrifice Ratio：％ of annual output lost in the process of reducing inflation by 1％】
(if ratio＝5＝＞to reduce 1％ inflation, Y will lose 5％)
Money Supply↓＝＞AD＝＞P↓ but un-E↑(Y↓)further(p.817 figure 10 A→B)
e
＝＞over time, P ↓＝＞π ↓(Phillips Curve shift left gradually)
＝＞back to initial natural un-E(p.817 figure 10 B→C)
e
During the process, people will be painful(if sacrifice ratio is large andπ adjust slowly)
2. Rational Expectations and the Possibility of Costless Disinflation
Rational Expectation(RE)：(Sargent, Lucas, Barro…)
People optimally use all information they have, including information about policies,
when forecasting the future.
p.818
If the government made a credible commitment to a policy of low inflation, people would
be rational enough to lower their expectations of inflation immediately. The short-run
Phillips Curve would shift left(quickly), and the economy would reach low inflation
quickly without the cost of temporarily high un-E and low output(i.e. sacrifice ratio ≒0)
3. Which is Correct？(The Volcker Disinflation)
p.819 figure 11：Volcker Disinflation
(1)1979(A) →1983(B)→1987(C, back to initial level of un-E) is painful
＝＞sacrifice ratio is high
(2)RE wrong？
 Although sacrifice ratio is high, but not so high as expected.
 RE does not hold because people do not believe Volcker
e
＝＞π did not fall & Phillips curve did not shift left quickly, so sacrifice ratio is
high.
Case Study：Why were inflation and en-E so low at the end of 1990s？(p.822)
p.820 Figure 12：The Greenspan Era(1984-2004 Fluctuations ofπand en-E are small)
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Greenspan & Bernake Challenges
Greenspan Era(1984-2006)：似乎 π＆ un-E are low(favorable supply shocks, oil P↓)
But： 2000 dot.com bubble＝＞r↓
＝＞2006.2 (Bernake step on)
＝＞Subpime＝＞Financial Crisis(2007.6) ＝＞…
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