Download Open Economy Macroeconomics: Basic Concepts

AP Macroeconomics Syllabus
Mr. Snyder
Welcome!
Seeing each of you in class today brings me great personal and professional satisfaction. By enrolling
in AP Macroeconomics you have made a wise choice for your educational future. You and your peers
will encounter an economic playing field unlike any other. This course will help you understand the
opportunities and challenges that await you.
For our study of Macroeconomics we will use McConnell, Brue and Flynn’s AP 19th edition
Economics as our text. You are responsible for bringing this book to class each day and for returning it
in good condition at the end of the semester. Many students have found it cost effective and
convenient to purchase a used copy of the text online.
Topics to be covered throughout the course
Ten Principles of Economics
We will discuss how economic production is measured
The role of the financial sector in determining a nation’s fate
How to thinking like an Economist
The interdependence and the gains/loss from Trade
Impact of International Trade
The Market Forces of Supply and Demand
Measuring a Nation’s Income
The correlation of national income and price determination
How to measuring the Cost of Living
Production and Growth
Saving, Investment and the Financial System
The impact of unemployment
The Monetary System
Money Growth and Inflation and stabilization
Open Economy Macroeconomics: Basic Concepts
Theory of practice
Aggregate Demand and Aggregate Supply
The influence of Monetary and Fiscal Policy on Aggregate Demand
The Short-Run Tradeoff between Inflation and Unemployment
Debating economic policy
How the utilization of resources within and across a county impacts economic activity,
both decline and progress, and how policymakers go about making decision impacting
aggregate programs.
In addition to the McConnell text, we will undertake extensive readings from daily newspapers,
news magazines, Internet news services, and other relevant sources of macroeconomics
information such as scholarly journals and publications of the regional United States Federal
Reserve banks. We will also engage in writing and various in-class activities.
Class Policies and Procedures:
First off, regular timely attendance is essential to the smooth functioning of this class. Your teacher
understands that some excused absences are unavoidable and asks that you schedule time away from
class so as to cause the fewest possible interruptions to your learning. Also, let your teacher know of
upcoming absences and take responsibility for making up any assignments resulting from excused
absences.
It is recommended that you develop good relationships with fellow students in class so that you can
consult others’ class notes when necessary. As upperclassmen you alone are responsible for catching
up any absences.
STUDENT RESPONSIBILITES AND EXPECTATIONS
The work done in this course is college level and it is expected that all students will treat it as such. A
significant amount of coursework shall be done outside the classroom walls. Students are expected to
participate fully, both in class and out, and to work diligently to get the most out of the course.
The following are the basic expectations and responsibilities for all students:
 Regular attendance is imperative Bring in class guarantees that you will participate in an array
of activities and discussion that cannot be done otherwise.
 If class is missed for any reason, students are responsible with keeping up with the course on
days absent and must work diligently to keep up.
 All coursework will be submitted on the due date. ALL LATE WORK will be assessed a
penalty of at least 25 percent and any work late more than one week will NOT be accepted.
 If the “late work” is associated with an excused absence, all work is due the day the student
returns to class; if unexcused, no credit will be given.
 Assigned readings, including chapter readings, will be completed on time and students will be
prepared for substantive discussions upon entering the classroom.
 Student work shall be done in conjunction with the notion that it benefits the whole. Much of
what we do in this class is collaborative and will be shared. Consider what you do to be an
integral component of your classmates’ education in addition to your own.
 Students will spend ample time outside of class preparing for the AP US Government and
Politics Exam. This is done in supplementation to all coursework completed both in and out of
the classroom and will invariably help in understanding the world in which you are soon to
embark.
COURSEWORK AND REQUIREMENTS
As stated above, all coursework is college-level. Below are descriptions of the overall coursework
students can expect to engage in.
 Textbook readings: Students will be assigned textbook chapters in conjunction with the course
of units of study. Students will be expected to complete all accompanying assignments in a
timely manner and should be prepared to supplement our discussing with readings from other
sources.
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Supplemental readings: In addition to the textbook, students will frequently be assigned other
reading relating to the current unit of study. Students will often be required to be prepared to
discuss and/or apply the readings to other activities within the course.
Vocabulary Flash Cards: vocabulary associated with Macroeconomics will be emphasized
throughout the course. Students will be responsible through various assignments for
incorporating and highlighting important vocabulary terms and applying them to real-world
contexts. All students will create their own flashcards as we move through each unit. They
must have their flashcards at all times for random checks/grades. Guidelines to follow.
In-class discussions: Students will participate and contribute substantively to discussions
carried out in class. Fundamentals of economics and important and controversial issues will be
among the discussion topics.
Current events portfolio: all students are required to maintain a current event portfolio in their
notebooks. The students must add a new story to their portfolio each week, providing
commentary and making connections to the course and current unit of study. Once again, this
will be randomly checked and graded – guidelines to follow.
Political data, graph, and cartoon analysis: a fundamental skill required in todays’ world is the
ability to read and interpret various charts, graphs, and data relevant to the political system and
process. Understanding and interpreting economically derived cartoons has also become very
important as more and more we are turning to these “amusements” to reach our audience. The
students will be expected to develop these skills and evaluate the effectiveness of these devices.
Essays: students will be required to write 1-3 page pieces analyzing relevant concepts, issues,
and events. Some will be done in class, others outside.
Projects/simulations: students will have the opportunity to engage in research projects,
presentations, debates, and simulations on various topics related to the course. Some projects
will be individual while others will require significant group collaboration.
Research project and presentation: Once the AP Exam has concluded, students will work in
pairs to research a timely topic or issue relevant to the course and create and deliver a
presentation to the class. This is the culminating course project and will comprise, unless the
County/State develops a required EOC, the Final Exam Grade.
An Important Note about Unexcused Absences and Late Work
My general policy is not to accept late work in this AP class. Even the most diligent student
experiences scheduling difficulties from time to time that interfere with timely completion of
homework, however. As part of our study of economics, a mechanism will be created that will permit
a limited number of opportunities to submit late assignments for credit. Details will be provided in
class.
By definition, there is no justification for an unexcused absence at EHS. Under no circumstances will
students be permitted to submit late work that was due on the day of an unexcused absence. Your
mature understanding of this policy will be greatly appreciated. I understand that you all have choices
to make. Please recognize that some choices result in negative consequences.
You will need a 3-ring binder
Along with the assignments, you can expect to receive a number of handouts during the semester and
it will be helpful to be able to retrieve them quickly and reliably. You will also be expected to use the
binder for storing any ongoing writing assignments, including weekly readings.
Grading
Grades will be based not only on test and quiz scores, but also on homework, readings, in-class
contributions, and indicators of overall preparedness and enthusiasm for the course material. The
success of this class depends on each student’s willingness to prepare and contribute, and to display an
attitude consistent with doing one’s best on the AP Exam. We can only take from the class what each
of you puts into it. Please do your best, always. Your best efforts will help everyone in your class.
In addition to 5 course long projects, you will be quizzed weekly on assigned readings and tested on
each chapter. We will review the released AP Macroeconomic tests and you will be expected to take a
released AP exam in January and a second one shortly before the actual exam. All students will be
required to take the exam and it will be a major grade in the marking period in which the actual exam
occurs. The course is divided into 7 Units, I will provide you with details in class. You will be tested
and quizzed in each unit on: Content – Vocabulary, Graphs and Charts, FRQs, LRQs and MC.
Common Traits of Successful AP Economics Students
Students who have been successful in AP Macroeconomics have a set of characteristics in common.
These include:
1. The student assumes personal responsibility for learning economics.
The instructor, the text, and the study guides cannot teach you economics. They are merely resources
to help you learn the subject. The successful student uses each to good.
2. The student brings and uses appropriate prerequisite skills in English, math, and
critical thinking to the learning of economics. The ability to read the English language carefully and
precisely is obviously needed. The ability to deal with algebraic concepts and simple geometry is also
required for success. Finally, the successful student must be able to think critically on issues.
3. The student devotes appropriate time and energy to learning the subject. Reading the
text in a skimming fashion saves time in the short run but those savings are costly over time.
Successful students read the text very carefully and take notes on the concepts presented.
4. The student masters basic concepts and vocabulary before moving on to more difficult
material. Economics concepts tend to build on each other, and the failure to comprehend the initial
concepts guarantees problems in the future.
5. The student reinforces new knowledge. Rather than moving on to the next chapter, the
successful student reads the chapter summary and discussion questions even though they may
not be assigned.
6. The student prepares properly for economics examinations. The foundation of good test
results is the vocabulary of the subject. Next come the basic concepts, followed by the more four
complex relationships. Finally come the practice test questions and the sample essays. Only after all
these are understood can the student feel prepared.
7. The student does not rely on mere memorization. While there is rote memory work in
learning any subject, economics is not a set of answers to be memorized. Economics is a way
of analyzing problems and predicting results.
8. The student is willing to ask for help and utilize the available resources. The student
who succeeds in economics class is willing to ask questions in and out of class. That student
recognizes the value of time and, rather than struggle for hours with a concept, is willing to ask
questions in class or to phone the instructor (not after 9:30 p.m.) to clarify concepts.
9. The student attends class. Life is far too short not to learn all you possibly can the first
time around. See also, An Important Note About Unexcused Absences and Late Work, above.
10. The student sees economics in everyday life and applies class concepts to the national
news and to personal decisions. In order to understand the subject thoroughly, you must use it daily.
Practice makes perfect but only if you practice perfectly!
COURSE OUTLINE: Essential Questions
Basic Economic Concepts
CONTENT/ESSENTIAL QUESTIONS
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How does scarcity affect decision making?
How does comparative advantage impact international trade?
What is the difference between change in supply/demand and change in quantities
supplied/demanded?
What relationship does the circular flow of money model illustrate?
Skills/Graphs/Formulas
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Interpret Production Possibility Curve
Create and Analyze Supply and Demand Graphs
Create and Interpret comparative advantage Charts
Analyze the Circular Flow of Money Model
Change in Demand/Supply v Change in quantity demanded/supplied
Factors of Supply and Demand
Price Floors and Ceilings
Elastic and Inelastic Supply and Demand
Measuring Economic Well Being
CONTENT/ESSENTIAL QUESTIONS
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Are the components of the GDP more important than the actual GDP? Explain.
How does inflation impact GDP?
How effectively does the unemployment rate measure the economic well-being of a nation?
Skills/Graphs
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Compute GDP using various means (C+I+G+(X-M)) and (W+I+R+P)
Breakdown the components of GDP (Income and Expenditure Approaches)
Interpret statistics with regard to the business cycle
Real GDP= Nominal GDP/ Price Index
Analyze the Phillips Curve
Distinguish between different types of unemployment (including what constitutes the
natural rate of unemployment
Price index= market basket for current year/ market basket for base year
Developing Fiscal Policy
CONTENT/ESSENTIAL QUESTIONS
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How does a shift in aggregate demand impact the price level and real GDP? (Classical and
Keynesian perspectives)
How does the Keynesian cross illustrate the multiplier effect?
What is the impact of taxation and spending on fiscal policy?
How has fiscal policy impacted past and current economic well-being?
Skills/Graphs/Formulas
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Analyze the Keynesian cross
Compare and contrast economic models
 Apply models to current and past fiscal policies
 Expansionary and Recessionary Gaps
 Credit Market Graph
 Demand Pull Inflation
 Cost Push Inflation
 Spending Multiplier
 MPC +MPS = 1
 Phillips Curve (Long and Short Run)
 MPC = change in consumption /change in income
 MPS= change in savings/ change in income
Money, Banking, and Fiscal Policy
CONTENT/ESSENTIAL QUESTIONS
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What is the purpose of money?
What are the types of money?
What is the role of the Federal Reserve System?
How does the Fed use monetary tools to manipulate the economy?
What monetary policies are used during a recession? An expansion?
Skills/Graphs/Formulas
 Money Multiplier= 1/required reserve ratio
 Analyze the difference between M1, M2, and M3
International Economics
CONTENT/ESSENTIAL QUESTIONS
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Why is international trade important? (Open and Closed Economy)
What is the impact of a strong/weak dollar on the US trade balance?
How does the foreign exchange rate impact fiscal and monetary policy?
How does a weak/strong dollar impact foreign and domestic spending and investment?
Skills/Graphs/Formulas
 Foreign Exchange Rate Graph
 Comparative Advantage Chart
Applications of Macroeconomics
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Federal Budget Activity
The Fed Challenge
Stock Market Portfolio Project
Business Project
Economic Theory Paper & Presentations
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Helpful Websites
www.reffonomics.com
http://apcentral.collegeboard.com/apc/public/courses/teachers_corner/2120.html
www.reffonomics.com
All the graphs you will need to know on youtube:
http://www.youtube.com/watch?v=YOMbRCywqCs&safety_mode=true&persist_safety_mode=1&saf
e=active
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Youtube Professor
Breaking down concepts in 60 seconds.
http://www.youtube.com/user/ACDCLeadership#g/p
According to the College Board, the objective portion of the AP Macro exam will break down as
follows:
Content Area Percentage Goals of Exam (multiple-choice section)
I. Basic Economic Concepts (8–12%)
A. Scarcity, choice, and opportunity costs
B. Production possibilities curve
C. Comparative advantage, specialization, and exchange
D. Demand, supply, and market equilibrium
E. Macroeconomic issues: business cycle, unemployment, inflation, growth
Course introduction: discussion of course goals, requirements, and approach via
the syllabus. How will you use the book and its ancillaries? Write out three or
more things you intend to do in pursuit of economic knowledge. We will then
finish the course introduction and begin our discussion of the course
requirements; graphs, their meaning, and economic data.
II. Measurement of Economic Performance (12–16%)
A. National income accounts
1. Circular flow
2. Gross domestic product
3. Components of gross domestic product
4. Real versus nominal gross domestic product
B. Inflation measurement and adjustment
1. Price indices
2. Nominal and real values
3. Costs of inflation
C. Unemployment
1. Definition and measurement
2. Types of unemployment
3. Natural rate of unemployment
In this unit we will measure national output/income
III. National Income and Price Determination (10–15%)
A. Aggregate demand
1. Determinants of aggregate demand
2. Multiplier and crowding-out effects
B. Aggregate supply
1. Short-run and long-run analyses
2. Sticky versus flexible wages and prices
3. Determinants of aggregate supply
C. Macroeconomic equilibrium
1. Real output and price level
2. Short and long run
3. Actual versus full-employment output
4. Business cycle and economic fluctuations
IV. Financial Sector (15–20%)
A. Money, banking, and financial markets
1. Definition of financial assets: money, stocks, bonds
2. Time value of money (present and future value)
3. Measures of money supply
4. Banks and creation of money
5. Money demand
6. Money market and the equilibrium nominal interest rate
B. Loanable funds market
1. Supply of and demand for loanable funds
2. Equilibrium real interest rate
3. Crowding out
C. Central bank and control of the money supply
1. Tools of central bank policy
2. Quantity theory of money
3. Real versus nominal interest rates
V. Stabilization Policies (20–30%)
A. Fiscal and monetary policies
1. Demand-side effects
2. Supply-side effects
3. Policy mix
4. Government deficits and debt
B. The Phillips curve
1. Short-run and long-run Phillips curves
2. Demand-pull versus cost-push inflation
3. Role of expectations
VI. Economic Growth (5–10%)
A. Definition of economic growth
B. Determinants of economic growth
1. Investment in human capital
2. Investment in physical capital
3. Research and development, and technological progress
C. Growth policy
VII. Open Economy: International Trade and Finance (10–15%)
A. Balance of payments accounts
1. Balance of trade
2. Current account
3. Financial account (formerly known as capital account)
B. Foreign exchange market
1. Demand for and supply of foreign exchange
2. Exchange rate determination
3. Currency appreciation and depreciation
C. Imports, exports, and financial capital flows
D. Relationships between international and domestic financial and goods markets
About the AP Macroeconomics Exam
The exam is 2 hours and 10 minutes long, and includes a multiple-choice section and a free response
section. You'll have 70 minutes to complete the multiple-choice section. You'll have 60 minutes for the
free-response section Fifty percent of the section score is based on the long essay while each short
essay contributes one-quarter to the free-response score. The multiple choice section accounts for twothirds of the grade and the free-response section is the final one-third.
CURRENT EVENT PROCEDURE
Current events are an integral component to studying and applying the fundamental concepts of
macroeconomics. The idea behind this assignment is to afford students the opportunity to follow
important events and issues arising in the World, and how economics are a part of our everyday lives,
whether we recognize it or not and you are being asked to provide commentary and insight, making
connections to our class, be it the Stock Market, our trade imbalance, or an analysis of the Debt
Clock.
DIRECTIONS (first, let me say, if Lake County allows, I will have you set up a wikispaces (preferred) or
google blogger site rather than a page in your notebooks – but we will cross that bridge as the school
year proceeds).
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Create a section dedicated to this assignment, titling it “AP Macroeconomics Current Events
Portfolio”.
A minimum of one current event per week is required and must be in place each and every
Monday beginning August 25th. You must include the following information in each post.
1. The date of your post
2. Current unit of study
3. A general headline or topic title (it can be the headline of the news story).
4. If found on line, the link to the article; if in print, the precise location. Please properly
cite the reference (I suggest using Knightcite.com.)
5. A brief synopsis of the story or issue (at least a paragraph giving the basic: who, what,
where, when, how, and why of the story, including its importance.
6. A more detail analysis providing your own insight into the story or issue, including
connections to what we’re learning in class.
7. Any vocabulary from the current or previous units used in the synopsis and analysis
should be bolded and highlighted.
Spend some time personalizing and tailoring the section to your own tastes.
A minimum of six (6) entries are required for each marking period.
FLASHCARDS ASSIGNMENT
An important component of understanding our government and the political process is to be familiar
with and be able to apply an array of vocabulary terms and concepts. This is also fundamental to
doing well on the AP Exam and going forward in the great big old world that is beckoning.
DIRECTIONS:
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You are charged with creating your own flashcards for each unit of study. You will create
them on your own time and follow your own organizational style. You must carry these
flashcards with you in a baggy or zip-lock back at all times. Obviously, your stack of flashcards
– and the bag in which they are carried – will grow significantly as the semester progresses.
The following are the basic requirements for this assignment:
Your flashcards are subject to random checks in class, each check being worth 10 points –
which CANNOT be made up, unless it is an excused absence, at which point they are due the
first day in class.
There is an associated “Midterm” and pre-Final grade that will be associated with the cards.
The Midterm will be the day before Christmas break, the pre-Final, the day afer the AP Exam.
The Course in a nutshell – I learned a lesson last year, students
do not read, nor prepare so, here is a final review for you. As we
go along in the course please ask if you are not sure. Note that
a lot of this review is just that, a review, so you will probably
not be able to connect the material until we get to the end.
Therefore it is essential that you know the underlined, bolded,
and italicized terms and expressions. as you read and we discuss
the material make sure your journal is up to date and your note
cards handy! Before the exam we will go thru this presentation,
line for line, graph for graph, formula by formula, for you
edification, delight, and success.
If reading this before the course is over scares you, well – good!
The state of our economy should scare each and every one of us!
remember, only you can make a difference, and, believe it or not,
just setting on your backside or looking the other way is making
a difference. Like in politics, your ignorance is seen by those in
power is an affirmation of what they are doing.
Basic Economic Concepts
Scarcity, Choice, and Opportunity Cost: The basic feature of economic life is that
people (and economies) find themselves in a situation of scarcity relative to their
wants, which are virtually unlimited. Therefore, they are forced to make choices
between economic goods, which are scarce and desirable. The major choices are what
to produce, how, and for whom. Much of what people want can be produced, but in
order to have more of a certain good, there must be a short-term reduction in the
production of another good (because of scarce resources). This is the opportunity
cost—namely, the highest- valued alternative that must be foregone in order to have
more of the first good. (For example, the opportunity cost for you of spending an hour
studying economics is the pleasure you would have gotten from reading a novel
instead.)
All activities that satisfy people’s wants and for which they are prepared to pay a price
are called production, whose final output includes goods, services, and capital
(factories, machines, etc.). The economic resources used in production are called the
production factors. The amount of factors available (resource endowments) and the
state of technology determine the position of the production possibility frontier/curve
(PPF), which graphically shows scarcity, choices, and opportunity costs. Any point
inside the PPF represents a waste of resources, as production of one good could be
increased without decreasing the output of the alternative good (zero opportunity
cost). Points on the PPF, therefore, show the potential level of output.
Because of the law of increasing costs (all units of any input are not equally productive
in the output of different goods), the frontier is usually concave to the origin, i.e., the
cost of good Y in terms of X increases as the production of Y increases. (Calculating
Opportunity Cost from a PPF - The absolute value of the slope is actually the
opportunity cost.) We measure the unit opportunity cost of good X as the quantity of
good Y you must give up divided by the quantity of good X you will get. Note,
therefore, that for two goods, the opportunity cost of good X is the reciprocal of the
opportunity cost of good Y.
Absolute advantage occurs when a country can produce more of a good than another
country using the same level of inputs. In a two-good case, one country may have an
absolute advantage in producing both goods. Comparative advantage is when a
country can produce a good at a lower opportunity cost than another country.
Therefore, even if one country has an absolute advantage in producing both goods,
each country will still have a comparative advantage in producing one good. When
every country specializes in producing the good for which it has a comparative
advantage and trades it for other goods, there are gains from trade (mutually
advantageous trade) because such specialization and exchange allows trade and
consumption (not production) at points outside the PPF, because global output rises.
The importing country can buy the good at a lower price than its own opportunity cost
of production.
Dynamic comparative advantage occurs when production involves substantial learning
by doing, which could change a country’s static comparative advantage from primary
products to manufactured goods. (Supply and Demand.) One way of allocating
resources to resolve the economic problem of scarcity is through prices determined by
the forces of supply and demand. A movement along the supply or demand curve is the
result of a change in the price (endogenous to the model), but a shift in the curve is the
result of a change in an exogenous factor, such as income, weather, tastes, prices of
other goods (complements and substitutes), costs of inputs, number of firms, etc.
An “increase in demand” means the demand curve has shifted out. An “increase in the
quantity demanded” means moving down along the demand curve (usually after a
shift in S and to correct the resulting disequilibrium—surplus or shortage).
Market equilibrium occurs where the demand and supply curves intersect. If the price
is not at an equilibrium (disequilibrium with S not equal to D), then there should
naturally be a process of adjustment in both the price and quantities over time to
attain equilibrium. This occurs because price functions as a rationing device to cut
shortages (when there is excess demand: D > S) and as a signaling device to producers
(the invisible hand) to increase or reduce production.
A supply shock occurs when there is a sudden cut in the supply of a particular good
(e.g., oil cuts or rice after a series of typhoons). As a result the supply curve shifts left
➞ equilibrium P up, Q down. (Main Economic Policy Objectives.)
It is generally agreed that a well-functioning economy is not troubled by either
inflation or unemployment (recession). These problems persist, especially when trying
to lower the government budget deficit or trade deficit and seeking the long-term
objective of steady economic growth.
Measurement of Economic Performance
The Circular Flow: There are four main players (sectors): households, firms,
government, and international (ROW). The flow at one point in time is fixed, but it can
be expanded (through the careful use of injections: I, G, and X), which leads to higher
living standards (growth in real GDP per capita). There is a monetary flow (expenditure
and income) and a physical flow (in the opposite direction), but in real terms, they are
equivalent. (Real and Nominal Values.)
The nominal value is what you first see: the interest rate, the wage, the calculated
expenditure on output (GDP), asset prices, etc. When the nominal value has been
adjusted for inflation, we have the real value in terms of the goods and services that
can actually be bought. If the nominal values are in terms of rates, we can find the real
value by using the relationship: Real rate = nominal rate – inflation rate (e.g., interest
rate or growth rate of GDP). If the nominal values are simply values, we find the real
value by: Real value = nominal value ÷ price index × 100 (e.g., real GDP, real wages)
(Measuring National Income)
We measure the flow of final output (of goods and services) during one year to
represent the economy’s “pie” and, thus, economic performance. Therefore, the
measurement does not include intermediate goods and secondhand goods (both would
be double counting—except for the factor income paid to sales personnel). Nor do
financial goods (shares, bonds, etc.) contribute to gross domestic product (GDP)
because they do not reflect real output.
Gross domestic product (GDP) measures the total output from factors of production
(resources) located within the country (some factors may be owned by overseas
residents).
Gross national product (GNP) measures the total output from factors of production
owned by the country’s residents, so it includes income from overseas assets and
subtracts income going overseas to foreign owners of assets. Therefore, GDP + net
factor incomes from abroad = GNP.
Net national product (or national income, which is usually measured at factor cost—
prices net of taxes and subsidies) is GNP less depreciation or “capital consumption”
because Net I = Gross I – depreciation. It, therefore, measures the flow of national
output (goods and services) that can be consumed or added to the stock of wealth
(assets). GDP figures, however, are often used as a rough measure of national income.
GDP can be measured in three ways because the circular flow tells us that total
expenditure is identical to total income is identical to total output. In the expenditure
approach, we can obtain data (on consumption, investment, government purchases,
and net exports) more quickly than output data. But we call the result GDP rather than
GDE.
We can also use the income approach to calculate GDI (Gross domestic income) by
adding up all wages (compensation of employees), interest, rent, and profits (WIRP).
Of less significance is the value-added method, which in effect measures the actual
output at each stage of production. Price changes do not reflect different output
levels. Therefore, nominal GDP (at current market prices) is divided by a price index
(the GDP deflator or the Consumer Price Index [CPI]) and multiplied by 100 to yield real
GDP.
Problems with GDP Figures: Actual output is not measured accurately. Household
production, for example, does make a major contribution to national income, but this
is not included in the GDP statistics because of measurement difficulties. Other
omitted economic activities include criminal activities (such as drug deals), subsistence
farming, and work for which the income is not declared in order to avoid paying taxes.
Welfare is not really measured at all.
National income statistics are used to compare standards of living between countries
and over time, but the statistics may be misleading. For example, changes in GDP do
not provide any information on changes in the quality of goods, income distribution,
composition of total output, environmental conditions, civil liberties, or leisure time
available.
International comparisons of absolute GDP figures usually use the current exchange
rate so that the figures have a common denominator (U.S. dollars), but foreign
exchange rates may not be a good indicator of the relative domestic purchasing
powers of different currencies. Only the prices of goods and services traded
internationally affect the exchange rate, which is also highly influenced by capital
movements.
Inflation (or deflation) is measured by percentage changes in the CPI (Consumer Price
Index), which is based on a basket of goods paid for by a typical household. The CPI is
found from the change in expenditure on the basket of goods divided by expenditure on
the same basket in the base year. Even though the basket is revised every five years in
line with data yielded by a household expenditure survey, quality, outlet, and
substitution biases lead to the CPI being overstated after the base year.
In the case of the GDP deflator (nominal GDP/real GDP), the basket changes every year
through a chained calculation. The average prices in any two consecutive years are
used to calculate real growth between these two consecutive years and then the GDP
deflator is estimated. Note that the GDP deflator, consequently, includes price changes
for capital goods.
Inflation benefits borrowers (debtors), including the government, and penalizes
creditors. It leads to uncertainty for businesses, which consequently are unwilling to
invest for the future. Inflation has recently been much lower than in the 1970s. This
has introduced the fear of deflation, which penalizes borrowing firms and
governments because: a) weaker unions and higher unemployment levels have
reduced pressure for wage hikes; b) wage rises have been associated with productivity
gains; c) deregulation has reduced costs; and d) globalization makes it harder for
producers to impose price hikes.
The unemployment rate is measured by the number of those unemployed (seeking a
job and able to work) divided by the number in the labor force (employed and
unemployed). Unemployment rate = Unemployed/(Employed + Unemployed) × 100.
To be unemployed, one must be looking for work and able to work. Therefore,
homemakers, students, retired persons, etc. are not included. Nor does the measure
include discouraged workers who have given up and left the labor force.
There are two main ways of measuring the number of unemployed: A labor force
survey (United States and Japan). A person is considered to be employed even if only
one hour was worked in the survey week. Counting those registered as unemployed at
public employment agencies (UK). Unemployment is a waste of resources (i.e., inside
the PPF below potential real GDP). It also requires extra transfer payments (social
security) from the government and therefore is a cost to the taxpayer.
Kinds of Unemployment (resulting from different causes): 1. Cyclical, demand deficient
(may need appropriate policies) 2. Frictional (still “full employment” and good for
productive resource allocation) 3. Structural/technological (need training, job mobility)
4. Seasonal (cannot be remedied by macro policies) 5. Disguised, i.e.,
underemployment and discouraged workers who do not appear in the official data
(need better data, for example, on job openings to applications ratio)
The natural rate of unemployment consists of frictional, seasonal, and structural
unemployment. It is often considered tantamount to “full” employment in
macroeconomics because the labor market has “cleared” at the prevailing wage rate
although there are mismatches in labor skills and available jobs.
National Income and Price Determination
Aggregate Demand and Aggregate Supply Model: Aggregate demand is made up of
consumption, planned investment, government expenditure (including public
investment), and net exports: AD = C + Ip + G + (X – M) (NB: Ip is planned investment)
Therefore, AD + Iu = GDP AD slopes down because of wealth effects on savings and
substitution effects on net exports, so higher prices lead to a lower quantity of AD.
Thus, a price rise leads to: a) lower real wealth (accumulated savings in the form of
bonds) ➞ higher savings and lower real C; b) higher export prices (and render import
prices relatively cheaper) ➞ lower net exports; and c) higher money demand ➞ higher
interest rates (lower bond prices) ➞ investment falls.
AD shifts in response to other factors, namely changes in autonomous spending and
subsequent multiplier effects.
Aggregate supply shows the total output of the economy. Determinants of AS include
changes in input prices, productivity (from technology), the legal and institutional
environment, and the quantity of available resources. Stagflation results when AS falls
(shifts left).
The long-run AS curve is vertical at potential real GDP (on the PPF with only structural
and frictional unemployment, which is tantamount to “full employment”).
The shape of the short-run AS curve differs between: a) the classical view (almost
vertical), which assumes that the economy automatically adjusts to shocks and,
therefore, that real output is determined by supply factors (resources and technology);
b) the Keynesian view (horizontal or sloped), because prices and wages are “sticky”
downwards; and c) the rational expectationist view (vertical) that the short-run AS
curve keeps shifting in response to wage change, because workers immediately
demand higher wages when prices rise.
The intermediate range is sloped because producers respond to higher prices in the
short run by increasing their output. Also there could be intermediate bottlenecks, or
output can only be increased in the SR before maintenance and other costs rise. AS =
AD + Iu so unplanned investment (changes in inventories) are included and AS
represents actual GDP (as on the circular flow).
If AD > AS, then inventory levels fall, resulting in rising prices and increases in output. If
AD < AS, inventories are swelling, leading to falling prices and cuts in output.
The short-run equilibrium (AD = AS), which determines the level of GDP, may not
necessarily be at the “full employment” (about 4 percent unemployment) level of GDP
on the LRAS schedule.
If equilibrium is below the full employment level, there is a recessionary gap. If
equilibrium is above the full employment level, there is an inflationary gap. Note:
Because leakages always equal actual (not planned) injections, S + T + M Ξ I + G + X, by
adding C to both sides, we can conclude that in equilibrium with no changes in
inventories (i.e., Iu = 0) AD = Y Ξ C + S + T. (Keynes’s Model of Income Determination
and Induced Consumption)
In the simple model (without government and trade), disposable income is allocated
either to consumption or to saving: Yd = C + S, but S is not necessarily equal to planned
investment. Consumption is assumed to be a linear function of income: C = a + bYd 0 <
b <1. The marginal propensity to consume is b.
Autonomous consumption (a) changes in response to changes in expected future
income, in interest rates, and in wealth. If a falls, then the consumption function and
AE shift down, which leads to a new lower equilibrium level of real GDP—a recession.
Induced consumption (and imports) change as income (level of economic activity or
GDP) changes. Note that I, G, and X are all considered to be autonomous, so their
levels are independent of income.
Household consumption (and thus savings) is a function of disposable income (Y minus
T) and investment is autonomous. Savings and investment are brought into
equilibrium through changes in output following changes in inventories.
The classical economist’s (and now neoclassical) view was that a recessionary gap
could be closed through falls in resource prices (including wages) so that “full
employment” equilibrium would be attained. But Keynes argued that prices are
inflexible downwards (“sticky prices”) because of rigid costs, especially prices of
imported materials (on long-term contracts) and wages. So, the AS may not shift right
in response to a fall in AD, and thus, equilibrium could occur at less than full
employment.
The multiplier results from subsequent rounds of induced spending that occur after
autonomous spending changes. Thus, it is the sum of an infinite geometric
progression: 1/(1 – b) = 1/mps. Since multiplier X change in autonomous spending =
change in GDP (or Y), or multiplier = change in GDP/change in autonomous spending.
(Price Effects and the Multiplier)
Even in an economy with unemployed resources, there are bottlenecks in some supply
areas that lead to price rises. One can then demonstrate that a rightward shift in the
AD function due to an injection of investment (or G or X) does not lead to the full
multiplier effect. The horizontal distance that AD shifts indicates the full multiplier
(two steps) without the price effect, but the new equilibrium with an upward sloping
short-run AS curve is one step back. This price effect is often called “crowding out” and
is analyzed in terms of the impact on investment. Rise in AD ➞ higher prices ➞ higher
money demand ➞ higher interest rates ➞ lower investment. In the long run, the
neoclassical argument would be that the short-run AS function shifts left as nominal
wages rise in response to price rises, and so real GDP returns to its potential level on
the vertical LRAS function but at a higher price level. Thus in the long run, the value of
the multiplier is zero.
Aggregate Expenditure Keynesian Model (no longer discussed in much detail) The 45degree line is equivalent to AS (real GDP or AE plus inventories), while the aggregate
planned expenditure function (AE) crossing it is equivalent to AD but with the
assumption of fixed prices.
The only equilibrium path of output that can be maintained is the output level at
which households will voluntarily continue to save exactly as much as businesses will
voluntarily continue to invest. But because quite different people are carrying out
planned investment and savings, it is always possible (after an autonomous change)
for these two amounts to differ, leading to disequilibrium, in which unplanned
investment (changes in inventories) is not zero. The vertical distance between the 45degree line and AE represents unplanned investment.
If inventories are building up (AE below the 45-degree line at the level of income above
equilibrium), then producers cut back output, and income falls in a movement along
the 45-degree line. The multiplier is easily visualized on the model because an increase
in autonomous spending is shown by an equivalent vertical shift in AE.
At the existing level of income, unplanned investment will then be negative as
inventories fall. Output, consequently, rises to a new equilibrium level of income
(GDP), as shown on the horizontal axis. Thus, the multiplier is simply the greater
horizontal change divided by the original vertical shift. Even though the Keynesian AE
function assumes fixed prices, a rise in prices can be shown by a downward shift in the
function and vice versa. Thus, an increase in autonomous spending that shifts up the
AE function is followed by a smaller “bounce” down (two steps up, one step slipping
back).
Therefore, there is a neat way of drawing both models (with the Keynesian on top!)
whereby different price levels are associated with three parallel (upward sloping) AE
functions. The higher is the price level, the lower is the AE function, because higher
prices are associated with a decrease in the quantity of AD. The different equilibrium
points between the 45-degree line (or AS in terms of national income) with the three
AE functions can be extended vertically down (dotted lines) to a single AD function in
another graph. It is then clear that higher prices are associated with a decrease in the
quantity of AD (real GDP on the horizontal axes of both models).
Financial Sector
Financial Assets as well as (liquid) money (in cash and demand deposits), there are
other kinds of financial assets, such as savings accounts, stocks (shares), and bonds,
that earn a return. The return (usually the real interest rate) compensates us for
deferred consumption, because present consumption is worth more to us than in the
future. Thus, there is a “time value of money”: access to money now is worth more
than the promise of it at a future date!
We also need to be compensated for inflation if we defer consumption by transferring
our money to another financial asset. Therefore, the nominal interest rate = the real
interest rate + the inflation rate.
The Money Market Money itself does not earn a return, but it has the special features
of being a “medium of exchange,” a “unit of account,” and a “store of value.” Note
that money is itself a kind of commodity with an opportunity cost equal to the rate of
interest because we have the choice of putting it into a savings account. Thus, the
money market, through a system of demand and supply, determines the quantity of
money in circulation and the prevailing rate of interest: r or i. The latter then helps
determine the level of investment (and of interest-sensitive consumption), which
affects the equilibrium level of real GNP. Note that there is an inverse relationship
between the interest rate and bond prices because bonds are traded at prices that
differ from the face value. The bond price brings the percentage yield on a bond into
line with interest rates.
The money supply is determined through the mechanics of credit creation (fractional
reserve banking leads to a banking multiplier, equal to one over the required reserve
ratio), with the central bank and private banks both playing important roles.
There are both narrow and broad definitions of the money supply. The monetary base
is just the sum of notes, coins (cash), and banks’ deposits at the central bank. M1 is
“cash and demand deposits” (plus travelers’ checks), and M2 adds in saving deposits.
Generally for the purpose of a theoretical analysis of the money market, we assume
that the liquid M1 represents the money supply, but in applied economics, M2 is
commonly used. One problem is that as financial products have become increasingly
diversified, the nature of the money supply and its impact on interest rates and real
GDP are less transparent. The determinants of money demand (liquidity preference)
are difficult to analyze. It can be flat or steep, and it shifts when P and Y change. Note
the following: a) As the interest rate rises (the price of bonds falls), the quantity of
money demand decreases because other financial assets (savings accounts) become
more attractive than cash, so the demand curve is downward sloping. (Asset and
speculative demand for money). b) As prices or incomes rise, the demand curve shifts
out because there is more demand for cash balances (what you have in your pocket).
(Transaction demand for money). c) There is also a precautionary demand for money
(keeping cash for a rainy day). Therefore, changes in confidence will lead to shifts in the
money demand curve. In the money market, the nominal interest rate is being
determined because nominal money is on the horizontal axis. Moreover, when inflation
occurs, the money demand curve shifts to the right, thereby increasing the nominal
interest rate.
The Loanable Funds Market and Crowding Out - Unlike in the short-term money
market, the long-run real interest rate is determined by the supply and demand of
loanable (investment) funds. The supply is a function of household savings (plus in
some cases of government savings, which may be negative). The demand for loanable
funds comes from both the corporate sector and the government when it runs a
budget deficit (expansionary fiscal policy).
When G > T ➞ budget deficit ➞ demand for loanable funds rises (or S falls) ➞ real
interest rate rises ➞ corporate investment in plant and equipment falls. Thus, private
investment is crowded out by the government’s expansionary fiscal policy.
There is also an indirect crowding-out effect in the money market, even when there is
no budget deficit. When real GDP and prices rise, money demand shifts to the right,
resulting in the rise of the nominal interest rate.
Monetary Policy (to control the money supply) The Central Bank (CB, or Fed), which is
the lender of last resort, conducts monetary policy through its control over the money
supply. Its tools, which can make either an expansionary (easy) or a contractionary
(tight) policy, are: 1. Open Market Operations: buying/selling government bonds,
which increases/ decreases the excess reserves of the commercial banks. 2. Changing
the discount rate (at which CB lends to banks): lowering/raising. 3. Changing the
required reserve ratio (leading to banking multiplier): lowering/ raising. This is a
powerful and blunt instrument for changing the reserve positions of banks, so it is not
used often.
Keynesian View Money supply (Ms) rises ➞ r falls ➞ investment & consumption rise ➞
AD rises. Keynesians argue that the speculative demand for money is particularly
important. People tend to hold cash when they expect bond prices to fall (interest
rates to rise) in the future. As a result the money demand curve would be rather flat
(elastic) and the velocity of circulation (V) is unstable.
V equals nominal GDP divided by the money supply. If V = 6, then the average wage
earner is basically keeping two months’ pay in the form of liquid money (cash and
mostly demand deposits). Empirically V has not been stable since the 1990s.
If money demand (Md) is more sensitive (elastic) to changes in the interest rate—the
curve is flatter—then changes in the money supply are less effective in changing the
interest rate. In the extreme case, Keynesians believe there might be a liquidity trap
when Md becomes flat (very sensitive to changes in [r]), and (r) can fall no further.
They also consider that Md is unstable (it shifts as the price level [P] and income [Y]
change) and that the investment schedule may be steep, which would indicate that
investment is not sensitive to changes in the interest rate. As a result, changes in the
money supply will only have a small, indirect effect on AD.
Monetarist View: Monetarists in general believe that the economy is inherently stable
and that there are severe lags in the effects of policies, meaning a contractionary
action meant to cool down a boom might hit in the throes of a recession. In other
words, they believe that discretionary policies are destabilizing. Changes in the money
supply do not affect real variables (interest rate, level of investment) but, instead,
simply encourage more spending (real balance effect), which leads to higher prices
without any increase in output. Thus, monetarists believe that the (classical) quantity
theory of money (equation of exchange) is valid because V (velocity) is stable (as well
as money demand). MV = PQ (= nominal GNP).Because nominal GDP rises but not real
GDP, the main impact of an expansionary monetary policy is on prices (boosting
inflation) following an increase in spending.
Since inflation is “the worst enemy,” according to most monetarists, their
recommended policy is simply to follow a nondiscretionary “monetary rule” whereby
the money supply should only expand at the same rate of growth as real GDP (an
“accommodating” policy) at a rate set between about 3 and 5 percent.
The monetarists argue that a stable growth in the money supply will allow
“expectations to be rational” without any “money illusion.” Monetarists see the link
between the money supply and spending (nominal GDP) as strong and direct.
What is confusing is that although monetarists do not advocate changes in the money
supply except at a steady pace to match the growth in real output, they seem to think
that money demand is not sensitive to changes in the interest rate (inelastic), and
investment demand is sensitive. Given their beliefs, monetary policy is a strong tool for
affecting AD, but they do not like to use it for fine-tuning the economy because of the
risk of sparking off an inflationary spiral. They argue that in the long run, the only
impact will be on the price level with no effect on real output.
Milton Friedman (of the Chicago School) argues that “Inflation is primarily a monetary
phenomenon, produced by a more rapid increase in the quantity of money than in
output.” He also asserts that the failure of the central bank (Federal Reserve System in
United States) to increase the money supply was the major cause of the Great
Depression in the 1930s. In other words, money is almost all that matters in
determining the stability and growth of the economy because it has a powerful and
direct effect on prices and nominal GDP. The Keynesians, however, believe that the
Great Depression could have been averted if the government had engaged in more
government spending and income tax cuts (fiscal policy), while monetary policy should
have played second fiddle. The New Keynesians see a role for monetary policy in
reducing the impact of crowding out through pursuing an expansionary monetary
policy at the same time as fiscal policy is managing AD.
Inflation, Unemployment, and Stabilization Policies
The Phillips Curve, Inflation, and the Natural Rate of Unemployment; Keynesian
economists believe that the two policy objectives of maintaining full employment and
stable prices were incompatible. Evidence for this belief was provided by the
downward sloping (inverse) Phillips curve with a trade-off between the inflation rate
(on the vertical axis) and unemployment rate.
However, starting in the 1970s many countries experienced both rising levels of
unemployment and increasing rates of inflation at the same time (so-called
“stagflation”), which appeared to arise from the Phillips curve shifting outwards. The
explanations offered were: 1. supply shocks, such as a more militant attitude by labor
unions and cost-push pressures that are not related to wage demands (e.g., higher
import prices for materials), and 2.the distinction between unexpected inflation (shortrun PC) and an anticipated rate of inflation.
When inflation is fully anticipated, nominal wages rise at the same rate as prices, so
companies no longer have the extra profit incentive to hire extra labor. The modified
Phillips model has a long-run curve (LRPC) that is vertical at the natural rate of
unemployment. There are downward-sloping short-run curves because of money
illusion, but ultimately, after an expansionary policy that temporarily lowers the
overall unemployment rate, the economy returns to the vertical line at a higher rate of
inflation.
The natural rate of unemployment (NAIRU: nonaccelerating-inflation rate of
unemployment) is that which, given the existing structure of the labor market, equates
the demand for and supply of labor when GDP is equal to potential (“full”
employment) GDP.
NAIRU is made up of frictional and structural unemployment, which are consistent with
a stable rate of inflation because they are caused by other factors, such as movements
between jobs and changes in economic structure.
Supply-siders also argue that NAIRU could be reduced with fewer regulations, less
labor union power, fewer unemployment benefits, and more labor mobility. Inflation
and Expectations.
The difference between the short-run and long-run aggregate supply curves (and
similarly for the Phillips curves) arises because of different expectations. In the short
run, a higher rate of inflation is not anticipated, so producers interpret price rises in
relative terms and respond with higher output and increased employment. Once
expectations match reality, then the short-run Phillips curve (SRPC) shifts out (SRAS to
left), and we return to the long-run vertical slope at potential GNP.
Thus, unanticipated inflation (usually demand-pull) leads to a (short-run) reduction in
unemployment (moving along the SR Phillips curve or upward-sloping part of AS
beyond LR equilibrium). This occurs because businesses think that the price rise signals
higher demand for their own products and rising profits (money illusion), so they
increase output. Because there is a fall in real wages, employed workers are hurt,
while employers prosper.
When inflation is unanticipated, nominal interest rates will not be sufficiently high to
compensate lenders and savers for the loss in the value of their assets. In other words,
when the money plus nominal interest is returned to them, they will not be able to buy
the quantity of goods and services equivalent to what they could have bought when
they made the loan or put their money into a savings account.
However, those who are borrowing for capital investment benefit in the short run,
until inflation becomes anticipated. Anticipated (expected) inflation shifts the SR
Phillips curve to the right (SRAS to the left) because of cost-push inflation in the form
of wage rises, as labor unions—now without any money illusion—insist on wage hikes
to compensate for price rises and higher demand for labor. (Similarly, nominal interest
rates have to be increased.) To stop the SRPC shifting right, therefore, there may have
to be policies to restrain labor union rights and activities. Expected inflation may also
engender demand-pull inflation as consumers rush to buy before expected price hikes.
Thus, a cost-push and demand-pull inflationary spiral could easily emerge.
Business Fluctuations and Policy lags because neither investment nor net exports are
induced, they may fluctuate unexpectedly, which will shift aggregate demand (AD) and
lead to short-run changes in real GDP. Discretionary fiscal and monetary policies aim to
tame the business cycle and bring actual and potential GNP in line with each other.
The timing of contractionary (or expansionary) policies becomes very difficult due to
lags in information, decision making, and implementation.
Economic data are not necessarily reliable and will always be a few months out of date.
The government may believe that the economy is overheating and so pursue a tight
monetary policy, but in fact, private investment has begun to fall, and so the higher
interest rates simply worsen the incipient recession. If, on the other hand, the
government pursues expansionary fiscal and monetary policies when the economy is
already approaching full employment, then it risks sparking off an inflationary spiral as
expectations of higher prices rise.
Inflation can be caused by both demand-side (AD rises) and cost-push (AS falls) factors.
(Fiscal Policy)
There are additional significant lags in the political process (as well as the possibility of
“pork barrel” spending) in pursuing fiscal policies, namely, discretionary changes in
government expenditure (G) and taxes (T) with the aim of managing AD. Thus, fiscal
policy is not appropriate when AS shifts leftward in the case of a supply shock, leading
to stagflation.
Keynesian theory indicates that relatively high levels of unemployment may be
reduced by fiscal measures that increase AD (planned aggregate expenditure) through
the multiplier. Many economists, however, now believe that such discretionary
measures are likely to affect prices rather than output even when there is excess
capacity, because: a) in the short run, the supply of many goods may be inelastic (a
vertical curve—the classical view); b) unions may look on such measures as a “green
light” to boost wages higher than productivity gains, which leads to a rise in the
expected rate of inflation—as in the rational expectationists’ view; and c) when G > T,
there is a budget deficit and bonds have to be issued (government borrowing) and
interest rates, will rise thereby “crowding out” private investment. In the loanable
funds market, either D shifts right or S shifts left as government savings fall.
Accumulated deficits over time will result in a higher national debt. (Balanced Budget
Multiplier)
Nonetheless, it is possible for the government to increase both G and T by the same
amount so that there is no deficit and no upward pressure on interest rates. There will
still be a multiplier equal to 1 because people not only cut their consumption to cope
with the tax hike but also reduce their savings. Thus during a recession, the
government could increase G and increase taxes by equivalent amounts with GDP
rising by the same amount because every $1 extra tax only leads to a $0.75 cut in
consumption (when the mpc equals 0.75). (Automatic Stabilizers)
In a recession, unemployment benefits automatically increase and tax payments fall
(as incomes decrease). As a result, G rises and T falls (vice versa during inflation). So
along with the discretionary policy choices above, the government’s budget results in
automatic stabilizers operating in the economy, namely: a) transfer payments adjust to
changes in unemployment, with the result that the multiplier effect of an autonomous
drop in aggregate demand is reduced and the resulting recession is less severe, and b)
direct income and business taxes dampen an inflationary economy, because the
percentage rises in nominal incomes and profits are taxed, often at a higher rate when
taxes are progressive. (N.B. When taxes are lump-sum or regressive, e.g., flat taxes,
they do not act as an automatic stabilizer.) (Fiscal and Monetary Mix) For example, a
contractionary fiscal policy (G down, T up) and a tighter monetary policy (Ms down ➞
r up) are used to deal with an inflationary gap. The net effect on interest rates (both
nominal and real) is indeterminate because the surplus on the government budget will
put downward pressure on interest rates.
Confidence is an important factor that is not yet properly incorporated in economic
theories. But economic forecasters know that business and consumer confidence can
make a big difference in determining whether an economic policy is successful.
Keynesians argue that government management of AD should engender confidence,
while monetarists would say that discretionary policies are destabilizing. The latter
believe that the absence of inflation is most important for engendering confidence.
Economic Growth and Productivity
Growth is the main macroeconomic target because it increases the amount of real
GDP in the long run and pushes out the PPF (long-run aggregate supply curve). Also it
is a way of tackling the dilemma of stagflation. Real economic growth depends on
human and natural resources, capital goods, technology, and the right “environment
for enterprise.”
The model shows that an increase in net (planned) investment (not just replacement
investment) leads to an increase in the human and physical capital stock, which is a
resource that increases productivity (output per unit of labor) and thereby allows a
higher level of potential real GDP (as LRAS shifts right). Higher productivity stems from
more education (human capital investment), technology, or better management.
The policies required are: 1. Lower real interest rates from an expansionary monetary
(but not fiscal) policy. 2. Lower corporate tax rates (to allow businesses to reinvest their
profits). 3. Tax breaks for businesses that invest in plant and equipment (i.e., tax
incentives). 4. Deregulation that lowers costs for businesses. 5. Higher savings that
increase the supply of loanable funds. (Therefore taxes on consumption are preferred
to taxes on business or savings, e.g., dividend or capital gains taxes.) 6. Effective
research and development in order to achieve technological progress.
Keynesians and monetarists agree that the LR aggregate supply curve can be shifted
out (the LRPC in) through productivity growth, technological advances, labor training,
and better labor mobility. Growth is usually measured by steady changes in real GDP
per capita.
For long-run economic growth without inflation it is necessary that there should be an
increase in potential GDP through an outward shift of the aggregate supply curve
along with the PPF. To achieve that, there must be an increase in labor productivity (or
immigration or technology), which is possible through higher capital investment and
better labor mobility. For more investment the economy needs lower interest rates
and a reasonable level of saving.
Once again, there are policy conflicts. Keynesians would argue that if aggregate
demand is deficient for long-run growth (because of a lack of consumer and business
confidence), then the government should intervene with expansionary fiscal and
monetary policies. They believe that inflation won’t be too serious because of sticky
prices and wages. Even if there were inflation, it would be short-term until the AS
curve shifts out on the back of greater investment in capital stock.
Monetarists (and RE economists) would say that government intervention leads to a
misallocation of resources (partly through crowding out) and that the price system is
flexible and works well to allocate resources efficiently so that investment is carried
out in the right places to maximize productivity gains. They favor supply-side policies
because of the danger of higher AD leading to inflation. This would distort the
workings of the price system and destabilize long-run prospects, especially when
inflation is anticipated because of government expansionary policies.
International Trade and Finance
Comparative Advantage must be revisited because there are different factor
endowments in different regions of the world, there is diversity in the conditions of
production between different countries. Using the same resource (input) quantities,
countries can produce different amounts. Moreover resources are relatively immobile
between countries. It seems sensible for countries to specialize in the economic
activities in which they have some kind of comparative advantage (lower opportunity
cost) and to engage in international trade because different commodities require
different combinations of resources.
For a country to gain from international trade, the opportunity cost of obtaining
certain goods through trade must be less than the opportunity cost of producing them
domestically, in which case the country can consume beyond its production possibility
frontier. In other words, “the terms of trade are lower than its own opportunity cost”
or “it can import more cheaply than by making the good itself.” Thus, the mutually
beneficial trading price lies between the two countries’ different opportunity cost
levels for a particular good. Note that we now have to consider whether the data
provided are for output levels (in which case the opportunity cost for good A is simply
the amount of B given up over the amount of A gained) or inputs.
In the case of labor or acreage or raw materials used for a certain level of output, we
instead put the amount of input used in for good A over the amount used for good B.
The result, though less intuitive, is still the opportunity cost. Although specialization
and trade lead to a greater output in total, there are some arguments for restricting
international trade through quotas and tariffs on imports in the case of infant
industries and strategic industries. Moreover, if a country has a high degree of
specialization in a product, then its economy is vulnerable either to changes in demand
or to technical innovations elsewhere.
Balance of Payments: The trade (in goods and services, including tourism) account is
the major part of the current account, which also includes net investment income—
profits, interest, and dividends—and net transfer payments (overseas aid).
Inflows and outflows of direct investment (as companies establish subsidiaries
overseas) and portfolio investment (in shares and bonds) along with loans comprise
the capital account. Often, as in the case of Japan, a surplus on the current account
(when exports exceed imports) is balanced by a deficit on the capital account (when
the economy is effectively lending its savings overseas). When there is an imbalance
on the two main accounts, the official settlements account has to be adjusted. A net
deficit requires the use of official foreign exchange reserves held at the Central Bank
(or borrowing from the International Monetary Fund), which means that the balance
on the official settlements is positive.
Exchange Rates: a freely floating exchange rate will not bring about an automatic and
rapid adjustment to a surplus or deficit on the current account of the balance of
payments because: 1. Resources are not perfectly mobile, so supplies of different
goods and services cannot be quickly adjusted to the changes in relative prices as the
exchange rate changes. There is a time lag, which is why the J-curve effect appears. 2.
In the case of a deficit, the resulting fall in the exchange rate, which makes imports
dearer, could lead to cost-push inflation (➞ export prices rise) and hence to further
currency depreciation. 3. A deficit on an economy’s current account is matched by a
surplus on the capital account, as long as foreign financial investors are willing to seek
returns through either portfolio or direct investment in the economy. 4. Floating
exchange rates tend to encourage speculation (hot money flows) on the capital
account, which can have a destabilizing influence on the balance of payments.
The Foreign Exchange Market: Be careful to distinguish between the following: 1.
Because of a trade surplus on the United States current account or inflow of foreign
financial “investment” funds seeking higher real interest rates in the U.S., there is
higher (derived) demand for dollars. This implies that the demand curve for U.S. dollars
shifts out, and the dollar appreciates (gets stronger) to remove the excess demand. In
other words, the Yen/$ rate is getting higher (the amount of yen we can buy with $1 is
greater) and the $/Yen rate is getting lower (the dollar cost of yen is decreasing). 2.
Because of a trade deficit on the U.S. current account or net outflow of U.S.
“investment” funds seeking higher interest rates overseas, there is a greater supply of
U.S. dollars, which implies that the supply curve shifts out, and the dollar depreciates
(gets weaker) to remove the excess supply. In other words, the Yen/$ rate is getting
lower (the amount of yen we can buy with $1 is less) and the $/Yen rate is getting
higher (the dollar cost of yen is rising).
The next stage is that in the case of number 1 above, the dollar appreciates and U.S.
exports become more expensive in Yen and Euro-denominated terms for Japanese or
European customers, so the amount of U.S. exports tends to fall. Meanwhile U.S.
imports are getting cheaper for U.S. customers (creating better terms of trade), so the
amount of imports increases. Both things tend to reduce the surplus on the current
account of the balance of payments, after a time lag. In the case of number 2 above,
the dollar depreciates, U.S. exports are getting cheaper in overseas currencies, and
U.S. imports in dollar-denominated terms are becoming more expensive, leading to
U.S. inflation. These things tend to reduce a deficit on the current account after the
initial J-curve effect of a larger trade deficit wears off. (Exports are cheaper overseas,
but they are not yet selling in a greater volume because of the time taken for overseas
customers to respond to lower prices.) Note that the balance of payments and hence
the exchange rate will be affected by inflation rate differentials (because of export
prices and relative prices for imports), real interest rate differentials (because of
financial investment flows), and growth rate differentials (because imports are induced
by income changes). Thus, fiscal and monetary policies have a major impact on
exchange rates.
ECONOMICS FINAL PROJECT
PURPOSE: To afford students the opportunity to examine in-depth a particular economic issue that is
both timely and relevant and to prepare them for the world they will soon be entering. They will be
expected lead fellow students in an in-depth discussion on that issue.
DIRECTIONS: You will work with a partner or two to research, analyze, and lead a discussion on a
significant political issue. You will spend a week researching and putting your discussion together.
The final time will be allocated for each group to present their materials, lead a discussion on their
presentation, and then debate the merits of their findings. Each group/individual will select one of the
following on a first-come-first-served basis. Only one group will be allowed to work on a topic.
Remember that you must elicit whole-class conversations. You should plan your presentation to meet
the following required “inclusions”, who you choose to lead the discussion and debate is up to your
group. Please feel free to use any supplemental material you feel necessary.
You presentation must include:
 A strong way of introducing your topic
 Background information on the issue (a brief history, relevant statistics, etc.)
 Arguments/debate over the issue
 Relevance of the issue to American government and society (the connection to any relevant
course concepts)
 Well-developed questions to ask the class as a way of leading the discussion in the direction(s)
you want to go
 Be prepared to debate your finds; remember, no matter your take, I will be the devils-advocate
in each and every debate.
 We will establish the time limits once the AP Exam is over.
The issues you will examine, you must develop your own focus question and present on the first day of
preparation.
1. Should America adopt public financing of political campaigns?
2. Does Affirmative Action advance racial equality?
3. Do we need national health insurance?
4. Are Americans overtaxed?
5. Should border security come first in stopping illegal immigration?
6. Is indefinite detention of suspected terrorists justified?
7. Is the use of torture against terrorist suspects justified?
8. Does the Tea Party represent a revival of America’s revolutionary ideals?
9. Should the United States pull out of the Middle East?
10. Should the death penalty be abolished?
11. Should gays and lesbians be allowed to marry?
PARENTAL ACKNOWLEDGEMENT
The students will need to provide their own:
1. Notebook suitable for Journal/Class notes – I suggest a Loose Leaf Binder with pockets to store
their work.
2. Paper
3. Pens (black or blue only)
4. 3 x 5 index cards
The student is EXPECTED to be in class and have their assignments complete. This course is taught
as if to college freshmen and I will not tolerate students neglecting their assignments nor conducting
themselves in a manner unacceptable in a college classroom.
The student is EXPECTED to be prepared. The quality of education begins and ends with the
student as the center of the educational experience. Improvement on ALL levels helps to establish a
sense of pride in who we are, and I expect every AP student to assist their fellow Panthers in achieving
great heights.
In today’s world we are looked at, not as an individual, but as what we have achieved. College
Admission offices look at what you have achieved, not so much clubs or sports, as everyone applying
lists the same things, but what you have attempted to do! Have you bravely gone where no one has
gone before? (Forgive this old Star Trek fan’s fancy)
I hope you will help us to develop a love of country, something that should be cherished,
enjoyed, and preserved, not just for our lifetime, but all generations to come. As everyone who has
ever been in my class or known me, please remember “THE POWER IS (Y)OURS!”
I, the parent(s)/guardian(s) have reviewed this syllabus and have a general understanding of
what is required of my/our child. If I have any questions at any time, I will contact Mr. Snyder
personally at the school at 357-4147, via email at [email protected].
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Student Signature
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Parent/Custodian Signature
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Parent/Custodian Signature
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Date
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Date
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Date
Parent Preferred Contact Information:
Mailing Address:
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Phone Number: __________________________________________________
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