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The five fundamental principles of macroeconomics: 1. The overall level and growth of income and output in a nation are determined by the interaction of households, firms, and governments as they produce, exchange, consume, save and invest. Economic interaction between these sectors typically takes place through markets. 2. Physical and human capital accumulation and technological advances are the primary means by which the standard-of-living grows in modern economies. 3. In the long-run, market prices balance supply and demand, so that resource availability determines production and income independently of aggregate demand. a) Real wages and employment are determined by the scarcity of labor and labor’s value in the production of goods. b) Real interest rates are determined by borrowing and lending in financial markets, and influence saving, consumption, and the allocation of resources over time. c) Money reduces the costs of transactions. In the long-run, the quantity of money is neutral. 4. In the short-run, fluctuations in aggregate demand and the quantity of money can cause recessions and unemployment owing to market rigidities. 5. Monetary policy and fiscal policy are tools available to the government to stabilize the economy. But expectations of policy can profoundly influence how macro policies work. GDP = C + I + G + NX Y=C+S+T GDP = Y I = S – B-G – B-ROW S + (T – G) = I + B-ROW National saving = lending to domestic firms and the rest of the world A 3-good example of GDP and real GDP 2000 A B C 2001 A B C %change 2000 A B C 2001 A B C %change p 2 4 6 q GDP 2000 4000 3000 12000 4000 24000 40000 Real GDP 4000 12000 24000 40000 2.2 2000 4400 4.4 3000 13200 6.6 4000 26400 44000 10.00% 4000 12000 24000 40000 0.00% p 2 4 6 Real GDP 4000 12000 24000 40000 q GDP 2000 4000 3000 12000 4000 24000 40000 2.2 2100 4620 4.1 3000 12300 6.2 4400 27280 44200 10.50% 4200 12000 26400 42600 6.50%