Download Review for Final I

Macro - Review
GDP = C + I + G + NX
MV = P Q (= $GDP)
GDP: Real and Nominal
• Gross Domestic Product (GDP): the market
value of all final goods and services
produced within a country during a year.
GDP = C + I + G + Ex – Im
= C + I + G + NX
• Real GDP adjusts for inflation
Nominal GDP = $GDP = P x Q
$ GDP = GDP Deflator x Real GDP
Real GDP = Q = $GDP/P
= Nominal GDP divided by
(deflated by) the GDP Price Deflator
Price Indexes (Base Year = 100)
• Consumer Price Index (CPI)
– cost over time of a typical bundle of goods
and services purchased by households.
CPI = Cost of Typical Market Basket Now
divided by
Cost of the Same Basket in Base Year
Inflation Rate = {Change in CPI} ÷ {Initial CPI}
• GDP Price Deflator (GDP Price Index)
– measures average prices over time of all
goods and services included in GDP.
Foreign Exchange Rate: Appreciation
and Depreciation
• A currency appreciates when it buys more of
a foreign currency.
– Appreciation makes foreign goods cheaper.
– Appreciation  Imports Up and Exports Down.
• A currency depreciates when it buys less of a
foreign currency.
– Depreciation makes foreign goods more
expensive.
– Depreciation  Imports Down and Exports Up.
Current Account vs. Financial Account
• The balance of payments must balance
Current Account + Financial Account = 0
– If we buy more goods and services from
foreigners than they buy from us, we have
to borrow the difference
 sell them our IOUs.
Capital inflows help finance domestic
investment and the government’s deficit
Unemployment
Unemployment rate: % of labor force not working.
number unemployed
Rate of
= number in the Labor Force
Unemployment
• Unemployed persons: not working and looking
• Labor force: Employed + unemployed
noninstitutionalized persons 16+ years of age
• Underemployed workers are treated as employed
• Discouraged workers are not in the labor force
• “Natural” or normal rate of unemployment (NAIRU)
Seasonal Unemployment
Frictional Unemployment: searching for jobs
Structural Unemployment: Imperfect match between
employee skills and requirements of available jobs.
• Cyclical Unemployment : Results from business cycle
Interest Rates: Nominal and Real
• Nominal Interest Rate (i): the interest
rate observed in the market.
• Real Interest Rate (r): the nominal rate
adjusted for inflation ().
Real Interest Rate = Nominal Interest Rate
– Inflation Rate
r=i-
• Low real interest rates spur business
investment spending (the I in C + I + G + NX)
Aggregate Demand (AD): the economywide demand for goods and services.
• Aggregate demand curve relates aggregate
expenditure for goods and services to the
price level
• The aggregate demand curve slopes
downward owing to price-level effects:
– Wealth Effect (Real Wealth/Real Balances)
– Interest Rate Effect
– International Trade Effect (Substitution)
Shifting Aggregate Demand Curve
Factors that Affect AD  Shifts in AD
AD = C + I + G + NX
• Consumption
– Income
– Wealth
– Interest Rates
– Expectations/Confidence
– Demographics
– Taxes
• Investment
– Interest Rates
– Technology
– Cost of Capital Goods
– Capacity Utilization
– Expectations/Confidence


Government Spending
Net Exports
– Domestic & Foreign
Income
– Domestic & Foreign
Prices
– Exchange Rates
– Government Policy
Aggregate Supply
• Aggregate Supply (AS): the quantity of real GDP
produced at different price levels.
Short-run Aggregate Supply SRAS slopes upward
– a higher price level (holding production costs and
capital constant in the short-run)
higher profit margins
firms want to produce more.
Long Run Aggregate Supply LRAS is vertical: higher
prices cannot elicit more output in the long-run.
• Resource costs are NOT fixed in the long-run.
– As prices rises, workers demand and get higher
wages
Profits don’t rise with price in long-run
AS is set by production possibilities in the long-run
Aggregate Supply:
Short – Run & Long – Run
Aggregate
Demand and
Supply
Equilibrium:
Short-run
and long-run
responses
to increase
in aggregate
demand
Aggregate Expenditures = AE = GDP
Y = AE = C + I + G + NX
• Disposable income = Yd = Y-T = after tax
income.
Yd = Y - T = C + S
Consumption is related to disposable income
(Y-T).
C = Ca +cYd
where c = Marginal Propensity to Consume = mpc
Ca = Autonomous consumption
 Additional income not consumed is saved
mpc + mps =1
Aggregate Expenditures = AE = GDP
In a closed economy, saving either finances
private investment (I) or the government’s
deficit (G – T)
S = I + (G – T) at equilibrium
Investment can be crowded out by the deficit
I = S – (G-T)
• Leakages from the spending stream (S + T)
= Injections to the spending stream (I + G)
• S+T=I+G
Shifts in the Consumption Function

Expected Future Income
–

Wealth
–

–

An increase in wealth raises current consumption and
lowers current saving.
Expected Real Interest Rate


An increase in expected future income will cause
current consumption to rise and your saving to fall.
Higher real return  incentive to save more … but
Higher return to saving  less needs to be put aside to
achieve the same desired future savings.
– Net effect: increased real interest rates reduce
consumption and increase saving.
Demographics
Taxes – Ricardian Equivalence: Anticipation of Future
Taxes
Imports and Exports
The demand for imports depends on current
economic activity, Y
IM = IMa + mpi Y


“mpi” is the marginal propensity to import
Exports are exogenously determined

they depend on conditions in foreign economies,
not our economy

Net exports is NX = EX – (IMa + mpi Y) or
NX = NXa – mpi Y

Net expects decrease as the economy expands
Demand-Side Equilibrium and the Multiplier
At equilibrium: Y = C + I + G + NX = AE
Increase in Y = Spending Multiplier x {Increase in
Autonomous Spending}
Multiplier = 1/(mps + mpi)
From Aggregate
Expenditure to
Aggregate
Demand:
As price level rises,
real money balances
decrease and
consumption function
shifts owing to
i) wealth effect
ii) interest rate effect
iii) international
competition
Circular
Flow