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•GDP: Spending Y = C + I + G + NX Money MV = PY •Circular flow Spending—Output—Income •Measuring GDP and Price Indexes •Unemployment Rate •Laborforce •Natural rate •Interest rate: nominal and real •Consumption function C = C0 + mpc x Yd •Aggregate Demand: C + I + G + NX •Shifts •Aggregate Supply: Short-run—Long-run •AD—AS Equilibrium •Automatic adjustment via price •Keynesian intervention •Fiscal Policy •Money •Functions •Money creation in banking system •Monetary Policy •Tools •Effects •Phillips Curve •Inflation—Unemployment Tradeoff ? •Expectations and “natural rate” •Economic Growth •Factor growth—investment •Technology Macro - Review GDP = C + I + G + NX MV = P Y (= $GDP) Circular Flow 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 $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. 2006 Cars Computers Oranges Quantity Price Quantity Price 10 4 1,000 $2,000 $1,000 $1 12 6 1,000 $3,000 $500 $1 $GDP in 2006 = 2006 Base Prices GDP in 2006|2006= P in 2006|2006 = 2007Base Prices GDP in 2006|2007= P in 2006|2007 = 2006 – 2007 Average Price Base GDP in 2006|avg P= P in 2006|avg P = 2007 $GDP in 2007 = % Growth = GDP in 2007|2006= % Growth = P in 2007|2006= GDP in 2007|2007= % Growth = P in 2007|2007= GDP in 2007|avg P= % Growth = P in 2007|avg P= 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 (). r=i- • Low real interest rates spur business investment spending (the I in C + I + G + NX) Consumption Function C = C0 + mpc * Yd C0 = Autonomous Consumption mpc = Marginal Propensity to Consume mpc+mps = 1 [what’s not consumed is saved] Yd = Disposable Income Aggregate Demand Curve AD = C + I + G + NX Factors that Shift AD 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: Short – Run & Long – Run Aggregate Demand and Supply Equilibrium: Short-run and long-run responses to increase in aggregate demand : : Automatic Adjustment via Price Change Macroeconomic Viewpoints Laissez - Faire Classical Monetarist New Classical Activist/Interventionist Keynesian New Keynesian Demand-Side Policy: Greater Spending Means Higher Prices Price Level (c) Aggregate Demand and Supply in the classical range of AS curve. (Prices rise without significant improvements in output and employment.) AD1 AD Y? Real GDP Fiscal Policy: Some Definitions • Fiscal policy: government spending and taxing – Demand-side policies – Supply-side policies: • Discretionary Fiscal Policy: • Automatic Stabilizers: – Progressive taxes – Unemployment insurance – Welfare payments / other transfer payments Functions of Money • Medium of exchange • Unit of account –Standard of Deferred Payment • Store of value Multiple Creation of Bank Deposits M1 Fractional Reserve Banking System: r = .1 Deposit expansion multiplier = 1/r (when banks lend all excess reserves and public redeposits proceeds of loans into the banking system no leakages) The Fed’s Policy Tools 1) Reserve Requirements 2) Discount rate “primary credit rate” 3) Open market operations • Manage the public’s expectations Inflation Targeting? How Money Supply Changes Affect GDP Aggregate Demand and Supply Phillips Curve Expectations and the Phillips Curve • Starting at (1): 5% unemployment and 3% inflation. People believe inflation will continue at 3% Curve I. • Then Fed hypes inflation to 6% unemployment falls to 3% (Point 2 on Curve I). • Expectations adjust to 6% inflation Wage demands up Economy moves to point (3) Unemployment returns to 5%. • If expectations adjust instantly, e.g., anticipating Fed’s policy, economy moves directly from (1) to (3). Economic Growth • Economic growth: an increase in Real GDP. • Small changes in rates of growth Big changes over many years • Per Capita Real GDP: real GDP divided by population. Determinants of Economic Growth • Size and quality of the labor force • Capital • Land/Natural Resources … are not a necessary condition for economic growth … they can be acquired through trade. • Technology