Download Review for Final II

Macro – Review II
GDP = C + I + G + NX
MV = P Q (= $GDP)
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
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
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: aimed at
achieving a policy goal.
• Automatic Stabilizer: fiscal policy that
changes automatically and
countercyclically as income changes.
– 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?
Fed Policy Linkages
Tools – Intermediate Targets – Goals
Equation of Exchange: relates
quantity of money to nominal GDP
–
–
–
–
–
M = money supply (some aggregate)
V = velocity of money (of the aggregate)
P = price level
Q = real GDP
PQ = nominal GDP
MV = PQ
(Note: V = PQ/M)
Money Demand
– Transactions demand
– Precautionary demand
– Speculative demand
… fear decline in the value of other assets, so
hold money as a safeguard.
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).
Expectations Formation
• Adaptive Expectations: expectations of the future
based on history
• The public acts on its expectations
The present depends on the past
• Rational Expectations: expectation based on all
available relevant information.
– The public understands how the economy
works.
– The public knows the structure and linkages
between variables in the economy.
– The public anticipates policy actions and their
consequence
– The public acts now on its expectations
The present depends on the future
New Classical Economics:
Rational Expectations  Policy Ineffectiveness
{Expansionary policy  movement from 1 to 3}
Macroeconomic Viewpoints
Laissez - Faire
Classical
Monetarist
New Classical
Activist/Interventionist
Keynesian
New Keynesian
The Modern
Keynesian Model:
Sticky Prices
 Demand
Management Policies
Can Stabilize an
Unstable Economy
Long and Variable Policy Lags
– 1. Recognition Lag: policymakers need time
to realize that there is a problem.
– 2. Reaction Lag: they need time to formulate
an appropriate policy response.
– 3. Effect Lag: policy takes time to implement
and work through the economy.
• Countercyclical policies can become
procyclical policies, worsening fluctuations
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
Determinants of 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