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UNIVERSITY OF ECONOMICS HO CHI MINH CITY MACROECONOMICS HUỲNH VĂN THỊNH [email protected] 1 HUỲNH VĂN THỊNH Home phone:(84.8) 39911812; (84.8) 66786400 Cell phone: 0989 0110 19 Email: [email protected] [email protected] Web: http://sites.google.com/site/huynhvanthinhsite http://sites.google.com/site/economicsfamily HUỲNH VĂN THỊNH [email protected] 2 MACROECONOMICS Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once. HUỲNH VĂN THỊNH [email protected] 3 Macroeconomics answers questions like the following: Why is average income high in some countries and low in others? Why do prices rise rapidly in some time periods while they are more stable in others? Why do production and employment expand in some years and contract in others? HUỲNH VĂN THỊNH [email protected] 4 CONTENTS Chapter 1 AGGREGATE DEMAND AGGREGATE SUPPLY AND EQUILIBRIUM Chapter 2 MEASURING AGGREGATE OUTPUT Chapter 3 THE MULTIPLIER MODEL HUỲNH VĂN THỊNH [email protected] 5 CONTENTS Chapter 4 THE IS – LM FRAMEWORK Chapter 5 OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS Chapter 6 INFLATION AND UNEMPLOYMENT HUỲNH VĂN THỊNH [email protected] 6 Chapter 1 Aggregate Demand, Aggregate Supply and Equilibrium HUỲNH VĂN THỊNH [email protected] 7 I. Aggregate Demand, AD AD= C + I + G + X – M 1. Consumption, C: The spending by households on goods and services, with the exception of purchases of new housing. • Durable goods (exception of purchases of new housing) • Non-durable goods • Services HUỲNH VĂN THỊNH [email protected] 8 • Mathematical Function: C = Co + Cm*Yd Co= Autonomous consumption Cm=MPC= Marginal propensity to consume Marginal consumption Cm = dC/dYd The marginal propensity to consume measures households’ willingness to change consumption spending as result of a change in disposable income Yd 0 < Cm < 1 HUỲNH VĂN THỊNH [email protected] 9 Example: C= 100 + 0.8*Yd Co= 100= Autonomous consumption, constant Cm=0.8= Marginal propensity to consume Yd change 1$ => C change 0.8$ Yd=Disposable income Yd = Y- T + Tr = Y – Tn = C + S HUỲNH VĂN THỊNH [email protected] 10 • • • • • • Y=GDP=Output=Gross domestic Product T=Tax Tr=Transfer payment Tn= Net tax = T – Tr C=Consumption S=Saving HUỲNH VĂN THỊNH [email protected] 11 • • • • • • Y = 100 T = 10 Tr = 6 Tn = T – Tr = 10 – 6 = 4 Yd = Y – T + Tr = Y – Tn =100-10+6=100-4=96 Yd = 96 = C+S HUỲNH VĂN THỊNH [email protected] 12 2. Saving, S: S = Yd – C S = -Co + (1-Cm)*Yd 1-Cm=MPS= Marginal propensity to save Cm + MPS = 1 Example: C=100+0.8*Yd S= -100 +(1-0.8)*Yd S= -100 +0.2*Yd HUỲNH VĂN THỊNH [email protected] 13 3. Net tax, Tn: Tn = T – Tr 3.1. Tax, T: T = To +Tm*Y To= Autonomous tax, constant Tm=Marginal tax Tm=dT/dY HUỲNH VĂN THỊNH [email protected] 14 Example: T=100+0.1*Y To=100= Autonomous tax, constant Tm=0.1= Marginal tax Y change 1$ => T change 0.1$ Marginal tax # Tax rate HUỲNH VĂN THỊNH [email protected] 15 Marginal tax, Tm: Tm=dT/dY Tax rate, t (%): t (%)= T/Y Example: T=100+0.1*Y Tm=0.1 HUỲNH VĂN THỊNH [email protected] 16 T=100+0.1*Y t (%)=???? Y T 0 100 100 110 200 120 HUỲNH VĂN THỊNH [email protected] t=T/Y infinity 110% 60% 17 But ???? dT/dY=T/Y ???? HUỲNH VĂN THỊNH [email protected] 18 dT/dY = T/Y To=0 Or Tm = t To=0 HUỲNH VĂN THỊNH [email protected] 19 3.2. Transfer payments, Tr: Transfer consist of government payments which involve no direct service by the recipient, such as unemployment insurance payment… Tr = Tro Autonomous transfer, constant HUỲNH VĂN THỊNH [email protected] 20 3.3 Net tax, Tn: Tn = T - Tr Tn = To + Tm*Y - Tr Tn = To - Tro + Tm*Y Tn = Tno + Tm*Y Tno = Autonomous net tax, constant Tno = To - Tro HUỲNH VĂN THỊNH [email protected] 21 Example: T=100+0.1*Y Tr=60 Tn=T-Tr=100+0.1*Y-60 Tn=(100-60)+0.1*Y Tn=40+0.1*Y HUỲNH VĂN THỊNH [email protected] 22 To = 100 = Autonomous tax Tr = 60 = Transfer Tno = 100 – 60 = 40 = Autonomous net tax Tm = 0.1 = Marginal tax HUỲNH VĂN THỊNH [email protected] 23 4. INVESTMENT, I: The spending on capital equipment, inventories, and structures, including new housing. * * * Capital equipment Structures (including new housing) Inventories HUỲNH VĂN THỊNH [email protected] 24 Mathematical function: I = Io + Imy*Y - Imi*i Io = Autonomous investment, constant Imy =Marginal Propensity to invest for Y Imi =Marginal propensity to invest for i Y = GDP = Output i = Interest rates HUỲNH VĂN THỊNH [email protected] 25 Imy > 0 ; Imi > 0 Y and i is inverse relationship Y and I is the same direction Example: I=350+0.4*Y-200*i Io = 350 = Autonomous investment Imy = 0.4 = Marginal propensity to invest for Y Y change 1$ => I change 0.4 $ HUỲNH VĂN THỊNH [email protected] 26 Imi = 200 = Marginal propensity to invest for i i increase 1% => I decrease 200 $ i decrease 1% => I increase 200 $ HUỲNH VĂN THỊNH [email protected] 27 5. Government Spending, G: The spending on goods and services by local, state, and federal governments. Does not include transfer payments because they are not made in exchange for currently produced goods or services. G=Go Autonomous Government Spending, constant HUỲNH VĂN THỊNH [email protected] 28 6. Net Exports, Xn, Nx: Xn = X – M Xn = Exports minus imports 6.1 Exports, X: A country exports domestic goods and services X = Xo Autonomous exports, constant Gross exports are exogenous, largely determined by the level of income in foreign countries. HUỲNH VĂN THỊNH [email protected] 29 6.2. Import, M: A country imports foreign-made goods and services M = Mo + Mm*Y Mo= Autonomous import, constant Mm=Marginal propensity to import Mm > 0 Y and M is the same direction HUỲNH VĂN THỊNH [email protected] 30 6.3. Net Exports, Xn: Xn = X – M Xn = Xo – (Mo +Mm*Y) Xn = (Xo – Mo) – Mm*Y Xn = Xno - Mm*Y Xno = Xo – Mo Xno = Autonomous net exports HUỲNH VĂN THỊNH [email protected] 31 Example: X = 250 M = 100 + 0.2*Y Xn = X – M = (250-100)-0.2*Y Xn = 150 - 0.2*Y Xo = 250 = Autonomous exports Mo = 100 = Autonomous imports Mm = 0.2 = Marginal propensity to imports Xno = 150 = Autonomous net exports HUỲNH VĂN THỊNH [email protected] 32 SUMMARY AD = C + I + G + X - M AD = C + I+ G + Xn C = Co + Cm*Yd S = -Co + (1-Cm)*Yd Yd = Y – T + Tr = Y – Tn = C + S HUỲNH VĂN THỊNH [email protected] 33 T = To + Tm*Y Tr = Tro Tn = T – Tr = Tno + Tm*Y I = Io + Imy*Y - Imi*I X = Xo M = Mo + Mm*Y Xn = X – M = Xno - Mm*Y G = Go HUỲNH VĂN THỊNH [email protected] 34 Aggregate Demand Curve: P, Price Level AD Y, Output HUỲNH VĂN THỊNH [email protected] 35 P, Price Level AD2 AD1 Y, Output HUỲNH VĂN THỊNH [email protected] 36 AD1 => AD2 => AD increase AD2 => AD1 => AD decrease AD increase (C+I+G+Xn) increase AD decrease (C+I+G+Xn) decrease HUỲNH VĂN THỊNH [email protected] 37 II. Aggregate Supply, AS: Aggregate Supply depends on the state of technology and the supply cost of available human resources, capital resources and natural resources. HUỲNH VĂN THỊNH [email protected] 38 Aggregate Supply Curve: P, Price Level AS Y, Output HUỲNH VĂN THỊNH [email protected] 39 P, Price Level AS1 AS2 Y, Output HUỲNH VĂN THỊNH [email protected] 40 AS1 => AS2 => AS increase AS2 => AS1 => AS decrease HUỲNH VĂN THỊNH [email protected] 41 AS increase * Decrease : +Cost of human Resources +Cost of Capital Resources +Cost of Natural Resources * Increase: +Technology HUỲNH VĂN THỊNH [email protected] 42 AS decrease * Increase : +Cost of human Resources +Cost of Capital Resources +Cost of Natural Resources * Decrease: +Technology HUỲNH VĂN THỊNH [email protected] 43 III. Aggregate Demand and Aggregate Supply The economy’s actual output and price level are determined by the interaction of aggregate demand and aggregate supply HUỲNH VĂN THỊNH [email protected] 44 P, Price Level ADo ASo Po Yo HUỲNH VĂN THỊNH [email protected] Y, Output 45 AD2 P, Price Level AD1 AS1 P2 P1 Y1 Y2 HUỲNH VĂN THỊNH [email protected] Y, Output 46 P, Price Level AD1 AS1 AS2 P1 P2 Y1 Y2 HUỲNH VĂN THỊNH [email protected] Y, Output 47 SUMMARY No change in the AS AD increase => P increase ; Y increase AD decrease => P decrease; Y decrease No change in the AD AS increase => P decrease ; Y increase AS decrease => P increase; Y decrease HUỲNH VĂN THỊNH [email protected] 48 Consumption Aggregate Demand Aggregate Supply Cost of Capital Resources Investment Government Spending Cost of Human Resources Aggregate Output General Price Level Cost of Natural Resources Technology Net Exports HUỲNH VĂN THỊNH [email protected] 49 CHAPTER 2 MEASURING AGGREGATE OUTPUT HUỲNH VĂN THỊNH [email protected] 50 I. Gross Domestic Product, GDP 1. Gross domestic product (GDP) is a measure of the income and expenditures of an economy. GDP is the total market value of all final goods and services produced within a country in a given period of time. HUỲNH VĂN THỊNH [email protected] 51 • “GDP is the Market Value . . .” – Output is valued at market prices. • “. . . Of All. . .” – Includes all items produced in the economy and legally sold in markets • “. . . Final . . .” – It records only the value of final goods, not intermediate goods (the value is counted only once). • “. . . Goods and Services . . .” – It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits). HUỲNH VĂN THỊNH [email protected] 52 • “. . . Produced . . .” – It includes goods and services currently produced, not transactions involving goods produced in the past. • “ . . . Within a Country . . .” – It measures the value of production within the geographic confines of a country. • “. . . In a Given Period of Time.” – It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months). HUỲNH VĂN THỊNH [email protected] 53 THE COMPONENTS OF GDP • GDP includes all items produced in the economy and sold legally in markets. • What Is Not Counted in GDP? – GDP excludes most items that are produced and consumed at home and that never enter the marketplace. – It excludes items produced and sold illicitly, such as illegal drugs. HUỲNH VĂN THỊNH [email protected] 54 2. CALCULATING GDP 2.1 Nominal GDP, GDPn: GDPn year t ($)=Σ(Pt*Qt) GDPn is the value of all final goods and services produced in the economy during a given year, calculated using the prices current in the year in which the output is produced. HUỲNH VĂN THỊNH [email protected] 55 2.2 Real GDP, GDPr: GDPr year t ($)=Σ(Po*Qt) GDPr is the total value of all final goods and services produced in the economy during a given year, calculated using the prices of a selected base year. HUỲNH VĂN THỊNH [email protected] 56 2.3 Expenditure Approach: GDP = C + I + G + X – M 2.4 Income Approach: GDP = w + i + r + П + De + Ti w = wage; i = interest ; r= rent П = Profits; De = Depreciation; Ti = Indirect tax HUỲNH VĂN THỊNH [email protected] 57 II. GDP deflator, GDPd: GDPd year t (100) = GDPn year t/GDPr year t GDPd year t (100) = Σ(Pt*Qt)/Σ(Po*Qt) The GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100. HUỲNH VĂN THỊNH [email protected] 58 III. Consumer Price Index, CPI: CPI year t (100)=Σ(Pt*Qo)/Σ(Po*Qo) Calculated by surveying market price for a market basket intended to represent the consumption. HUỲNH VĂN THỊNH [email protected] 59 IV. Producer Price Index, PPI: PPI year t (100)=Σ(Pt*Qo)/Σ(Po*Qo) A measure of the cost of a typical basket of goods and services purchased by producers HUỲNH VĂN THỊNH [email protected] 60 V. Inflation, Inf: Inf year t (%)= =[Price Index year t/Price Index year (t-1)]-1 “Price Index” maybe GDP deflator or CPI or PPI Inf > 0 => Inflation Inf < 0 => Deflation Inf year t(%)= [(1+gGDPn year t)/(1+gGDPr year t)]-1 HUỲNH VĂN THỊNH [email protected] 61 VI. GDP growth, g, gGDP: 1. Annual growth: gGDPn year t(%)=[GDPn year t/GDPn year (t-1)]-1 gGDPr year t(%)=[GDPr year t/GDPr year (t-1)]-1 [Excel =rate(….)] gGDPn year t(%)=[(1+gGDPr year t)*(1+Inf year t)]-1 gGDPr year t(%)=[(1+gGDPn year t)/(1+Inf year t)]-1 Inf year t(%)= [(1+gGDPn year t)/(1+gGDPr year t)]-1 HUỲNH VĂN THỊNH [email protected] 62 Example: GDPn year 2000 = 100 $ GDPn year 2001 = 120 $ gGDPn year 2001 = (120/100)-1 =20% GDPr year 2000 = 100 $ GDPr year 2001 = 110 $ gGDPr year 2001 = (110/100)-1 =10% Inf year 2001=(1+20%)/(1+10%)-1=9.09% HUỲNH VĂN THỊNH [email protected] 63 2. The average growth over the period: gGDP/Period=(GDP t/GDPo)^(1/X)-1 GDPt = GDP period t GDPo = GDP period o X=Nper= The number of Periods = (t - o) gGDPn/Period=(GDPn t/GDPn o)^(1/X)-1 gGDPr/Period=(GDPr t/GDPr o)^(1/X)-1 [Excel =rate(….)] HUỲNH VĂN THỊNH [email protected] 64 Example: GDPn 2000 = 100 $ GDPn 2005 = 200 $ gGDPn/year (2000 ->2005) = =(200/100)^(1/(2005-2000))-1=14.87% HUỲNH VĂN THỊNH [email protected] 65 gGDPn/month (2000 -> 2005) = =(200/100)^(1/((2005-2000)*12))-1=1.16% gGDPn/6 months (2000 -> 2005) = =(200/100)^(1/((2005-2000)*2))-1=7.18% HUỲNH VĂN THỊNH [email protected] 66 GDPr 2000 = 100 $ GDPr 2005 = 180 $ gGDPr/year (2000 ->2005) = =(180/100)^(1/(2005-2000))-1=12.47% gGDPr/month (2000 -> 2005) = =(180/100)^(1/((2005-2000)*12))-1=0.98% gGDPn/6 months (2000 -> 2005) = =(200/100)^(1/((2005-2000)*2))-1=6.05% HUỲNH VĂN THỊNH [email protected] 67 VII. GDP per capita (Per capita Income, PCI) PCI year t = GDPr year t/POP year t POP = Population GDP year 2000 = 1000 $ POP year 2000 = 100 (People) PCI year 2000 = 1000/100 =10 $ gPCI year t (%)= [(1+gGDPr year t)/(1+gPOP year t)]-1 gPCI year t(%)=[PCI year t/PCI year(t-1)]-1 HUỲNH VĂN THỊNH [email protected] 68 VIII. Forecast the related years GDP a = GDP b*(1+gGDP/Period)^(Period a – Period b) Example: GDP 2000 = 100 $ gGDP/year =10% GDP 2005 =100*(1+10%)^(2005-2000)=161.05 GDP 1995 =100*(1+10%)^(1995-2000)=62.09 [Excel FV(…) or PV(…)] HUỲNH VĂN THỊNH [email protected] 69 CHAPTER 3 THE MULTIPLIER MODEL HUỲNH VĂN THỊNH [email protected] 70 I. EQUILIBRIUM OF AD AND AS We have: AD=C+I+G+X-M AS=Y For AS=AD or Y=C+I+G+X-M HUỲNH VĂN THỊNH [email protected] 71 And C=C+Cm*Yd Yd=Y-T+Tr=Y-Tn=C+S T=To+Tm*Y Tr=Tro HUỲNH VĂN THỊNH [email protected] 72 G=Go X=Xo M=Mo+Mm*Y I=Io+Imy*Y (Keyness: Assuming that Imi=0) HUỲNH VĂN THỊNH [email protected] 73 ….Finally, we have: Y=m*Ado Y: Equilibrium Income m: Ado Multiplier, Expenditure Multiplier Ado: Autonomous Aggregate Demand HUỲNH VĂN THỊNH [email protected] 74 m = 1/[1-Cm*(1-Tm)-Imy+Mm] Ado =[Co + Io + Go + Xo – Mo -Cm*(To-Tro)] HUỲNH VĂN THỊNH [email protected] 75 Example: C=100+0.8*Yd T=20+0.1*Y Tr=32 I=50+0.4*Y G=55 X=40 M=15+0.2*Y HUỲNH VĂN THỊNH [email protected] 76 Equilibrium Income is: Y=m*Ado m=1/[1-0.8*(1-0.1)-0.4+0.2]=12.50 Ado=100+50+55+40-15-0.8*(20-32)=269.60 Y=12.50*=3370 When Equilibrium Income, we have: T=20+0.1*Y=20+0.1*3370=357 HUỲNH VĂN THỊNH [email protected] 77 Tn=T-Tr=357-32=325 Yd=Y-Tn=3370-325=3045 C=100+0.8*Yd=100+0.8*3045=2536 S=Yd – C=3045-2536=509 I=50+0.4*Y=50+0.4*3370=1398 Xn=X-M=40-(15+0.2*Y)=25-0.2*Y=25-0.2*3370= Xn= -649 (Deficit) HUỲNH VĂN THỊNH [email protected] 78 Budget=B=T-Tr-G=Tn-G B=(To-Tro)+Tm*Y-Go=Tno+Tm*Y-G If: B > 0 => Surplus B < 0 => Deficit B = 0 => Equilibrium B=Tn-G=325-55=270 (Surplus) HUỲNH VĂN THỊNH [email protected] 79 II. EXPENDITURE MULTIPLIER: The expenditure multiplier measures the multiplied effect changes in autonomous spending have upon equilibrium income Y=m*Ado =>ΔY=m*ΔAdo ΔAdo= ΔCo+ ΔIo+ ΔGo+ ΔXo - ΔMo -Cm*(ΔTo- ΔTro) HUỲNH VĂN THỊNH [email protected] 80 ΔC=ΔCo+Cm*ΔYd ΔS=-ΔCo+(1-Cm)*ΔYd ΔYd=ΔY-ΔT+ΔTr=ΔY-ΔTn ΔT=ΔTo+Tm*ΔY ΔTr=ΔTro ΔTn=ΔTno+Tm*ΔY HUỲNH VĂN THỊNH [email protected] 81 ΔG=ΔGo ΔX= ΔXo ΔM=ΔMo+Mm*ΔY ΔXn= ΔXno-Mm*ΔY ΔI=ΔIo+Imy*ΔY ΔB=ΔT- ΔTr - ΔG= ΔTn- ΔG= ΔTno+Tm*ΔY- ΔGo HUỲNH VĂN THỊNH [email protected] 82 If: m=1, when Ado increase 1$ => Y increase 1 $ m=10, when Ado increase 1$ => Y increase 10$ m=100, when Ado increase 1$=>Y increase 100$ HUỲNH VĂN THỊNH [email protected] 83 From: 1 m [1 Cm *(1 Tm) Im y Mm] If we want to increase the value of m: Cm lead to 1 Imy lead to 1 Tm lead to 0 Mm lead to 0 HUỲNH VĂN THỊNH [email protected] 84 Example: C=30+0.8*Yd T=50+0.1*Y Tr=40 G=200 X=60 M=20+0.2*Y I=35+0.4*Y HUỲNH VĂN THỊNH [email protected] 85 m= 12.50 Ado= Y= Tn= Yd C= S= Xn= B= 3,712.50 381.25 3,331.25 2,695.00 636.25 -702.50 181.25 HUỲNH VĂN THỊNH [email protected] 86 If ΔGo change = ΔTno= ΔAdo= ΔY= ΔTn= ΔYd= ΔC= ΔS= ΔXn= ΔB= HUỲNH VĂN THỊNH [email protected] 100.00 1,250.00 125.00 1,125.00 900.00 225.00 -250.00 25.00 87 CHAPTER 4 THE IS-LM FRAMEWORK HUỲNH VĂN THỊNH [email protected] 88 This chapter develops schedules for equilibrium in the goods (IS) and money (LM) market. HUỲNH VĂN THỊNH [email protected] 89 I. Product Market Equilibrium: The IS Curve Equilibrium Income AD=AS AD=C+I+G+Xn AS=Y C=Co+Cm*Yd I=Io+Imy*Y-Imi*i G=Go Xn=Xno-Mm*Y Yd=Y-Tn Tn=Tno+Tm*Y HUỲNH VĂN THỊNH [email protected] 90 …..Finally we have IS equation: (IS) Y=(m*Ado)-(m*Imi)*i m=1/[1-Cm*(1-Tm)-Imy+Mm] Ado=Co+Io+Go+Xno-Cm*(To-Tro) Xno=Xo-Mo HUỲNH VĂN THỊNH [email protected] 91 The slope of IS: -m*Imi (negative) Imi=0 => Vertical IS curve the interest elasticity of investment demand is zero Imi=Small=> Steep IS curve the interest elasticity of investment demand is low HUỲNH VĂN THỊNH [email protected] 92 Imi=high => Flat IS curve the interest elasticity of investment demand is high Imi=Infinity => Horizontal IS curve the interest elasticity of investment demand is infinity HUỲNH VĂN THỊNH [email protected] 93 Steep IS Curve i Vertical IS Curve Horizontal IS Curve Flat IS Curve Y HUỲNH VĂN THỊNH [email protected] 94 IS increase IS shift to the right IS decrease IS shift to the left HUỲNH VĂN THỊNH [email protected] 95 Factors that shift the IS schedule: HUỲNH VĂN THỊNH [email protected] 96 Example: C=10+0.8*Yd T=20+0.1*Y Tr=15 G=250 X=50 M=30+0.2*Y I=120+0.4*Y-10*i Find IS equation for equilibrium income in the goods market? HUỲNH VĂN THỊNH [email protected] 97 (IS) Y=(mt*Tm+m*Ado)-(m*Imi)*i m=1/[1-0.8*(1-0.1)-0.4+0.2]=12.50 mt= -0.8*12.50=-10 Tno=20-15=5 Ado=10+120+250+50-30-0.8*5=396 Imi=10 (IS) Y=(12.50*396)-(12.50*10)*i (IS) Y = 4950 - 125*i HUỲNH VĂN THỊNH [email protected] 98 Government Spending increases 10$, ceteris paribus, Find IS2 equation for equilibrium income in the goods market? IS2=IS+ΔIS or Y2=Y+ ΔY ΔY=m*ΔAdo ΔTno=ΔTo- ΔTro ΔAdo=ΔCo+ ΔIo+ ΔGo+ ΔXno-Cm* ΔTno ΔXno= ΔXo- ΔMo HUỲNH VĂN THỊNH [email protected] 99 ΔAdo = ΔGo=10; ΔTno=0 Δ Y=m* Δ Ado ΔY= 12.50*10=125 (IS2) Y2=Y+ Δ Y=(4950+125) -125*i (IS2) Y2 = 5075 – 125*i [(IS) Y = 4950 - 125*i] HUỲNH VĂN THỊNH [email protected] 100 II. Money Market Equilibrium: The LM Curve 1. The Money System: 1.1. Money Supply: HUỲNH VĂN THỊNH [email protected] 101 The meaning of money: Money is the set of assets in an economy that people regularly use to buy goods and services from other people. HUỲNH VĂN THỊNH [email protected] 102 The Functions of Money: Money has three functions in the economy: – Medium of exchange – Unit of account – Store of value HUỲNH VĂN THỊNH [email protected] 103 • Medium of Exchange – A medium of exchange is an item that buyers give to sellers when they want to purchase goods and services. – A medium of exchange is anything that is readily acceptable as payment. HUỲNH VĂN THỊNH [email protected] 104 • Unit of Account – A unit of account is the yardstick people use to post prices and record debts. • Store of Value – A store of value is an item that people can use to transfer purchasing power from the present to the future. HUỲNH VĂN THỊNH [email protected] 105 • Liquidity is the ease with which an asset can be converted into the economy’s medium of exchange. HUỲNH VĂN THỊNH [email protected] 106 • Commodity money takes the form of a commodity with intrinsic value. – Examples: Gold, silver, cigarettes. • Fiat money is used as money because of government decree. – It does not have intrinsic value. – Examples: Coins, currency, check deposits. HUỲNH VĂN THỊNH [email protected] 107 • Currency (Cu) is the paper bills and coins in the hands of the public. • Demand deposits (D) are balances in bank accounts that depositors can access on demand by writing a check. HUỲNH VĂN THỊNH [email protected] 108 – The money supply (Sm, M) refers to the quantity of money available in the economy. – Monetary policy is the setting of the money supply by policymakers in the central bank. HUỲNH VĂN THỊNH [email protected] 109 • Open-Market Operations – The money supply is the quantity of money available in the economy. – The primary way in which the CB (Central Bank) changes the money supply is through open-market operations. • The CB purchases and sells Government bonds HUỲNH VĂN THỊNH [email protected] 110 • Open-Market Operations – To increase the money supply, the CB buys government bonds from the public. – To decrease the money supply, the CB sells government bonds to the public. • Banks can influence the quantity of demand deposits in the economy and the money supply. HUỲNH VĂN THỊNH [email protected] 111 • Reserves (R) are deposits that banks have received but have not loaned out. • In a fractional-reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest. HUỲNH VĂN THỊNH [email protected] 112 • The reserve ratio (R/D) is the fraction of deposits that banks hold as reserves. HUỲNH VĂN THỊNH [email protected] 113 • When a bank makes a loan from its reserves, the money supply increases. • The money supply is affected by the amount deposited in banks and the amount that banks loan. – Deposits into a bank are recorded as both assets and liabilities. – The fraction of total deposits that a bank has to keep as reserves is called the reserve ratio. – Loans become an asset to the bank. HUỲNH VĂN THỊNH [email protected] 114 Banking Money Creation with FractionalReserve • This T-Account shows a bank that… – accepts deposits, – keeps a portion as reserves, – and lends out the rest. • It assumes a reserve ratio (R/D) of 10%. First National Bank Assets Reserves $10.00 Liabilities Deposits $100.00 Loans $90.00 Total Assets $100.00 HUỲNH VĂN THỊNH [email protected] Total Liabilities $100.00 115 Money Creation with FractionalReserve Banking • When one bank loans money, that money is generally deposited into another bank. • This creates more deposits and more reserves to be lent out. • When a bank makes a loan from its reserves, the money supply increases. HUỲNH VĂN THỊNH [email protected] 116 The Money Multiplier • How much money is eventually created by the new deposit in this economy? HUỲNH VĂN THỊNH [email protected] 117 The Money Multiplier • The money multiplier (K) is the amount of money the banking system generates with each dollar of reserves. HUỲNH VĂN THỊNH [email protected] 118 The Money Multiplier Increase in the Money Supply = $190.00! HUỲNH VĂN THỊNH [email protected] 119 The Money Multiplier Original deposit = $100.00 • 1st Natl. Lending = 90.00 (=.9 x $100.00) • 2nd Natl. Lending = 81.00 (=.9 x $ 90.00) • 3rd Natl. Lending = 72.90 (=.9 x $ 81.00) • … and on until there are just pennies left to lend! • Total money created by this $100.00 deposit is $1000.00. (= 1/.1 x $100.00) HUỲNH VĂN THỊNH [email protected] 120 • The money multiplier is the reciprocal of the reserve ratio (R/D): Sm=M = 1/(R/D) • Example: – With a reserve requirement, R/D = 20% or .2: – The money multiplier is 1/.2 = 5. HUỲNH VĂN THỊNH [email protected] 121 The CB’s Tools of Monetary Control • The Central Bank (CB) has three tools in its monetary toolbox: – Open-market operations – Changing the reserve requirement – Changing the discount rate HUỲNH VĂN THỊNH [email protected] 122 The CB’s Tools of Monetary Control • Open-Market Operations – The CB conducts open-market operations when it buys government bonds from or sells government bonds to the public: • When the CB sells government bonds, the money supply decreases. • When the CB buys government bonds, the money supply increases. HUỲNH VĂN THỊNH [email protected] 123 The CB’s Tools of Monetary Control • Reserve Requirements – The CB also influences the money supply with reserve requirements. – Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits. HUỲNH VĂN THỊNH [email protected] 124 The CB’s Tools of Monetary Control • Changing the Reserve Requirement – The reserve requirement is the amount (%) of a bank’s total reserves that may not be loaned out. – Increasing the reserve requirement decreases the money supply. – Decreasing the reserve requirement increases the money supply. HUỲNH VĂN THỊNH [email protected] 125 The CB’ Tools of Monetary Control • Changing the Discount Rate – The discount rate is the interest rate the CB charges banks for loans. • Increasing the discount rate decreases the money supply. • Decreasing the discount rate increases the money supply HUỲNH VĂN THỊNH [email protected] 126 SUMMARY • The term money refers to assets that people regularly use to buy goods and services. • Money serves three functions in an economy: as a medium of exchange, a unit of account, and a store of value. • Commodity money is money that has intrinsic value. • Fiat money is money without intrinsic value. HUỲNH VĂN THỊNH [email protected] 127 SUMMARY • The central bank, regulates the Nation monetary system. • It controls the money supply through openmarket operations or by changing reserve requirements or the discount rate. HUỲNH VĂN THỊNH [email protected] 128 SUMMARY • When banks loan out their deposits, they increase the quantity of money in the economy. • Because the CB cannot control the amount bankers choose to lend or the amount households choose to deposit in banks, the CB’s control of the money supply is imperfect. HUỲNH VĂN THỊNH [email protected] 129 SUMMARY H=Cu+R Sm=Cu+D=K*H H=B=High Power Money Cu=Currency R=Reserver Sm=M=Money Supply, Supply of Money K=Money Multiplier HUỲNH VĂN THỊNH [email protected] 130 SUMMARY K=Sm/H=(Cu+D)/(Cu+R)= =(Cu/D+D/D)/(Cu/D+R/D)= Cu 1 D K R Cu D D HUỲNH VĂN THỊNH [email protected] 131 SUMMARY Cu/D= Currency ratio R/D= Reserve ratio Sm=K*H ΔSm=K*ΔH If: K=1, when H increase 1$=> Sm increase 1$ K=10, when H increase 1$=> Sm increase 10$ K=100, when H increase 1$=> Sm increase 100$ HUỲNH VĂN THỊNH [email protected] 132 SUMMARY From K, if we want to increase the value of K: R/D=> Decrease =>R=> Decrease =>D=>Increase Cu/D=>Decrease =>Cu=> Decrease =>D=> Increase HUỲNH VĂN THỊNH [email protected] 133 SUMMARY Example: H=100; Cu/D=10% ; R/D=5% K=(1+Cu/D)/(R/D+Cu/D)= =(1+10%)/(5%+10%)=7.33 Sm=K*H=7.33*100=7.33 Cu=10%D R=5%D HUỲNH VĂN THỊNH [email protected] 134 SUMMARY H=Cu+D=10%D+5%D=100 D=100/15%=666.67 Cu=10%D=66.67 R=5%D=33.33 If ΔH =20 => Δ Sm=K* ΔH=7.33*20=146.60 …. HUỲNH VĂN THỊNH [email protected] 135 1.2 Money Demand, Dm, Md, L, Lp: Money is demanded because of its transactions use and its quality as a store of value. Money is also a component of investors’ portfolios. Dm=Dmo+Dmy*Y-Dmi*i Dm = Demand for money Dmo = Autonomous Money Demand Dmy = Marginal Money Demand for Y Dmi = Marginal Money Demand for i HUỲNH VĂN THỊNH [email protected] 136 Y=Income, output; i= Interest rate Dmy > 0 ; Dmi > 0 Dm and i is inverse relationship Dm and Y is the same direction Example: Dm=100+0.4*Y-200*I Dmo=100; Dmy=0.4 ; Dmi=200 When Y increase 1$=> Dm increase 0.4$ When i increase 1%=> Dm decrease 200$ HUỲNH VĂN THỊNH [email protected] 137 2. The LM curve: Equilibrium exits in the money market when the demand for money equals the supply of money. We assume that the money supply is controled by the central bank (Sm=K*H), we also continue to assume that the price level is constant. Demand for money Dm=Dmo+Dmy*Y-Dmi*i Sm=Dm=>…. HUỲNH VĂN THỊNH [email protected] 138 =>The LM Equation: (LM)i=(Dmo-Sm)/Dmi + (Dmy/Dmi)*Y Dmo=Autonomous Money Demand Sm=Money Supply Dmi=Marginal Money Demand for i DmY=Marginal Money Demand for Y Y=Income, Output i=Interest rate HUỲNH VĂN THỊNH [email protected] 139 The Slope of LM: Dmy/Dmi (Positive) Dmi=0 => Vertical LM curve the interest elasticity of Money demand is zero Dmi=Small=> Steep LM curve the interest elasticity of Money demand is low HUỲNH VĂN THỊNH [email protected] 140 Dmi=high => Flat LM curve the interest elasticity of Money demand is high Imi=Infinity => Horizontal LM curve the interest elasticity of Money demand is infinity HUỲNH VĂN THỊNH [email protected] 141 i Vertical LM Curve Steep LM Curve Flat LM Curve Horizontal LM Curve Y HUỲNH VĂN THỊNH [email protected] 142 LM increase LM shift to the right LM decrease LM shift to the left HUỲNH VĂN THỊNH [email protected] 143 Factors that shift the LM schedule: HUỲNH VĂN THỊNH [email protected] 144 Example: H=100; Cu/D=20%; R/D=5%; Dm=200+0.4*Y-10*i Find LM equation for the Money Market Equilibrium ? (LM)i=(Dmo-Sm)/Dmi + (Dmy/Dmi)*Y Dmo=200 Sm=K*H=[(1+20%)/(5%+20%)]*100=4.80*100=480 Dmy=0.4 Dmi=10 HUỲNH VĂN THỊNH [email protected] 145 (LM) i=(200-480)/10 + (0.4/10)*Y (LM) i= -28 + 0.04*Y Central Bank increases H=10, ceteris paribus Find LM2 equation for the Money Market Equilibrium ? From (LM)i=(Dmo-Sm)/Dmi + (Dmy/Dmi)*Y =>(ΔLM)Δi=(ΔDmo - ΔSm)/Dmi + (Dmy/Dmi)*ΔY ΔSm=K*ΔH (LM2)=LM+ ΔLM or i2 = i +Δi HUỲNH VĂN THỊNH [email protected] 146 ΔSm=K*ΔH=4.80*10=48 Dmi=10 (ΔLM)Δi=(ΔDmo - ΔSm)/Dmi+ (Dmy/Dmi)*ΔY (ΔLM)Δi=(0 - 48)/10 + (0.4/10)*0= Δi=- 48/10= - 4.80 (LM) i= -28 + 0.04*Y (LM2) i2=(-28-4.8) + 0.04*Y (LM2) i2= -32.8 + 0.04*Y HUỲNH VĂN THỊNH [email protected] 147 III. The IS and LM combined The point of intersection of the IS and LM curves gives the combination of the interest rate and income (io, Yo) which produces equilibrium for both the money and product markets. HUỲNH VĂN THỊNH [email protected] 148 i IS LM io Y Yo HUỲNH VĂN THỊNH [email protected] 149 IS2 i IS1 LM1 i2 i1 Y1 Y2 HUỲNH VĂN THỊNH [email protected] Y 150 i IS1 LM1 LM2 i1 i2 Y1 Y2 HUỲNH VĂN THỊNH [email protected] Y 151 No change in the IS LM increase => i decrease ; Y increase LM decrease => i increase; Y decrease No change in the LM IS increase => i increase ; Y increase IS decrease => i decrease; Y decrease HUỲNH VĂN THỊNH [email protected] 152 Example: (IS) Y = 4950 - 125*i (LM) i= -28 + 0.04*Y Find the income level and rate of interest at which there is simultaneous equilibrium in the money and goods markets i=28.33 (%/year) Y=1408.33 ($) HUỲNH VĂN THỊNH [email protected] 153 HUỲNH VĂN THỊNH [email protected] 154 © 2007 Thomson South-Western • Open and Closed Economies – A closed economy is one that does not interact with other economies in the world. • There are no exports, no imports, and no capital flows. – An open economy is one that interacts freely with other economies around the world. HUỲNH VĂN THỊNH [email protected] 155 • An open economy interacts with other countries in two ways. – It buys and sells goods and services in world product markets. – It buys and sells capital assets in world financial markets. HUỲNH VĂN THỊNH [email protected] 156 THE INTERNATIONAL FLOW OF GOODS AND CAPITAL • The Flow of Goods: Exports, Imports, and Net Exports – The United States is a very large and open economy—it imports and exports huge quantities of goods and services. – Over the past four decades, international trade and finance have become increasingly important. HUỲNH VĂN THỊNH [email protected] 157 • Exports are goods and services that are produced domestically and sold abroad. • Imports are goods and services that are produced abroad and sold domestically. HUỲNH VĂN THỊNH [email protected] 158 • Net exports (NX) are the value of a nation’s exports minus the value of its imports. • Net exports are also called the trade balance. HUỲNH VĂN THỊNH [email protected] 159 • A trade deficit is a situation in which net exports (NX) are negative. – Imports > Exports • A trade surplus is a situation in which net exports (NX) are positive. – Exports > Imports • Balanced trade refers to when net exports are zero—exports and imports are exactly equal. HUỲNH VĂN THỊNH [email protected] 160 • Factors That Affect Net Exports – The tastes of consumers for domestic and foreign goods. – The prices of goods at home and abroad. – The exchange rates at which people can use domestic currency to buy foreign currencies. HUỲNH VĂN THỊNH [email protected] 161 – The incomes of consumers at home and abroad. – The costs of transporting goods from country to country. – The policies of the government toward international trade. HUỲNH VĂN THỊNH [email protected] 162 The Flow of Financial Resources: Net Capital Outflow • Net capital outflow refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. • A U.S. resident buys stock in the Toyota corporation and a Mexican buys stock in the Ford Motor corporation. HUỲNH VĂN THỊNH [email protected] 163 • When a U.S. resident buys stock in Telmex, the Mexican phone company, the purchase raises U.S. net capital outflow. • When a Japanese residents buys a bond issued by the U.S. government, the purchase reduces the U.S. net capital outflow. HUỲNH VĂN THỊNH [email protected] 164 • Variables that Influence Net Capital Outflow – The real interest rates being paid on foreign assets. – The real interest rates being paid on domestic assets. – The perceived economic and political risks of holding assets abroad. – The government policies that affect foreign ownership of domestic assets. HUỲNH VĂN THỊNH [email protected] 165 The Equality of Net Exports and Net Capital Outflow • For an economy as a whole, Xn and NCO must balance each other so that: NCO = Xn • This holds true because every transaction that affects one side must also affect the other side by the same amount. HUỲNH VĂN THỊNH [email protected] 166 Saving, Investment, and Their Relationship to the International Flows • Net exports is a component of GDP: Y = C + I + G + Xn • National saving is the income of the nation that is left after paying for current consumption and government purchases: Y – C – G = I + Xn HUỲNH VĂN THỊNH [email protected] 167 • National saving (S) equals Y – C – G so: S = I + Xn • Or Domestic + Net Capital Saving = Investment Outflow S = I HUỲNH VĂN THỊNH [email protected] + NCO 168 International Flows of Goods and Capital: Summary © 2007 Thomson South-Western THE PRICES FOR INTERNATIONAL TRANSACTIONS: REAL AND NOMINAL EXCHANGE RATES • International transactions are influenced by international prices. • The two most important international prices are the nominal exchange rate and the real exchange rate. HUỲNH VĂN THỊNH [email protected] 170 • The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another. HUỲNH VĂN THỊNH [email protected] 171 • The nominal exchange rate is expressed in two ways: – In units of foreign currency per one U.S. dollar. – And in units of U.S. dollars per one unit of the foreign currency. HUỲNH VĂN THỊNH [email protected] 172 • Assume the exchange rate between the Japanese yen and U.S. dollar is 80 yen to one dollar. – One U.S. dollar trades for 80 yen. – One yen trades for 1/80 (= 0.0125) of a dollar. HUỲNH VĂN THỊNH [email protected] 173 • Appreciation refers to an increase in the value of a currency as measured by the amount of foreign currency it can buy. • Depreciation refers to a decrease in the value of a currency as measured by the amount of foreign currency it can buy. HUỲNH VĂN THỊNH [email protected] 174 • If a dollar buys more foreign currency, there is an appreciation of the dollar (Exchange rate increase) • If it buys less there is a depreciation of the dollar (Exchange rate decrease) HUỲNH VĂN THỊNH [email protected] 175 Real Exchange Rates • The real exchange rate is the rate at which a person can trade the goods and services of one country for the goods and services of another. HUỲNH VĂN THỊNH [email protected] 176 • The real exchange rate compares the prices of domestic goods and foreign goods in the domestic economy. – If a case of German beer is twice as expensive as American beer, the real exchange rate is 1/2 case of German beer per case of American beer. HUỲNH VĂN THỊNH [email protected] 177 • The real exchange rate depends on the nominal exchange rate and the prices of goods in the two countries measured in local currencies. HUỲNH VĂN THỊNH [email protected] 178 • The real exchange rate is a key determinant of how much a country exports and imports. Nominal ex change rate× Domestic price Real exchange rate= Foreign price HUỲNH VĂN THỊNH [email protected] 179 • A depreciation (fall) in the U.S. real exchange rate means that U.S. goods have become cheaper relative to foreign goods. • This encourages consumers both at home and abroad to buy more U.S. goods and fewer goods from other countries. HUỲNH VĂN THỊNH [email protected] 180 • As a result, U.S. exports rise, and U.S. imports fall, and both of these changes raise U.S. net exports. • Conversely, an appreciation in the U.S. real exchange rate means that U.S. goods have become more expensive compared to foreign goods, so U.S. net exports fall. HUỲNH VĂN THỊNH [email protected] 181 SUMMARY • Net exports are the value of domestic goods and services sold abroad minus the value of foreign goods and services sold domestically. • Net capital outflow is the acquisition of foreign assets by domestic residents minus the acquisition of domestic assets by foreigners. HUỲNH VĂN THỊNH [email protected] 182 SUMMARY • An economy’s net capital outflow always equals its net exports. • An economy’s saving can be used to either finance investment at home or to buy assets abroad. HUỲNH VĂN THỊNH [email protected] 183 SUMMARY • The nominal exchange rate is the relative price of the currency of two countries. • The real exchange rate is the relative price of the goods and services of two countries. HUỲNH VĂN THỊNH [email protected] 184 SUMMARY • When the nominal exchange rate changes so that each dollar buys more foreign currency, the dollar is said to appreciate or strengthen. • When the nominal exchange rate changes so that each dollar buys less foreign currency, the dollar is said to depreciate or weaken. HUỲNH VĂN THỊNH [email protected] 185 CHAPTER 6 HUỲNH VĂN THỊNH [email protected] 186 • Unemployment and Inflation – The natural rate of unemployment depends on various features of the labor market. • Examples include minimum-wage laws, the market power of unions, the role of efficiency wages, and the effectiveness of job search. • The inflation rate depends primarily on growth in the quantity of money, controlled by the Central Bank. HUỲNH VĂN THỊNH [email protected] 187 • Unemployment and Inflation – Society faces a short-run tradeoff between unemployment and inflation. – If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation. – If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment. HUỲNH VĂN THỊNH [email protected] 188 • The Phillips curve shows the short-run tradeoff between inflation and unemployment. HUỲNH VĂN THỊNH [email protected] 189 Figure 1 The Phillips Curve Inflation Rate (percent per year) B 6 A 2 Phillips curve 0 4 7 HUỲNH VĂN THỊNH [email protected] Unemployment Rate (percent) 190 The Phillips curve shows the short-run combinations of unemployment and inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve. The greater the aggregate demand for goods and services, the greater is the economy’s output, and the higher is the overall price level. A higher level of output results in a lower level of unemployment. HUỲNH VĂN THỊNH [email protected] 191 How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply Price Level 102 Inflation Rate (percent per year) Short-run aggregate supply 6 B 106 B A High aggregate demand Low aggregate demand 0 (b) The Phillips Curve 7,500 8,000 (unemployment (unemployment is 7%) is 4%) Quantity of Output A 2 Phillips curve 0 HUỲNH VĂN THỊNH [email protected] 4 (output is 8,000) Unemployment 7 (output is Rate (percent) 7,500) 192 An Adverse Shock to Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply Price Level AS2 P2 3. . . . and raises the price level . . . B A P Aggregate supply, AS (b) The Phillips Curve Inflation Rate 1. An adverse shift in aggregate supply . . . 4. . . . giving policymakers a less favorable tradeoff between unemployment and inflation. B A PC2 Aggregate demand 0 Y2 Y 2. . . . lowers output . . . Quantity of Output Phillips curve, P C 0 HUỲNH VĂN THỊNH [email protected] Unemployment Rate 193