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86 Cards in this Set
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Macroeconomics studies the |
overall or aggregate behavior of the economy |
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Two most important macro issues |
1) understanding the world's economic function 2) trying to improve the economy's performance |
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Three most important indicators of macroeconomic performance |
1) Real GDP (and real GDP per capita): a measure of the quantity of goods and services produced in an economy in a given year 2) Inflation rate: a measure of how prices change 3) Unemployment rate: seeking jobs/work force |
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GDP in the US Inflation in the US Unemployment in the US |
always increasing but during GD and after WW2 fluctuated wildly but now stays between 0 and 5 Usually between 5 and 10% other than 25% in GD |
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Logarithmic Scale: |
equal distance represented by equal % changes |
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Economic Models: supply and demand model example: |
simplify complex realities to explain the economy's behavior and relate variables --> usually it is necessary to use multiple models
demand equation: Qd = D(P,Y) --> Y is aggregate income, P is price of new cars, Qd is quantity of cars that buyers demand --> shows that Qd is related to P and Y --> demand/supply curves show the relationships between Qd/s and P --> one down one up slope |
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General Functional Notation: |
shows variables that are related / affect Qd example: Qd = D(P,Y)
shows the precise quantitative relationship example: D(P,Y) = 60 - 10P + 2Y |
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Effects of an 1. Increase in income 2. Increase in the price of steel
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1. Increases Qd at each price --> curve shifts right and equilibrium price and quantity increase 2. Reduces Qs at each price --> curve shifts left and equilibrium price goes up and Q goes down |
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Endogenous variables: Exogenous variables:
In the model of supply and demand for cars... |
1. Determined in the model 2. Determined outside of the model: the model takes their values and behavior as given
endogenous: P Qd, Qs exogenous: Y, Ps |
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Flexible prices Sticky prices
Impact on economy |
Assumed that prices are flexible and adjust to supply and demand - known as market clearing
in the short run, many prices are sticky and adjust sluggishly in response to changes in S/D
If sticky, demand may not equal supply If flexible, markets clear in a different economy |
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Krugman says |
last 30 years of macro failed and Keynes rocks |
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Myths about Macro |
1) Economic models are too mathematical (main criterion of a good paper is an idea) 2) Economic models are too abstract (simulates behavior of thousands of households) 3) Macro studies perfect markets and people (true in 1970s; now not so much) 4) Economics failed to predict the crisis (very hard to do so but economists better than most) 5) Macro research gives no lessons on future (ex in this class like zombies screwing Japan)
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Macroeconomics... before the Great Depression after the Great Depression after the 1970s |
market would self correct --> government bad Keynes: failure to spend decreases aggregate demand, so gov has to spend to avoid crisis real shocks explain business cycles in the US
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Gross Domestic Product |
Summarizes all economic activity over a period of time in terms of a single number --> measures total output and total income --> v important |
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Two definitions of GDP |
1) Total expenditure on domestically-produced final goods and services 2) Total income earned by domestically-located factors of production
expenditure equals income because every dollar a buyer spends becomes income to the seller |
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The Circular Flow: |
Firms pay households, which buy from firms Households provide labor, firms create goods
Can calculate GDP from income (firms to homes) or expenditures (homes to firms) --> equal |
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stock, quantity measured... flow, quantity measured... |
at a point in time (a person's wealth) per unit of time (a person's annual saving) |
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Intermediate Goods: |
Are not consumed for their own sake but are used in the production of other goods (beef is used to make hamburgers, a final good) |
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Value Added |
The value of output minus the value of the intermediate goods used to produce that output --> value added of a miller is the difference between the value of output (flour) and the value of the intermediate good (wheat) --> the sum of the value added at each stage of production equals the value of the final output
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GDP and value added/final goods |
GDP = value of final goods = sum of value added at all stages of production because value of final goods already includes that of IG
--> counting both intermediate and final goods in GDP would be double counting |
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Components of GDP C: I: G: NX: Identity: |
consumption investment government spending net exports Y = C + I + G + NX (value of total output = aggregate expenditure) |
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Consumption: durable goods: nondurable goods: services: |
the value of all goods and services bought by households, and it includes three things
last a long time (cars, home appliances) last a short time (food, clothing) services (intangible items --> most spent on this) |
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Buying a house: Renting a house: Living in a house: |
Investment Services Imputed rental value goes into services
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Imputation v no Imputation |
Imputed services like rental value and public servants have estimated values
durables like cars, underground economies, and meals cooked at home are left out of GDP
--> if France counted prostitution in its GDP, it would overtake the UK's economy |
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Investment: Three areas of investment: |
spending on capital, a physical asset used in future production
1. Business fixed investment: spending on plant and equipment 2. Residential fixed investment: spending by consumers and landlords on new housing units 3. Inventory Investment: the chance in the value of all firms' inventories |
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Aggregate investment equals --> Used goods: --> Inventories: --> investment is: |
total spending on newly produced capital goods --> one party spends x the other receives x --> no net impact on aggregate demand --> inventory investment = difference in inventory value from year to year (can be negative) --> spending on new capital |
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output equals expenditure because |
unsold output goes into inventory and is counted as "inventory investment" --> firms purchase their unsold output, which goes into expenditure |
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Government spending (G) |
-includes all government spending on goods and services -excludes transfer payments (unemployment insurance) because they do not represent spending --> people who receive transfer payments use these funds to pay for consumption, so including them is double counting in GDP
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Net Exports (NX) exports: imports: |
exports - imports value of goods and services sold to other countries value of goods and services purchased from other countries
NX equals net spending from abroad on g&s
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GDP measures |
1. Total income 2. Total output 3. Total expenditure 4. The sum of value added at all stages in production of final goods
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Gross National Product: Gross Domestic Product: GNP - GDP: |
-Total income earned by the nation's factors of production regardless of where they're located -Total income earned by domestically-located factors of production regardless of nationality -Factor payments (wages, profits, rent, etc.) from abroad minus factor payments to abroad
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Reasons GNP may exceed GDP: Reasons GDP may exceed GNP: |
-country has lent overseas and is earning income from these foreign investments or a significant number of citizens have left to work overseas -country has done a lot of borrowing from abroad or foreigners have invested in the country (income earned by foreign-wened domestically - located capital) or country has many immigrants |
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GDP is the: Nominal GDP: Real GDP: US nominal v real GDP |
-value of all final goods and services produced -measures these values using current prices -measures values using prices of a base year -real is greater until base year then they intersect |
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Changes in nominal GDP can be due to... Changes in real GDP can be due to... |
-changes in prices or quantity produced -changes in quantities b/c of base year prices |
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Inflation rate: GDP Deflator measures GDP Deflator = |
-the percentage increase in overall level of prices -the price level -nominal GDP/real GDP |
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Consumer Price Index is CPI... CPI = |
-another measure of the overall level of prices -tracks costs of living and adjusts for inflation -use basket of goods --> (cost of basket in that month)/(cost of basket in base period) * 100 ---> housing most significant part of basket |
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CPI overstates inflation because |
1) Substitution Bias (consumers can't substitute goods whose prices have fallen in the CPI) 2) Introduction of new goods (new goods could increase the real value of the dollar but they do not reduce the CPI due to fixed weights) 3) Unmeasured changes in quality (quality improvements increase the value of the dollar but are not fully measured) |
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CPI v GDP Deflator -Prices of capital goods: -Prices of imported consumer goods: -The basket of goods: -Level of inflation: |
-In GDP Deflator but not CPI -In CPI but not GDP Deflator -CPI fixed, GDP deflator changes annually -CPI overstates it and GDP Deflator understates |
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Categories of the population |
employed: working at a paid job unemployed: not employed but looking for a job labor force: employed plus unemployed (can produce goods and services) unemployment rate: unemployed / labor force not in labor force: doesn't want to be employed |
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Unemployment rate: Labor force participation rate: |
-the % of the labor force that is unemployed -the fraction of the adult population that participates in the labor force (works or wants to --> more women have been participating) |
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The establishment survey |
-BLS surveys business for payroll statistics -diverges due to treatment of self employed persons and new firms not being counted |
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GDP and Welfare: Happy Planet Index: Human Development Index:
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-Can't measure welfare because all not equal -Looks at life satisfaction and life expectancy -Education + life expectancy - correlated w/ GDP
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Jones and Klenow:
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-GDP per person indicates welfare across countries and living standards in WE = to US -Developing countries poorer than GDP says |
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National Income Model |
-a closed economy, market-clearing model -supply side: factor markets (supply, demand, P) -demand side: determinants of C, I, and G -Equilibrium: goods and loanable funds markets
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Factors of Production |
K: capital (tools, machines, structures used in production) L: labor (the physical and mental efforts of workers) |
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The Production Function: The Production Function Shows: Returns to Scale: Assumptions: |
-Y = F(K,L) -how much output (Y) the economy can produce from K units of capital and L units of labor -Scale inputs by z, if output increases by z then CRS, more than z then IRS< less than z DRS -Capital (Kbar) and labor (Lbar) are fixed, so output is determined by these fixed quantities
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The distribution of national income |
determined by factor prices --> the prices per unit firms pay for the factors of production --> wage = price of L --> rental rate = price of k |
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Notation W: R: P: W/P: R/P |
nominal wage nominal rental rate price of output real wage (measured in units of output) real rental rate |
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Factor prices determined by
factor demand: |
supply (fixed) and demand in factor markets
assume in competitive markets W, R, and P given --> a firm hires each unit of labor if the cost does not exceed the benefit (real wage v MPL) |
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Marginal Product of Labor MPL= Slope of Production Function: Diminishing Marginal Returns: |
extra output a firm can produce using an additional unit of labor (other inputs fixed)
MPL = F(K,L+1) - F(K,L)
is the slope of the production function (L v Y)
As an input increases with all other inputs constant, marginal product of that input falls |
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MPL is the firm's If MPL > W/P If MPL < W/P If MPL = P
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labor demand curve
benefit of hiring one more worker > the cost, so firms can increase profits by hiring a worker
benefit of the last worker hired < the cost, so firms can increase profits by firing a worker
firms cannot increase its profits -> equilibrium, thus proving that MPL is the labor demand curve
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Equilibrium real wage |
Labor supply is a vertical line, and the point it intersects labor demand is the real wage |
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MPL = MPK = MPK decreases as MPK curve is the Maximum profits when |
W/P R/P K increases --> diminishing returns to capital firm's demand curve for renting capital MPK = R/P |
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For K v Y, |
K bar intersects MPK at equilibrium R/P |
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total labor income = total capital income = dividing by P If production function has CRS |
-W/P(Lbar) = MPL * Lbar -R/P(Kbar) = MPK * Kbar -adjusts for inflation - if price changes and wage does not, it will be shown that income decreases -Ybar (national income) = MPL * Lbar (labor income) + MPK * Kbar (capital income) |
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The Cobb Douglas Production Function |
-has constant factor shares: Y = A(K^a)(L^1-a) -alpha is the capital's share of total income --> capital income = MPK * K = alpha * Y --> labor income = MPL * L = (1 - alpha) * Y --> A is the level of technology --> Labor's share is about .75 (capital .25) |
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Closed economy, market clearing model |
Supply side: 1. factor markets (supply, demand, price) 2. Determination of output/income
Demand side: 1. Determinants of C I and G
Equilibrium 1. Goods market 2. Loanable funds market |
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Components of aggregate demand |
C = consumer demand for g&s I = demand for investment goods G = government demand for g&s no NX because its a closed economy |
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Consumption, C Disposable income: Consumption Function: Marginal Propensity to Consume (MPC): Slope of the consumption function: |
income - taxes (Y-T) C = C(Y-T) so an increase in Y-T increases C The chance in C when disposable income increases by one dollar MPC (axis: (Y-T) v C, upward linear curve)
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Investment I Investment function: real interest rate (r): Investment function graph:
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I = I(r) denotes the nominal interest rate corrected for inflation --> cost of borrowing; opportunity cost of using funds to finance investment spending
As r increases, investment decreases --> axis I v r --> investment function has a (-) slope |
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Government spending G = G excludes Assume G and T |
government spending on goods and services transfer payments (insurance benefits) exogenous (fixed) --> Gbar and Tbar |
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Aggregate Demand: Aggregate Supply: Equilibrium: real interest rate adjusts to, and is |
C(Ybar - Tbar) + I(r) + Gbar Ybar = F(Kbar, Lbar) Ybar = C(Ybar - Tbar) + I(r) + Gbar to equate demand with supply --> it has no bar and is thus an endogenous variable (only one) |
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Loanable funds market -demand for funds: -supply for funds: -price of funds: |
investment saving real interest rate |
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Demand for loanable funds comes from
Loanable Funds Demand Curve |
investment: firms and people borrow to finance spending --> depends negatively on r --> r is the price of loanable funds (opp cost)
same as the investment demand curve (I v r) |
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Supply of loanable funds comes from
Loanable funds supply curve..
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saving: homes use savings to make deposits, which can be used by firms to borrow and the government does not spend all of its taxes
is vertical because national saving does not depend on r |
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Types of savings -private saving: -public saving: -national saving: |
(Y - T) - C T - G S = private plus public = Y - C - G |
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budget surplus if budget deficit if balanced budget if government finances deficit by |
T > G --> T - G = budget surplus = public saving T < G --> G - T = budget deficit = - public saving T = G, balanced budget, public saving = 0 borrowing through treasury bonds
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Loanable funds market equilibrium |
X axis: S, I --> equilibrium level of investment y axis: r --> equilibrium real interest rate equilibrium: when I(r) intersects Sbar |
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r adjusts
IF LF market is in equilibrium, |
to equilibrate the goods market and the loanable funds market simultaneously
Y - C - G = I, so Y = C + I + G = same as goods market, so the two equilibriums are equal |
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To master a model, be sure to know: |
1) which variables are endo and exo 2) the definition, slope, and what shifts curves |
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The Loanable Funds Model Things that shift the saving curve: Things that shift the investment curve:
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-public saving --> fiscal policy changes G or T and private saving --> preferences and tax laws --> increase in Gbar decreases Sbar --> S decrease, so I shifts to the left so r increases -technological innovations (firms buy new technology) and tax laws (investment tax credit) --> an increase in desired investment shifts I upward and increases r but S remains the same
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Savings depend on r because |
-an increase in r makes saving more attractive -an increase in r makes big items more expensive -an increase in r could reduce s (income effect) --> higher r makes net savers better off so consumption of normal goods rises --> substitution effect says an increase in r will either increase s or leave s unchanged |
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an increase in investment demand |
raises r, which leads to an increase in saving, which leads to I increasing |
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Money is Money functions as Types of money |
-the stock of assets that ca be readily used to make transactions -a medium of exchange (buys stuff), a store of value (transfers purchasing power from the present to the future) and a unit of account (people use it to measure value) -fiat money (no intrinsic value), commodity money (intrinsic value) |
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the money supply is monetary policy is monetary policy is conducted by money supply = |
-the quantity of money available in the economy -the control over the money supply -the central bank (FED) using open market operations (purchase and sale of gov bonds) -C + D (currency + demand deposits (bank)) |
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Reserves (R): 100 percent reserve banking: Fractional reserve banking: a bank's liabilities/assets: |
-the portion of deposits banks have not lent -banks hold all deposits as reserves -banks hold fraction of their deposits as reserves -deposits = liabilities, assets = reserves and outstanding loans |
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let C = 1000 -With no banks -With 100% reserve banking -Fractional reserve banking -Total money supply in fractional system |
-D = 0, M = C = 1000 -D = 1000 = M, C = 0, has no impact on M -D = 1000, R = 200, loans = 800 --> M = 1800, then the bank with 800 loans some of it --> creates $$ -(1/rr) * 1000 --> rr = ratio of reserves to deposits |
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A fractional reserve system creates Bank loans give borrowers
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money but not wealth some new money and an = amount of new debt
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Bank capital: Leverage: Highly leveraged banks: Capital requirement: |
-resources bank owners have put into the bank -borrowed money supplements existing funds for purposes of investment = assets (reserves + loans + securities) / capital (owner's equity) -are vulnerable because assets could fall -minimum amount of capital required to ensure banks can pay off depositors (during the crisis gov gave $$ to encourage more lending) |
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Exogenous variables in the money supply
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-Monetary base (B = C + R, controlled be FED) -Reserve deposit ratio (rr = R/D, bank policy) -Currency deposit ratio (cr = C/D, ppl decision) |
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M = m = |
m * B = C + D cr + 1 / cr + rr
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If rr <1, If monetary base changes by deltaB, m is the |
m >1 deltaM = m * deltaB money multiplier - the increase in the money supply resulting from a 1 dollar increase in B |
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The instruments of monetary policy -open market operations: -the discount rate: -reserve requirements: -interest on reserves: |
-changes B by buying (inc) or selling gov bonds -changes B by changing interest rate on loans to banks (lowering the rate increases B) -changes rr by making a minimum rr ratio -changes rr by changing interest rate on reserves |
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FED can't precisely control M because
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-households can change cr, changing m and M -banks often hold excess reserves (above the reserve requirement), changing rr, m and M
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Quantitative easing: |
-FED bought bonds to reduce long term rates to prevent money multiplier from falling |
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In the great depression |
loss of confidence in banks: cr increased so m decreased
banks become more cautious: rr increases so m decreases |
