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GDP = C + I + G + NX MV = P Q (= $GDP)

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Presentation on theme: "GDP = C + I + G + NX MV = P Q (= $GDP)"— Presentation transcript:

1 GDP = C + I + G + NX MV = P Q (= $GDP)
Macro - Review GDP = C + I + G + NX MV = P Q (= $GDP)

2 Circular Flow

3 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

4 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.

5 Unemployment rate: % of labor force not working.
number unemployed number in the Labor Force Rate of 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

6 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)

7 Aggregate Demand (AD): the economy-wide 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)

8 Shifting Aggregate Demand Curve

9 Factors that Affect AD  Shifts in AD
AD = C + I + G + NX Consumption Income Wealth Interest Rates Expectations/Confidence Demographics Taxes Investment Technology Cost of Capital Goods Capacity Utilization Government Spending Net Exports Domestic & Foreign Income Domestic & Foreign Prices Exchange Rates Government Policy

10 firms want to produce more.
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 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

11 Aggregate Supply: Short – Run & Long – Run

12 Aggregate Demand and Supply Equilibrium: Short-run and long-run responses to increase in aggregate demand

13 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

14 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

15 Shifts in the Consumption Function
Expected Future Income An increase in expected future income will cause current consumption to rise and your saving to fall. Wealth An increase in wealth raises current consumption and lowers current saving. Expected Real Interest Rate 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

16 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)

17 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

18 Demand-Side Policy: Greater Spending Means Higher Prices
(c) Aggregate Demand and Supply in the classical range of AS curve. (Prices rise without significant improvements in output and employment.) Price Level AD1 AD Y? Real GDP

19 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

20 Functions of Money Medium of exchange Unit of account Store of value
Standard of Deferred Payment Store of value 6

21 16


23 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) Instructor Notes: 1) When a bank receives deposits, it keeps 25 percent in reserves and lends 75 percent. 2) The amount lent becomes a new deposit at another bank. 3) The next bank in the sequence keeps 25 percent and lends 75 percent, and the process continues until the banking system has created enough deposits to eliminate its excess reserves. 4) The running tally tells us the amounts of deposits and loans created at each stage. 5) At the end of the process, an additional $100,000 of reserves creates an additional $400,000 of deposits. 59

24 3) Open market operations Manage the public’s expectations
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? 23

25 Fed Policy Linkages Tools – Intermediate Targets – Goals

26 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.

27 How Money Supply Changes Affect GDP

28 Aggregate Demand and Supply  Phillips Curve

29 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).

30 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

31 New Classical Economics: Rational Expectations  Policy Ineffectiveness {Expansionary policy  movement from 1 to 3}

32 Macroeconomic Viewpoints Laissez - Faire. Classical. Monetarist
Macroeconomic Viewpoints Laissez - Faire Classical Monetarist New Classical Activist/Interventionist Keynesian New Keynesian

33 The Modern Keynesian Model: Sticky Prices  Demand Management Policies Can Stabilize an Unstable Economy

34 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

35 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

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