1. Important issues in macroeconomics
Macroeconomics, the study of the economy as a whole, addresses many topical issues:
Why does the cost of living keep rising?
Why are millions of people unemployed, even when the economy is booming?
What causes recessions? Can the government do anything to combat recessions? Should it?

2. Important issues in macroeconomics
Macroeconomics, the study of the economy as a whole, addresses many topical issues:
What is the government budget deficit? How does it affect the economy?
Why does the U.S. have such a huge trade deficit?
Why are so many countries poor? What policies might help them grow out of poverty?

3. U.S. Real GDP per capita (2000 dollars)
9/11/2001
First oil price shock
long-run upward trend…
Second oil price shock
Great Depression
World War II

4. U.S. inflation rate (% per year)

5. U.S. unemployment rate (% of labor force)

6. Why learn macroeconomics?
1. The macroeconomy affects society’s well-being.
Each one-point increase in the unemployment rate is associated with:
920 more suicides
650 more homicides
4000 more people admitted to state mental institutions
3300 more people sent to state prisons
37,000 more deaths
increases in domestic violence and homelessness

7. Why learn macroeconomics?
2. The macroeconomy affects your well-being.
change from 12 mos earlier
percent change from 12 mos earlier

8. Why learn macroeconomics?
3. The macroeconomy affects politics.
Unemployment & inflation in election years
year U rate inflation rate elec. outcome
% 5.8% Carter (D)
% 13.5% Reagan (R)
% 4.3% Reagan (R)
% 4.1% Bush I (R)
% 3.0% Clinton (D)
% 3.3% Clinton (D)
% 3.4% Bush II (R)
% 3.3% Bush II (R)

9. A multitude of models
So we will learn different models for studying different issues (e.g., unemployment, inflation, long-run growth).
For each new model, you should keep track of
its assumptions
which variables are endogenous, which are exogenous
the questions it can help us understand, and those it cannot

10. Prices: flexible vs. sticky
Market clearing: An assumption that prices are flexible, adjust to equate supply and demand.
In the short run, many prices are sticky – adjust sluggishly in response to changes in supply or demand. For example,
many labor contracts fix the nominal wage for a year or longer
many magazine publishers change prices only once every 3-4 years

11. Prices: flexible vs. sticky
The economy’s behavior depends partly on whether prices are sticky or flexible:
If prices are sticky, then demand won’t always equal supply. This helps explain
unemployment (excess supply of labor)
why firms cannot always sell all the goods they produce
Long run: prices flexible, markets clear, economy behaves very differently

12. Outline of this course:
Introductory material (Chaps. 1 & 2) and the Classical Theory (Chaps. 3, 4, & 6) How the economy works in the long run, when prices are flexible
Business Cycle Theory (Chaps. 9-12) How the economy works in the short run, when prices are sticky
Policy debates (Chaps ) Should the government try to smooth business cycle fluctuations? Is the government’s debt a problem?
Growth Theory (Chaps. 7 & 8) The standard of living and its growth rate over the very long run

13. Metaphors for the Economy
Human Body
Machine

15. Do you remember…
…the meaning and measurement of the most important macroeconomic statistics?
Gross Domestic Product (GDP)
The Consumer Price Index (CPI)
The unemployment rate

16. Gross Domestic Product: Expenditure and Income
Two definitions:
Total expenditure on domestically-produced final goods and services.
Total income earned by domestically-located factors of production.
Expenditure equals income because every dollar spent by a buyer becomes income to the seller.

17. The Circular Flow Households Firms Income ($) Labor Goods
Expenditure ($)
Households
Goods
Firms

18. The expenditure components of GDP
consumption
investment
government spending
net exports

19. Consumption (C)
definition: The value of all goods and services bought by households. Includes:
durable goods last a long time ex: cars, home appliances
nondurable goods last a short time ex: food, clothing
services work done for consumers ex: dry cleaning, air travel.

20. U.S. consumption, 2007 (Q3) Services Nondurables Durables Consumption
% of GDP
$ billions
$9,785.7
70.0%
5,857.8
2,846.3
1,081.6
41.9
20.4
7.7
source: Bureau of Economic Analysis, U.S. Department of Commerce

21. Investment (I) Includes:
Definition 1: Spending on [the factor of production] capital.
Definition 2: Spending on goods bought for future use
Includes:
business fixed investment Spending on plant and equipment that firms will use to produce other goods & services.
residential fixed investment Spending on housing units by consumers and landlords.
inventory investment The change in the value of all firms’ inventories.

22. U.S. investment, 2007 (Q3) Inventory Residential Business fixed
% of GDP
$ billions
$2,162.9
15.5%
35.4
627.3
1,500.2
0.3
4.5
10.7
source: Bureau of Economic Analysis, U.S. Department of Commerce

23. Investment vs. Capital Note: Investment is spending on new capital.
Example (assumes no depreciation):
1/1/2007: economy has $31,818b worth of capital
during 2007: investment = $2,163b
1/1/2008: economy will have $33,981b worth of capital

24. Government spending (G)
G includes all government spending on goods and services..
G excludes transfer payments (e.g., unemployment insurance payments), because they do not represent spending on goods and services.

25. U.S. government spending, 2007 (Q3)
$ billions
% of GDP
Govt spending
$2,716.5
19.5%
Federal
990.3
1,762.2
673.5
316.8
7.1
12.4
4.8
2.3
Non-defense
source: Bureau of Economic Analysis, U.S. Department of Commerce
Defense
State & local

26. Net exports, 2007 (Q3) NX = EX – IM $ billions % of GDP Net Exports
- $694.7
- 5.0%
Exports
1,685.7
12.0
Imports
2,380.4
17.0

27. aggregate expenditure
An important identity
Y = C + I + G + NX
value of total output
aggregate expenditure

28. A question for you: Suppose a firm
produces $10 million worth of final goods
but only sells $9 million worth.
Does this violate the expenditure = output identity?

29. Why output = expenditure
Unsold output goes into inventory, and is counted as “inventory investment”…
…whether or not the inventory buildup was intentional.
In effect, we are assuming that firms purchase their unsold output.

30. GDP: An important and versatile concept
We have now seen that GDP measures
total income
total output
total expenditure
This is why economists often use the terms income, output, expenditure, and GDP interchangeably.

31. GNP vs. GDP
Gross National Product (GNP): Total income earned by the nation’s factors of production, regardless of where located.
Gross Domestic Product (GDP): Total income earned by domestically-located factors of production, regardless of nationality.

32. In your country, which would you want to be bigger, GDP, or GNP?
Discussion question:
In your country, which would you want to be bigger, GDP, or GNP?
Why?

33. (GNP – GDP) as a percentage of GDP selected countries, 2002
For the U.S., GDP and GNP are very close. Thus, students may not realize why we bother teaching them the difference.
The data on this slide makes clear that the difference is very important for many countries.
Source: World Bank.

34. Real vs. nominal GDP
GDP is the value of all final goods and services produced.
nominal GDP measures these values using current prices.
real GDP measure these values using the prices of a base year.

35. Practice problem, part 1 Compute nominal GDP in each year.
2006
2007
2008 P Q
good A
$30
900
$31
1,000
$36
1,050
good B
$100
192
$102
200
205
Compute nominal GDP in each year.
Compute real GDP in each year using 2006 as the base year.

36. Answers to practice problem, part 1
nominal GDP multiply Ps & Qs from same year 2006: $46,200 = $30  $100  : $51, : $58,300
real GDP multiply each year’s Qs by 2006 Ps 2006: $46, : $50, : $52,000 = $30  $100  205

37. Real GDP controls for inflation
Changes in nominal GDP can be due to:
changes in prices.
changes in quantities of output produced.
Changes in real GDP can only be due to changes in quantities,
because real GDP is constructed using constant base-year prices.

38. U.S. Nominal and Real GDP, 1950–2006
Real GDP (in 2000 dollars)
Source:
Nominal GDP

39. GDP Deflator
The inflation rate is the percentage increase in the overall level of prices.
One measure of the price level is the GDP deflator, defined as

40. Practice problem, part 2
Nom. GDP
Real GDP
GDP deflator
Inflation rate
2006
$46,200
n.a.
2007
51,400
50,000
2008
58,300
52,000
Use your previous answers to compute the GDP deflator in each year.
Use GDP deflator to compute the inflation rate from 2006 to 2007, and from 2007 to 2008.

41. Answers to practice problem, part 2
Nominal GDP
Real GDP
GDP deflator
Inflation rate
2006
$46,200
100.0
n.a.
2007
51,400
50,000
102.8
2.8%
2008
58,300
52,000
112.1
9.1%

42. Consumer Price Index (CPI)
A measure of the overall level of prices
Published by the Bureau of Labor Statistics (BLS)
Uses:
tracks changes in the typical household’s cost of living
adjusts many contracts for inflation (“COLAs”)
allows comparisons of dollar amounts over time

43. How the BLS constructs the CPI
1. Survey consumers to determine composition of the typical consumer’s “basket” of goods.
2. Every month, collect data on prices of all items in the basket; compute cost of basket
3. CPI in any month equals

44. Exercise: Compute the CPI
Basket contains 20 pizzas and 10 compact discs.
For each year, compute
the cost of the basket
the CPI (use 2004 as the base year)
the inflation rate from the preceding year
prices:
pizza CDs
2004 $10 $15
2005 $11 $15
2006 $12 $16
2007 $13 $15

45. Answers: Cost of Inflation basket CPI rate 2004 $350 100.0 n.a.% % %

46. The composition of the CPI’s “basket”
Each number is the percent of the “typical” household’s total expenditure.
source: Bureau of Labor Statistics,

47. Reasons why the CPI may overstate inflation
Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen.
Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights.
Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured.

48. The size of the CPI’s bias
In 1995, a Senate-appointed panel of experts estimated that the CPI overstates inflation by about 1.1% per year.
Now, the CPI’s bias is probably under 1% per year.

49. CPI vs. GDP Deflator prices of capital goods
included in GDP deflator (if produced domestically)
excluded from CPI
prices of imported consumer goods
included in CPI
excluded from GDP deflator
the basket of goods
CPI: fixed
GDP deflator: changes every year

50. Two measures of inflation in the U.S.
Percentage change from 12 months earlier
source:

51. Labor Market Data Household survey (60,000 HH)
Employer survey (160,000 B+GA)

52. Categories of the population
employed working at a paid job
unemployed not employed but looking for a job
labor force the amount of labor available for producing goods and services; all employed plus unemployed persons
not in the labor force not employed, not looking for work

53. Two important labor force concepts
unemployment rate percentage of the labor force that is unemployed
labor force participation rate the fraction of the adult population that “participates” in the labor force

54. Exercise: Compute labor force statistics
U.S. adult population by group, December 2007
Number employed = million
Number unemployed = 7.7 million
Adult population = million
source: Bureau of Labor Statistics, U.S. Department of Labor.
Use the above data to calculate
the labor force
the number of people not in the labor force
the labor force participation rate
the unemployment rate

55. Answers: data: E = 146.2, U = 7.7, POP = 233.2
labor force L = E +U = = 153.9
not in labor force NILF = POP – L = – = 79.3
unemployment rate U/L x 100% = (7.7/153.9) x 100% = 5.0%
labor force participation rate L/POP x 100% = (153.9/233.2) x 100% = 66.0%

56. Exercise: Compute percentage changes in labor force statistics
Suppose
population increases by 1%
labor force increases by 3%
number of unemployed persons increases by 2%
Compute the percentage changes in
the labor force participation rate:
the unemployment rate: 2%
1%

57. Two measures of employment growth
Percentage change from 12 months earlier
Source:

58. A Long Run Model:
Where Income Comes From
and Where it Goes
macro

59. Outline of model A closed economy, market-clearing model Supply side
factor markets (supply, demand, price)
determination of output/income
Demand side
determinants of C, I, and G
Equilibrium
goods market
loanable funds market
It’s useful for students to keep in mind the “big picture” as they learn the individual components of the model in the following slides. 59

60. The production function
denoted Y = F (K, L)
shows how much output (Y ) the economy can produce from K units of capital and L units of labor
reflects the economy’s level of technology
exhibits constant returns to scale

61. Returns to scale Initially Y1 = F (K1 , L1 )
Scale all inputs by the same factor z:
K2 = zK1 and L2 = zL1
(e.g., if z = 1.25, then all inputs are increased by 25%)
What happens to output, Y2 = F (K2, L2 )?
If constant returns to scale, Y2 = zY1
If increasing returns to scale, Y2 > zY1
If decreasing returns to scale, Y2 < zY1
This material has been improved and expanded from the previous edition of these PowerPoints. However, it is longer: 7 slides instead of 2. To shorten your presentation, you might consider omitting one or two of the following three examples, and/or eliminating one of the two “now you try” in-class exercises.

62. Returns to scale: Example 1
constant returns to scale for any z > 0 62

63. Returns to scale: Example 2
decreasing returns to scale for any z > 1 63

64. Returns to scale: Example 3
increasing returns to scale for any z > 1 64

65. NOW YOU TRY: Returns to Scale
Determine whether each of these production functions has constant, decreasing, or increasing returns to scale:
(a)
(b)

66. NOW YOU TRY: Answers, part (a)
constant returns to scale for any z > 0

67. NOW YOU TRY: Answers, part (b)
constant returns to scale for any z > 0

68. Assumptions of the model
Technology is fixed.
The economy’s supplies of capital and labor are fixed at
Emphasize that “K” and “L” (without bars on top) are variables - they can take on various magnitudes. On the other hand, “Kbar” and “Lbar” are specific values of these variables. Hence, “K = Kbar” means that the variable K equals the specific amount Kbar.
Regarding the assumptions:
In chapters 7 and 8 (the Economic Growth chapters), we will relax these assumptions: K and L will grow in response to investment and population growth, respectively, and the level of technology will increase over time.

69. Determining GDP
Output is determined by the fixed factor supplies and the fixed state of technology:
Again, emphasize that “F(Kbar,Lbar)” means we are evaluating the function at a particular combination of capital and labor. The resulting value of output is called “Ybar”. 69

70. 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
Recall from chapter 2: the value of output equals the value of income. The income is paid to the workers, capital owners, land owners, and so forth. We now explore a simple theory of income distribution. 70

71. Notation W = nominal wage R = nominal rental rate P = price of output
W /P = real wage (measured in units of output)
R /P = real rental rate
It might be worthwhile to refresh students’ memory about nominal and real variables.
The nominal wage & rental rate are measured in currency units.
The real wage is measured in units of output.
To see this, suppose W = $10/hour and P = $2 per unit of output.
Then, W/P = ($10/hour) / ($2/unit of output) = 5 units of output per hour of work.
It’s true, the firm is paying the workers in money units, not in units of output. But, the real wage is the purchasing power of the wage - the amount of stuff that workers can buy with their wage. 71

72. How factor prices are determined
Factor prices are determined by supply and demand in factor markets.
Recall: Supply of each factor is fixed.
What about demand?
Since the distribution of income depends on factor prices, we need to see how factor prices are determined.
Each factor’s price is determined by supply and demand in a market for that factor. For instance, supply and demand for labor determine the wage. 72

73. Demand for labor
Assume markets are competitive: each firm takes W, R, and P as given.
Basic idea: A firm hires each unit of labor if the cost does not exceed the benefit.
cost = real wage
benefit = marginal product of labor 73

74. Marginal product of labor (MPL )
definition: The extra output the firm can produce using an additional unit of labor (holding other inputs fixed):
MPL = F (K, L +1) – F (K, L) 74

75. NOW YOU TRY: Compute & graph MPL
L Y MPL
0 0 n.a.
1 10 ?
2 19 ?
3 27 8
4 34 ?
5 40 ?
6 45 ?
7 49 ?
8 52 ?
9 54 ?
10 55 ?
a. Determine MPL at each value of L. b. Graph the production function. c. Graph the MPL curve with MPL on the vertical axis and L on the horizontal axis.
This exercise is pretty basic review. It’s good for students who have not had principles of economics in a few years, and students whose graphing skills could benefit from some remedial attention. Many instructors could probably “hide” or omit this and the next slide from their presentations.

76. NOW YOU TRY: Answers
This exercise is pretty basic review. It’s good for students who have not had principles of economics in a few years, and students whose graphing skills could benefit from some remedial attention.

77. MPL and the production functionY
output 1
MPL
As more labor is added, MPL  1
MPL
(Figure 3-3 on p.52)
It’s straightforward to see that the MPL = the prod function’s slope: The definition of the slope of a curve is the amount the curve rises when you move one unit to the right. On this graph, moving one unit to the right simply means using one additional unit of labor. The amount the curve rises is the amount by which output increases: the MPL.
Slope of the production function equals MPL
MPL 1 L
labor 77

78. Diminishing marginal returns
As a factor input is increased, its marginal product falls (ceteris paribus).
Intuition: Suppose L while holding K fixed
 fewer machines per worker
 lower worker productivity
Tell class: Many production functions have this property.
This slide introduces some short-hand notation that will appear throughout the PowerPoint presentations of the remaining chapters:
The up and down arrows mean increase and decrease, respectively.
The symbol “” means “causes” or “leads to.”
Hence, the text after “Intuition” should be read as follows:
“An increase in labor while holding capital fixed causes there to be fewer machines per worker, which causes lower productivity.”
Many instructors use this type of short-hand (or something very similar), and it’s much easier and quicker for students to write down in their notes. 78

79. NOW YOU TRY: Identifying Diminishing Marginal Returns
Which of these production functions have diminishing marginal returns to labor?
Answers:
(a) does NOT have diminishing MPL; MPL = 15, regardless of the value of L.
(b) and (c) both feature diminishing MPL
To get the answers:
- using calculus: take the derivative of F( ) with respect to L. The resulting expression is the MPL. Looking at this expression, determine whether MPL falls as L rises. (Or, take derivative of your MPL function w.r.t. L and see whether it’s positive, negative, or zero.)
- using algebra: plug in any value for K and another value for L. See what happens if you increase L, then increase it again, and again. This may require a calculator.
- finally, you can sketch the graph of these production functions (Y on the vertical, L on the horizontal, assuming a given value of K). If you know the general shape of the square root function, then it’s easy to tell that (b) and (c) have diminishing marginal returns.

80. NOW YOU TRY: MPL and labor demand
L Y MPL
0 0 n.a.
2 19 9
3 27 8
4 34 7
5 40 6
6 45 5
7 49 4
8 52 3
9 54 2
Suppose W/P = 6.
If L = 3, should firm hire more or less labor? Why?
If L = 7, should firm hire more or less labor? Why?
If L=3, then the benefit of hiring the fourth worker (MPL=7) exceeds the cost of doing so (W/P = 6), so it pays the firm to increase L.
If L=7, then the firm should hire fewer workers: the 7th worker adds only MPL=4 units of output, yet cost W/P = 6.
The point of this slide is to get students to see the idea behind the labor demand = MPL curve.

81. MPL and the demand for labor
Units of output
Units of labor, L
Each firm hires labor up to the point where MPL = W/P.
MPL, Labor demand
Real wage
Quantity of labor demanded
It’s easy to see that the MPL curve is the firm’s L demand curve.
Let L* be the value of L such that MPL = W/P.
Suppose L < L*. Then, benefit of hiring one more worker (MPL) exceeds cost (W/P), so firm can increase profits by hiring one more worker.
Instead, suppose L > L*. Then, the benefit of the last worker hired (MPL) is less than the cost (W/P), so firm should reduce labor to increase its profits.
When L = L*, then firm cannot increase its profits either by raising or lowering L.
Hence, firm hires L to the point where MPL = W/P.
This establishes that the MPL curve is the firm’s labor demand curve. 81

82. The equilibrium real wage
Units of output
Units of labor, L
Labor supply
The real wage adjusts to equate labor demand with supply.
MPL, Labor demand
equilibrium real wage
The labor supply curve is vertical: We are assuming that the economy has a fixed quantity of labor, Lbar, regardless of whether the real wage is high or low.
Combining this labor supply curve with the demand curve we’ve developed in previous slides shows how the real wage is determined. 82

83. Determining the rental rate
We have just seen that MPL = W/P.
The same logic shows that MPK = R/P :
diminishing returns to capital: MPK  as K 
The MPK curve is the firm’s demand curve for renting capital.
Firms maximize profits by choosing K such that MPK = R/P .
In our model, it’s easiest to think of firms renting capital from households (the owners of all factors of production). R/P is the real cost of renting a unit of K for one period of time.
In the real world, of course, many firms own some of their capital. But, for such a firm, the market rental rate is the opportunity cost of using its own capital instead of renting it to another firm. Hence, R/P is the relevant “price” in firms’ capital demand decisions, whether firms own their capital or rent it. 83

84. The equilibrium real rental rate
Units of output
Units of capital, K
Supply of capital
The real rental rate adjusts to equate demand for capital with supply.
MPK, demand for capital
equilibrium R/P
The previous slide used the same logic behind the labor demand curve to assert that the capital demand curve is the same as the downward-sloping MPK curve.
The supply of capital is fixed (by assumption), so the supply curve is vertical.
The real rental rate (R/P) is determined by the intersection of the two curves. 84

85. The Neoclassical Theory of Distribution
states that each factor input is paid its marginal product
a good starting point for thinking about income distribution 85

86. How income is distributed to L and K
total labor income = ________ = _________
total capital income = _______ = __________
If production function has constant returns to scale, then
The last equation follows from Euler’s theorem, discussed in text on p. 55.
national income
labor income
capital income 86

87. The ratio of labor income to total income in the U.S., 1960-2007
Labor’s share of total income
Labor’s share of income is approximately constant over time. (Thus, capital’s share is, too.)
This graph appears in the textbook as Figure 3-5 on p.59.
Source: 87

88. The Cobb-Douglas Production Function
The Cobb-Douglas production function has constant factor shares:
 = capital’s share of total income:
capital income = MPK x K =  Y
labor income = MPL x L = (1 –  )Y
The Cobb-Douglas production function is:
where A represents the level of technology. 88

89. The Cobb-Douglas Production Function
Each factor’s marginal product is proportional to its average product:
These formulas can be derived with basic calculus and algebra. 89

90. Labor productivity and wages
Theory: wages depend on labor productivity
U.S. data:
period
productivity growth
real wage growth
2.1%
2.0%
2.8%
1.4%
1.2%
2.5%
2.4%
The table shows the average annual rates of productivity and real wage growth in each time period.
Source: Economic Report of the President 2008
and US Department of Commerce 90

91. A closed economy, market-clearing model
Outline of model
A closed economy, market-clearing model
Supply side
factor markets (supply, demand, price)
determination of output/income
Demand side
determinants of C, I, and G
Equilibrium
goods market
loanable funds market
DONE 
DONE 
We’ve now completed the supply side of the model.
Next  91

92. Demand for goods & services
Components of aggregate demand:
C =
I =
G =
(closed economy: no NX )

93. Consumption, C
def: ________________ is total income minus total taxes: Y – T.
Consumption function: C = C (Y – T )
Shows that (Y – T )  C
def: ___________________________ is the increase in C caused by a one-unit increase in disposable income.

94. The consumption function
Y – T

95. Investment, I The investment function is I = I (r ),
where r denotes the __________________, the nominal interest rate corrected for inflation.
The real interest rate is
________________________________
________________________________.
So, r  I

96. The investment functionr I

97. Government spending, G G = govt spending on goods and services.
G excludes _______________________ (e.g., social security benefits, unemployment insurance benefits).
Assume government spending and total taxes are exogenous:

98. The market for goods & services
Aggregate demand:
Aggregate supply:
Equilibrium:
The ___________________ adjusts to equate demand with supply.

99. The loanable funds market
A simple supply-demand model of the financial system.
One asset: “loanable funds”
demand for funds: _________________
supply of funds: _________________
“price” of funds: __________________

100. Demand for funds: Investment
The demand for loanable funds…
_____________________________: Firms borrow to finance spending on plant & equipment, new office buildings, etc. Consumers borrow to buy new houses.
_____________________________, the “price” of loanable funds (cost of borrowing).

101. Loanable funds demand curveI
The investment curve is also the demand curve for loanable funds.

102. Supply of funds: Saving
The supply of loanable funds comes from saving:
________________________________

103. Types of saving private saving = public saving = national saving, S =

104. EXERCISE: Calculate the change in saving
Suppose MPC = 0.8 and MPL = 20.
For each of the following, compute S :
a. G = 100
b. T = 100
c. Y = 100
d. L = 10

105. digression: Budget surpluses and deficits
If T > G, budget ______ = (T – G ) = public saving.
If T < G, budget ______ = (G – T ) and public saving is negative.
If T = G , “_______________,” public saving = 0.
The U.S. government finances its deficit by ________________________.

106. Loanable funds market equilibrium
S, I

107. The special role of r
r adjusts to equilibrate the _______ market and the _______________ market simultaneously:
This slide establishes that we can use the loanable funds supply/demand diagram to see how the interest rate that clears the goods market is determined.
Explain that the symbol  means each one implies the other. The thing on the left implies the thing on the right, and vice versa.
More short-hand: “eq’m” is short for “equilibrium” and “LF” for “loanable funds.”

108. Mastering the loanable funds model
Things that shift the saving curve:
Things that shift the investment curve
Continuing from the previous slide, let’s look at all the things that affect the S curve. Then, we will pick one of those things and use the model to analyze its effects on the endogenous variables. Then, we’ll do the same for the I curve.

109. CASE STUDY: The Reagan deficits
Reagan policies during early 1980s:
____________________________
Both policies reduce national saving:

110. CASE STUDY: The Reagan deficits
S, I

111. Are the data consistent with these results?
variable 1970s 1980s
T – G –2.2 –3.9 S r I
T–G, S, and I are expressed as a percent of GDP
All figures are averages over the decade shown.

112. An increase in investment demand
S, I

113. Saving and the interest rate
Why might saving depend on r ?
How would the results of an increase in investment demand be different?
Would r rise as much?
Would the equilibrium value of I change?