Macroeconomics 352x Study Guide
Macroeconomics 352x Study Guide ECON 352
Popular in Economics
This 12 page Study Guide was uploaded by Manisha Malhotra on Monday October 3, 2016. The Study Guide belongs to ECON 352 at University of Southern California taught by Fatemeh Ibrahimi Nazarian in Fall 2016. Since its upload, it has received 4 views. For similar materials see in Economics at University of Southern California.
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Date Created: 10/03/16
Chapter 1: Introduction to Macroeconomics • Macroeconomics the study of the structure and performance of national economies and of the policies that governments use to try to affect economic performance • Longrun economic growth of the U.S. is the result of a rising population (steady increase in the # of available workers) and average labor productivity (the amount of output produced per unit of labor input for example, per worker or per hour of work) • because today’s typical worker is so much more productive, Americans enjoy a significantly higher standard of living than would have been possible years ago • rates of saving and investment are important for growth and the rate at which technological change and other factors help increase the productivity of machines and workers • Business cycle shortrun, but sometimes short contractions and expansions in economic activity • downward phase of a business cycle is called a recession • Unemployment recessions are accompanied by an increase in unemployment (# of people who are available for work and are actively seeking work but cannot find jobs) • unemployment rate = # of unemployed / total labor force (# of people people working or seeking work) • Inflation when the prices of goods and services are rising over time • inflation only occurred during war time • deflation prices of most goods and services fell • inflation rate % increase in the average level of prices over a year • high inflation means the economy tends to function poorly, people spend money as soon as they get it • The International Economy • open economy extensive trading and financial relationships with other national economies • closed economy doesn’t interact economically with the rest of the world • U.S. imports are goods and services produced abroad and purchased by people in the U.S.; U.S. exports are goods and services produced in the U.S. and sold to people in other countries • trade surplus exports exceed imports • trade deficit imports over exports • Macroeconomic Policy (Affects economic performance) • fiscal policy determined at the national, state, and local levels concerns gov spending and taxation • monetary policy determines the rate of growth of the nation’s money supply and is under the control of the central bank (gov institution) (the Fed) • aggregation summing individual economic variables to obtain economywide totals, difference between macroeconomics and microeconomics • Macroeconomists don’t forecast because they are not good at it • cannot take into account all the factors • Macroeconomic analysts monitor the economy and think about the implications of current economic events • private sector determine how general economic trends will affect their employers’ financial investments, their opportunities for expansion, the demand for their products, etc.; assist in policymaking • Macroeconomic research makes general statements about how the economy works • economic theory a set of ideas about the economy that has been organized in a logical framework • 1. state the question • 2. make provisional assumptions that describe the economic setting • 3. work out the implications of the theory • 4. conduct an empirical analysis to compare the implications of the theory with the data • 5. evaluate the results of your comparisons • most economic theories are developed developed in terms of an economic model simplified description of some aspect of the economy • evaluate an economic model by applying 4 criteria: 1. Are its assumptions reasonable and realistic? 2. Is it understandable and manageable enough to be used in studying real problems? 3. Can its implications be evaluated by comparing them with data obtained in the real world (empirical analysis)? 4. When the implications and the data are compared, are the implications of the theory consistent with the data? • most economic data is collected and published by the Federal gov • positive analysis examines the economic consequences of a policy but doesn’t address the question of whether those consequences are desirable (only objective) • normative analysis determine whether a certain policy should be used (involves personal value judgement) • economists may agree on the positive analysis of a question but disagree on the normative part because of differences in values • the Classical Approach • invisible hand (Adam Smith) if there are free markets and individuals conduct their economic affairs in their best own interests, the overall economy will work well and prices adjust reasonably quick to achieve equilibrium in all markets • key assumption: the various markets in the economy must function smoothly and without impediments such as minimum wages and interest rate ceilings • wages and prices must adjust rapidly to equate quantities demanded and supplied and this will bring the market into equilibrium (there is no pressure for wages or prices to change) • when quantity demanded exceeds quantity supplied, prices must rise to bring the market into equilibrium • gov should have a limited role in the economy • the Keynesian Approach assumed wages and prices adjust slowly meaning that quantities demanded and quantities supplied might not = each other, therefore there is unemployment because wages and prices don’t adjust to equalize the # of people that firms want to employ with the number of people who want to work • government should increase its purchases of goods and service, therefore raising the demand for output • this would reduce unemployment because to meet the higher demands for their products, businesses would have to employ more workers • Great Depression shook many economists faith in the classical approach; the Keynesian approach dominated macroeconomic theory and policy from WW2 until 1970 • during Keynesian time, economists believed that the gov could promote economic growth while avoiding inflation or recession • stagflation (1970) high unemployment and high inflation • weakened Keynesian approach • based on a single economic model: 1. Individuals, firms, and the government interact in goods markets, asset markets, and labor markets 2. The model’s macroeconomic analysis is based on the analysis of individual behavior (try to maximize own satisfaction) 3. Keynesians and classicals both agree that in the long run, prices and wages fully adjust to achieve equilibrium in the markets for goods, assets, and labor 4. The basic model that we present may be used with either the classical assumption that wages and prices are flexible or the Keynesian assumption that wages and prices are slow to adjust Chapter 2: The Measurement and Structure of the National Economy • national income accounts accounting framework used in measuring current economic activity • based on the idea that the amount of economic activity that occurs during a period of time can be measured in terms of • 1. the amount of output produced, excluding middle output (the product approach) • 2. the incomes received by the producers of output (the income approach) • 3. the amount of spending by the ultimate purchasers of output (the expenditure approach) • each approach gives a different perspective on the economy; however, all 3 approaches give identical measurements of the amount of current economic activity The Product Approach • adding market value of goods and services produced • this approach makes use of the valueadded concept • value added of any producer is the value of its output the value of the inputs it purchases from other producers (sum the value added by all producers) The Income Approach • adding all income received by producers of output, including wages received by workers and profits received by owners of firms The Expenditure Approach • adding the amount spent by all ultimate users of output • product approach (market value) and the expenditure approach (spending) must give the same measure of economic activity • what the seller receives must = what the buyer spent (total expenditure = total income generated) • fundamental identity of national income accounting: total production = total income = total expenditure The Product Approach to Measuring GDP • GDP the market value of final (new) goods and services newly produced within a nation during a fixed period of time • using market value to measure production makes sense because it takes into account differences in the relative economic performance of different goods and services (non market goods can’t be formalized, no $ assigned) • underground economy includes both legal activities hidden from government record keepers and illegal activities such as prostitution, drug dealing, etc. • gov make adjustments for underreported income • the value of the services provided by government, such as defense, public education, and the building and maintenance of roads and bridges do not pass through markets • value gov services at their cost of production • newly produced goods and services • intermediate goods and services used up in the production of other goods and services in the same period that they themselves were produced • final goods and services goods and services that are not intermediate • capital good a good that is itself produced (which rules out natural resources such as land) and is used to produce other goods (houses and apartments) • not used in the same period that it is produced; capital goods are final goods • inventories stocks of unsold finished goods, goods in process, and raw materials held by firms • inventory investment is treated as a final good because increased inventories on hand imply greater productive capacity in the future • Gross National Product (GNP) the market value of final goods and services newly produced by domestic factors of production during the current period • include in U.S. GNP but not U.S. GDP because they don’t represent production taking place within the U.S. • when foreign capital or labor is used in the U.S., the output produced and the income earned are part of U.S. GDP but not GNP • net factor payments from abroad (NFP) income paid to domestic factors of production by the rest of the world income paid to foreign factors of production by the domestic economy • GDP = GNP NFP The Expenditure Approach to Measuring GDP • Y = GDP = C (consumption) + I (investment) + G (gov purchases of goods and services) + NX (net exports of goods and services) Consumption (largest consumption of expenditure) • spending by domestic households on final goods and services, including those produced abroad • consumer durables longlived consumer items such as cars, televisions, furniture, and major appliances; house is an investment • nondurable goods shorterlived items such as food, clothing, fuel • services education, health care, financial services, transportation Investment • spending for new capital goods, called fixed investment and increases in firms inventory holding called inventory investment • Fixed investment: • business fixed investment spending by businesses on structures and equipment and software • residential investment spending on the construction of new houses and apartment buildings Gov Purchases of Goods and Services • any expenditure by the government for a currently produced good or service, foreign or domestic • transfers a category that includes government payments for social security, insurance, etc.; not included in GDP Net exports • exports imports • exports are added to total spending because they represent spending on final goods produced in a country The Income Approach to Measuring GDP • add the incomes received by producers, including profits, and taxes paid to the government • national income sum of 8 types of income • compensation of employees, proprietor’s income, rental income of persons, corporate profits, net interest, taxes on production and imports, business current transfer payments, current surplus of government enterprises • Statistical discrepancy data on income are compiled from different sources than data on production; the production measure the income measure • national income + the statistical discrepancy = net national product (NNP) • depreciation the value of the capital that wears out during the period over which economic activity is being measured • depreciation is subtracted from total income • net national product + depreciation = gross national product (GNP) • the income of the private sector (households and businesses) private disposable income the amount of income the private sector has available to spend • private disposable income = Y (GDP) + NFP (net factor payments from abroad) + TR (transfers received from the government) + INT (interest payments on the government’s debt) T (taxes) • Net government income the part of GDP that is not at the disposable of the private sector • net government income = T (taxes paid by the private sector) TR (transfers) INT (interest payments on the government debt) • Y + NFP = gross national product • GDP + NFP = GNP • wealth = the value of assets the value of liabilities • depends on the rate of saving • national wealth the wealth of an entire nation • depends on the rate at which individuals, businesses, and governments in the economy save • saving of any economic unit is the unit’s current income its spending on current needs • saving rate = saving/income • private saving = private disposable income consumption • government saving = net government income government purchases • breaks down into government consumption (portion devoted to current needs) and government investment (portion spent on longlived capital goods) • government budget surplus = government receipts (Tax revenue, T) government outlays (sum of gov purchases of goods and services) • when gov receipts are less than gov outlays, the difference between outlays and receipts is known as the government budget deficit • national saving = private saving + government saving, saving of the economy as a whole • national saving = total income of the economy spending to satisfy current needs • private saving is used to fund new capital investment, provide the resources the government needs to finance its budget deficits, and acquire assets from or lend to foreigners • current account balance (CA) = payments received from abroad in exchange for currently produced goods and services payments made to foreigners by the domestic economy • uses of saving identity economy’s private saving is used in 3 ways: • investment • gov budget deficit • current account balance • flow variables variables that are measured per unit of time (rate of change in a stock variable) • stock variables defined at a point in time • flow = the rate of change of the stock • wealth = assets liabilities • wealth is a stock variable; saving is a flow variable • national wealth = the country’s domestic physical assets (Stock of capital goods and land) and its net foreign assets • net foreign assets country’s foreign assets (foreign stocks, bonds, factories owned by domestic residents) foreign liabilities (domestic physical and financial assets owned by foreigners) • national wealth can change through national saving • nominal variables variables measured in terms of current market values • problem: can’t compare the values of GDP at 2 different parts in time (did they change quantities of goods/services or did inflation occur) • real variable an economic variable that is measured by the prices of a base year • real GDP (constantdollar GDP) the physical volume of an economy’s final production using the prices of a base year • nominal GDP (currentdollar GDP) dollar value of an economy’s final output measured at current market prices • price index measure of the average level of prices for some specified set of goods and services, relative to the prices in a specified base year • GDP deflator price index that measures the overall level of prices of goods and services included in GDP • GDP deflator always equals 100 in the base year • consumer price index (CPI) measures the prices of consumer goods • interest rate rate of return promised by a borrower to a lender • An interest rate indicates how quickly the nominal, or dollar, value of an interest bearing asset increases over time, but it does not reveal how quickly the value of the asset changes in real, or purchasingpower terms • real interest rate the rate at which the real value or purchasing power of the asset increases over time • nominal interest rate the rate at which the nominal value of an asset increases over time • real interest rate = nominal interest rate inflation rate • expected real interest rate = nominal interest rate expected rate of inflation` • real GDP measures the increase in physical production Chapter 3: Productivity, Output, and Employment • factors of production (capital goods, labor, raw materials, land, energy, etc.) the greater the quantities of factors of production used, the more goods and services are produced • capital (factories and machines) and labor (Workers) • production function relating the amount of output produced to quantities of capital and labor utilized • Y = AF(K,N) • A (total factor productivity) productivity (measures technology, allows capital and labor to be utilized more efficiently) • 1. the production function slopes upward from left to right (marginal product of capital is positive) • 2. the slope of the production function becomes flatter from left to right (although more capital always leads to more output, it does so at a decreasing rate) DIMINISHING MARGINAL PRODUCTIVITY OF CAPITAL • marginal product of capital (MPK) increase in output produced that results from a 1unit increase in capital (delta Y / delta k) • MPK = slope of the production function • diminishing marginal productivity of labor • marginal product of labor (MPN) = delta Y / delta N • supply shock (productivity shock) change in an economy’s production function • an adverse supply shock lowers the MPN downward shift of the production function • production changes are due to changes in employment • make the following assumptions for labor demand • 1. workers are all alike • 2. firms view the wages of the workers they hire as being determined in a competitive labor market and not set by the firms themselves • 3. In making the decision about how many workers to employ, a firm’s goal is to earn the highest possible level of profit • firm will continue to hire until the benefit of an extra worker (the value of extra goods or services produced) = the cost (employee salary) • marginal revenue product of labor (MRPN) measures the benefit of employing an additional worker in terms of the extra revenue produced • MRPN = P x MPN • real wage the real cost of adding another worker • real wage = W/P • a decrease in the real wage raises the amount of labor demanded and an increase in the real wage decreases the amount of labor demanded • when the MPN curve and the real wage line intersect, it is the profitmaximizing amount of labor inputlabor demanded • changes in the real wage are represented as movements along the labor demand curve • labor demand curve shifts in response to factors that change the amount of labor that firms want to employ at any given level of the real wage • beneficial supply shock shifts the MPN curve upward and to the right and raises the quantity of labor demanded at any given real wage • an increase in the capital raises worker productivity and increases the MPN at any level of labor • aggregate demand for labor sum of the labor demands of all the firms in an economy • demand for labor is determined by firms • supply of labor is determined by individuals or members of a family making a joint decision • aggregate supply of labor the sum of the labor supplied by everyone in the economy • leisure all of the job activities include eating, sleeping, etc. • the incomeleisure tradeoff • an increase in the real wage raises the benefit in terms of income of working an additional hour and makes the worker want to supply more labor • substitution effect of a higher real wage workers to supply more labor in response to a higher reward • work rather than skydive (substitute labor for leisure) • income effect of a higher real wage tendency of workers to supply less labor in response to becoming wealthier • winning the lottery • substitution effect raises the quantity of labor supplied and income effect reduces it • the longer an increase in the real wage is expected to last, the larger the income effect is and the more likely it is that the quantity of labor supplied will be reduced • total amount of labor supplied rises in response to a temporary increase in the real wage but falls in response to a permanent increase in the real wage • demonstrates income and substitution effect • shifts labor supply curve any factor that changes the amount of labor supplied at a given level of the current real wage • an increase in wealth shifts the labor supply curve to the left • an increase in the expected future real wage has a pure income effect that shifts the curve to the left • an increase in working age population causes the labor supply curve to shift to the right • an increase in participation rate causes the labor supply curve to shift to the right • equilibrium is when total quantity of labor demanded = total quantity of labor supplied • real wage adjusts reasonably quickly to equate labor supply and labor demand • if labor supply is less than labor demand, firms competing for scarce workers bid up the real wage • if labor supply is less than labor demand, firms decrease the wage • fullemployment level of employment: equilibrium level of employment • full employment output (potential output) level of output that firms in the economy supply when wages and prices have fully adjusted 3 categories of employment: 1. employed 2. unemployed 3. not in the labor force • labor force all employed and unemployed workers • unemployment rate fraction of the labor force that is unemployed • participation rate fraction of the adult population in the labor force • employment ratio employed fraction of the adult population • discouraged workers people who have become so discouraged by lack of success at finding a job that they stop searching • unemployment spell period of time that an individual is continuously unemployed • duration length of time that an unemployment spell lasts 1. most unemployment spells are of short duration, about 2 months or less 2. most people who are unemployed on a given date are experiencing unemployment spells with long duration • employment will never reach 0 because of frictional and structural unemployment • frictional unemployment unemployment that arises as workers search for suitable jobs and firms search for suitable workers • structural unemployment longterm and chronic unemployment that exist even when the economy is not in a recession • unskilled or low skilled workers often are unable to obtain desirable long term jobs • reallocation of labor from industries that are shrinking • natural rate of unemployment rate of unemployment that prevails when output and employment are at the fullemployment level (due to frictional and structural unemployment) • cyclical unemployment = actual unemployment rate natural rate of unemployment • positive when employment and output are below fullemployment levels • negative when output and employment exceed fullemployment levels • Okun’s law gap between an economy’s fullemployment output and its actual level of output increases by 2% points for each % point the unemployment rate increases Chapter 4: Consumption, Saving, and Investment • national level of desired consumption (C^d) aggregate quantity of goods and services that households want to consume • obtained by adding up the desired consumption of all households • desired national saving (S^d) level of national saving that occurs when aggregate consumption is at its desired level • save for retirement • consumptionsmoothing motive desire to have a relatively even pattern of consumption over time (Avoiding periods of very high or very low consumption) • marginal propensity to consume (MPC) the fraction of additional current income that she consumes in the current period • also applies to declines in current income • an increase in an individual’s expected future income is likely to lead that person to increase current consumption and decrease current saving • an increase in wealth increases current consumption and reduces current saving • substitution effect of the real interest rate on saving tendency to reduce current consumption and increase future consumption as the price of current consumption, 1 + r, increases • income effect of the real interest rate on saving change in current consumption that results when a higher real interest rate makes a consumer richer or poorer • for a saver, who is a receipient of interest payments, the income effect of an increase in the real interest rate is to increase current consumption and reduce current saving • for a saver, the income and substitution effects work in opp directions, with the income effect reducing saving and the substitution effect increasing saving • for a borrower, the income effect of an increase in the real interest rate is to increase saving • both the substitution effect and the income effect of an increase in the real interest rate increase the saving of a borrower • interest earnings are taxed • expected aftertax real interest rate after tax nominal interest rate expected inflation rate • temporary increase in gov purchases reduces both desired consumption and desired national saving • a current tax cut, which raises current incomes but lowers expected future incomes, could either raise or lower current desired consumption • Ricardian equivalence proposition idea that tax cuts do not affect desired consumption and also do not affect desired national saving • a tax cut will increase desired consumption and reduce desired national saving • a high rate of investment means capital stock is growing quickly • desired capital stock amount of capital that allows the firm to earn the largest expected profit • expected future marginal product of capital (MPK^f) benefit from increasing investment today by 1 unit of capital • user cost of a capital expected real cost of using a unit of capital for a specified period of time • user cost of capital sum of the depreciation cost and the interest cost • firm’s desired capital stock is the capital stock at which the expected future marginal product of capital = the user cost of capital • decline in user cost downward shift of the user cost line • decrease in the expected real interest rate or any other change that lowers the user cost of capital increases the desired capital stock • an increase in the expected future marginal product of capital at any level of capital raises the desired capital stock • taxadjusted user cost of capital how large the beforetax future marginal product of capital must be for a firm to willingly add another unit of capital • depreciation allowances allow the firm to reduce its total tax payment • investment tax credit • increased effective tax rate lowers the capital • gross investment total purchase or construction of new capital goods • when gross investment exceeds depreciation, the capital grows • net investment = change in capital over the year, or the difference between gross investment and depreciation • the real interest rate is the key economic variable whose adjustments help bring the quantities of goods supplied and demanded into balance • goods market equilibrium may not always be in balance cause firms may produce more than consumers want to spend • goods market is in equilibrium when desired national saving = desired investment • a change in the economy that raises desired national saving shifts the curve to the right, and change that reduces desired national saving shifts the saving curve to the left • a change in the economy that raises desired investment shifts the investment curve to the right, and a change that lowers desired investment shifts the investment curve to the left
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