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Review of Chapter 10 and 13

by: Kayla Notetaker

Review of Chapter 10 and 13 Econ 253-101

Marketplace > Marshall University > Economcs > Econ 253-101 > Review of Chapter 10 and 13
Kayla Notetaker
GPA 4.0
Principles of Macroeconomics
Dr. Yuanyuan (Catherine) Chen

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About this Document

This is the collection of notes on the lectures from Dr. Chen's Macroeconomics class, chapters 10 and 13. Many of the formulas, such as the Average of Standard Living, growth rate, and the Rule of...
Principles of Macroeconomics
Dr. Yuanyuan (Catherine) Chen
Study Guide
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This 13 page Study Guide was uploaded by Kayla Notetaker on Tuesday October 20, 2015. The Study Guide belongs to Econ 253-101 at Marshall University taught by Dr. Yuanyuan (Catherine) Chen in Fall 2015. Since its upload, it has received 47 views. For similar materials see Principles of Macroeconomics in Economcs at Marshall University.


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Date Created: 10/20/15
Macroeconomics 253 1 Chapter 10 Economic Growth Financial Systems and Business Cycles Economic Growth the ability of firms to expand by means of having up to date equipment hiring workers having new technology Firms acquire funds for these through households 0 Business Cycle the alternation of expansion and recession through an economy considered short term Calculating Growth Rates LongRun Growth rising productivity will result in the increase of the average standard of living 0 The best measure of this is through calculating the Real GDP per capita per person 0 Use Real GDP instead of Nominal GDP to adjust for the changes in price levels Real GDP focuses more on output than price 0 To find the change overtime Real GDPQ Real GDPu Real GDPt1 x 100 Example You are comparing the growth from 1900 to 2000 The Real GDP in 1900 was 6000 while the Real GDP in 2000 was 45000 45000 6000 6000 x 100 A or 650 growth Average Annual Growth Rate For shorter periods of time For example if the average growth rate of 2012 is 21 33 in 2013 and 2 in 2014 21 2012 33 2013 2 2014 247 Annual 3 number of years involved Growth Rate gtM If there would happen to no change you put 0 for the year with no change This does NOT mean that year produced nothing it means that year produced the same amount as the previous year Rule of 70 How many years will it take for real GDP per capita to double uses the Rule of 70 to calculate L Number of Years Growth Rate To Double For instance if the growth rate is 5 70 5 14 Years Macroeconomics 253 2 gt do NOT use 005 for 5 Use the actual percentage number What determines the rate of LongRun Growth Labor Productivity the quantity of goods and services that are produced by one worker or by one hour 0 Two factors determine Labor Productivity 0 Quantity of capital K per hour 0 Technology 0 Capital Stock the total amount of physical capital per hour in other words as capital stock increases so does worker productivity 0 Human Capital the knowledge and skill a worker accumulates through eXperience and training Technological Change increase in the quantity of outputs firms produce using a certain quantity of inputs 0 Technology refers to the processes a firm uses to turn limited inputs into outputs goods and services 0 Most change is focused on new machinery and equipment 0 Entrepreneurs and the government have important in uences o Entrepreneurs bring together factors of production labor capital natural resources to produce the goods and services They make the decisions to introduce new technology 0 Government plays a role in providing property rights for entrepreneurs Side note Potential GDP 0 The level of real GDP attained when all firms are producing at capacity 0 Increases every year as the labor force and capital stock grow and technological change occurs Real GDP 1 Change in technology big component in Potential GDP Time The Business Cycle 0 Alternating periods of eXpansion and recession over time o Expansion increase in production employment and income 0 Recession decrease in production employment and income Idealized Business Cycle Graph Real GDP Peak l Trough Recession Expansion Expansion 1900 2090 Time Remember m Peak Recession Expansion Trough V Leading Indicators of the Business Cycle 0 Average work week of production of workers 0 Average initial weekly claims for unemployment insurance 0 New orders for consumer goods and market adjusted for in ation 0 New orders for non defense related capital goods 0 Index of supplier deliveries 0 New building permits 0 Index of stock prices 0 Index of consumer expectations Macroeconomics 253 3 Macroeconomics 253 4 Business Cycle e ects on In ation Rate 0 In ation usually increases during eXpansions especially near the end 0 Consequently in ation decreases during recession Unemployment Rate 0 Recessions cause unemployment rate to rise rms pro ts decline and lay off more workers 0 The lag in the unemployment rate 0 When recessions are over unemployment continues to rise for a short time o This is because firms are reluctant to hire in the beginning of recovery firms have not yet seen increase in sales Business Cycle Trends By the end of expansion 0 Interest rates will go up 0 Wages will increase 0 Firms prices will fall 0 HH and Firm debt will increase At the beginning of a recession 0 Capital goods spending decreases 0 Spending on durables and houses will decrease 0 Production by firms will slow 0 Profits will fall 0 General spending will decrease When are we in Recession The National Bureau of Economic Research NBER defines recession as 0 Significant decline in economic activity lasting more than a few 3 months 0 Usually announces well after the recession has begun Durables goods that typically last for three or more years generally more eXpensive than nondurables Nondurables goods that typically do not last beyond three years Durables Fluctuates Real GDP Trend Nondurables rather consistent Macroeconomics 253 5 Will the US Economy ever Stabilize In general the US has experienced periods of economic stability due to longer expansions shorter recessions and less severe uctuations in real GDP Some explanations from economists as to how this happened are 0 Increasing importance of services and decreasing importance of goods 0 Overtime services have made up a larger portion of GDP than durables purchases go toward more services than durables o The establishment of unemployment insurance as well as other gov programs that provide funds to unemployed 0 These programs make it possible for the unemployed to still have spending power and can spend more than they could have otherwise Additional spending is thought to shorten recessions 0 Federal policies are enacted to stabilize the economy 0 Use macroeconomic policies to try ending recessions and prolonging expansions 0 Increased stability of financial system 0 Without a stable financial system recessions will be more severe Financial Systems 0 System of financial markets and intermediaries though which firms acquire funds from HHs o Consists of Savers buyers and Borrowers sellers 0 Financial Markets markets where financial securities stocks and bonds are bought and sold I Financial securities documents in paper or electronic states the terms in which funds pass from buyer to seller 0 Stocks represents partial ownership of a firm for a HH saver 0 Bonds represents a promise from the firm borrower to repay a fix amount of the fund FirmsCorporations Assets B011 d8 Liabilities Stocks paid in the form of Dividends Stockholder s Equity 0 Financial Intermediaries firms such as banks mutual funds pension funds and insurances I Acts as a go between for savers and borrowers I Borrow funds from savers and lend to borrowers Insurance example HH 1 Insurance Company car house life Savers gt HH 2 gt etc Investments gt Borrowers Receives Funds HH 3 from HHs Macroeconomics 253 6 Three Key Services Provided By Financial Systems 0 Risk a chance that value of financial security will change relative to what you expect 0 Risksharing allows savers to spread money among financial investments 0 Liquidity how easy a financial security can be exchanges for cash 0 Provides savers with a market in which they can sell holdings for cash 0 Information provides collections and communicates information 0 Includes facts about borrowers and expectations about returns on financial securities The Macroeconomics of Savings and Investments 0 Total value of saving S in economics M equal total value of investments I 0 To recap we know the formula for Calculating GDP Y c I G NX o In an open economy there is interaction with other economies such as trade and borrowing and lending o In a closed economy an economy with no trading or borrowing and lending with other economies NX is 0 and the relationship between GDP and companies is instead I Y c I G 0 Now we rearrange in terms of investment I I Y c G 0 Private Savings Sprivate Cqual to what HHs retain of their income after purchases of goods and services c and after paying taxes T o HHs receive income from supplying factors of production working Y and from the gov in terms of Transfer Payments TR 0 Therefore we calculate Private Savings using the following formula 39 SprivateYTR C T 0 Public Savings Spublic Cqual to the tax revenue that the gov retains after spending on gov purchases and transfer payments 0 We calculate Public Savings using the following formula 39 Spublic T G TR 0 So if we wanted to calculate National Savings S we add together Public and Private Savings 0 S Y TR c T private T G TR public 0 More simply S Y c G 0 Remember national Savings always equals Investment or S I o Spublic gt 0 budget surplus T gt G TR 0 Spublic lt 0 budget deficit T lt G TR 0 Spublic 0 balanced budget T G TR Macroeconomics 253 4 Chapter 11 cont Loanable Funds 0 Interaction of borrowers and lenders that determines the market interest rate and quantity of loanable funds exchanged o The demand for loanable funds is determined by the willingness affirms to borrow money to engage in new Investment projects 0 The supply for loanable funs is determined by the wiling ofHHs to save and by the extent of government savingdissolving 0 EX How would a decrease in HH saving effect the equilibrium interest rate and quantity of loanable funds Real Interest SL1 A decrease in HH saving means an Rate increase in spending Increase in E2 spending means using more E1 Loanable Funds This causes a leftward shift in the supply curve causing a rising interest rate and a decrease in the Quantity of Loanable DL Funds Q2 Q1 Quantity of Loanable Funds 0 EX How would a decrease in Government Spending effect the equilibrium interest rate and quantity of loanable funds Real Interest A decrease in Government spending Rate means an increase in saving E2 Increase in government spending E1 means more for Loanable Funds This causes a rightward shift in the supply curve causing a decrease in interest rate and an increase in the Quantity of Loanable Funds Q1 Q2 Quantity of Loanable Funds gtkThe professor claimed this would NOT be on the exam but still sees this as important Macroeconomics 253 4 Chapter 13 Aggregate demand and Aggregate Supply Analysis The Aggregate Demand and Aggregate Supply Model 0 Model that eXplains the short run uctuations in real GDP and price level Short run Price Aggregate Supply Level Aggregate Demand Real GDP 0 The Aggregate Demand Carve AD shows the relationship between the price level and the real GDP demanded by HHs firms and the government 0 Does not involve price change 0 The ShortRan Aggregate Supply Carve SRAS shows the relationship between the price level and the Quantity of real GDP supplied by firms Why do Curves Slope a Certain Way and What Does it Mean 0 Aggregate Demand why the curve slopes down 0 A fall in price level increases the Q of real GDP demanded by HHs firms and government 0 Changes in price level in uence each component of aggregate demand c I and NX Government purchases are usually controlled by policy and law and therefore are unaffected by price level change 0 Change in Consumption The Wealth Effect 0 HH consumption c is determined by income I Income rises consumption rises income falls consumption falls 0 However consumption also depends on wealth the difference between a HH s assets and debts and is NOT the same as income I So when price levels rise consumption decreases and real value of HH wealth also decreases and vice versa if price levels fall consumption and real value will rise 0 This reduces the demand for goods and services demand for goods and services will increase in vice versa case 0 Change in Investment The Interest Rate Effect 0 When prices increase HHs and firms need more money to buy and sell goods and services This causes HHs and firms to try to increase their money by holding more making withdrawals from banks in the form of loans selling assets like bonds 0 When the interest rate increases so does the cost of borrowing funds I Firms will be less likely to eXpand because they will borrow less I HHs will borrow less when buying houses consumption is somewhat affected here too as HHs will also be less likely to buy durable goods such as cars I The reduction in spending decreases the demand for goods and services 0 A higher price level increased interest rates and less investment spending decreased quantity of goods and services demanded Macroeconomics 253 4 o A lower price level decreased interest rates and more investment spending increased quantity of goods and services demanded 0 Change in Net EXports The International Trade Effect 0 Net Exports Spending by Foreign HHs and Firms on US goods and services Exports minus the spending by US HHs and firms on foreign goods and services Imports 0 If the price level in the US rises US eXports become more eXpensive and imports are cheaper If the US sells less eXports and takes in more imports net eXports will decrease 0 All three effects are reasons why the Aggregate Demand curve is downward sloping 0 Overall and Increase in Price Level will lead to a Decrease in Real GDP Demanded 0 These effects cause movements along the AD curve Shifts versus Movements along the AD curve 0 Remember the AD curve eXplains the relationship between price level and Quantity of Real GDP demanded assuming everything else is held constant 0 In other words if other variables besides the price level changes this will cause a shift in the demand curve rather than a movement along it as seen previously 0 Variables that shift AD curve include 0 Changes in government policy I Monetary policy actions that the federal reserve take to manage the money supply and interest rate to pursue a Macroeconomic objective I If the federal reserve makes the interest rate rise Investment and Consumption spending will fall and vice versa The Shift will look like this price An increase in Interest Rate means a decrease in Level Monetary Supply consumption spending and Investment spending because the higher interest AD1 rate raises the price of borrowing HHs and AD Firms will borrow less causing the decrease in Q 2 of AD and a leftward shift in the curve Real GDP I Fiscal Policy changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives 0 Not taken by Federal Reserve 0 The increase or decrease in taX affects disposable income thus affecting consumption I An increase in government purchases shifts the AD curve to the right while a decrease in government purchases shift it to the left The shift would look like this Price Level Macroeconomics 253 4 Because government purchases are a component of AD an increase in government purchases will shirt the AD curve to the right Lower personal AD2 income taxes and lower business taxes also shift the AD curve to the right as this allows HHs more disposable income and firms increased Real GDP profitability However an increase in personal income tax andor business tax will look like this Price An increase in personal or business taxes means a Level decrease in disposable income for HHs and a decrease in profitability for firms shifting the AD1 AD curve to the left AD2 Real GDP 0 Changes in expectations of Households and Firms If HHs are more optimistic about future income they are likely to increase current spending causing an increase in consumption Likewise if firms are more optimistic about future profitability they too are likely to increase in Investment spending Both cause a shift in the AD curve to the right If HHs are more pessimistic about future income they are likely to decrease current spending and save more causing a decrease in consumption Likewise if firms are pessimistic about future profitability they will do less Investment spending and also save Both cause a shift to the left of the AD curve 0 Changes in Foreign Variables If foreign Households and Firms buy fewer domestic US goods and services andor if the domestic country US buys more foreign goods and services Net Exports will fall causing the AD curve to shift to the left If US domestic GDP increases faster than foreign GDP US imports will increase also causing Net Exports to fall and a leftward shift of the AD curve Net Exports also will fall if the exchange rate between the US dollar and foreign currencies rise 0 This is because the foreign currency in the US will rise resulting in fewer exports and the price of foreign products will fall resulting in more imports Any increase in Net Exports however will shift the AD curve to the right 0 NX will increase if US GDP increase more slowly than in other countries or if the value of the US dollar falls in other countries Macroeconomics 253 1 Ch 13 cont An increase an Aggregate Demand shift to the right means 0 Interest rates have decreased 0 Government purchases G have increased 0 Taxes have decreased 0 HHs expectations on future income and f1rm s expectations of future pro tability have become optimistic o The growth rate of domestic GDP compared to foreign GDP has decreased 0 The exchange rate has decreased Aggregate Supply There are two Aggregate Supply curves Long Run Aggregate Supply LRAS and Short Run Aggregate Supply SRAS o Long Run Aggregate Supply a vertical line that shows the relationship in the long run between the price level and the Quantity of Real GDP supplied 0 Referred to as potential GDP or F tillEmployment GDP 0 Real GDP is determined by the number of workers level of technology and the amount of capital stock K 0 Changes in Price Level do NOT affect the level of GDP in long run An example of the difference between the different curves discussed is shown below LRAS Price SRAS Level AD Real GDP 0 Short Run Aggregate Supply upward curve describes relationship between the Proce Level and the Quantity of goods and services firms are willing to supply eetems paribus all else equal 0 As the price levels increase the Quantity of goods and services firms are willing to supply will increase also 0 As prices of nal goods and services rise price of inputs workers wages price of raw material rise more slowly 0 Some firms are slow to adjust their prices as prices levels increase or decrease It is believed that firms and workers fail to predict changes in Price Level accurately There are three popular explanations as to how this makes the SRAS curve go upward 0 Contracts make some wages and prices sticky when prices and wages are said to be sticky this means they do not respond quickly to change in supply or demand 0 Contracts hold deals constant since workers and firms cannot accurately predict changes in Price Level they do not correctly build long term contracts and risk future losses Macroeconomics 253 2 0 Firms are often slow to adjust wages many wages and salaries are xed those that aren t get adjusted annually If price levels increase before the annual adjustment profitability of hiring and producing more output rises while it has the opposite affect if prices levels are decreasing 0 Firms also do not like cutting wages bad for morale can cause valued workers to quit and look for new employment 0 Menu Costs make some prices sticky part of how firms set their prices is based on what they expect future prices to be Alternating prices of some items that you previously set a price for can be costly 0 Ex Having to print small changes in price in a restaurant s menu the cost of remaking all the menus might cost more than it s worth Shifts along the ShortRun Aggregate Supply Curve VS Movements If the price level changes while other variables stay constant that would cause a shift either up or down along the curve If anything else changes it will cause a shift either left or right For instance price SRASz An increase in Capital Stock means a firm can Level produce more output with more workers at any price level causing the rightward shift a SRAsl Positive Technological change also causes a rightward shift as more efficient technology increases productivity while keeping the firms cost of production the samereduced Real GDP price SRASz If workers and firms expect the future Price level to Level change they will try to adjust wages and prices For example if they expect an increase of 2 the SRAS1 leftward shift will shift by the same amount ceterus paribus When predictions of price level changes are wrong workers and firms must compensate If adjustments Real GDP are made to a price level that was higher than expected the SRAS curve will shift to the left It will shift to the right if adjustments must be made to a price level that was lower than expected If the price of an important natural resource rises the cost of producing outputs will rise and therefore shift the SRAS curve to the left Macroeconomics 253 3 The LongRim Macroeconomic Equilibrium We expect that the economy will produce at the level of Potential Full GDP LRAS So the Long Run Macroeconomic Equilibrium occurs when Aggregate Demand and Short Run Aggregate Supply intersect at the Long Run Aggregate Supply Level LRAS RA53 GDP SRASL Deflator 39 SRASZ At Point A is the Equilibrium 6 x A D 1 AD3 Potential Real GDP GDP Unexpected Change in Price of Resources Supply Shock unexpected event that causes the SRAS curve to shift right or left depending on the direction of the change 0 If the uneXpected change in input price is an increase the SRAS curve will shift to the left 0 This is also known as a negative supply shock 0 If the uneXpected change in input price is a decrease the SRAS curve will shift to the right 0 This is also known as a positive supply shock o Negative supply shocks are more common than positive 0 Sudden increased shifts cause Stag ation inflation combined with recession GDP LRAS SRASZ Deflator SRAsl Price Level B A Real GDP 0 With a lower level of output people become unemployed and products go unsold Lower expectations about future prices means GDP LRAS SRA51 0 Workers accept lower wages D fl e ator SRAS2 0 Firms decrease prices Just to sell product Price Level 0 SRAS shift to the right B Real GDP


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