Final Study Guide for Macroeconomics 2105
Final Study Guide for Macroeconomics 2105 ECON 2105 080
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This 19 page Study Guide was uploaded by Gunawork on Thursday December 10, 2015. The Study Guide belongs to ECON 2105 080 at Georgia State University taught by Brian Hunt in Fall 2015. Since its upload, it has received 117 views. For similar materials see PRINCIPLES OF MACROECONOMICS in Economcs at Georgia State University.
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Date Created: 12/10/15
MacroEcon 2105 Final Study Guide Intro. to Macroeconomics - As economy changes in composition naturally… - Chaos is still a natural formation *While Macro is the “whole pie”, Micro is the specific “slice of the pie” Different people form different areas affect the economy’s growth and downfall. Ø Inflation – could be healthy; not when it’s a hyper inflation, it shouldn’t pass a certain limit; slow rate of inflation is good for the economy and people as a whole. - Inflation changes of money and the usage of money. Ø Deflation – dangerous/ worse; it’s more expensive. Macroeconomics vs. Microeconomics MicroEcon focuses on how decisions are made by individuals and firms and the consequences of those decisions. Example: Ø How much it would cost for a university or college to offer a new course – the cost of the instructor’s salary, the classroom facilities, the class materials, and so on. Ø Having determined the cost, the school can then decide whether to offer the course by weighing the costs and benefits. MacroEcon examines examines the aggregate behavior of the economy (that is, how the actions of all the individuals and firms in the economy interact to produce a particular level of economic performances as a whole. Example: Ø Overall level of prices in the economy (how high or how low they are relative to prices last year) rather than the price of a particular good or service. In macroeconomy the behavior of the whole economy is greater than the sum of individuals actions and market outcomes. Example: - Paradox of thrift: when families and businesses are worried about the possibility of economic hard times, they prepare by cutting their spending. - This reduction is spending depresses the economy as consumers spend less and businesses react by laying off workers. - As a result, families and businesses may end up worse off than if they hadn’t tried act responsibly by cutting their spending. MICROECONOMIC QUESTIONS MACROECONOMIC QUESTIONS Go to business school or take a job? How many people are employed in the economy as a whole? What determines the salary offered by What determines the overall salary levels Citibank to Cherie Camajo, a new paid to workers in a given year? Columbia MBA? *Save or spend *Regulator *Taxer MICROECONOMIC QUESTIONS MACROECONOMIC QUESTIONS What determines the cost to a university or What determines the overall level of prices college of offering a new course? in the economy as a whole? What government policies should be What government policies should be adopted to make it easier for low-income adopted to promote full employment and students to attend college? growth in the economy as a whole? What determines whether Citibank opens a What determines the overall trade in goods, new office in Shanghai? services and financial assets between the United States and the rest of the world? Macroeconomics: theory and policy Ø In a self regulating economy, problems such as unemployment are resolved without government interventions, but through the working of the invisible hand. Ø According to Keynesian economics, economic slumps are caused by inadequate spending and they can be mitigated by government interventions. Ø Monetary policy uses changes in the quantity of money to alter interest rates and affect overall spending. Ø Fiscal policy uses changes in government spending and taxes to affect overall spending. Y = C + I + G <> saves… consumer induced, investor induced, govt. induced Defining GDP - The market value of all final goods and services produced in a nation within a specific period of time - Functions as a “barometer” for the economy - Sum of output from all economic activity - Output becomes income o Look at output as income • Focus on REAL growth! • Transfer payment is not government spent. National Income = wages + instant payments + rent + profits Output = Total Income Three uses of GDP data Why is GDP useful to examine? 1. Estimate living standards across time and nations 2. Measure economic growth 3. Determine whether an economy is experiencing a short-run expansion or recession Measuring living standards • Total GDP - May not always be the best standard to compare countries - Doesn’t adjust for population size of country • Per capita GDP - GDP per person (GDP divided by population) - Average living standards in a nation The peaks and valley of the graph explain the business cycle. - Peak and Trough is where the correction is not too steep. Business cycle <> Real GDP • Short-run fluctuations in economic activity that can cause output to be above or below the long-run trend. • Real GDP is measuring economic growth versus per capita. Parts of the business cycle… - Expansion - Contraction - Peak - Trough • A little inflation is good, but too much can slow down the economic GROWTH. • Demand driven. GDP counts market value. Each quantity was sold at a market value. Quantity x Price = Market Value Looking closely at how we measure GDP Why does GDP include both goods and services? - Goods • Tangibles • Food, clothing, cars, houses - Services • Intangibles • Health care, entertainment, advice, travel, banking - The composition of our industries and economy has greatly changed over the last 50 years. Intermediate versus final goods Intermediate goods - Goods that firms repackage or bundle with other goods to be sold at a later stage • Milk sold to a coffee shop • Tires sold to a car manufacturer Final goods - Goods sold to the final users, or consumers To get an accurate GDP estimate and avoid double counting - Final goods are included in GDP - Intermediate goods are NOT included in GDP • NGDP (Nominal Gross Domestic Product) NGDP = (Pc) (Qc) Looking closely at how we measure GDP Quantity x Price = Market Value Total GDP = National Output • Form of dividend • Expenditures Looking at GDP as different types of expenditures The Bureau of Economic analysis (BEA) is the U.S. government agency that tallies GDP data, a task is called national income accounting. • Consumption driven economy GDP = C + I + G + NX NX is (export – import) C = consumption - Durable goods - Nondurable goods - Services (this is a blessing!) I = investment - Plant/ equipment - Inventory investment (what we produce?) - New residential/ housing stats. G = government purchases - Defense goods - Non-defense goods - Federal - State & local NX = net exports - Exports - Imports • Trade deficit Real vs. Nominal GDP - Real GDP - measures with prices held constant over time - Nominal GDP - measured current prices - Price level– an index to measure prices of goods and services in an economy - GDP deflator – a measure of the price level that includes prices of final goods and services in GDP. – Used to “deflate” out inflation from nominal GDP so we can find real GDP. Nominal NGDP = (Px) (Qx) + (Py) (Qy) …. (Pn) (Qn) - P = price - Q = quantity Real Base period: RGDPcy = (Px)^By (Qy)^Cy + (Py)^By (Qy)^Cy …. (Pn)^By (Qn)^cy • Real growth looks at purchasing power. • Focus on raising residual income than inflation. Finding Real GDP RealGDP = Nominal GDP t×100 t PriceLevel t Example. • Find Real GDP for 2010 – “2010 GDP in 2005 prices” – Fill in equation, use t = 2010 numbers from table $14.5265 RealGDP 2010= ×100= $13.0869 trillion 111 Growth Rates – Tell us how fast our economy is growing – Can be calculated using a percent change formula – A negative growth rate means the economy is contracting GDP 2010GDP 2009 NominalGDPgrowthin 2010= ×100 GDP 2009 Other useful evaluative formulas - %Δ Real GDP + %Δ Price Level = %Δ Nominal GDP - PR = (Vpresent – Vpast) / Vpast x 100 *PR: percent rate *Vpresent: present or future value *Vpast: past or present value Shortcomings of GDP *During recessions wages go down. Unemployment rate = u = # of unemployed / labor force x 100 CPI percentage X2 – x1/x1 times 100 Inflation rate P2-p1/p1 times 100 PriceLevelToday PriceToday = PriceEarlier× PriceLevelEarlier labor force LaborForceParticipat ion rate = ×100 population • Nonmarket goods – Think about goods and services produced, but never sold, even though they create value for society – Washing dishes, mowing a lawn – In less-developed societies where houses produce many of their own goods, GDP may be a poor measure of economic output • Underground economy – Hidden, uncounted transactions – Sometimes legal • Waitress tips, landscaper cuts a lawn – Sometimes illegal • Exchanges of narcotics – Size of underground economy? • 10% of GDP (estimated) in United States • 45% in developing countries • Smaller in United States due to stronger economy and less corruption • The Quality of the Environment – GDP is unable to distinguish how goods are produced – Country A • 10 million units of output • Clean energy, clean air – Country B • 10 million unit of output • No environmental standards, health problems – Equal GDP, but is well-being the same? • Leisure time – GDP does not capture how long it takes to produce goods and services – Average work week • South Korea: 46 hours per week • Netherlands: 28 hours • USA: 36 hours • Japan: 36 hours Alternative measures of economic well-being • Other measures of well-being – Life expectancy – Education levels – Access to healthcare – Crime rates – Environmental quality • Reality – Alternative measures difficult to quantify – GDP is correlated with most of these other measures anyway • Gross Domestic Product (GDP) – The market value of all final goods and services produced in a nation within a specific period of time – To find real GDP, we must adjust nominal GDP for inflation • Business Cycle – Short-run fluctuations in economic activity that can cause output to be above or below the long-run trend *Real GDP is GDP adjusted for inflation or change in the price level *Nominal GDP is GDP in current prices unadjusted for inflation AD = C + I + G + NX LRAS = SRAS = AD Y = C + I + G + NX A budget deficit occurs when government outlays exceed revenue. It is also possible for the government to have a budget surplus, which occurs when revenue excee ds outlays. A debt is the total of all accumulated and unpaid deficits. Monetary policy is the use of the money supply to influence the economy. Monetary base = bank reserves + currency in circulation Monetary policy = bank deposits + currency Fiscal policy is the use of government spending and taxes to influence the economy. Expansionary fiscal policy occurs when the government increases spending or decreases taxes to stimulate the economy toward expansion. Expansionary monetary policy- occurs when a central bank acts to increase the money supply in an effort to stimulate the economy. (is monetary policy that increases aggregate demand) Contractionary fiscal policy occurs when the government decreases spending or increases taxes to slow economic expansion. Contractionary monetary policy- occurs when a central bank takes action that reduces the money supply in the economy. (is monetary policy that reduces aggregate demand) The use of fiscal policy to counteract business-cycle fluctuations is known as countercyclical fiscal policy. The marginal propensity to consume (MPC) is the portion of additional income that is spent on consumption: MPC = change in consumption / change in income The formula for this spending multiplier is: m^s = 1 / (1– MPC) Crowding-out occurs when private spending falls in response to increases in government spending. The Laffer Curve: Total income tax revenue depends on the level of income and the tax rate: income tax revenue = tax rate × income At low tax rates, increasing tax rates leads to increasing overall tax revenues. ↑ income tax revenue = ↑tax rate × income However, if tax rates get too high, increasing them further will decrease income. ↓ income tax revenue = ↑tax rate × ↓↓income Commodity money involves the use of an actual good in place of money. money supply (M) = currency + deposits required reserves = rr × deposits excess reserves = total reserves - required reserves The formula for the money multiplier is: m^m = 1 / rr TR = ER + AR E = excess; A = actual Countercyclical Policy Tools //////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// The aggregate demand curve Y = f (k, c) Y = C + I + G + NX Y = supply (AS) C and I and G = demand side (AD) Shifts of the aggregate demand curve The aggregate demand curve shifts because of: § changes in expectations § wealth § the stock of physical capital § government policies § fiscal policy § monetary policy The aggregate supply curve shows the relationship between the aggregate price level and the quantity of aggregate output in the economy. The Short-Run Aggregate Supply Curve § The short-run aggregate supply curve is upward-sloping because nominal wages are sticky in the short run: § a higher aggregate price level leads to higher profits and increased aggregate output in the short run. § The nominal wage is the dollar amount of the wage paid. § Sticky wages are nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages. W = Px (multiplied by) mp W=wages mp=productivity Shifts of the Short-Run Aggregate Supply Curve § Changes in § commodity prices § nominal wages § productivity § lead to changes in producers’ profits and shift the short-run aggregate supply curve. y= f (k, c) => Long-Run Aggregate Supply Curve § The long-run aggregate supply curve shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible. From the Short Run to the Long Run Details from the graphs above^ (a) Leftward shift of the short-run aggregate supply curve 1. Productivity (deceases) 2. Nominal wages (increases) 3. Causing commodity prices to-go-up (b) Rightward shift of the short-run aggregate supply curve 1. Nominal wages (decrease) 2. Commodity prices (decrease) 3. Productivity (increases) The AS–AD Model The AS-AD model uses the aggregate supply curve and the aggregate demand curve together to analyze economic fluctuations. Long-Run Macroeconomic Equilibrium § The economy is in long-run macroeconomic equilibrium when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve. Recessionary Gap 1. Nominal wages decreases 2. Commodity/ input prices decreases 3. Productivity increases Inflationary Gap 1. Nominal wages increases 2. Commodity/ input increases 3. Productivity decreases Gap Recap • There is a recessionary gap when aggregate output is below potential output. • There is an inflationary gap when aggregate output is above potential output. • The output gap is the percentage difference between actual aggregate output and potential output. v Where’s the Deflation? § The AD–AS model says that either a negative demand shock or a positive supply shock should lead to a fall in the aggregate price level—that is, deflation. In fact, however, the United States hasn’t experienced an actual fall in the aggregate price level since 1949. Negative Supply Shocks • Negative supply shocks pose a policy dilemma: a policy that stabilizes aggregate output by increasing aggregate demand will lead to inflation, but a policy that stabilizes prices by reducing aggregate demand will deepen the output slump. Supply Shocks versus Demand Shocks in Practice § Recessions are mainly caused by demand shocks. But when a negative supply shock does happen, the resulting recession tends to be particularly severe. § There’s a reason the aftermath of a supply shock tends to be particularly severe for the economy: macroeconomic policy has a much harder time dealing with supply shocks than with demand shocks. Macroeconomic Policy § Economy is self-correcting in the long run. § Most economists think it takes a decade or longer!!! § John Maynard Keynes: “In the long run we are all dead.” § Stabilization policy is the use of government policy to reduce the severity of recessions and rein in excessively strong expansions. The Multiplier: An Informal Introduction § The marginal propensity to consume, or MPC, is the increase in consumer spending when disposable income rises by $1. § The marginal propensity to save, or MPS, is the increase in household savings when disposable income rises by $1. § Increase in investment spending = $100 billion § + Second-round increase in consumer spending = MPC × $100 billion § + Third-round increase in consumer spending = MPC × $100 billion 3 § + Fourth-round increase in consumer spending = MPC × $100 billion Total increase in real GDP = (1 + MPC + MPC2 + MPC3 + . . .) × $100 billion § So the $100 billion increase in investment spending sets off a chain reaction in the economy. The net result of this chain reaction is that a $100 billion increase in investment spending leads to a change in real GDP that is a multiple of the size of that initial change in spending. § How large is this multiple? The Multiplier: An Informal Introduction § An autonomous change in aggregate spending is an initial change in the desired level of spending by firms, households, or government at a given level of real GDP. § The multiplier is the ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change. output = input income = wages + interest + rent + profits overall change in y Δy = Δwages + Δinterest + Δrent + Δprofits Assumptions 1. Taxes are = 0 = T 2. P, pi^2 = 0 3. r 4. No trade Income-Expenditure Equilibrium § The economy is in income–expenditure equilibrium when aggregate output, measured by real GDP, is equal to planned aggregate spending. § Income–expenditure equilibrium GDP is the level of real GDP at which real GDP equals planned aggregate spending. § When planned aggregate spending is larger than Y*, unplanned inventory investment is negative; there is an unanticipated reduction in inventories and firms increase production. § When planned aggregate spending is less than Y*, unplanned inventory investment is positive; there is an unanticipated increase in inventories and firms reduce production. The Keynesian cross is a diagram that identifies income–expenditure equilibrium as the point where a planned aggregate spending line crosses the 45-degree line. Consumer Spending § The consumption function is an equation showing how an individual household’s consumer spending varies with the household’s current disposable income. The Consumption Function - Deriving the Slope of the Consumption Function Aggregate Consumption Function § The aggregate consumption function is the relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending. Investment Spending § Planned investment spending is the investment spending that businesses plan to undertake during a given period. § It depends negatively on: Ø interest rate Ø existing production capacity § And positively on: Ø expected future real GDP. § According to the accelerator principle, a higher rate of growth in real GDP leads to higher planned investment spending. § According to the accelerator principle, a lower growth rate of real GDP leads to lower planned investment spending. Inventories and Unplanned Investment Spending § Inventories are stocks of goods held to satisfy future sales. § Inventory investment is the value of the change in total inventories held in the economy during a given period. § Unplanned inventory investment occurs when actual sales are more or less than businesses expected, leading to unplanned changes in inventories. § Actual investment spending is the sum of planned investment spending and unplanned inventory investment. Planned Aggregate Spending and GDP GDP = C + I YD = GDP C = A + MPC × YD Planned aggregate spending is the total amount of planned spending in the economy. AE Planned = C + I planned Government outlays = Government spending + Transfer payments • Difference between government spending and transfer payments? – Spending is when the government buys something in the marketplace – A transfer is when money is moved from one group to another Major Categories of National Government Spending • Mandatory outlays – Determined by ongoing programs such as Social Security and Medicare. – Cannot be altered during the budget process. – Altering requires long-run changes to existing laws. • Discretionary outlays – Can be altered when the annual budget is set. – Bridges, roads, payments to government workers, defense spending. The Laffer Curve • Outlays are government spending. • Revenues are gathered by taxes. • The debt is the cumulative sum of all yearly deficits. • Social Security and Medicare make up the largest portion of outlays, and this share has increased due to demographic changes. • The U.S. income tax system is progressive. • Fiscal policy is the use of government spending [G] and taxes to influence the economy. • Countercyclical fiscal policy has the goal of smoothing out cycles (ups and downs). • Increases in [G] and tax cuts must be paid for by borrowing. • Fiscal policy isn’t perfect because of lags, crowding out, and savings adjustments. • A higher MPC means a larger spending multiplier in the economy. • The Laffer curve shows the relationship between tax rates and tax revenues collected. § Commodity money is a good used as a medium of exchange that has other uses. § A commodity-backed money is a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods. § Fiat money is a medium of exchange whose value derives entirely from its official status as a means of payment. § A monetary aggregate is an overall measure of the money supply. § Near-moneys are financial assets that can’t be directly used as a medium of exchange but can readily be converted into cash or checkable bank deposits. § • A T-account summarizes a bank’s financial position. § A bank run is a phenomenon in which many of a bank’s depositors try to withdraw their funds due to fears of a bank failure. • Deposit Insurance - guarantees that a bank’s depositors will be paid even if the bank can’t come up with the funds, up to a maximum amount per account. • Capital Requirements - regulators require that the owners of banks hold substantially more assets than the value of bank deposits. • Reserve Requirements - rules set by the Federal Reserve that determine the minimum reserve ratio for a bank. For example, in the United States, the minimum reserve ratio for checkable bank deposits is 10%. • The discount window is an arrangement in which the Federal Reserve stands ready to lend money to banks in trouble. • The monetary base is the sum of currency in circulation and bank reserves. • The money multiplier is the ratio of the money supply to the monetary base. • The federal funds market allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves. • The federal funds rate is the interest rate determined in the federal funds market. • The discount rate is the rate of interest the Fed charges on loans to banks. • Open-market operations by the Fed are the principal tool of monetary policy: the Fed can increase or reduce the monetary base by buying government debt from banks or selling government debt to banks. The Opportunity Cost of Holding Money § Short-term interest rates are the interest rates on financial assets that mature within six months or less. § Long-term interest rates are interest rates on financial assets that mature a number of years in the future. § According to the liquidity preference model of the interest rate, the interest rate is determined by the supply and demand for money. § The money supply curve shows how the nominal quantity of money supplied varies with the interest rate. § Inflation targeting occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target. § monetary neutrality: changes in the money supply have no real effect on the economy. So monetary policy is ineffectual in the long run. 1. The money demand curve arises from a trade-off between the opportunity cost of holding money and the liquidity that money provides. The opportunity cost of holding money depends on short-term interest rates, not long-term interest rates. Changes in the aggregate price level, real GDP, technology, and institutions shift the money demand curve. 2. According to the liquidity preference model of the interest rate, the interest rate is determined in the money market by the money demand curve and the money supply curve. The Federal Reserve can change the interest rate in the short run by shifting the money supply curve. In practice, the Fed uses open-market operations to achieve a target federal funds rate, which other short-term interest rates generally track. 3. Expansionary monetary policy reduces the interest rate by increasing the money supply. This increases investment spending and consumer spending, which in turn increases aggregate demand and real GDP in the short run. Contractionary monetary policy raises the interest rate by reducing the money supply. This reduces investment spending and consumer spending, which in turn reduces aggregate demand and real GDP in the short run. 4. The Federal Reserve and other central banks try to stabilize the economy, limiting fluctuations of actual output around potential output, while also keeping inflation low but positive. Under the Taylor rule for monetary policy, the target interest rate rises when there is inflation, or a positive output gap, or both; the target interest rate falls when inflation is low or negative, or when the output gap is negative, or both. Some central banks engage in inflation targeting, which is a forward-looking policy rule, whereas the Taylor rule is a backward-looking policy rule. In practice, the Fed appears to operate on a loosely defined version of the Taylor rule. Because monetary policy is subject to fewer implementation lags than fiscal policy, it is the preferred policy tool for stabilizing the economy. 5. In the long run, changes in the money supply affect the aggregate price level but not real GDP or the interest rate. Data show that the concept of monetary neutrality holds: changes in the money supply have no real effect on the economy in the long run.
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