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Intermediate Macro Economics

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by: Randy Diaz

Intermediate Macro Economics

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Randy Diaz
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Week one introduction into the material
Dr. Bomburger
Class Notes




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"Better than the professor's notes. I could actually understand what the heck was going on. Will be back for help in this class."
Weldon Rau I

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This 15 page Class Notes was uploaded by Randy Diaz on Thursday January 14, 2016. The Class Notes belongs to at University of Florida taught by Dr. Bomburger in Winter 2016. Since its upload, it has received 41 views.


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Better than the professor's notes. I could actually understand what the heck was going on. Will be back for help in this class.

-Weldon Rau I


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Date Created: 01/14/16
Economic Model:  Individuals, firms, government interact in the goods market, asset market,  and labor markets.  The model’s macroeconomic analysis is based on the analysis of individual  behavior.  Try to maximize their own economic satisfaction, given their needs, desires,  opportunities, and resources.  Long run prices and wages fully adjust to achieve equilibrium in the markets for goods, assets, and labor.  The basic model can represent classical or Keynesian assumptions of change in wages and prices. Summary Chapter 1 Macroeconomics is the study of the structure and performance of national  economies and the policies that governments use to try to affect economic  performance. Important topics in macroeconomics include the determinants of long­run economic growth, business cycles, unemployment, inflation,  international trade and lending, and policy. Because macroeconomics covers the economy as a whole macroeconomists  ignore fine distinctions among different kinds of goods firms or markets and  focus on national totals such as aggregate consumption. The process of  adding individual economic variables to obtain economy wide totals is  called aggregation. The activities engaged in by macroeconomists include forecasting,  macroeconomic analysis, macroeconomic research, and data development. The goal of macroeconomic research is to be able to make general  statements about how the economy works Macro economic research makes  progress toward this goal by developing economic theories and testing them  empirically—that is, by seeing whether they are consistent with data  obtained from the real world. A useful economic theory is consistent with  the data and the observed behavior of the real­world economy. A positive analysis of an economic policy examines the economic  consequences of the policy but does not address the question of whether  those consequences are desirable. A normative analysis of a policy tries to  determine whether the policy should be used. The Classical approach to macroeconomics is based on the assumptions that individuals and firms act in their own best interests and that wages and  prices adjust quickly to achieve equilibrium in all markets. Under these  assumptions the invisible hand of the free­market economy works well, with only a limited scope for the government intervention of an economy. The Keynesian approach to macroeconomics assumes that wages and prices do not adjust rapidly and thus the invisible hand may not work well.  Keynesians argue that, because of slow wage and price adjustment,  unemployment may remain high for a long time. Keynesians are usually  more inclined than classicals to believe that government intervention in the  economy may help improve economic performance. Chapter 1 Vocabulary: Aggregation: The summing of individual economic variables to obtain  economy wide totals. Average Labor Productivity: The amount of output produced per unit of  labor input Closed Economy: Does not interact economically with the rest of the world Deflation: Falling of prices Economic Model: A simplified description of some aspect of the economy. Economic Theory: A set of ideas about the economy that has been  organized in a logical framework. Empirical Analysis: Equilibrium: A situation in which the quantities demanded and supplied are equal. Fiscal Policy: Government spending and taxation in the national, state, and  local government. Inflation: Rising prices Invisible Hand: If there are free markets and individuals conduct their  economic affairs to their own best individual interests the overall economy  will work well. Macroeconomics: Monetary Policy: Determines the rate of growth of the nation’s money  supply and is under the control of a government institution known as the  Central Bank (in US it is the FEDERAL RESERVE). Open Economy: Extensive trading and financial relationships with other  national economies. Normative Analysis: Determines if a certain policy should be used. Positive Analysis: Examines the economic consequences of a policy. Trade Deficit: When imports are larger than exports Trade Surplus: When exports are larger than imports Business Cycle: The fluctuations in economic activity that an economy  experiences over a period of time. Summary Chapter 2 The National income accounts are an accounting framework used in measuring  current economic activity. The National Income accounts measure activity in three  ways: the product approach, the expenditure approach, and the income  approach. Although each gives the same value (Y) for current economic activity,  all three approaches are used because each gives a different perspective on the  economy. Gross domestic product (GDP) is the broadest measure of aggregate economic  activity occurring during a specified period of time. The product approach  measures GDP by adding the market values of final goods and services newly  produced in an economy; this approach sums the value added by all producers. The expenditure approach measures GDP by adding the four categories of spending:  consumption, investment, Government purchases, and net exports. The income  approach measures GDP by adding all the incomes, including taxes, wages and  profits, generated by economic activity. The income of the private sector (domestic house­holds and businesses) is called  private disposable income. Private disposable income equals income received from private sector activities (GDP plus net factor payments from abroad, or GNP) plus  payments received from the government (transfers and interest on government  debt) minus taxes paid to the government. The net income of the government  sector equals taxes collected minus transfer payments and interest paid on  government debt. Private disposable income and net government income sum to  GNP. Saving is the portion of an economic unit’s current income that it doesn’t spend to  meet current needs. Saving by the private sector, called private saving, equals  private disposable income minus consumption. Government saving, which is the  same as the government budget surplus, equals the government’s net income minus its purchases of goods and services (assuming that government purchases are  devoted solely to government consumption rather than partially to government  investment) Equivalently, government savings equals government receipts minus  government outlays. National saving is the sum of private saving and government  saving; it equals GDP plus net factor payments from abroad minus consumption  and government purchases. The uses­of­saving identity states that private saving equals the sum of  investment, the government budget deficit, and the current account balance.  Equivalently, national saving equals the sum of investment and the current account balance. The national wealth of a country equals its physical assets, such as capital, plus its net foreign assets. National wealth increases in two ways: through changes in the  value of existing assets and through national saving. National saving adds to  national wealth because national saving is used either for investment, thus adding  to physical capital, or for lending to foreigners an amount that equals the current  account balance, which increases the country’s net foreign assets. Nominal GDP is the value of an economy’s final output measured at current  market prices. Real GDP is a measure of the physical volume of the economy’s  final output. Real GDP equals nominal GDP divided by the GDP deflator.  (Chained dollars or reduced by price index) A price index is a measure of the current price level relative to a base year. The  GDP deflator measures the overall price level of goods and services included in  GDP. The consumer price index (CPI) measures the price level of a basket of  consumer goods. The rate of inflation is the percentage change of the price level,  as measured by percentage rate of change of a price index such as the GDP deflator or the CPI. An interest rate is a rate of return promised by a borrower to a lender. The nominal interest rate is the rate at which the nominal value of an interest­bearing asset  increases over time. The real interest rate, or the nominal interest rate minus the  rate of inflation, is the rate at which the value of an asset grows in real, or  purchasing power, terms. Borrowing and lending decisions are based on the  expected real interest rate, which is the nominal interest rate less the expected rate  of inflation. Chapter 2 Vocabulary: Budget deficit: The difference between outlays and receipts. When negative. Budget surplus: The difference between outlays and receipts. When positive. Capital good: a good that is itself produced and is used to produce other goods. Consumer price index: measures the prices of consumer goods. Consumption: is spending by domestic households on final goods and services,  including those produced abroad. Depreciation: is the value of the capital that wears out during the period over  which economic activity is being measured. Expected real interest rate: the nominal interest rate minus the expected rate of  inflation. Current account balance: payments received from abroad in exchange for  currently produced goods and services. Expenditure approach: measures activity by adding the amount spent by all  ultimate users of the output of an economy. Final goods and services: goods and services that are going to be consumed and  do not produce other goods and services. Flow variables: variables that are measured per unit of time. Fundamental identity of national Inventories: are stocks of unsold finished goods, goods in process and raw  materials held by firms. Investment: includes spending for new capital goods, called fixed investments and increases in firms’ inventory holdings. Fixed investment: spending by a business on structures (factories, warehouses,  and office buildings for example) and equipment (such as machines, vehicles and  furniture). Residential investment: spending on the construction of new houses and  apartment buildings. (Shelter for long periods of time.) National income: the sum of the five types of income; compensation of  employees, proprietor’s income, rental income, corporate profits, net interest. Compensation of employees: income of workers excluding the self­employed that includes wages, salaries, employee benefits, and employer contributions to social  security. Proprietors’ income: income of the non­incorporated self­employed. Rental income: income earned by individuals whom own land or structures that  they rent to others. Price index: measure of the average level of prices for some specified set of goods and services.  Private disposable income: measures the amount of income the private sector has  available to spend. Private saving: private disposable income minus consumption Income accounting measures: economic activity by adding all income received  by producers of output, including wages received by workers and profits received  by owners of firms. GDP deflator: (P=GDP/Y) is a specific price index that measures overall level of  prices of goods and services included in the GDP. National income accounts: Accounting framework used in measuring current  economic activity. National saving: the saving of the economy as a whole Product approach: measures economic activity by adding market values of goods and services produced. Real GDP: constant dollar GDP measured by a base year =“Y”=GDP/P. Government outlays: The sum of government purchases of goods and services. Government purchases: includes any expenditure by the government for  currently produced goods or service, foreign or domestic, is the third major  component of spending. Government receipts: tax revenue Government saving: net government income National wealth: assets minus liabilities of the entire nation Real interest rate: rate at which the real value or purchasing power of the asset  increases over time. Real variable: measured by the prices of a base year. Quality adjustment bias: when inflation is overestimated because of  advancements in quality of product or services are not considered. Substitution bias: when a good or services product increases but there is a  substitute that consumers switch to that equally satisfies them. Saving: current income minus it’s spending. Net exports: exports minus imports Net factor payments from abroad: to be income paid to domestic factors of  production by the rest of the world minus income paid to foreign factors of  production by the domestic economy. Gross domestic product: the broadest measure of aggregate economic activity by  using income, expenditure and production approaches one may get a holistic view  on the economy. Net foreign assets: country’s foreign assets minus foreign liabilities. Stock variables: defined at some point in time. Transfers: government payments for social security Medicare benefits,  unemployment insurance, welfare payments and so on, in which the party receives  payments not made in exchange for current goods or services. Gross national product: is the market value of final goods and services newly  produced by domestic factors of production during the current period (as opposed  to production taking place within a country, which is GDP) Income approach: measures economic activity by adding all income received by  producers of output, including wages received by workers and profits. Income­expenditure identity: Y=CIGNX Interest rate: a rate of return promised by a borrower to a lender. Net government income: taxes paid by the private sector minus payments from  the government to the private sector and interest payments on the government debt. Net national product: national income plus indirect business taxes. Nominal GDP: current dollar GDP (current market prices) Underground economy: includes both legal activities hidden from government  record keepers. Uses­of­saving identity: an economy’s private saving is used in three ways;  investment, government budget deficit, or the current account balance Value added: the value of output minus the value of inputs it purchases from other producers Intermediate goods and services: used up in the production of other goods and  services. Nominal interest rate: is the rate at which the nominal value of an asset increases  over time. Nominal variables: variables such as GDP measured in terms of current market  values. Wealth: assets minus liabilities. Variables: GDP = Nominal GDP Y= Real GDP P=Price Index K= Capital N= Labor C= Consumption I= Investment G= Government spending NX= Net exports Exports­Imports Intro Aggregate models: GDP= PY GDP/P=Y Resources: Types of models  Stochastic models are formulated using stochastic processes. They model  economically observable values over time. Most of econometrics is based on statistics to formulate and test hypotheses about these processes or estimate  parameters for them. A widely used bargaining class of simple econometric  models popularized by Tinbergen and later Wold are autoregressive models  models, in which the stochastic process satisfies some relation between  current and past values. Examples of these are autoregressive moving  average models and related ones such as autoregressive conditional  heteroscedasticity (ARCH) and GARCH models for the modelling of  heteroscedasticity.  Deterministic models may be purely qualitative (for example, relating to  social choice theory) or quantitative (involving rationalization of financial  variables, for example with hyperbolic coordinates, and/or specific forms of  functional relationships between variables). In some cases economic  predictions in a coincidence of a model merely assert the direction of  movement of economic variables, and so the functional relationships are  used only stoical in a qualitative sense: for example, if the price of an item  increases, then the quantity demanded for that item will decrease. For such  models, economists often use two­dimensional graphs instead of functions.  Qualitative models – although almost all economic models involve some  form of mathematical or quantitative analysis, qualitative models are  occasionally used. One example is qualitative scenario planning in which  possible future events are played out. Another example is non­numerical  decision tree analysis. Qualitative models often suffer from lack of  precision. “There were other deficiencies in the theory, some of which were closely  connected. The standard theory assumed that technology and preferences were  fixed. But changes in technology, R & D, are at the heart of capitalism…” Joseph Stiglitz' 2001 Nobel Prize lecture reviews his work on Information Asymmetries. Assumptions: This is where economics becomes an art; the decisions and  background created for economic models. Production Function: Positive Marginal Products MPN=DF/DN>0 MPN=DF/DK Diminishing Returns & constant returns D 2 F/ DN 2 <0 D 2 F/ DK 2 <0 Model: Y(N,K)= Profit function: First Derivative maximization: Second derivative maximization:


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