Principles of Macroeconomics
Principles of Macroeconomics Econ 102
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This 6 page Class Notes was uploaded by April Jerde on Thursday September 17, 2015. The Class Notes belongs to Econ 102 at University of Wisconsin - Madison taught by Elizabeth Kelly in Summer 2015. Since its upload, it has received 7 views. For similar materials see Principles-Macroeconomics in Economcs at University of Wisconsin - Madison.
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Date Created: 09/17/15
ECON 102 FALL2004 SECOND MIDTERM This is not meant to be a complete list but is instead a guideline of many of the topics covered Professor Kelly reserves the right to question material that is not listed here or that is found in your text but was not covered in the large lecture Please review your notes carefully and work the practice questions If you need additional questions remember to check the website for help wwwsscwisceduekellyeconl02 MACROECONOMIC MEASUREMENTS General concepts Index numbers and base period 7 Index numbers are a series of numbers used to track a variable s rise or fall over time They are based upon the concept of considering a certain year in the available data as a benchmark and measuring changes in the variable of interest with respect to the benchmark year eg See pg 140 7 141 of Hall and Lieberman Real vs Nominal Variables 7 A nominal variable is measured in current prices while a real variable is measured in purchasing power or constant dollars Measuring GDP Gross Domestic Product 7 the total value of all nal goods and services produced for the market place during a given year within the nation s borders GDP consumption private investment government expenditure exports 7 imports Measurement of GDP can be done using one of four methods 1 The summation of price times quantity for each nal good or service produced in an economy during a year 2 The value added approach where one sums the value added at each stage of production in order to calculate GDP 3 The factor payments approach which sums the payments made to labor capital land and entrepreneurs to calculate GDP 4 The expenditure approach which sums up spending by households businesses government and the foreign sector to calculate GDP Circular Flow Diagram 7 a chart showing the monetary and real ows or transactions between households and firms Measuring In ation Consumer Price Index 7 an index constructed from year to year using a basket of consumer goods targeting on measuring aggregate price changes in consumer goods and services See the Appendix to Chapter 6 in Hall and Lieberman for CPI computation Measuring and C ategorizing Unemployment The Labor force 7 the group of people in the economy who are actively working or looking for a job The Unemployment Rat 7 the total number of people not working divided by the total number of people in the labor force Remark It is important to understand the four categories of unemploymentfrictional seasonal structural and cyclical as well as the cost of unemployment Full Employmentthe level of employment associated with full employment of resources in an economy or a level of employment where there is no cyclical unemployment Hence the full employment level of unemployment is equal to the sum of frictional and structural unemployment THE CLASSICAL MODEL Assumptions markets clear by price adjustment there is a market for labor loanable funds and for each good and service all capital labor and land are being used Labor Market Full Employment is achieved by the economy on its own there is no need for government intervention In particular the real wage will adjust instantaneously such that the quantity of labor demanded is equal to the quantity of labor supplied There is no cyclical unemployment in this model Remark In the labor market households supply labor while businesses demand labor The quantity of labor households supply increases as the real hourly wage increases the quantity of labor businesses demand decreases as the real hourly wage increases Aggregate Production Function It shows the total output an economy can produce with di erent quantities of labor holding constant land capital and technology The principle of the diminishing returns to labor tells us that as the number of workers employed increases output will initially increase at an increasing rate and then eventually increase at a decreasing rate we can see this from the shape of the aggregate production function As the employment of labor increases the amount of capital available per laborer decreases leading to lower productivity for subsequently hired workers Therefore as the number of workers increases the output produced increases but by smaller amounts Say s law Total spending Total value of production or supply will create its own demand Remember in a model in which households consume save and pay taxes and government and business have a role in spending Say s law does not generally hold it does only if Leakages income earned but not spent Injections spending from sources other then Households Leakages Savings Taxes Imports S T M Injections Investments Government spending Exports I G Exports This condition in the Classical model is guaranteed by the eguilibrium in the loanable funds market Loanable funds market In general the Supply of loanable funds Savings S The supply of loanable fund increases as the real interest rate increases Demand for loanable funds Government s demand for loanable funds Businesses demand for loanable funds Government s demand for loanable funds Budget Deficit GT This demand is not affected by the real interest rate Businesses demand for loanable funds Investments I It decreases as the real interest rate increases Remark make sure you know how to deal with a Budget Surplus instead of a Budget Deficit In this case the Government does not demand funds it supplies them QUANTITY THEORY OF MONEY Supply of Money controlled by the Government or Central bank M S M Demand for Money demand for transactions MD kPY where Y Real GDP and hence PY is the nominal GDP k percentage of income that people desire to hold as money In equilibrium money supply money demand or MS MD Remember in the Classical model a change in the supply of money does not a ect the real GDP it affects the price level and the Nominal GDP PY DEMAND MANAGEMENT POLICIES Fiscal Policy a change in G or 7 designed to change total spending and then total output in the economy In the Classical model these policies have a crowding out effect AG AC A the increase in G completely crowds out private sector spending consumption investment The total spending is therefore unchanged and government policy in the Classical model is ine ctive in pushing the economy to the full employment level of GDP indeed in this model there is no need for government intervention because the economy reaches the full employment by its own Moneta Policy a change in the supply of money to achieve macroeconomic goals In the Classical model any change inM will be re ected in a change in the price level P ECONOMIC GROWTH Economic Growth is de ned as the increase of real GDP in a country over a de ned period of time Sources of economic growth are 1 increase in employment which causes growth through a movement along the production function 2 increase in the capital stock and changes in the level of technology which cause growth through a shift of the production function at any level of employment Average standard of living The average standard of living defined as GDP per capita in a country increases over time if real GDP grows faster than the population CONTRACTIONS AND EXPANSIONS A country faces a contraction recession when actual output is lower than the Full Employment or potential level of output unemployment rate is relatively high A country faces an expansion boom when actual output is higher than the potential or full employment level of output unemployment rate is relatively low The Classical model is inadequate to explain these uctuations that affect the economy in the Short Run SHORT RUN KEYNESIAN MODEL The basic features of the model are in this model income in uences spending and spending in uences income the model focuses on spending the model focuses on the short run Total Spending is the sum of a Fquot 0 3 1 Consumption spending household spending on the consumption of goods and services In the Keynesian model consumption spending has a positive linear relationship to disposable income Disposable income Y T Consumption C a bY T where a autonomous consumption income the part of consumption spending that is independent of income AC b 7 MPC Marginal Propens1ty to Consume AY T the amount by which consumption spending rises when disposable income rises by one dollar Investment spending plant and equipment purchases by rms new home construction and planned inventory adjustment In the Keynesian model developed thus far investment spending is treated as a constant autonomously determined value Government purchases goods and services that government agencies buy during the year In the Keynesian model Government purchases are treated as a autonomously determined value Net Exports foreign sector contribution to total spending In the Keynesian model net exports are treated as a autonomously determined value and they are computed as Net Exports NX X 7 M Total Exports 7 Total Inputs Aggregate Expenditure AE the sum of consumption and investment spending government purchases and net exports It is the total spending of the economy as a whole AECIGNXCIG XiM Equilibrium GDP in the Short Run Keynesian model the level of output at which output and aggregate expenditure are equal Graphically the equilibrium GDP is the point at which the aggregate expenditure line crosses the 450 line At this point we have YAE see Chapter 10 Figure 8 in your book p 260 Mathematically the equilibrium GDP can be obtained from the following equation a bT I G NX T you should be able to derive this equation from the equilibrium equality Y AE if you can t do it check Chapter 10 Appendix 1 in the book The Short Run Keynesian model can explain uctuations in the economy Indeed the equilibrium GDP does not necessarily equal Full Employment GDP therefore equilibrium employment can be either lower or greater than full employment check Chapter 10 Figures 8 and 9 in your book p262263 GOOD LUCK
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