GDP: Spending Y = C + I + G + NX Money MV = PY Circular flow Spending—Output—Income Measuring GDP and Price Indexes Unemployment Rate Laborforce Natural.

•GDP: Spending Y = C + I + G + NX Money MV = PY

•Circular flow Spending—Output—Income

•Measuring GDP and Price Indexes•Unemployment Rate

•Laborforce•Natural rate

•Interest rate: nominal and real•Consumption function

C = C0 + mpc x Yd

•Aggregate Demand: C + I + G + NX•Shifts

•Aggregate Supply: Short-run—Long-run•AD—AS Equilibrium

•Automatic adjustment via price•Keynesian intervention

•Fiscal Policy•Money

•Functions•Money creation in banking system

•Monetary Policy•Tools•Effects

•Phillips Curve•Inflation—Unemployment Tradeoff ?•Expectations and “natural rate”

•Economic Growth•Factor growth—investment•Technology

Macro - ReviewMacro - Review

GDP = C + I + G + NXGDP = C + I + G + NX

MV = P Y (= $GDP)MV = P Y (= $GDP)

Circular Flow

GDP: Real and Nominal• Gross Domestic Product (GDP): Gross Domestic Product (GDP): the market

value of all final goods and services produced within a country during a year.

GDP = C + I + G + Ex – Im GDP = C + I + G + Ex – Im

= C + I + G + NX= C + I + G + NX• Real GDPReal GDP adjusts for inflation

$GDP = P x Q $ GDP = GDP Deflator x Real GDP$ GDP = GDP Deflator x Real GDP

Real GDP = Q = $GDP/P = Nominal GDP divided by

(deflated by) the GDP Price Deflator

Price Indexes (Base Year = 100)Price Indexes (Base Year = 100)• Consumer Price Index (CPI)Consumer Price Index (CPI)

– cost over time of a typical bundle of goods and services purchased by households.

CPI = Cost of Typical Market Basket CPI = Cost of Typical Market Basket NowNow

divided bydivided by

Cost of the Same Basket in Base YearCost of the Same Basket in Base Year

Inflation Rate = {Change in CPI} Inflation Rate = {Change in CPI} ÷ {Initial CPI}÷ {Initial CPI}

• GDP Price Deflator (GDP Price Index)GDP Price Deflator (GDP Price Index)– measures average prices over time of all

goods and services included in GDP.

2006 2007

Quantity Price Quantity Price

Cars

Computers

Oranges

10

4

1,000

$2,000

$1,000

$1

12

6

1,000

$3,000

$500

$1

$GDP in 2006 = $GDP in 2007 =

% Growth =

2006 Base Prices

GDP in 2006|2006= GDP in 2007|2006=

% Growth =

P in 2006|2006 = P in 2007|2006=

2007Base Prices

GDP in 2006|2007= GDP in 2007|2007=

% Growth =

P in 2006|2007 = P in 2007|2007=

2006 – 2007 Average Price Base

GDP in 2006|avg P= GDP in 2007|avg P=

% Growth =

P in 2006|avg P = P in 2007|avg P=

UnemploymentUnemployment

Rate ofUnemployment

= number unemployednumber in the Labor Force

Unemployment rate: % of Unemployment rate: % of labor forcelabor force not working. not working.

• Unemployed persons: not working and looking• Labor force: Employed + unemployed

noninstitutionalized persons 16+ years of age• Underemployed workers are treated as employed• Discouraged workers are not in the labor force

• “Natural” or normal rate of unemployment (NAIRU)(NAIRU)Seasonal UnemploymentFrictional Unemployment: searching for jobsStructural Unemployment: Imperfect match between employee skills and requirements of available jobs.• Cyclical Unemployment : Results from business cycle

Interest Rates: Nominal and RealInterest Rates: Nominal and Real

• Nominal Interest Rate (i): the interest rate observed in the market.

• Real Interest Rate (r): the nominal rate adjusted for inflation ().

r = i - r = i - • Low real interest rates spur business

investment spending (the II in C + II + G + NX)

Consumption Function

C = C0 + mpc * Yd

C0 = Autonomous Consumption

mpc = Marginal Propensity to Consume

mpc+mps = 1 [what’s not consumed is saved]

Yd = Disposable Income

Aggregate Demand Curve

AD = C + I + G + NX

Factors that Shift AD

• Consumption– Income– Wealth– Interest Rates– Expectations/Confidence– Demographics– Taxes

• Investment– Interest Rates– Technology– Cost of Capital Goods– Capacity Utilization– Expectations/Confidence

AD = C + I + G + NXAD = C + I + G + NX

Government Spending Net Exports

– Domestic & Foreign Income

– Domestic & Foreign Prices

– Exchange Rates– Government Policy

Aggregate Supply: Short – Run & Long – Run

Aggregate Demand and

Supply Equilibrium:

Short-run and long-run responses to increase in aggregate demand

::

AutomaticAdjustment

viaPrice Change

Macroeconomic ViewpointsLaissez - Faire

ClassicalMonetaristNew Classical

Activist/InterventionistKeynesianNew Keynesian

Demand-Side Policy: Greater

Spending Means Higher Prices

Real GDP

Pri

ce

Le

ve

l

(c) Aggregate Demand and Supply in the classical range of AS curve. (Prices rise without significant improvements in output and employment.)

AD1

AD

Y?

Fiscal Policy: Some Definitions• Fiscal policy: government spending and

taxing– Demand-side policies– Supply-side policies:

• Discretionary Fiscal Policy:• Automatic Stabilizers:

– Progressive taxes– Unemployment insurance– Welfare payments / other transfer payments

Functions of Money

• Medium of exchange

• Unit of account

–Standard of Deferred Payment

• Store of value

Multiple Creation of Bank Deposits M1Fractional Reserve Banking System: r = .1

Deposit expansion multiplier = 1/r(when banks lend all excess reserves and public redeposits proceeds of loans into the banking system no leakages)

The Fed’s Policy Tools

1) Reserve Requirements

2) Discount rate

“primary credit rate”

3) Open market operations

• Manage the public’s expectations

Inflation Targeting?

How Money Supply Changes Affect GDP

Aggregate Demand and Supply Phillips Curve

Expectations and the Phillips Curve

• Starting at (1): 5% unemployment and 3% inflation. People believe inflation will continue at 3% Curve I.

• Then Fed hypes inflation to 6% unemployment falls to 3% (Point 2 on Curve I).

• Expectations adjust to 6% inflation Wage demands up Economy moves to point (3) Unemployment returns to 5%.

• If expectations adjust instantly, e.g., anticipating Fed’s policy, economy moves directly from (1) to (3).

Economic Growth• Economic growth: an increase in Real GDP.• Small changes in rates of growth

Big changes over many years • Per Capita Real GDP: real GDP divided by

population.

Determinants of Economic Growth• Size and quality of the labor force• Capital• Land/Natural Resources … are not a necessary

condition for economic growth … they can be acquired through trade.

• Technology