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

GDP = C + I + G + NX MV = P Y (= $GDP) Macro - Review GDP = C + I + G + NX MV = P Y (= $GDP)

Circular Flow

GDP: Real and Nominal 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 = C + I + G + NX Real GDP adjusts for inflation $GDP = P x Q $ 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) Consumer Price Index (CPI) cost over time of a typical bundle of goods and services purchased by households. CPI = Cost of Typical Market Basket Now divided by Cost of the Same Basket in Base Year Inflation Rate = {Change in CPI} ÷ {Initial CPI} GDP Price Deflator (GDP Price Index) measures average prices over time of all goods and services included in GDP.

2006 2007 Quantity Price Cars Computers Oranges 10 4 1,000 $2,000 $1,000 $1 12 6 $3,000 $500 $GDP in 2006 = $GDP in 2007 = % Growth = 2006 Base Prices GDP in 2006|2006= GDP in 2007|2006= P in 2006|2006 = P in 2007|2006= 2007Base Prices GDP in 2006|2007= GDP in 2007|2007= P in 2006|2007 = P in 2007|2007= 2006 – 2007 Average Price Base GDP in 2006|avg P= GDP in 2007|avg P= P in 2006|avg P = P in 2007|avg P=

Unemployment rate: % of labor force not working. number unemployed number in the Labor Force Rate of Unemployment = 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) Seasonal Unemployment Frictional Unemployment: searching for jobs Structural Unemployment: Imperfect match between employee skills and requirements of available jobs. Cyclical Unemployment : Results from business cycle

Interest 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 -  Low real interest rates spur business investment spending (the I in C + I + G + NX)

C = C0 + mpc * Yd Consumption Function 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

AD = C + I + G + NX Factors that Shift AD Consumption Income Wealth Interest Rates Expectations/Confidence Demographics Taxes Investment Technology Cost of Capital Goods Capacity Utilization 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 : : Automatic Adjustment via Price Change

Macroeconomic Viewpoints Laissez - Faire. Classical. Monetarist Macroeconomic Viewpoints Laissez - Faire Classical Monetarist New Classical Activist/Interventionist Keynesian New Keynesian

Demand-Side Policy: Greater Spending Means Higher Prices (c) Aggregate Demand and Supply in the classical range of AS curve. (Prices rise without significant improvements in output and employment.) Price Level AD1 AD Y? Real GDP

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 Store of value Standard of Deferred Payment Store of value 6

16

Multiple Creation of Bank Deposits  M1 Fractional 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) Instructor Notes: 1) When a bank receives deposits, it keeps 25 percent in reserves and lends 75 percent. 2) The amount lent becomes a new deposit at another bank. 3) The next bank in the sequence keeps 25 percent and lends 75 percent, and the process continues until the banking system has created enough deposits to eliminate its excess reserves. 4) The running tally tells us the amounts of deposits and loans created at each stage. 5) At the end of the process, an additional $100,000 of reserves creates an additional $400,000 of deposits. 59

3) Open market operations Manage the public’s expectations 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? 23

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).

Determinants of 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