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

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 Nominal GDP = $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.

Foreign Exchange Rate: Appreciation and Depreciation A currency appreciates when it buys more of a foreign currency. Appreciation makes foreign goods cheaper. Appreciation  Imports Up and Exports Down. A currency depreciates when it buys less of a foreign currency. Depreciation makes foreign goods more expensive. Depreciation  Imports Down and Exports Up.

Current Account vs. Financial Account The balance of payments must balance Current Account + Financial Account = 0 If we buy more goods and services from foreigners than they buy from us, we have to borrow the difference  sell them our IOUs. Capital inflows help finance domestic investment and the government’s deficit

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 (). Real Interest Rate = Nominal Interest Rate – Inflation Rate r = i -  Low real interest rates spur business investment spending (the I in C + I + G + NX)

Aggregate Demand (AD): the economy-wide demand for goods and services. Aggregate demand curve relates aggregate expenditure for goods and services to the price level The aggregate demand curve slopes downward owing to price-level effects: Wealth Effect (Real Wealth/Real Balances) Interest Rate Effect International Trade Effect (Substitution)

Shifting Aggregate Demand Curve

Factors that Affect AD  Shifts in AD AD = C + I + G + NX 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 Profits don’t rise with price in long-run Aggregate Supply (AS): the quantity of real GDP produced at different price levels. Short-run Aggregate Supply SRAS slopes upward a higher price level (holding production costs and capital constant in the short-run) higher profit margins firms want to produce more. Long Run Aggregate Supply LRAS is vertical: higher prices cannot elicit more output in the long-run. Resource costs are NOT fixed in the long-run. As prices rises, workers demand and get higher wages Profits don’t rise with price in long-run AS is set by production possibilities in the long-run

Aggregate Supply: Short – Run & Long – Run

Aggregate Demand and Supply Equilibrium: Short-run and long-run responses to increase in aggregate demand

Aggregate Expenditures = AE = GDP Y = AE = C + I + G + NX Disposable income = Yd = Y-T = after tax income. Yd = Y - T = C + S Consumption is related to disposable income (Y-T). C = Ca +cYd where c = Marginal Propensity to Consume = mpc Ca = Autonomous consumption Additional income not consumed is saved mpc + mps =1

Aggregate Expenditures = AE = GDP In a closed economy, saving either finances private investment (I) or the government’s deficit (G – T) S = I + (G – T) at equilibrium Investment can be crowded out by the deficit I = S – (G-T) Leakages from the spending stream (S + T) = Injections to the spending stream (I + G) S + T = I + G

Shifts in the Consumption Function Expected Future Income An increase in expected future income will cause current consumption to rise and your saving to fall. Wealth An increase in wealth raises current consumption and lowers current saving. Expected Real Interest Rate Higher real return  incentive to save more … but Higher return to saving  less needs to be put aside to achieve the same desired future savings. Net effect: increased real interest rates reduce consumption and increase saving. Demographics Taxes – Ricardian Equivalence: Anticipation of Future Taxes

Net exports is NX = EX – (IMa + mpi Y) or NX = NXa – mpi Y Imports and Exports The demand for imports depends on current economic activity, Y IM = IMa + mpi Y “mpi” is the marginal propensity to import Exports are exogenously determined they depend on conditions in foreign economies, not our economy Net exports is NX = EX – (IMa + mpi Y) or NX = NXa – mpi Y Net expects decrease as the economy expands

Demand-Side Equilibrium and the Multiplier At equilibrium: Y = C + I + G + NX = AE Increase in Y = Spending Multiplier x {Increase in Autonomous Spending} Multiplier = 1/(mps + mpi)

From Aggregate Expenditure to Aggregate Demand: As price level rises, real money balances decrease and consumption function shifts owing to i) wealth effect ii) interest rate effect iii) international competition

Circular Flow