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

2. Circular Flow

3. 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

4. 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.

5. 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

6. 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)

7. 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)

8. Shifting Aggregate Demand Curve

9. 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

10. firms want to produce more.
Aggregate Supply
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 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

11. Aggregate Supply: Short – Run & Long – Run

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

13. 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

14. 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

15. 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

16. 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)

17. 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

18. 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

19. Fiscal Policy: Some Definitions
Fiscal policy: government spending and taxing
Demand-side policies
Supply-side policies:
Discretionary Fiscal Policy: aimed at achieving a policy goal.
Automatic Stabilizer: fiscal policy that changes automatically and countercyclically as income changes.
Progressive taxes
Unemployment insurance
Welfare payments / other transfer payments

20. Functions of Money Medium of exchange Unit of account Store of value
Standard of Deferred Payment
Store of value 6

21. 16

23. 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

24. 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

25. Fed Policy Linkages Tools – Intermediate Targets – Goals

26. Equation of Exchange: relates quantity of money to nominal GDP
M = money supply (some aggregate)
V = velocity of money (of the aggregate)
P = price level
Q = real GDP
PQ = nominal GDP
MV = PQ
(Note: V = PQ/M)
Money Demand
Transactions demand
Precautionary demand
Speculative demand
… fear decline in the value of other assets, so hold money as a safeguard.

27. How Money Supply Changes Affect GDP

28. Aggregate Demand and Supply  Phillips Curve

29. 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).

30. Expectations Formation
Adaptive Expectations: expectations of the future based on history
The public acts on its expectations
The present depends on the past
Rational Expectations: expectation based on all available relevant information.
The public understands how the economy works.
The public knows the structure and linkages between variables in the economy.
The public anticipates policy actions and their consequence
The public acts now on its expectations
The present depends on the future

31. New Classical Economics: Rational Expectations  Policy Ineffectiveness {Expansionary policy  movement from 1 to 3}

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

33. The Modern Keynesian Model: Sticky Prices  Demand Management Policies Can Stabilize an Unstable Economy

34. Long and Variable Policy Lags
1. Recognition Lag: policymakers need time to realize that there is a problem.
2. Reaction Lag: they need time to formulate an appropriate policy response.
3. Effect Lag: policy takes time to implement and work through the economy.
Countercyclical policies can become procyclical policies, worsening fluctuations

35. Determinants of 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