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

2. 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

3. 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

4. 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)

5. 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

6. 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

7. 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

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

9. 16

11. 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

12. 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

13. Fed Policy Linkages Tools – Intermediate Targets – Goals

14. 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.

15. How Money Supply Changes Affect GDP

16. Aggregate Demand and Supply  Phillips Curve

17. 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).

18. 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

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

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

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

22. 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

23. 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

24. 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