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Three major concerns of macroeconmics
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growth, unemployment, and inflation
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Real Potential GDP
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The CBO's estimate of the output the economy would produce with a high rate of use of its capital and labor resources. The data is adjusted to remove the effects of inflation
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Real GDP
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The inflation adjusted value of the goods and services produced by labor and property located in the United States.
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GDP
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is the inflation adjusted value of the goods and services produced by labor and property located in the United States.
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The unemployment rate represents
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represents the number of unemployed as a percentage of the labor force
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Labor force data
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restricted to people 16 years of age and older, who currently reside in 1 of the 50 states or the District of Columbia, who do not reside in institutions (e.g., penal and mental facilities, homes for the aged), and who are not on active duty in the Armed Forces.
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U-3 unemployment rate
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are available and looking for work but unable to find employment
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Economic models
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are simplified versions of a more complex reality
irrelevant details are stripped away they are used to
show relationships between variables
explain the economy's behavior
devise policies to improve economic performance
irrelevant details are stripped away they are used to
show relationships between variables
explain the economy's behavior
devise policies to improve economic performance
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Y
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aggregate income
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Demand equation
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Qd = D[P,Y]
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General functional notation
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shows only that the variables are related Qd = D[P,Y]
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Specific functional form
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shows the precise quantitative relationship
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Demand curve
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shows the relationship between quantity demanded and price, other things equal.
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Supply curve
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shows the relationship between quantity supplied and price other things equal
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Supply equation
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Qs = S[P,Ps]
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Effects of an increase in income (Demand)
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increase the quantity consumers demand at each price, shifting the demand curve to the right.
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Effects of a item price increase (Supply)
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reduces the quantity of items producers supply at each price, shifting supply to the left
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Endogenous variables
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determined in the model P, Qd, Qs
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Exogenous variables
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determined outside the model: the model takes their values and behavior as given. Y, Ps
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Solve for equilibrium P and Q
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steps?
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Market clearing
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An assumption that prices are flexible, adjust to equate supply and demand
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In the short run (prices)
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many prices are sticky
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sticky prices
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adjust sluggishly in response to changes in supply or demand
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GDP depends on factors of production
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amount of Labor, capital, and technology.
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In the long run what rules
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supply rules
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In the short run what rules
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aggregate demand rules
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In the long run the rate of money growth determines the rate of inflation
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but it does not affect the rate of unemployment
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There is a trade-off between inflation and
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unemployment in the short run
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Gross Domestic Product: Expenditure and Income
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Total expenditure on domestically-produced final goods and services. Total income earned by domestically-located factors of production
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Expenditure
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income because every dollar spent by a buyer becomes income to the seller
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Value added
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The value of output minus the value of the intermediate goods used to produce that output
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Value of total output equation
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Y = C + I + G + NX
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Consumption
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Durable goods, nondurable goods, and services.
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Investment
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Spending on goods bought for future use
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Three components of I
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Business fixed investment, Residential fixed investment, and change in inventory
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Stock
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a quantity measured at a point in time
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Flow
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a quantity measured per unit of time.
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Government spending (G)
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includes all government spending on goods and services excluding transfer payments
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Net Exports
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NX = EX - IM
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GDP measures
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total income, total output, total expenditure, and the sum of value-added at all stages in the production of final goods
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GNP
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GDP + factor payments from abroad minus factor payments to abroad
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nominal GDP
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measures the values using current prices
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real GDP
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measures values using the prices of a base year
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Changes in nominal GDP can be due to
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changes in prices and changes in quantities of output produced
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Changes in real GDP can only be due to
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changes in quantities because it uses constant base-year prices
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Inflation rate
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the percentage increase in the overall level of prices
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GDP deflator
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measures price level. 100 x Nominal GDP/Real GDP
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chain-weighted real GDP
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updates the base year every year, so it is more accurate than constant-price GDO
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Consumer Price Index (CPI)
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A measure of the overall level of prices by the BLS
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Substitution bias
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The CPI uses fixed weights, so it cannot reflect consumers' ability to substitute toward goods whose relative prices have fallen
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Introduction of new goods
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The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights.
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Unmeasured changes in quality
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Quality improvements increase the value of the dollar, but are often not fully measured.
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Prices of capital goods
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included in GDP deflator (if produced domestically) excluded from CPI
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Prices of imported consumer goods
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included in CPI excluded from GDP deflator
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The basket of goods
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CPI: fixed GDP deflator: changes every year
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The PCE defaltor
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Another measure of the price level: Personal Consumption Deflator, the ratio of nominal to real consumer spending
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How the PCE is like the CPI
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only includes consumer spending and includes imported consumer goods
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How the PCE is like the GDP deflator
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the "basket" changes over time
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employed
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working at a paid job
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unemployed
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not employed but looking for a job in last 4 weeks
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labor force
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the amount of labor available for producing goods and services. Sum of all employed plus unemployed persons
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not in the labor force
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not employed, not looking for work
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unemployment rate
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percentage of the labor force that is unemployed
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labor force participation rate
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the fraction of the adult population that "participates" in the labor force
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employment population ratio
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employment divided by adult population
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Involuntary part-time workers
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Individuals who would like a full-time job but who are working only part time - they are employed
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Discouraged workers
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Individuals who would like a job but have given up searching for one
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Problems in measuring unemployment
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marginally attached to the labor force
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Employment-population ratio
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Total employment (from the household survey) divided by the total population over age 16
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Neoclassical model
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an approach to economics that relates supply and demand to an individual's rationality and his ability to maximize utility or profit. Involves multiple markets.
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3 types of markets the macroeconomy involves
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Goods (and services) Market
Factors Market or Labor market , needed to produce goods and services
Financial market
Factors Market or Labor market , needed to produce goods and services
Financial market
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Three types of agents in an economy
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Households, Firms, and Government
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Goods market
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Supply: firms produce the goods
Demand: by households for consumption, government spending, and other firms demand them for investment
Demand: by households for consumption, government spending, and other firms demand them for investment
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Labor market
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Supply: Households sell their labor services.
Demand: Firms hire labor to produce the goods
Demand: Firms hire labor to produce the goods
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Financial market
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Supply: households supply private savings: income less consumption
Demand: firms borrow funds for investment; government borrows funds to finance expenditures.
Demand: firms borrow funds for investment; government borrows funds to finance expenditures.
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The production function
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Y = F[K,L] shows how much output Y the economy can produce from K units of capital and L units of labor
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factor prices
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the price a firm pays for a unit of factor of production
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W/P
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real wage
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R/P
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real rental rate
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Marginal product of labor (MPL)
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The extra output the firm can produce using an additional unit of labor
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Diminishing marginal returns
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As a factor input is increased, its marginal product falls (other things equal)
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MPL and the demand for labor
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Each firm hires labor up to the point where MPL = W/P
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Equilibrium real wage
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Adjust to equate labor demand with supply
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Neoclassical theory of distribution
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states that each factor input is paid its marginal product
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Disposable income
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total income minus total taxes Y - T
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Consumption function
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C = C[Y - T]
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Marginal propensity to consume (MPC)
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the change in C when disposable income increases by one dollar (the slope of the consumption function)
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real interest rate
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r, the nominal interest rate corrected for inflation
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Aggregate demand:
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C[Y-T] + I[r] + G
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Aggregate supply
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Y = F[K,L]
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Equilibrium
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Y=C[Y-T] + I[r] + G
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Loanable funds market
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a hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders
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Loanable funds demand curve
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r on the y axis I on the x axis. Negative slope I[r]
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Private saving
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[Y-T]-C
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Public saving
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[T-G]
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National saving
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S
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Budget surplus
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If T>G
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Budget deficit
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If T<G
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Loanable funds supply curve
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r on the y axis, S,I on the x axis inelastic slope of consumption function.
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Things that shift the saving curve
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fiscal policy: changes in G or T. Public and private savings
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Reagan deficits
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Savings curve shifts left. completely inelastic
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An increase in investment demand
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the demand curve shifts to the right
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An increase in investment demand when savings depends on r
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An increase in investment demand raises r,
which induces an increase in the quantity of saving,
which allows I to increase.
which induces an increase in the quantity of saving,
which allows I to increase.
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Crowd out
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Increase in government purchases cause the interest rate to increase and investment to decrease
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