Recession
Periods when GDP and employment do badly
Inflation
A rise in overall level of prices
Deflation
A fall in overall level of pricesq
GDP
the total value of all final goods and services produced in an economy in a year
How to measure GDP
1) Add up the total value of the production of final goods and services in an economy
Real GDP
The total value of final goods and services produced in an economy in a year calculated as if prices had stayed at the level of some given a base year (Because prices affect GDP, we may want to do an adjustment if we want to track the
output of an economy over time.)
Labor force
Employment + unemployment
Unemployment rate
Number of unemployed workers / labor force
Real wage
Wage rate divided by price level
Real income
Income divided by price level
Shoe-leather costs
High inflation discourages you to hold money and you need to put effort in ways to avoid holding money
Monetary policy
Uses changes in the quantity of money to alter interest rates and affect overall spending
The Fed can set the interest rate by adjusting the money supply up or down
Fiscal policy
Uses changes in government spending and taxes to affect overall spending
taxes,
• government transfers,
• government purchases of goods and services
to shift the aggregate demand curve
Trade deficit
When the value of goods and services bough from foreigners is more than the value of goods and services it sells to them
what are : National income and product accounts
Keep track of the flows of money between different sectors of the economy
Government transfers
Payments by the government to individuals for which no good or service is provided in return
Disposable income
Equal to income plus government transfers minus taxes, is the total amount of household income available to spend on consumption and to save
Government borrowing
Is the total amount of funds borrowed by federal state and local governments in the financial markets
Governemnt purchases of goods and services
Are total expenditures on goods and services by federal state and local governments
Intermediate goods and services
Goods and services bough from one firm by another firm - that are inputs for productive or final goods and services
Aggregate spending
The sum of consumers spending, investment spending, government purcahses of goods and services, and exports minus imports is the total spending on domestically produced final goods and services in the economy
Value added (of a producer)
The value of its sales minus the value of its purchases of intermediate goods and services
What is included in the GDP
Domestically produced final goods and services, including capital goods, new construction of structures and changes to inventories
Aggregate output
The economies total quantity of output of final goods and services
Nominal GDP
The value of all final goods and services produced in the ceconomy during a given year, calculated using the prices current in the year in which the output is produced or just gdp
Chained dollars
Chained dollars is a method of adjusting real dollar amounts for inflation over time, to allow the comparison of figures from different years.
Aggregate price level
A measure of the overall level of prices in the economy
Market basket
A hypothetical set of consumer purchases of goods and services
Price index formula
Cost of market basket in given year/ cost of market basket in base year
Inflation rate
The percent change per year in a price index typically the consumer price index
Consumer price index (CPI)
Measures the cost of the market basket of a typical urban american family
Inflation rate formula
Price index in year 2- price index year 1/price index year 1
Jobless recovery
A period in which the real GDP growth rate is positive but the unemployment rate is still rising
Frictional unemployment
Unemployment due to the time workers spend in job search
Structural unemployment
More people are seeking jobs in a particular labor market than there are jobs available at the current wage range, even when the economy is at the peak of the business cycle
Efficiency wages
Wages that employers set above the equilibrium wage rate as an incentive for better employee performance
Natural rate of unemployment
The unemployment rate that arises from the effects of frictional plus structural unemployment (Structural + Frictional)
Cyclical unemployment
The deviation of the actual rate of unemployment from the natural rate due to downturns in the business
Real wage
The wage rate divided by the price level
Nominal interest rate
The interest rate expressed in dollar terms
Budget surplus
The difference between tax revenue and government spending when tax revenue exeeds government spending
Budget deficit
is the difference between tax revenue and government spending when government spending exeeds tax revenue
Budget balance
Is the difference between tax revenue and government spending
National savings
: the sum of private savings and the budget balance, is the total amount of savings generated withing the economy
Net capital inflow formula
NCI = Capital inflow - capital outflow or Imports - Exports
Loanable funds market
the interest rate is determined by the demand for and supply of loanable funds. The term loanable funds includes all forms of credit, such as loans, bonds, or savings deposits
a hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders
Equilibrium interest rate
The interest rate at which the quantity of loanable funds supplied equals the quantity of loanable funds demanded
Crowding out
Occurs when a government budget deficit drives up the interest rate and leads to reduced investment spending
Fisher effect
An increase in expected future inflation drives up the nominal interest rate, leaving the expected real interest rate unchanged
Real interest rate formula
Real interest rate = Nominal interest rate - inflation rate
Financial asset
A paper claim that entitles the buyer to future income from the seller
Loan
A lending agreement between an individual lender and an individual borrower
Loan backed security
An asset created by pooling individual loans and selling shares in that pool
Financial intermediary
An institution that transforms the funds it gathers fromm many individuals into financial assets
Mutual fund
A financial intermediary that creates a stock portfolion and then resells shares of this portfolio to individual investors
Pension fund
A type of mutual fund that holds assets in order to provide retirement income to its memberrs
Bank deposit
A claim on a bank that obliges the bank to give the depositor his or her cash when demanded
Efficient market hypothesis
Asset prices embody all publicly available information
Random walk
The movement over time of an unpredicted variable
Marginal propensity to consume (MPC)
The increase in consumer spending when disposable income rises by 1$
Marginal propensity to save (MPS)
The increase in household savins when dispoable income rises by 1$
Autonomous change in aggregate spending
: Is an initial change in the desired level of spending by firms, households, or governments at a given level of real gdp
Multiplier
How much extra income and spending is created from an initial change in spending
Ex. 100 Billion spent on home construction. This raises people disposable income –> Raises consumption of those people →firms produce more →more output.
Consumer function
is an equation showing how an individual households consumer spending varies with the households current disposable income.
Aggrecation consumer function
Is the relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending
Planned investment spending
Is the investment spending that businesses intend to undertake during a given period.
Accelerator principle
A higher growth rate of real GDP leads to higher planned investment spending, but a lower growth rate of real GDP leads to lower planned investment spending
inventory investment
Is the value of the change in total inventories held in the economy during a given period
unplanned inventory investment
: Occurs when actual sales are more or less than businesses expected, leading to unplanned changes in inventories
Actual investment spending
Is the sum of planned investment spending and unplanned inventory investment
Planned aggregate spending
Is the total amount of planned spending in the economy
INcome expenditure equilibrium
When aggregate output, measured by real GDP, is equal to planned aggregate spending
Income-expenditure equilibrium GDP
Is the level of real GDP at which real GDP equals planned aggregate spending
Aggregate demand curve
Shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, the government aned the rest of the world
GDP formula
C + I + G + X -IM
C= consumer spending
I = Investment spending
G = government purchases of goods and services
X = exports to other countries
IM = Imports
Wealth effect
Is the effect on consumer spending caused by the effect of a change in the aggregate price level on the purcahsing power of consumers assets
Interest rate effect
A higher aggregate price level makes households hold more money and leads to a rise in interest rates (and a fall in investment spending and
consumer spending).
Aggregate supply curve
Shows the relationship between the aggregate price level and the quantity of aggregate output supplied in the economie
Nominal wage
Is the dollar amount of the wage paid
Sticky wages
Are nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages
Short run aggregate supply curve
Shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed
Long run aggregate supply curve
Shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible
In the long run (inflation deflation)
Has the same effect as someone changing all prices by the same proportino. As a result, changes in the aggregate price level do not change the quantity of aggregate output supplied in the long run
Potential outupt
Is the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible
AD-AS model
The aggregate supply curve and the aggregate demand curve are used together to analyze the economic fluctuations
Short run macroeconomic equilibrium
When the quantity of aggregate supply supplied is equal to the quantity demanded
SHort run equilibrium aggregate price level
The aggregate price leevl in the short run macroeconomic equilibrium
Demand shock
An even that shifts the aggregate demand curve
SRAS curve
Short run aggregate supply curve
Supply shock
An even that shifts the short run aggregate supply curve
Stagflation
The combination of inflation and falling aggregate output
Long run macroeconomic equilibrium
When the point of short run macroeconomic equilibrium is on the long run aggregate supply curve
Recessionary gap
When aggregate outpput is below potential output
Output gap formula
((Actual aggregate output - potential output) /potential output) x 100
Output gap
The percentage difference between actual aggregae output and potential output
Self correcting
When shocks to aggregate demand affect aggregate output in the short run, but not in the long run
Stabilization policy
The use of government policy to reduce the severity of recessions and rein in exessive strong expansion
Social insurance programs
Are government programs intended to protect families against economic hardship
Expansionary fiscal policy
Is a fiscal policy that increases aggregate demand
ex.
an increase in government purchases of goods and services
• a cut in taxes
• an increase in government transfers
Contradictionary fiscal policy
Is a fiscal policy that reduces aggregate demand
e.x.
a reduction in government purchases of goods and services
• an increase in taxes
• a reduction in government transfers
Lump sum taxes
Taxes that dond depnd on the taxpayers income
Automatic stabilizers
Are government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economic contracts and automatically contractionary when the economy expands
Discretionary fiscal policy
Is fiscal policy that is the result of deliberate actions by policy makers rather than rules
Cyclically adjusted budget balance
Is an estimate of what the budget balance would be if real GDP were exactly equal to potential output
Fiscal year
Runs from October 1 to September 30th and is labeled according to the calendar year in which it ends
Public debt
Is government debt held by individuals and institutions outside the government
Debt-GDP ratio
Is the government debt as a percentage of GDP
Implicit liabilities
Are spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debtstatistics
Checkable bank deposits
Are bank accounts on which people can write checks
Medium of exchange
Is an asset that individuals acquire for the purpose of trading goods and servies rather than for their own consumption
Sore of value
Is a means of holding purcahsing power over time
Commodity-backed money
Is a medium of exchange with no intrinsic vlaue whose ultimate value is guaranteed by a promise that it can be converted into valuable goods
Fiat money
Is a medium of exchange whose value derives entirely form its official status as a means of payment
Near moneys
Are financial assets that cant be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits
Reserve ratio
Is the fraction of bank deposits that a bank holds as a reserve
Bank run
Is a phenomenon in which many of a banks depositors will try to withdraw their funds due to fears of a bank failure
Reserve requirements
Are rules set by the federal reserve that determine the minimum reserve ratio for banks
Discount window
Is an arrangement in which the Federal reserve stands ready to lend money to banks in trouble
Exess reserves
Are banks reserves over and above its required reserve
Monetary base
Is the sum of currency in circulation and bank reserves
Central bank
An institution that oversees and regulates that banking system and controles monetary base
Federal funds market
Allows banks that fall short of the reserve requirements to borrow funds from banks with exess reserves
Commercial bank
Accepts deposits and is covered by deposit insurance
Investment bank
Trades its financial assets and is not covered by deposit insurance
Savings and loan (thrift)
Is another type of deposit taking bank, usually specialized in issuaing home loans
Leverage
When a financial institution finances its investments with borrowed funds
Sublime lending
Is lending to home buyers who dont meet the usual criteria for being able to afford their payments
Securitization
A pool of loans is assembled and shares of that pool are sold to investors
Short term interest rates
Are the interest rates on financial assets that mature within less than a year
Long term interest rates
Are interest rates on financial assets that mature a number of years in the future
Money demand curve
Shows the relationship between the interest rate and the quantity of money demanded
–
–
Target federal funds rate
Interest rates between banks
Expansionary monetary policy
Is monetary policy that increases aggregate demand
Contractionary monetary policy
Is monetary policy that decreases aggregate demand
Taylor rule for monetary policy
Is a rule that sets the federal funds rate according to the level of the inflation rate and either the output gap or the unemployment rate
Inflation targeting
Occurs when the central bank sets an explicit target for the finlation rate and sets monetary policy in order to hoit that target
Zero lower bound for interest rates
Means that interest rates cannot fall below zero
Monetary neutrality
Changes in the monetary supply have no real effect on the economy
Paradox of thrift
The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving.
Increase in government spending leads to
Increased government spending is likely to cause a rise in aggregate demand (AD). This can lead to higher growth in the short-term. It can also potentially lead to inflation
A decrease in government taxation leads to
lowering taxes raises disposable income, allowing the consumer to spend additional sums, thereby increasing GNP. (gross national product)
GDP Deflator
Simply put, the GDP price deflator shows how much a change in GDP relies on changes in the price level.
GDP Deflator formula
Nominal GDP / Real GDP x 100
Change in Real GDP formula
(GDPt1 - GDP t0)/GDPt0 x 100
Why are both inflation and deflation considered undesireable
Inflation: Savings become worth less, prices need to be updated
Deflation: People wont want to spend their money –> lower GDP
National accounts
Track spending of consumers, sales of producers, business investment spending, government spending etc.
Marginally attached worker
Someone who would like to work, has looked for jobs, but not in the last months
GDP doubling time (rule of 70)
70/growth rate %
Labor productivity
Output per worker
What leads to higher productivity
Physical capital (buildings, machines) Human capital (How educated is the workforce) Technological progress
The aggregate production function
How productivity depends on Physical capital, human capital and technological progress
1) If physical capital rises, The increase in real GDP per worker becomes smaller
2) If technology or human capital rises, that is not the case anymore
3)
Convergence hypothesis
relatively poor countries should have higher rates of
growth of real GDP per capita than relatively rich countries.
What is the impact of limited natural resources on long run economic growth
1) How large are the supplies of key natural resources
2) How effective will technology be at finding alternatives to natural resources
3) Can long run economic growth continue in the face of resource scarcity?
Savings formula government
S = Tax revenues - Government transfers -government spending
Investment spending formula
National savings + NCI = Private saving + budget balance + Exports - Imports
What happens to demand for loanable funds when interest rate declines
Demand for loanable funds goes up
What happens to the supply of loanable funds as interest rate goes up
Supply of loanable funds increases
Factors that can cause the demand curve for loanable funds to shift
Changes in perceived business opportunities
Changes in government borrowing
Factors that can cause the supply curve for loanable funds to shift
Changes in private savings behavior
Changes in net capital inflows
Three tasks of a financial system
1) reducing transaction cost
2) Reducing risk (Financial risk, diversification)
3) Providing liquidity
Marginal propensity to consume formula
Change in consumer spending/Change in disposable income
Total increase in GDP formula (multiplier effect)
1/(1-MPC) x Autonomous change in aggregate spending
Consumption function formula
c = a + MPC * yd
c = consumer spending a= what a family would spend with zero income (constant) yd = households disposable income MPC = marginal propensity to consumer
What causes a shift in planned aggregate spending
Change in interest rate or a change in wealth
Interest rate effect
A higher aggregate price level makes households hold more money and leads to a rise in interest rates (and a fall in investment spending and
consumer spending).
What shifts the aggregate demand curve
Change in expectation (optimistic shift right)
Change in Wealth (Rise –> shift right)
Change in Fiscal policy (Increased spending or less tax –> shift right
Change in Monetary policy (Increase quantity of money –> shift right)
How do sticky wages affect SRAS
Profit per unit = Price per unit - Production cost per unit
A higher aggregate price level leads to higher profits and increases aggregate output in the short run
What shifts the SRAS
When commodity prices fall –> shift right
When Nominal wages fall –> shift right
When workers become more productive –> shift right
Inflationary gap
When potential output is below aggregate output
What causes expansionary fiscal policy
-an increase in government purchases of goods and services
• a cut in taxes
• an increase in government transfers
what causes a contractionary fiscal policy
- a reduction in government purchases of goods and services
- an increase in taxes
- a reduction in government transfers
Lags in fiscal policy
It takes time to:
1. realize the recessionary or inflationary gap by collecting and analyzing economic
data.
2. develop a plan.
3. implement the action plan (spending the money).
shadow bank
Doesnt accept deposits and isnt covered by deposit insurance or regulations that make conventional banks safer (includes:)
- investment banks
- insurance companies
- hedge fund companies
- money market fund companies
How does the Federal bank increase money supply
It will buy T-Bills
How does the Fed bank decrease money supply
It will sell T-Bills –> Fewer resevers –> less loans by banks
opportunity cost of holding money rises if:
The interest rates are rising
–
–
What shifts the money demand curve left/right
Decrease in money demand shifts left
Increase in money demand shifts right
Money supply curve
shows how the nominal quantity of money supplied changes the interest rate
circular flow diagram
A simple way of thinking about the Macroeconomy
Four sectors of the economy
Government, households,firms and rest of word
Households breakdown
ncome through factor markets (wage from working, interests from capital etc.)
→Households own factors of production (labor, land, physical capital, human capital, financial capital) and sell the use of these
to firms.
Pay taxes: income –taxes : disposable income
Disposable income is spent on consumption, what is left are
personal savings.
Personal savings are invested via financial markets (banks, stocks, etc.)
Government breakdown
Has income through taxation and borrowing, spends by buying goods and services and through government transfers
Firms breakdown
Are financed through financial markets
By inputs from factor markets engage in investment spending
Rest of the world breakdown
A ountry is not closed our isolated. Goods and services are exported or imported. Countries can borrow and lend
alternative ways of calculating gdp
Look at what has been spent on acquiring (domestically produced) total goods and services.
Adding up total factor income earned by households from firms in the economy.
Producer price index
a typical basket of goods purchased by producers
Labor force participation rate (formula):
labor force / population aged 16 and older) * 100
Actual rate of unemployment formula
Natural + Cyclical = Structural + Frictional + Cyclical
menu costs
updating prices costs time and effort
Inflation has economic costs because of unit of account (definition)
it may become increasingly hard to use the currency as a unit of
account and makes various economic decisions less efficient, harder
If inflation is high who benefits who loses
So if inflation is higher than expected, those who lend out lose and those who borrowed gain!
What increases physical capital
Savings and investment spending
What increases human capital
Education
What increases technological capital
Research and development
Tradgedy of the commons
an economics problem in which every individual has an incentive to consume a resource, but at the expense of every other individual—with no way to exclude anyone from consuming.
Savings–investment spending identity
savings and investment spending are always equal for the economy as a whole
Savings (gov) formula
T − TR − G
• T = the value of tax revenues, TR = the value of government transfers, G = the value of government spending
Savings (national) formula
SNational = SGovernment + Sprivate
Capital outflow
savings from people in home country go to investment abroad
Capital inflow:
savings from abroad go to investment in home country
Present value
the amount of money needed today to receive a given
amount of money at a future date given the interest rate.
Present value formula (ex money needed)
PV = FV/1+r
An increase for demand for loanable funds creates:
A rise in the equillibrium interest rate
Global loanable funds market
arises when international capital flows are so large
that they equalize interest rates across countries.
What changes the interest rate
Anything that shifts either the supply of loanable funds curve or the demand for loanable funds curve changes the interest rate.
Three tasks of a financial system
Reducing transaction cost
Reducing risk
Providing liquidity
Marginal propensity to save formula
1-MPC
total increase in GDP due to multiplier formula
Total increase in real GDP = (1 + MPC + MPC2 + MPC3 + . . .) × $100 billion
total increase in real GDP formula
1/1-MPC x 100Billion
If ΔAAS = autonomous change in aggregate spending and
• ΔY = change in real GDP
dY formula
Multiplier formula
1/1-MPC *dAAS
Multiplier = dY/dAAS or 1/1-MPC
Aggregate consumer function (disposable income consumer) + formula
the relationship for the economy as a whole between aggregate disposable income and aggregate consumer spending
c = a + MPC × yd
what tends to drive the booms and busts in the business cycle.
Investment spending
Two possible sources of a shift of planned aggregate spending line
Change in interest rate or wealth
The aggregate demand curve shifts because of
expectations.
• wealth.
• size of the existing stock of physical capital.
• government policies.
Increase in aggregate demand shifts the curve to the right
Short run aggregate supply curve shifts because of
commodity prices
• nominal wages
• productivity
Decrease in short run aggregate supply shift the cuve to the left
short run equilibrium aggregate output
is the quantity of aggregate output produced in the short-run macroeconomic equilibrium.
A widely used measure of fiscal health is the
Debt to GDP ratio
Money must function as
- a medium of exchange.
- a store of value.
- a unit of account.
T-account
a tool for analyzing a business’s financial position by
showing the business’s assets and liabilities
Bank reserves
the currency that banks hold in their vaults, plus their
deposits at the Federal Reserve
Reserve ratio formula
the fraction of bank deposits that a bank holds as
reserves ($100,000/$1,000,000 = 10%)
If the Fed wants to increase money supply it will
buy T bills
to pay for the T-bills, Fed electronically increases the reserves of the seller
• with more reserves, banks increase loans
• money supply increases as the loans/money creation process ripples through the economy
If the Fed wants to decrease money supply they will
Sell T bills
• in exchange for the T-bills, Fed decreases the reserves of the seller
• with fewer reserves, banks decrease loans
• money supply decreases as the loans/money creation process ripples through
the economy in reverse
what shifts the money demand curve?
Changes in aggregate price level
Changes in real GDP
Changes in Technology
Changes in institutions
The liquidity preference model of the interest rate asserts:
that the interest rate is determined by the supply and demand for money.
The money supply curve shows
how the nominal quantity of money supplied varies with the interest rate.
Private savings formula
GDP−Taxes+Government transfers−consumption
Investment spending formula
Privatesavings + Budgetbalance + Netcapitalinflow
Or
Nationalsavings+Netcapitalinflow
