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Econ 111: Macroeconomics, Ch. 5 - 10


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Sticky Prices
refer to prices that do not always adjust rapidly to maintain equality between quantity supplied and quantity demanded
Fallacies of Classical Models
Classical economists believed that recessions (downturns in the economy) were self-correcting. These models failed with the Great Depression, thus giving rise to Macroeconomics.
The Keynesian Revolution
Authored The General Theory of Employment, Interest and Money. He reasoned that it wasn’t prices and wages that determine the level of employment, but instead the level of aggregate demand for goods and services
Employment Act of 1946
established the President’s Council of Economic Advisors (a group of economists who advise the president on economic issues) and committed the federal government to intervening in the economy to prevent large declines in output and employment.
a phrase coined by Walter Heller (chairman of the Council of Economic Advisors under Kennedy & Johnson), refers to the government’s role in regulating inflation and unemployment
Stagflation occurs when the overall price level rises rapidly (inflation) during periods of recession or high and persistent unemployment (stagnation)
Three major concerns of macroeconomics
inflation, output growth, and underemployment
inflation vs. deflation vs. hyperinflation
Inflation is an increase in the overall price level; Hyperinflation is a period of very rapid increases in the overall price level; Hyperinflation is generally detrimental to the economy (generally about 2,000% per year); Deflation refers to a decrease in the overall price level
is a period during which aggregate output declines. Conventionally, a period in which aggregate output declines for two consecutive quarters
fiscal policy
The government’s spending and taxing policies (government purchases of goods and services/taxes/transfer payments, nat'l sec.)
expansionary fiscal policy
government can cut taxes and/or raise spending to get the economy out of a slump
contractionary fiscal policy
government can raise taxes and/or cut spending to bring the economy out of an inflation
monetary policy
refers to the tools used by the Federal Reserve to control the quantity of money in the economy
supply-side policies
refer to government policies that focus on stimulating aggregate supply instead of aggregate demand
Four groups of macroeconomics
1) Households (together with firms comprise the private sector)
2) Firms (together with households comprise the private sector)
3) The government (the public sector)
4) The rest of the world (the international sector)
transfer payments
cash payments made by the government to people who do not supply goods, services, or labor in exchange for these payments. They include social security benefits, veterans’ benefits, and welfare paymentsx
Three Market Arenas
Goods-and-services market, labor market, money (financial) market
Goods-and-services market
firms and the government supply, households demand
Labor Market
households supply labor, firms and the government demand labor
Money Market
households purchase stocks and bonds from firms and supply them with funds; conversely, households may demand funds by borrowing to finance various purchases
Gross domestic product
the total market value of all final goods and services produced within a given period by factors of production located within a country
Intermediate goods
goods that are produced by one firm for use in further processing by another firm. These goods do not count toward GDP
value added
is the difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage
Two ways to calculate GDP
we can either sum up the value added at each stage of production or we can take the value of all final sales
Gross national product
the total market value of all final goods and services produced within a given period by factors of production owned by a country’s citizens, regardless of where the output is produced
expenditure approach
a method of computing GDP that measures the amount spent on all final goods during a given period.
four main categories of expenditure
personal consumption (C)
Gross private investment (I)
Government Consumption (G)
Net Exports (EX - IM)
Durable goods vs. nondurable goods vs. services
goods that last a relatively long time / goods that are used up fairly quickly / the things we buy that do not involve the production of physical things
change in business inventories
the amount by which firms’ inventories change during a period. Inventories are the goods that firms produce now but intend to sell later; GDP is reflected in this case as final sales + change in business inventories
net investment
the gross investment minus depreciation
Expenditure apprach to GDP
GDP = C + I + G + (EX – IM)
income approach to GDP
method of computing GDP that measures the income—wages, rents, interest, and profits—received by all factors of production in producing final goods.
Equation of income approach to GDP
GDP = national income + depreciation + (indirect taxes – subsidies) + net factor payments to the rest of the world + other
Net national product
is the gross national product minus depreciation; a nation’s total product minus what is required to maintain the value of its capital stock
Personal Income
PI = national income – (corporate profits – dividends) – social insurance payments + interest income received from the government and households + transfer payments to households
disposable personal income
personal income minus personal income taxes. It is the amount that households have to spend or save
personal saving
the amount of disposable income that is left after total personal spending in a given period
personal saving rate
the percentage of disposable personal income that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously
nominal GDP
gross domestic product measured in current dollars. This can be misleading, as it does not account for inflation
real GDP
nominal GDP adjusted for price changes
What is the post-1996 method of calculating GDP?
“splitting the difference” between two base years; that is, output is measured in two base years (i.e., output times price1999 plus output times price2000, divided by two)
GDP Deflator
measures overall price level changes, which means that you first use quantity weights between two base years, and average. Then, using that quantity, multiply times the price of two base years, then average.
Gross national income (GNI)
GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation
one who is 16 years old or older who is not working, is available for work, and has made specific efforts to find work during the previous 4 weeks
labor force
employed + unemployed
unemployment rate
unemployed ÷ (employed + unemployed)
labor-force participation rate
labor force ÷ population
discouraged-worker effects
The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks f the unemployed and the labor force
frictional unemployment
refers to the portion of unemployment that is due to the normal working of the labor market; used to denote short-run job/skill matching problems
structural unemployment
refers to the portion of unemployment that is due to changes in the structure of the economy that results in a significant loss of jobs in certain industries
cyclical unemployment
refers to the unemployment that occurs as a normal part of the functioning of the economy; sometimes taken as the sum of frictional unemployment and structural unemployment (generally, 4-6%)
natural rate of unemployment
the increase in unemployment that occurs during recessions and depressions. Results from the fundamental problem that firms are producing less
a price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer.
Why does CPI overstate the cost of living?
1. Quality change and new product bias
2. Substitution bias (people buy cheaper goods)
3. Outlet substitution bias (cheap outlet stores)
Producer Price Index
measure the prices that producers receive for products at all stages in the production process
Three main categories of PPI
finished goods, intermediate materials, and crude materials.
slope of consumption function = ∆C ÷ ∆Y
∆S ÷ ∆Y
What is the 45Ëš line good for?
it is used to show the points at which C = Y (y-axis = x-axis), equilibrium
Equilibrium is achieved when
aggregate output and planned aggregate expenditure are equal
Saving/investment approach to equilibrium
C + S = C + I
the ratio of the change in the equilibrium level of output to a change in some autonomous variable
autonomous variable
is a variable that is assumed not to depend on the state of the economy—that is, it does not change when the economy changes (i.e., planned investment)
∆Y =
∆I • (1 ÷ MPS)
discretionary fiscal policy
refer to changes in taxes or spending that are the result of deliberate changes in government policy
net taxes
taxes paid by firms and households to the government minus transfer payments to households by the government
Disposable (after-tax) income (Yd)
total income minus net taxes: Y – T
budget deficit
difference between what a government spends and what it collects in taxes in a given period: G – T
government spending multiplier
the ratio of the change in the equilibrium level of output to a change in government spending
Tax Multiplier
– (MPC ÷ MPS)
balanced-budget multiplier
the ratio of change in the equilibrium level of output to a change in government spending where the change in government spending is balanced by a change in taxes so as not to create any deficit. The balanced-budget multiplier is equal to one
Tax Multiplier vs. Balanced-Budget Multiplier
An increase in government spending has a direct initial effect on planned aggregate expenditure; a tax increase does not. The initial effect of the tax increase is that households cut consumption by the MPC times the change in taxes. This change in consumption is less than the change in taxes, because the MPC is less than 1
Automatic Stabilizers
revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP
fiscal drag
the negative effect on the economy that occurs when average tax rates increase because taxpayers have moved into higher income brackets during an expansion. This effect has been mitigated by the indexation of tax rates
full-employment budget
What the federal budget would be if the economy were producing at a full-employment level of output (it serves as a benchmark to compare applied fiscal policy)
structural deficit
the deficit that remains at full employment
cyclical deficit
is the deficit that occurs because of a downturn in the business cycle
Properties of Money
means of payment, store of value, unit of account
Transactions Money: money that can be directly used for transactions
Broad Money: M1 plus savings accounts, money market accounts, and other near monies
Net Worth
Assets – Liabilities
required reserve ratio
the percentage of its total deposits that a bank must keep as reserves at the Federal Reserve
excess reserves =
actual reserves - required reserves
money multiplier =
Money multiplier = 1 ÷ required reserve ratio
Federal Open Market Committee (FOMC)
a group composed of the seven members of the Fed’s Board of Governors, the president of the New York Federal Reserve Bank, and 4 of the other 11 district bank presidents on a rotating basis; it sets goals concerning the money supply and interest rates and directs the operation of the Open Market Desk in New York
Open Market Desk
the office in the New York Federal Reserve Bank from which government securities are bought and sold by the Fed
discount rate
the interest rate that banks pay to the Fed to borrow from it
Open Market Operations
refer to the purchase and sale by the Fed of government securities in the open market; it is a powerful tool used to expand or contract the amount of reserves in the system and thus the money supply
An open market sale of securities by the Fed results in
a decrease in reserves and a decrease in the supply of money by an amount equal to the money multiplier times the change in reserves
An open market purchase of securities by the Fed results in
an increase in reserves and an increase in the supply of money by an amount equal to the money multiplier times the change in reserves.

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