Eco105 Macro midterm

Types of employment

-Employed working full-time or part-time at paid job -Unemployed: not doing paid work and actively searching for job; on temporary layoff; about to start new job -Not in the labour force not employed or unemployed (full-time student, homemaker, retiree)

No-Left Alone, Markets Fail Often-Hands On camp belives

-Fallacy of composition macroeconomic and microeconomic outcomes are different -Markets cause business cycles through connection failures between input and output markets, roles of money, banking, and expectations -Market failure is more likely than government failure -Government should be hands-on

Healthy and unhealthy types of unemployment

-Frictional unemployment due to normal labour turnover and job search; healthy part of a changing economy; not a problem -Structural unemployment due to technological change or international competition making workers' skills obsolete;mismatch between skills workers have and the skills new jobs require; healthy part of changing economy; problem requiring retraining. -Seasonal unemployment due to seasonal changes in weather; healthy;not a problem -Cyclical unemployment due to business cycle fluctuations in economic activity; unhealthy part of changing economy; problem needs fixing

Unemployment rate misses

-Involuntary part-time workers employed part time, would rather have full-time job, but can't find one. -Discouraged workers want to work but have given up actively searching for jobs -Labor Underutilization Rate unemployment rate including unemployed involuntary part-time workers, discouraged workers

Time periods for macroeconomic analysis are

-Long run-a period of time long enough for all prices and wages to adjust to equilibrium; economy at potential GDP, the full employment outcome of coordinated smart choices. -Short run- a period of time when some input prices do not change; not all prices have adjusted to clear all markets. Difference based on real world observations that rices adjust more slowly in input (labour) markets in in output markets.

For any economy with money, M x V = Px Q, where

-M quantity of money -V velocity of money number of times a unit of money changes hands during a year -P average prices- Consumer Price Index - Q aggregate quantity of real output - Px Q nominal GDP There must be enough money, multiplied by velocity, to allow sales of all output produced (nominal GDP)

Yes-Left Alone, Markets Self-Adjust- Hands off camp belives

-Macroeconomic and microeconomic outcomes are the same -External events or government policy cause business cycles -Government failure is more likely than market failure -Government should be hands-off

Supply shocks

-Negative supply shocks directly increase costs or reduce inputs, decreasing short-run aggregate supply SAS shifts leftward -Positive supply shocks directly decrease costs, increase inputs, or improve productivity, increasing short-run aggregate supply SAS shifts rightward

Increases in labour

-Quantity - population growth, immigration, labour force participation rate Quality - increases in human capital-Participation Rates increased earning potential from work Labour Force experience, on-the-job training, education

Short-run aggregate supply macro economic players

-Short-run aggregate supply quantity of real GDP macroeconomic players plan to supply at different price levels. -Law of short-run aggregate supply as price level rises, aggregate quantity supplied of real GDP increases. Changes in price level cause movement along an unchanged short-run aggregate supply curve (SAS)

Relation between natural rate of unemployment and potential GDP

-When unemployment = natural rate;real GDP = potential GDP; full employment -When unemployment > natural rate;real GDP < potential GDP; recessionary output gap; cyclical unemployment -When unemployment < natural rate; real GDP > potential GDP; inflationary output gap

Market for loanable funds

-banks coordinate supply of loanable funds (saving) with demand for loanable funds (borrowing for investment spending) -Interest rate is the price of loanable funds -If banks loan out savings to business borrowers who spend on new factories and equipment, that spending replaces consumer saving Short-run aggregate supply still = aggregate demand

Economic growth

-expansion of economy's capacity to produce products and services; increase in potential GDP (per person). -Macro production possibilities frontier (PPF) shows maximum combinations of products and services a country can produce when all inputs fully employed. -On macro PPF, all inputs fully employed; economy producing at potential GDP -Inside macro PPF, some inputs unemployed; economy producing below potential GDP

Realized real interest rate

=nominal interest rate adjusted for inflation = nominal interest rate - inflation rate

Negative output gap

A negative recessionary gap occurs when real GDP is below potential GDP.

Positive output gap

A positive inflationary gap exists when real GDP is above potential GDP.

Law of aggregate demand

All aggregate demand plans are in the short run -Aggregate demand quantity of real GDP macroeconomic players plan to demand at different price levels -Law of aggregate demand as price level rises, aggregate quantity demanded of real GDP decreases

Economic model

An economic model is a simplified representation of the real world, focusing attention on what's important for understanding. Economic models assume all other things not in the model do not change. Mental equivalent of controlled experiments in the laboratory.

Macroeconomic players

Are consumers, buisnesses, government. make two kinds of plans for supplying real GDP Supply plans for existing inputs Supply plans to increase inputs. Focus on business supply plans as most important. Production takes time, so business supply plans are based on expectation of what demand will be when products come to market.

Role of citizens

As a citizen, you vote for governments that make policy decisions that influence our economy's performance. Those policies could make the difference between boom and bust, between steady growth in living standards and prolonged recession. You can make an informed choice by understanding the basics of macroeconomics and using that knowledge to come to your own conclusion about the fundamental macroeconomic question.

When is GDP the best measure of living standards

As long as there are no significant changes over time in the extent of non-market production, the underground economy, environmental damage, leisure, political freedoms, and social justice, most economists believe the growth of real GDP per person is still the best measure of the increase in the standard of living and well-being for a country.

Full employment still has

At full employment (natural rate) there is still structural and frictional and seasonal unemployment.

Demand pull and cost push

Both demand-pull and cost-push inflation require an accompanying increase in the quantity of money. Over time, trade-offs between unemployment and inflation of the original Phillips Curve become complicated due to changes in -Expectations of inflation -Natural rate of unemployment

Buisness supply existing inputs

Business supply plans for existing inputs with fixed input prices are like microeconomic choices about quantity supplied

CPI and inflation

CPI fixes quantities in the shopping basket to isolate impact of changing prices only on cost of living -When prices rise, CPI misses quantity switches to cheaper substitutes and new/improved products -Inflation rate based on the CPI overstates increases in cost of living.

Demand shocks

Changes in factors other than the price level that change aggregate demand and shift aggregate demand curve (AD) Expectations Interest rates Government policy GDP in R.O.W. - Exchange rates -Y and P move in same direction Unemployment and inflation move in opposite directions; like Phillips Curve

Input prices and short-run aggregate supply curve

Changes in input prices shift short-run aggregate supply curve (SAS) but not long-run aggregate supply curve (LAS). -Rising input prices shift SAS leftward -Falling input prices shift SAS rightward

Comparative Statics for Macroeconomics

Changes in real GDP, unemployment, and inflation are the result, not the cause, of economic events. Thinking like an economist means analysing a situation using comparative statics Start with one equilibrium situation (intersection of aggregate supply and aggregate demand, other things the same) -Change one other thing/variable -Compare resulting equilibrium situation (intersection of aggregate supply and aggregate demand after change) in terms of real GDP, unemployment, and inflation.

Consumer/business/world choices

Consumer choices:spend income or save buy Canadian products and services, or imports Business choices: investment spending - business purchases of new factories and equipment hiring workers or not buying inputs domestically or importing selling outputs domestically or exporting Rest of World (R.O.W.) choices: - buying Canadian exports and selling imports to Canada - investing money in Canada or accepting Canadian investments

Components of Aggregate Demand

Consumers plan to spend (C) a fraction of disposable income and save the rest. -Consumer spending is largest, most stable component of aggregate demand. Businesses plan investment spending (1) for new factories and equipment Investment spending plans change quickly because easily postponed and affected by interest rates. Investment spending is the most volatile component of aggregate demand

AGGREGATE DEMAND

Demand plans by macroeconomic players (consumers, businesses, government,)determine the aggregate quantity demanded. Demand shocks from changes in expectations, interest rates, government policy, GDP in R.O.W., exchange rates change aggregate demand.

How do Markets fail

Due to economies of scale or externalities, markets can fail to produce outcomes in the public interest. Government policy can improve market outcomes by acting in the public interest.

Economic growth affect on potential GDP

Economic growth increases potential GDP (per person) -Shifts macro PPF outward -Caused by increases in the quantity or quality of a country's inputs, including technological change Memorize graph

Fallacy of composition and aggregate demand

Fallacy of composition makes macroeconomic law of aggregate demand different from microeconomic law of demand -When prices rise for all Canadian products and services, only substitutes are imports from R.O.W. -Canadians buy more imports, and R.O.W. buys fewer Canadian exports Planned spending on aggregate demand planned C + planned / + planned G + planned (X- IM)

How GDP is calculated

GDP is calculated by adding up the value of all final products and services produced annually in a country. It includes only final products and services -consumed directly by consumers - and excludes intermediate products and services to avoid double counting. In this case, the dealer sold the kayak to her customer for $800. Thus, the production of a kayak adds $800 to GDP .

Outcomes

Good outcomes are higher gross domestic product (GDP) lower unemployment low and predictable inflation

Government role

Governments set rules of the game and can choose to interact in any aspect of the economy, including policy

Performance indicators

Gross domestic product, unemployment, and inflation

High input prices and long/short run supply curve

Higher inputs prices cause a decrease in SAS, but do not affect LAS because there is no change in the quality or quantity of inputs.

Nominal and real GDP

If 2002 happens to be the year used as a standard for constant prices, nominal GDP in 2002 is equal to real GDP in 2002. Assuming a standard year of 2002, to calculate real GDP for 2008, we use the prices in 2002 and quantities in 2008.

Economic contraction

If the economy goes into a contraction, the unemployment rate exceeds the natural rate; additional unemployment is cyclical unemployment; and real GDP falls below potential GDP.

Positive demand shocks effects

Increase aggregate demand, AD shifts rightward More optimistic expectations (1) Lower interest rates (I or C Higher government spending or lower taxes (Gor C Increased GDP in R.O.W. (X) Lower value of Canadian dollar (X and Inf) -cause an inflationary gap rising average prices, increased real GDP, decreased unemployment

Inputs affecting supply

Increases in inputs cause a rightward shift of both LAS and SAS.

Inflation helps/harms who

Inflation helps borrowers who pay back with less valuable dollars. Inflation harms those who are on fixed incomes or who save.

Negatives of inflation

Inflation is a worry because of falling value of money Inflation reduces purchasing power of people with fixed (unchanged dollar) income or savings Inflation affects interest rates

Theory of money and inflation

Inflation is always accompanied by increases in quantity of money -But increase in quantity of money does not always cause inflation, especially when Q (real GDP) is below potential GDP -Not all inflation is caused by increases in quantity of money

How do governments fail

It is possible that government policy may not act in the public interest. Lobbying, campaign contributions, and political pressure can cause governments to act in the interests of businesses, labour organizations, or other special interest groups. Even when aiming for the public interest, government policy makers often lack timely and accurate information for making smart policy decisions. The complexity of the economy, the banking system, changeable expectations, and connections to the global economy make it easy for government policy makers to make "honest mistakes" when trying to solve complex, interconnected macroeconomic problems. When government policy fails to serve the public interest, it is called government failure.

Participation rate formula

Labour force/Students working-age population

Long run

Long run is defined in terms of the economy being at potential GDP, which is the full employment outcome of coordinated smart choices.

LONG-RUN AGGREGATE SUPPLY

Long-run aggregate supply models the macroeconomic target outcomes of potential GDP and full employment with existing inputs. Long-run aggregate supply quantity real GDP supplied when all inputs fully employed. Long-run aggregate supply curve (LAS) vertical line at potential GDP; potential GDP does not change when price level changes.

Summary image

Memorize image (saved in favs)

Introduction to the Aggregate Supply & Aggregate Demand Model

Model of aggregate supply & aggregate demand explains When the economy hits targets of potential GDP, full employment, stable prices When the economy misses targets, resulting in business cycles, unemployment, inflation -Caused by shifts of aggregate supply & aggregate demand Supply shocks and demand shocks -Differences between Yes and No camps on origins of shocks, nd how economy responds after a shock.

Who chooses policies

Monetary policy is chosen by the Bank of Canada and banking system. Fiscal policy is chosen by government.

Negative/ Positive demand shocks

Negative demand shocks decrease aggregate demand, AD shifts leftward Positive demand shocks increase aggregate demand, AD shifts rightward

Fiscal policy

One of the forms of government policy decisions to purposefully leave the economy alone or influence is fiscal policy.Uses government purchases, taxes, and transfers to achieve the macroeconomic outcomes of steady growth, full employment, and stable prices.

Labor Force Participation Rate

Percentage of working-age population in the labour force (employed or unemployed). Labor Force Participation Rate= Labour Force/Working-age population X100

Inflation

Persistent rise in average prices and fall in value of money -You must spend more to get same products and services as before -Your money is worth less

Existing inputs are unused or unemployed at

Points inside PPF Any quantity of real GDP less than potential GDP

Potential GDP

Potential GDP (full-employment output) is modeled as Points on production possibilities frontier (PPF)

Review of Comparative Statics for Microeconomics

Price and Quantity changes are the result, not the cause, of economic events. Thinking like an economists means analyzing a situation using comparative statics. Start with one equilibrium situation (intersection of supply and demand, other things the same) -Change one other thing/variable -Compare resulting equilibrium situation (intersection of supply and demand after the change) in terms of price and quantity.

Increases in capital

Quantity - more factories and equipment Quality-technological change-improvements in quality of capital through innovation, research, development

Increases in entrepreneurship

Quantity and quality interrelated Better management techniques, organization, worker/management relations

Increases in land and resources

Quantity-bringing land and resources not connected to markets into the circular flow Quality-due to increases in capital used with land

Real and potential GDP

Real GDP = potential GDP at points on the macro PPF in the long run.

Real GDP calculation

Real GDP is calculated using quantities for the year in which the calculation occurs, but prices for the standard year. Since the standard year is 2002, to calculate real GDP for 2002, we use the prices in 2002 and quantities in 2002.

Positive output gap

Real GDP is greater than potential GDP, so the output gap is positive, and the economy is experiencing inflationary pressures from tight supplies.

Cost-push inflation

Rising average prices caused by decreases in supply -Does not fit Phillips Curve -Caused by supply shocks events directly affecting businesses' costs, prices, and supply -Decrease in supply pushes up output prices, while pushing economy into contraction, increasing unemployment. -Can cause stagflation combination of recession (unemployment) and inflation.

AS/AD Model Puts Together

SAS (Short-Run Aggregate Supply) Short-Run supply plans by all macro players with fixed input prices AD (Aggregate Demand) Short-run demand plans by all macro players LAS (Long-Run Aggregate Supply) Different from SAS and AD. LAS is a performance target, where all economists want the economy to end up.

Where do AS/AD models intersect

Short-run macro equilibrium at intersection SAS and AD Long-run macro equilibrium at intersection SAS and AD and LAS -Aggregate quantity supplied = Aggregate quantity demanded of real GDP +Potential GDP

Stagflation

Stagflation combines high unemployment and high inflation, violating the inverse relation in the Phillips Curve.

Say's law

Supply creates its own demand

SHORT-RUN AGGREGATE SUPPLY

Supply plans for existing inputs determine the aggregate quantity supplied. Supply plans to increase the quantity and quality of inputs, together with supply shocks, change aggregate supply.

Supply plans

Supply plans to increase quantity or quality of inputs cause increase in aggregate supply increase in economy's capacity to produce real GDP. Changes in quantity or quality of inputs shift both long-run aggregate supply curve (LAS) and short-run aggregate supply curve (SAS) in same direction. Both aggregate supply curves shift rightward for increase in inputs; leftward for decrease in inputs.

Impact of taxes

Taxes redistribute income between different macroeconomic players, but do not affect the quality of life for the economy as a whole.

Thinking like a macroeconomist

The Canadian economy is complex with connections between the banking system, changeable expectations, and the global economy. The key to thinking enough like a macroeconomist, to understand how the economy as a whole works, and how well it is performing, is to focus on connections inside the economy and out to the rest of the world.

Phillips curve

The Phillips Curve shows an immediate trade-off /inverse relation between unemployment and inflation consistent with demand-pull stories of inflation. Cost-push inflation (simultaneous unemployment and inflation) changes in expectations and changes in the natural rate of unemployment complicate the original Phillips Curve.

cyclical unemployment in a recessionary gap

The cyclical unemployment in a recessionary gap is added to the natural rate to get the unemployment rate.

Economics is science of thinking quote

The full quote is "Economics is a science of thinking in terms of models, joined to the art of choosing models which are relevant to the contemporary world."

Hands on view

The hands - on view argues that, if left alone by government, the self - adjusting mechanisms of market economies can be slow and weak so that business cycles, long periods of unemployment that reduce living standards, and rising or falling prices will recur regularly. This view argues for a hands - on approach for government.

Hands off view

The hands-on camp believes that most economic problems are caused internally as unintended by-products of normally functioning markets. This camp emphasizes that money, banks, and expectations can block the connections between input and output markets as origins of business cycles. The hands-off camp, on the other hand, believes that government policy causes business cycles.

GDP

The most important concept for understanding your standard of living, and perhaps the most basic macroeconomic concept, is gross domestic product (GDP). GDP is the value of all final products and services domestically produced annually in a country.

Output gap

The output gap is the difference between real GDP and potential GDP.

Output gap calculation

The output gap is the difference between real GDP and potential GDP. In 2014, using 2013 prices, potential GDP is $550. Using 2013 prices, real GDP in 2014 = $5x 15 + $11 × 45 = $570 output gap in 2014 = $570 - $550 = $20

Labour force

The size of the labour force is the number of employed plus unemployed.

velocity of money

The velocity of money is the number of times a unit of money changes hands during a year.

Unemployment Rate

Unemployment Rate= Unemployed/labor force X 100

Unemployment and GDP relationship

Unemployment tends to be inversely related (when one goes up, the other goes down) to growth in levels of GDP. As GDP goes down, unemployment goes up. When the economy shrinks, employment decreases, and unemployment increases. When unemployment increases, workers have a disadvantage when bargaining for higher wages.

Inflation is a worry because

Unpredictable prices create risk and discourage business investment Expectations of inflation can cause inflation Predictable inflation rates between I and 3 percent are Bank of Canada's aim

Value adding formula

Value added is the value of a business's outputs minus the value of intermediate products and services bought from other businesses. Thus, the business's value added here is ($2,000 - $500) = $1,500.

Value adding impact

Value added solves the problems of double counting and of distinguishing between final and intermediate products and services.

Velocity and GDP

Velocity is fixed (constant) and real GDP is assumed equal to potential GDP.

The "mantra" for calculating GDP

Y (GDP) = C (consumption) + I (business investment) + G (government spending) + X (exports) - IM (imports).

Supply Shocks

Y and P move in opposite directions Unemployment and inflation move in same direction: inconsistent with original Phillips Curve

Inflation rate calculation

annual percentage change in Consumer Price Index Inflation Rate=CPI for current year-CPI for previous year/CPI for previous year X100

Economic growth rate

annual percentage change in real GDP per person Real GDP per person growth rate (percent)= Real GDP per person this - Real GDP per person last year/Real GDP per person last year/100

"Yes Markets Self-Adjust"

answer is based on Say's law supply creates its own demand (F. Hayek)

"No Markets Fail Often"

answer is from J. M. Keynes, founder of macroeconomics in| 930s

Economic models

assume all other things not in the model do not change. The mental equivalent of controlled experiments in a laboratory.

Paradox of thrift

attempts to increase saving cause total savings to decrease because of falling employment and incomes

Negative supply shocks

cause stagflation rising average prices, decreased real GDP. increased unemployment

Creative destruction

competitive business innovations generate profits for winners, improving living standards for all, but destroy less productive or less desirable products and production methods

Impact of Negative demand shocks

decrease aggregate demand. AD shifts leftward More pessimistic expectations (I) Higher interest rates (l or C) Lower government spending or higher taxes (Gor C) Decreased GDP in R.O.W. (X) Higher value of Canadian dollar (X and IM) -cause a recessionary gap falling average prices, decreased real GDP, increased unemployment

Labour force formula

employed + unemployed

Government failure

government policy fails to serve the public interest

Quantity theory of money

increase in quantity of money causes an equal percentage increase in inflation rate Takes equation M x V = P x Q, fixes V and fixes Q at potential GDP "Printing money causes inflation"

Core inflation rate

inflation rate excluding volatile categories (review in fav pics)

Market failure

market outcomes are inefficient or inequitable and fail to serve the public interest

Consumer Price Index (CPI)

measure of average prices of fixed shopping basket of products and services

Full employment

not zero percent unemployment, but zero percent cyclical unemployment

Rule of 70

number of years it takes for initial amount to double is roughly 70 divided by annual percentage growth rate eg (1% =70, 2% =35, 3% =23.3) Keep dividing percent by 70

Nominal interest rate

observed interest rate; dollars received per year in interest as percentage of dollars saved

Deflation

persistent fall in average prices and a rise in value of money -Consumers postpone spending, causing economic contraction and increasing unemployment -Deflation benefits savers but hurts borrowers

Productivity

quantity of real GDP produced by an hour of labour -Increases in productivity increase living standards -More can be produced -Reduced amount of work time required to buy products and services

Potential GDP

real GDP when all inputs fully employed labour, capital, land/resources, entrepreneurship Short-run goal for economic performance Outcome if invisible hand works perfectly Potential GDP per person= potential GDP divided by the population

Circular flow model of economic life

reduces the complexity of the Canadian economy to three sets of players who interact in markets households, businesses, and governments. In input markets, households are sellers, businesses are buyers In output markets, households are buyers, businesses are sellers

Demand-pull inflation

rising average prices caused by increases in demand -explains Phillips Curve's trade-off between unemployment and inflation. -During expansions, demand is key force causing shortages and pulling up prices for inputs (wages) and outputs.

Positive supply shocks

shocks cause falling average prices, increased real GDP, continued full unemployment

Natural Rate of Unemployment

unemployment rate at full employment; includes frictional, structural, seasonal unemployment

Language of business cycles

up and down fluctuations of real GDP around potential GDP -Expansion:period during which real GDP increases -Peakhighest point of an expansion -Contraction:period during which real GDP decreases -Trough-lowest point of a contraction Recession: 2+ successive quarters of contraction of real GDP

Fallacy of composition

what is true for one is not true for all: the whole is greater than the sum of the individual parts

All macroeconomists agree that:

• there is some role for government (setting the rules of the game), but differ on how big a role there should be for fiscal and monetary policy; • prices and markets adjust, but differ on how long the adjustments take (how quick is "quickly" ?); • business cycles happen even without government failure, but differ in focusing on the relatively steady growth of market economies in the long run ("Yes"), or focusing on the ups and downs of business cycles in the short run ("No").