ECON- chapter 19-27

Suppose that interest rate rises. AD moves left because:

- firms and households reduce their planned investments, decreasing aggregate demand. --> workers then lose their jobs, and firms experience decreases in sales. ________________________________________ -workers become willing to accept lower wages, and firms expect lower prices for their output. --> so the SRAS curve moves to the right, with goods and services sold for lower prices, until we return to full-employment

The wealth effect

How a CHANGE IN THE PRICE LEVEL affects consumption (C) --> household consumption is most strongly determined by income, but it is also affected by wealth. --> some household wealth is held in nominal assets; so as price level rise, the real value of household wealth declines. This results in less consumption.

HYPERINFLATION

Hyperinflation results when central banks increase the money supply at a rate far in excess of the growth rate of real GDP. --> this might happen when governments want to spend much more than they raise through taxes, so they force their central bank to "buy" government bonds. --> Hyperinflation tends to be associated with SLOW growth, if not SEVERE RECESSION

Based on these data, the inflation rate from 2016 to 2017 is the percentage change in the CPI:

((122-120)/120) x 100= 1.7% Since the CPI measures consumer prices, it is often referred to as the cost-of-living index. --> CPI-inflation is sometimes used to generate "fair" increased in wages for workers, and government benefits.

Unemployment rate calculated

(Number of unemployed/labor force) x 100 8.03 million/157.07 x100 = 5.1% umemployed

employment-population ratio calculated

(employment/working-age population) x 100 149.04 million/251.1 million x100= 59.3% employed

labor force participation rate calculated

(labor force/working-age population) x 100 149.04 million/251.1 million x100 = 62% participating

newly industrializing countries

--> the 1980s and 1990s have seen some countries progress out of the "developing" category, like Singapore, South Korea, and Taiwan

Recessions and the Components of AD examples of 2007-2009 recession

-CONSUMPTION spending fell, relative to potential GDP during the recession (this is unusual b/c consumption usually stays steady during a recession) -residential INVESTMENT had been falling before the recession, and continued during it. Spending on residential investment has continued to be below the pre-recession boom levels. -NET EXPORTS increased (became less negative). it was part due to the falling value of the $US. after the recession, net exports started to decrease, but then have stayed relatively steady.

SRAS Shifts: Expected Future Prices

-If workers and firms believe the price level will rise by a certain amount, they will try to adjust their wages and prices accordingly. --> widely-held expectations of future price-level increases are self-fulfilling

Long-Run Macroeconomic Equilibrium

-In the long run, we expect the economy to produce at the level of potential GDP-- i.e., the LRAS level. -->So the long run macroeconomic equilibrium occurs when the AD and SRAS curves intersect at the LRAS level. --> our next task is to explain why long-run maroeconomic equilibrium cannot occur at any other level of output. --> for simplicity, assume: 1. No inflation; the current and expected-future price level is 100. 2. No long-run growth; i.e. the LRAS curve is not moving.

The Multiplier Effect in Action

-Initially, real GDP rises by the amount of the increase in autonomous expenditure. This causes an increase in real GDP, which causes an increase in production, which causes an increase in real GDP.....

creative destruction

-Joseph Schumpeter developed a model of growth emphasizing his view that new products unleashed a "gale of creative destruction" (the automobile replaced the horse-drawn carriage, this 'creation' DESTROYED carriage makers and associated firms)

Reserves

-Reserves are deposits that a bank keeps as cash in it's vault or on deposit with the Federal Reserve. --> the bank does not keep enough deposits on hand to cover all of its deposits. This is how the bank makes a profit: lending out or investing money deposited with it.

Aggregate expenditure (AE)

-Total spending in the economy: the sum of consumption, planned investment, government purchases, and net exports --> upward sloping because, there is positive relationship between real GDP and aggregate expenditure

PSYSICAL capital is rival and excludable....

-a PRIVATE GOOD-- and this results in its DIMINISHING RETURNS

HUMAN capital is non-rival and non-excludable...

-a PUBLIC GOOD--and hence results in INCREASING RETURNS-- not at the firm level, but at the economy level

"lender of last resort"

-a central bank, like the FEDERAL RESERVE, can help to prevent bank runs and panics by acting as a LENDER OF LAST RESORT, promising to make loans to banks in order to pay off depositors --> this assurance helps make people confident in being able to eventually receive their money and prevents the panic. (in the late 19th and early 20th centuries, the United States experienced several bank panics)

aggregate demand (AD) curve

-a curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government --> downward sloping because it reflects the inverse relationship between the price level and the level of planned aggregate expenditure

long-run aggregate supply curve:

-a curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied --> in the long run, the level of real GDP is determined by the number of workers, the level of technology, and the capital stock (factories, machinery, etc). --> NONE of these elements are AFFECTED by the price level. ----> so, the long-run aggregate supply curve DOESN'T DEPEND ON THE PRICE LEVEL; its a vertical line, at the level of potential or full-employment GDP

AD shifts: changes in monetary policy

-a government policy change could shift aggregate demand. There are 2 categories of government policies here: 1. Monetary policy 2. Fiscal policy

Aggregate Demand and Aggregate Supply Model

-a model that explains the short-run fluctuations in real GDP and the price level. --> it will help us to understand why real GDP, the level of employment, and the price level fluctuate. In the short run, real GDP and he price level are determined by the intersection of the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve

Business cycle/recession

-a recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade. --> the federal government does not define when a recession starts or ends --> the typical media definition of a recession is "two consecutive quarters of declining real GDP" ____________________________ The period of recession starting in late 2007 and ending in mid 2009 was the longest/most severe since the Great Depression of the 1930s, prompting some to refer to it as the "Great Recession"

SRAS Shifts: Unexpected Changes in Price and Resources

-a supply shock is an unexpected event that causes the short-run aggregate supply curve to shift. -->example: oil prices increase suddenly. firms immediately anticipate rising input prices, and as a consequence, will only produce the same amount of output if their own prices rise. --> unexpected input price INCREASE- DECREASES SRAS; unexpected input price DECREASES would INCREASE SRAS.

Knowledge together with entrepreneurship leads to economic growth

-accumulation of human capital is a KEY DETERMINANT of economic growth. Increases in human capita result from RESEARCH AND DEVELOPMENT, and other technological advances.

aggregate supply and time frame

-aggregate supply refers to the quantity of goods and services that firms are willing and able to supply. --> the relationship between this quantity and the price level is different in the long and short run.

3. menu costs make some prices sticky (related to why the SRAS curve is upward-sloping)

-altering prices is sometimes costly in itself. Firms have menu costs when it costs them money to change prices, for example by having to print new catalogs. A small "optimal" change in price may not be worth the hassle for a firm to perform.

should the federal budget be balanced?

-although many economists believe the federal budget should be balanced when the economy is at potential GDP, few believe it should be balanced during a recession. --> during a recession, tax revenues fall; to balance the budget, spending would have to fall also-- making the recession worse. --> in fact, some economists argue that the federal budget should normally be in deficit. Just as households and firms borrow money to implement long-term investments, they argue that the federal government should do the same. --> especially since the government can borrow so cheaply

Model of Economic Growth

-an economic growth model SEEKS TO EXPLAIN growth rates in real GDP per capita over time.

SRAS Shifts: Factors of Production and Technology

-an increase in the AVAILABILITY OF THE FACTORS OF PRODUCTION, like labor and capital, allow more production at any price level. --> a decrease in the availability of these factors decreases SRAS --> improvements in technology allow productivity to improve, and hence the level of production at any given price level.

2. firms are often slow to adjust wages (related to why the SRAS curve is upward-sloping)

-annual salary reviews are "normal", for example. Also, firms dislike cutting wages-- it's bad for morale.

Unemployment Through Business Cycles

-as firms see their sales start to fall in a recession, they generally reduce production and lay off workers. -notice that unemployment often continues to rise after the end of each recession

the price level (how it affects the level of consumption)

-as prices rise, household wealth falls. --> if you have $100,000 in the bank, that will fewer products at higher prices. Consequently, higher prices result in lower consumption spending.

Required reserves

-banks in the US are required to hold required reserves: reserves that a bank is legally required to hold, based on its checking account deposits.

the establishment of unemployment insurance

-before the 1930s, unemployment insurance and other government transfer programs like social security did not exist. These programs increase the ABILITY of consumers to PURCHASE goods/services during recession

Dynamic AD and AS Model

-before, we did not allow change in price levels (no inflation) and there was no long-run growth. Therefore, our LRAS did not move. --> continually-increasing real GDP, shifts LRAS to the right (economic growth) --> AD also ordinarily shifts to the right -->SRAS shifting to the right expect when workers and firms expect high rates of inflation.

public goods, such as human capital generation, result in "free-riding:"

-benefitting from goods and services you do not pay for

Fiscal policy

-changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives. --> increasing or decreasing taxes affects disposable income, and hence consumption. The government can also alter its level of government purchases.

Current disposable income (how it affects the level of consumption)

-consumer expenditure is largely determined by how much money consumers receive in a given year. --> we measure this by personal income, minus personal income taxes, plus government transfer payment much as Social security. --> income expands most years; hence so does consumption!

consumption tends to follow a relatively smooth, upward trend; its growth declines during periods of recession. What affects the level of consumption?

-current disposable income -household wealth -expected future income -the price level -interest rate

Differences in Incomes across Countries

-economists often refer to the "high-income countries" (or industrial countries) of Western Europe, Australia, Canada, Japan, New Zealand, and US, in comparison to the poorer "developing countries" of the rest of the world -->real GDP per capita is markedly different across the world, even after correcting for cost of living differences. In 2012 it ranged from a high of $103,900 in Qatar to a low of $400 in the Democratic Republic of the Congo

adjustments to macroeconomic equilibrium

-equilibrium in the economy occurs when spending on output is equal to the value of output produced, that is: AE= Y

we conclude that saving must equal investments: S=I

-firms borrow loanable funds from households. --> they borrow more when households demand a lower return on their money-- a lower real interest rate. -households supply loanable funds to firms. --> they provide more when firms offer them a greater reward for delaying consumption--a higher real interest rate GOVERNMENTS, through their saving or dissaving, affect the quantity of funds that "pass through" to firms

cash flow (how it effects planned investment)

-firms often pay for investments out of their own cash flow, the difference between the cash revenues received by a firm and the cash spending by the firm. --> the largest contributor to cash flow is profit. During recession profits fall for most firms, decreasing their ability to finance investment.

Is Government Debt a Problem?

-for now, the federal government is at no serious risk of defaulting on its obligations, because: -the interest rate can borrow money at is very low. -the size of the interest payments on the debt is low relative to the size of the federal budget-- around 11 percent. --> in the long run, a debt that increases in size relative to GDP can pose a problem-- potentially crowding out investment, which is a key component of long term growth. --> this problem is reduced if the government debt was incurred to finance infrastructure, education, or research and development; these serve as a long-term investment for the economy

taxes (how it effects planned investment)

-higher corporate income taxes on profits decrease the money available for reinvestment and decrease incentives to invest by diminishing the expected profitability of investment. --> similarly, investment tax incentives tend to increase investment

the interest rate (how it affects the level of consumption)

-higher real interest rate encourage saving rather than spending; so they result in lower spending, especially on durable goods

AD shifts: changes in Expectations

-households or firms could become more optimistic about the future, increasing consumption or investment respectively. --> of course, the opposite could also occur

The Multiplier and the Marginal Propensity to Consume

-how can we know the eventual value of the multiplier? -in each "round", the additional income prompts households to consume some fraction (the marginal propensity to consume) __________________________ the total change in equilibrium real GDP equals: the initial increase in planned investment spending= $100 billion -> plus the first induced increase in consumption= MPC x $100 billion --> plus the second induced increase in consumption= MPC x (MPC x $100 billion) =MPC^2 x $100 billion and so on.....

How long Does adjustment to Long-Run Equilibrium Take?

-how long does it take to restore full employment? --> It depends on the SEVERITY OF THE SUPPLY SHOCK, but it is likely to take several years. ________________________________________ -an alternative to waiting this long is to use fiscal or monetary policy to increase aggregate demand. --> this will result in permanently higher prices buy may be worth the cost

More Capital or Technological Change?

-if a country is relatively lacking in capital-- like many of the developing countries- increases in capital will be very effective at increasing real GDP per capita -In countries where the amount of CAPITAL is already relatively HIGH, TECHNOLOGICAL CHANGE becomes a more effective way to increase output per hour

AD shifts: changes in Foreign Variables

-if foreign incomes rise more slowly than ours, their imports of our goods fall; if ours rise more slowly, our imports fall --> if our EXCHANGE RATE (the value of the $US) rises, our exports become more expensive, so foreigners buy less of them (and we buy more imports, also). ---> 3 elements affect net exports: the price level in the US relative to other countries, real GDP growth in the US relative to other countries, and the $US exchange rate. The 2nd and 3rd can SHIFT AD; but the 1st causes MOVEMENT ALONG AD

discount loans and discount rate

-in 1914, the Federal reserve system started. -"the Fed" makes loans to banks called discount loans, charging a rate of interest called the discount rate. --> during the great depression in the 1930s, many banks were hit by bank runs. Afraid of encouraging bad banking practices, the Feds refused to make discount loans to many banks, and more than 5,000 banks failed. Today, many economists are critical of the Fed's decisions in the early 1930s, believing they made the Great Depression worse.

contractionary monetary policy in the dynamic model

-in 2005, the Fed believed the economy was in long-run equilibrium -in 2006, the Fed believed aggregate demand growth was going to be "too high", resulting in excessive inflation. --> so the Feds raised the federal funds rates-- a contractionary monetary policy, designed to decrease inflation -->the result: lower real GDP and less inflation in 2006, than would otherwise have occured

Expansionary Monetary Policy in the Dynamic Model

-in period 1, the economy is in long-run equilibrium at $17 trillion. --> the Fed forecasts that aggregate demand will not rise fast enough, so that in period 2, the short-run equilibrium will fall below potential GDP, at $17.3 trillion. --> so the Fed uses expansionary monetary policy to increase aggregate demand. --> the result: real GDP at its potential; and a higher level of inflation than would otherwise have occurred.

Can the Fed Eliminate Recessions?

-in practice, monetary policy is much harder to get right than the graphs make it appear. --> completely offsetting a recession is NOT REALISTIC; the best the Fed can hope for is to make recessions milder and shorter _______________________________________ Another complicating factor is that current economic variables are rarely known; we usually can only know them for the past-- i.e. with a lag. --> ex. - in November 2001, NBER announced that the economy was in recession that has begun in March 2001

Supply Shock

-in the previous analyses, AD moved suddenly. What if instead SRAS moved suddenly? We call this a SUPPLY SHOCK. --> for example, suppose a sudden increase in oil prices shifts SRAS to the left. ---> this causes STAGFLATION, a combination of inflation and recession, usually resulting from a supply shock.

adjustment to macroeconomic equilibrium

-in this economy, macroeconomic equilibrium occurs at $10 trillion. --> what if real GDP were lower, say 8 trillion? --> aggregate expenditure would be higher than GDP, so inventories would fall. This would signal firms to INCREASE production, INCREASING GDP. --> the reverse would occur if real GDP were above 10 trillion. ______________________ Macroeconomic equilibrium can occur anywhere on the 45 degree line. Ideally, we would like it to occur at the level of POTENTIAL GDP. --> if equilibrium occurs at this level, unemployment will be low-- at the natural rate of unemployment, or the full employment level.

Inflation Through Business Cycles

-inflation tends to rise towards the end of an expansion and fall over the course of each recession

An expansionary Fiscal Policy in the Dynamic Model

-initially, the economy is in long-run equilibrium -the federal government projects that aggregate demand will not rise by enough to maintain full employment. -it enacts an expansionary fiscal policy to increase aggregate demand, hopefully to the full employment level. --> the price level is HIGHER than it would have been without the expansionary fiscal policy

According to Schumpeter, the entrepreneur is central to economic growth; and the profits of entrepreneurs provide the incentive for bringing together the factors of production-- labor, capital, natural resources-- in new ways. More so, the entrepreneurs:

-introduce new good, new method of production -opening of a new market. markets may have exited before in another area or for another product -seize a new source of supply or raw materials -new organization of any industry. Create a monopoly or brake one! --> AS A RESULT, entrepreneurs create MAJOR ECONOMIC CHANGES.

expectations of future profitability (how it effects planned investment)

-investment goods, such as factories, office buildings, machinery, and equipment, are long-lived. -->Firms build more of them when they are optimistic about future profitability. --> purchases of new housing are included in planned investment. In recessions, households have reduced wealth, and less incentive in new housing

planned investment and what affects it?

-investment has increased over time, but unlike it has not increased smoothly, and recessions decrease investment more. Investment is subject to larger changes than is consumption. Investment declined significantly during the recession of 1980, 1981-1982, 1990-1991, 2001, and 2007-1009. ________________________ what affects it? -expectations of future profitability -interest rate -taxes cash flow

contractionary fiscal policy

-involves DECREASING government or INCREASING taxes --> this works just like expansionary fiscal policy, only in reserve. --> if the government believes real GDP will be ABOVE POTENTIAL GDP, it can enact contractionary fiscal policy in an attempt to restore long-run equilibrium-- decreasing inflation.

expansionary fiscal policy

-involves INCREASING government purchases or DECREASING taxes. --> if the government believes real GDP will be BELOW POTENTIAL GDP, it can enact expansionary fiscal policy in an attempt to restore long-run equilibrium-- decreasing umemployment

household wealth (how it affects the level of consumption)

-it can be thought of as its assets (like home, stocks and bonds, and bank accounts) minus its liabilities (mortgages, student loan, etc). --> households with greater wealth will spend more on consumption, even with similar incomes. --->recent studies estimate that an extra $1,000 in wealth will result in $40-50 in extra consumption spending

planned investment vs actual investment

-main difference b/w GDP vs. AE is ACTUAL investment vs. planned investment --> the difference is that planned investment spending does not include the build-up of inventories planned investments= actual investments - unplanned change in inventories

the increasing importance of services

-manufacturing (especially of durable goods) is more strongly affected by recessions. The economy is based more on services now, decreases the effect of the business cycle on GDP

active federal government stabilization policies

-many, though not all, economists believe that active government policies to lengthen expansion and minimize the effects of recessions have had the desired effect.

Tax Rates Matter

-marginal tax rates matter because the larger they are, the larger will be the behavioral response to the tax: -individual income tax --> affects labor supply decisions and the returns to entrepreneurship -corporate income tax --> affects the incentives of firms to engage in investment -tax on dividends and capital gains -->affects the supply of loanable funds from households to firms and hence the real interest rate --> also affects the way firms disburse profit-- 2003 reduction in dividend tax led some firms like Microsoft to pay dividends for the first time

expected future income (how it affects the level of consumption)

-most people prefer to keep their consumption fairly stable from year to year, a process known as "consumption-smoothing."

The Long-Run Effects of Tax Policy

-most taxes are assessed as a percentage of some economic activity, like individual income, corporate income, or capital gains. --> when an individual decides how much to work, he bases the decision on how much an hour of work will increase his ability to consume goods and services-- the POSTTAX WAGE --> when a firm decides how many people to employ, it considers how much it has to pay in total for each worker: THE PRETAX WAGE

arguments against economic growth might be?

-negative effects on the environment -depletion of natural resources -diminishment of distinctive cultures

Net Exports

-net exports equals exports minus imports. The value of new exports is affected by: --> price level in US vs. the price level in other countries --> US growth rate vs growth rate in other countries --> US dollar exchange rate US. net exports have been NEGATIVE the last few decades. The value typically becomes higher (less negative) during a recession, as spending on imports falls.

1. contracts make some wages and prices "sticky" (related to why the SRAS curve is upward-sloping)

-prices and wages are said to be "sticky" when they do not respond quickly to changes in demand or supply. Some firms and workers fail to predict price level changes, and hence do not correctly build them into long-term contracts

Because firms don't enjoy the entire benefit of their knowledge capital, they don't produce enough of it. The public good nature of knowledge capital leads to a role for government policy in:

-protecting intellectual property with patents and copyrights -->copyrights: granting the exclusive right to use the creation during and 70 years after the creator's lifetime -subsidizing research and development -->gov. might preform research directly-- like NASA and National Institute of health-- or subsidize researchers at institutions like universities. Similarly, they can provide incentives to firms performing R&D -subsidizing education --> in order to preform search and development, workers need to be technically trained. If firms provide this training, they recoup the cost of paying workers lower wages, decrease the incentive for workers to take such jobs.... a solution to this is having the government subsidize education, as it does in all high income countries

Government purchases

-real government purchases include purchases at all levels of government: federal, state, and local. - this category does not include transfer payments; only purchases for which the government receives some good or service. -government purchases have generally, though not consistently, increased over time; exceptions include the early 1990s (end of cold war) and due to state and local cutbacks after 2009

discretionary fiscal policy

-refers to intentional actions the government takes to change spending on taxes.

1. Open market operations (one of the fed monetary policy tool)

-refers to the buying and selling of Treasury securities by the Federal Reserve in order to control the money supply. --> to increase the money supply, the Fed directs its trading desk in New York to buy U.S. treacury securities-- treasury "bills", "notes", and "bonds" which are short term (1 year), medium term (2-10 years), or long term (30 yrs) tradable koans to the U.S. Treasury. ---> to decrease the money supply, the Fed sells its securities. _____________________________________________ These open market operations can occur very quickly, and are easily reversible.

The industrial Revolution

-significant economic growth didn't really begin until the Industrial Revolution, the application of MECHANICAL power to the production of goods and services which began in England around 1750. Before this, production of most goods had relied on human or animal power. --> the use of mechanical power allowed England/other countries to begin to experience lONG-RUN ECONOMIC GROWTH

Tax Simplification

-simpler taxes would also lead to economic gains for society. -the current tax code is extremely complicated-- over 3,000 pages long -the IRS estimates that taxpayers spend more that 6.4 billion hours each year filling out their tax returns-- 45 hours per tax return. --> a simplified tax code would increase economic efficiency by reducing the number of decisions households and firms make solely to reduce their tax payments.

interest rate (how it effects planned investment)

-since buisness investment is sometimes sinanced by borrowing, the real interest rate is an important consideration for investing. --> a HIGHER real interest rate results in LESS investment spending, and a lower real interest rate results in more investment spending.

Autonomous and Induced Expenditures

-small change in planned aggregate expenditure causes a larger change in equilibrium real GDP ______________________ Planned investment, government purchases, and net exports are AUTONOMOUS EXPENDITURES: their level DOES NOT depend on the level of GDP. --> but CONSUMPTION has both an autonomous and induced effect. So its level does depend on the level of GDP, and this produced the upward-sloping AE line. ----> an increase in an autonomous expenditure shifts the aggregate expenditure LINE UPWARD! When this happens, real GDP increases by more than the change in autonomous expenditure; this is the MULTIPLIER EFFECT. --> the value of the increase in equilibrium real GDP divided by the increase in autonomous expenditures is the multiplier.

automatic stabilizers

-some forms of government spending and taxes automatically increase or decrease along with the business cycle (automatic stabilizers) --> example: unemployment insurance payments are larger during a recession

Poorly-Timed Monetary Policy

-suppose a recession begins in August 2016 -the Fed. finds our about the recession with a lag -in June 2017, the Fed starts expansionary monetary policy, but the recession has already ended.. --> by keeping interest rates low for too long, the Fed encourages real GDP to go far beyond potential GDP. The result: high inflation....and the next recession will be more severe!!!

Expansion

-suppose that firms become more optimistic about the future. --> they increase their investment, shifting AD to the right ________________________________________ -Employment falls below its natural rate, forcing employers to pay more; the increased demand for goods raises prices. --> firms and workers raise their expectations about the price level, shifting SRAS to the left-- restoring long run equilibrium

An Increase in the Demand for Loanable funds

-suppose that technological change occurs so that investments become more profitable for firms. --> this will increase the demand for loanable funds --> the real interest rate will rise, as will the quantity of funds loaned

"Crowding Out" in the Market for Loanable Funds

-suppose the government runs a budget deficit. To fund the deficit, it sells bonds to households, decreasing the supply of funds available to firms. --> this raises the equilibrium real interest rate, and decreases the funds loaned to firms. --> this is referred to as crowding out: THE DECLINE IN PRIVATE EXPENDITURES as a result of INCREASES IN GOVERNMENT PURCHASES . -in practice, the effect of government budget deficits and surpluses on the equilibrium interest rate is relatively small

The Supply-Side Effect of a Tax Change

-tax reform has the potential to significantly increase real GDP in the long run beyond the increases that would otherwise occur -the magnitude of the effect is uncertain, however. --> for example, while people might like to work more if tax rates are lowered, they might be constrained by employers expecting a particular work week (like 40 hours)

monetary policy

-the actions the federal reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives. --> if the federal reserve causes interest rates to RISE, investment spending will FALL; if it causes interest rates to FALL, investment spending will RISE

Shifts of the AD Curve vs. Movements along it

-the aggregate demand curve shows the relationship between the price level and real GDP demanded, holding everything else CONSTANT. --> a change in the price level not caused by a component of real GDP changing results in a movement along the AD curve. --> a change in some component of aggregate demand, on the other hand, will shift the AD curve.

Why do growth rates matter?

-the difference between 1.3% and 2.3% may not seem like much; but over a long period, it makes a REMARKABLE difference. -Over 50 years, a 1.3 growth rate leads to about a 91% increase in real GDP per capita. --> a 2.3% growth rate leads to a 212% increase IN THE LONG RUN, small differences in economic growth rates result in BIG differences in living standards

2. Discount policy (one of the fed monetary policy tool)

-the discount rate is the interest rate paid on money banks borrow from the Fed. By lowering the discount rate, the Fed encourages banks to borrow (and hence held out) more money, increasing the money supply. Raising the discount rate has the opposite effect.

a contractionary fiscal policy in the dynamic model

-the economy starts once more in long-run equilibrium. -the federal government projects that aggregate demand will rise so much that employment is beyond the full employment level, causing high inflation --> it enacts a contractionary fiscal policy to decrease aggregate demand, again ideally to the full employment level.

3. Reserve requirements (one of the fed monetary policy tool)

-the fed can alter the required reserve ratio. A decrease would result in more loans being made, increasing the money supply. an increase would result in fewer loans being made.

Countercyclical Fiscal Policy

-the federal government's actions described on the previous slides constitute a countercyclical fiscal policy __________________________________________ Bear in mind that: -the effects described assume CETERIS PARIBUS: everything else is staying the same, including monetary policy. -contractionary fiscal policy is not really causing prices to fall; it's causing inflation to be lower than it otherwise would have been.

The Effect of Fiscal Policy in the Long Run

-the fiscal policy we have concentrated on so far was intended to address short-run goals of stabilizing the economy. -->But other fiscal policy actions are intended to have long-run impacts on potential GDP-- i.e. on aggregate supply, rather than aggregate demand. --> Hence, these actions are often referred to as SUPPLY-SIDE ECONOMICS -Most such policies are based on changing taxes in order to increase incentives to work, save, invest, and start a business.

Why is the AD Curve Downward sloping?

-the interest-rate effect: a change in the price level affects investment (I) -the international-trade effect: how a change in the price level affects net exports (NX) -->each effect moves in the same direction: an increase in the price level decreases real GDP

The Multiplier in Reverse

-the multiplier can work in reverse too, like it did during the Great Depression of the 1930s. Several events, including the stock market crash of october 1929, led to reductions in investments by firms. --> real GDP fell, so consumers cut back on spending, prompting firms to reduce production more, so consumers spent even less...aggregate expenditures fell initially, due to the decrease in investment. --> this prompted a multiplied effect on equilibrium real GDP. ----> recovery from the Great depression took many years; unemployment remained above 10% until the U.S. entered World War II in 1941

increased stability of the financial system

-the severity of the Great Depression of the 1920s was in part caused by instability in the financial system; similar instability exacerbated the recession of 2007-9. Returning to macroeconomic stability will require a stable financial system.

marginal propensity to consume

-the slope of the consumption function! --> shows the relationship between consumption spending and disposable income. households spend a consistent fraction of each extra dollar of real disposable income on consumption. MPC= change in consumption/change in disposable income= ∆C/∆YD

What is the usual cause of inflation?

-the usual cause of inflation is total spending increasing faster than production. --> AD moves further right than does LRAS --> SRAS moves to the right; but the anticipated rise in the price level causes it to move less far than LRAS. --> long run equilibrium is restored, but with a higher price level.

the Consumption Function

-there is a VERY STRONG relationship between INCOME and CONSUMPTION ____________________________________ The line, which represents the relationship between consumption and disposable income (figure b), is called the CONSUMPTION FUNCTION.

How sticky are wages?

-there is disagreement among economists about how sticky wages and prices actually are. -to examine this, it is best to look at individual worker-level data. -some recent studies have done this, finding firms are reluctant to cut workers (nominal) wages. Instead, they: --> offer lower salaries to new hires --> fire current workers --> decrease raises or freeze pay

why are not all countries becoming rich?

-there must be a PROPER ENVIRONMENT for efficient market and improved technology: -->wars and revolutions. They make investment and technological growth difficult -->failure to enforce rule of law. Corruption and incompetence. --> poor public health, education. Urban bias for schools, hospitals. Workers are less productive (brain drain) --> low rates of saving and investment. Undeveloped and insecure financial systems create and "vicious cycle" of low savings and investments, preventing growth. -----> when governments prioritize low inflation over low unemployment, or low taxes over investment in infrastructure or education, they are responding to the preference of the RICH

Eventual effect of the Multiplier

-we cannot say how long this adjustment to macroeconomic equilibrium will take--how many "rounds", back and forth. --> but we can calculate the value of the multiplier, as the eventual change in real GDP divided by the change in autonomous expenditure (planned investment, in this case): _______________ with a multiplier of 4, each $1 increase in planned investment (or any other autonomous expenditure) eventually increases equilibrium real GDP by $4.

High Rates of Inflation

-we know that the usual cause of inflation is total spending increasing faster than production. --> very high rates of inflation-- in excess of 100 percent per year-- are known as HYPERINFLATION

bank run and bank panic

-what if depositors lost confidence in a bank, and tried to withdraw their money all at once? --> this situation is know as a bank run; it many banks simultaneously experience bank runs, a bank panic occurs.

Short-run aggregate supply curve

-while the LRAS is vertical, the SRAS is upward sloping. Why? --> as prices of final goods and services rise, prices of inputs-- such as the wages of workers or the price of natural resources-- rise more slowly --> a secondary reason is that some firms are slow to adjust their prices when the price level rises or falls ____________________________________________ Economists tend to believe that some firms and workers fail to accurately predict changes in the price level. Based on this, there are 3 potential explanations for why the SRAS curve is upward-sloping: 1. contracts make some wages and prices "sticky" 2. firms are often slow to adjust wages 3. menu costs make some prices sticky

Adjustment back to Potential GDP from a Supply Shock

-with the lower level of output, people are unemployed and products go unsold. --> workers accept a lower wage, and firms decrease prices in order to clear inventories. ---> with the decrease in expectations about prices, SRAS moves to the right, restoring long-run equilibrium

SRAS Shifts: Adjustments to Errors in Past Expectations

-workers and firms sometimes make incorrect predictions about the price level. -as time passes, they will attempt to compensate for these errors -->suppose everyone failed to predict an increase in the price level. Prices rise, therefore so does output -->then ONCE FIRMS AND WORKERS NOTICE the rising price, they update their expectations and increase their price demands, decreasing short-run aggregate supply.

Not in labor force:

1. Not available for work --> homemakers, retirees, full-time students, etc.) 2. Available for work but not currently working --> discouraged workers ** -->not currently looking because of child care responsibilities or transportation or other problems

1. when banks gain reserves..... 2. when banks lose reserves....

1. They make new loans, and the money supply expands. 2. The banks lose reserves, they reduce their loans, and the money supply contracts __________________________________________ --> this establishes the important relationship between banks and the money supply

Summarizing the Multiplier Effect

1. the multiplier effect occurs both for an increase and a decrease in planned aggregate expenditure 2. because the multiplier is greater than 1, the economy is sensitive to changes in autonomous expenditure 3. the larger the MPC, the larger the value of the multiplier. 4. our model is somewhat simplified, omitting some real-world complications. for example, as real GDP changes, imports, inflation, interest rates, and income taxes will change. This generally means that the value we estimate for the multiplier, from the MPC, is too high.

Factor Affecting Labor Productivity Growth

:increases in capital per hour worked --> quantity capital -->technological change (level of technology) -->property rights

income, consumption, and saving

By definition, disposable income not spent is SAVED. Therefore, we can write: National income= consumption + saving +taxes Y= C+S+T any change in national income can be decomposed into changes in the items on the right hang side: ∆Y= ∆C+∆S+∆T we assume net taxes do not change, so ∆T=0; then: now divided thru by ∆Y: ∆Y/∆Y = ∆C/∆Y + ∆S/∆Y

Who buys the goods??

Consumption (C): spending by households on goods and services Planned investment (I): Planned spending by firms on capital goods, and by households on new homes. Government purchases (G): spending on all levels of government on goods and services New exports (NX): the value of exports minus the value of imports AE= C+I+G+NX

new exports

EXPORTS MINUS IMPORTS -since we want to count domestic production (production in the United States), we add up the value of the goods and services sold to foreigners, and subtract the value of the goods and services sold to Americans by foreigners.

What is Fiscal Policy?

Fiscal policy refers to changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives (price stability, high employment, stability of financial markets and institutions, economic growth) (state taxes and spending are not generally aimed at affecting national level objectives)

M1

M1 is the narrowest definition of the money supply; the sum of currency in circulation, checking account deposits in banks, and holdings of traveler's checks.

M2

M2 is a broader definition of the money supply: it includes M1, plus saving account balances, small-denomination time deposits, balances in money market deposit accounts, and institutional money market fund shares

A formula for the Multiplier

This becomes a infinite sum: TOTAL CHANGE IN GDP= $100 billion + MPC x $100 billion + MPC^2× $100 billion + MPC^3 × $100 billion + MPC^4 × $100 billion + ... WHICH we can rewrite as: TOTAL CHANGE IN GDP= $100 billion x (1 + MPC + MPC2 + MPC3 + MPC4 + ...) by factoring out the initial $100 billion increase in investment. Since MPC is less than 1, the expression in parentheses is: 1/1- MPC -->In our case, MPC = 0.75; so the multiplier is 1/(1-0.75) = 4. A $100 billion increase in investment eventually results in a $400 billion increase in equilibrium real GDP. The general formula for the multiplier is: change in equilibrium real GDP/ change in autonomous expenditure = 1/1-MPC

A Simple CPI Calculation

This table here gives the information we need to create the CPI in 2016 and 2017, using the basket of goods from 1999.

A Simple CPI Calculation (continued)

This table shows the CPI formula applied with the given prices

GPD can be expressed as the sum of these:

Y= C (consumption) +I (investment) +G (government purchases) +NX (net exports)

short-run aggregate supply (AS) curve

a curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms.

Aggregate Expenditure Model

amount produced= aggregate output= Y amount that people want to buy = planned aggregate expenditure = AE in this model the equilibrium is when AE=Y ____________________________________________ : a macroeconomic model that focuses on the short-run relationship between total spending and real GDP, assuming that the price level is constant

Business cycles over time

annual fluctuations in real GDP were typically greater before 1950 than after. --> business cycles have been particularly mild since the mid-1980s, some people call this period "the Great Moderation" _____________________________ -the increasing importance of services -the establishment of unemployment insurance -active federal government stabilization policies -increased stability of the financial system

Average living standards are determined by average labor productivity....

as workers become more productive, income per capita rises __________________ increase in volume of labor, A->B increase in labor productivity, A->C

The Effects of Fiscal Policy on Real GDP and the Price Level

congress and the president carry out fiscal policy through: --> changes in government purchases. (a change in government purchases DIRECTLY affects aggregate demand) --> Changes in taxes (a change in taxes changes income; this in turn affects consumption, and so it has an indirect effect on aggregate demand.

consumption and national income

disposable income = national income - net taxes --> since "net taxes" are equal to taxes minus transfer payments, we can write: national income = GDP = disposable income+ net taxes -if we assume that net taxes do not change as national income changes, we have the result that ANY CHANGE in DISPOSABLE income is the same as the change in NATIONAL income

inventories

goods that have been produced but not yet sold

the interest-rate effect

how a change in the price level affects investments.... --> when prices rise, households and firms need more money to finance buying and selling. --> this increases in demand for money causes the "price" of holding money (the interest rate) to rise. DISCOURAGING firm investment

the international-trade effect

how a change in the price level affects net export (NX) --> when US rice levels rise, US exports become more expensive and imports become relatively cheaper. Fewer exports and more imports means net exports falls

M1 VS M2

in our discussion of money, we will therefore: 1. Treat both currency and checking account balances as "money", but nothing else. (traveler's checks are insignificant). 2. Realize that banks play an important role in the money supply, since they control what happens to money when it is in a checking account.

More growth occurs through new products, new markets....

markets that people are not aware that they want!!

the four components of real GDP

real GDP has four components: consumption (C), investments (I), government purchases (G), and net exports (NX): Y= C+I+G+NX government purchases are generally determined by the decisions of policymakers; but each of the other changes, depends on the price level.

The Goals of Monetary Policy

since WWII, the Fed has carried out an active monetary policy monetary policy: the actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy goals. 1. Price Stability 2. High Employment 3. Stability of financial markets and institutions --> they are essential to a growing economy. The Fed makes funds available to banks in times of crisis, ensuring confidence in those banks. In 2008, the Fed temporarily made these discount loans available to investment banks also, in order to ease their liquidity problems. 4. Stable economic growth --> it encourages long-run investment, which is itself necessary for growth. It is not clear to what extent the Fed can really encourage long-run investment, beyond meeting the previous three goals.

Natural rate of unemployment=

structural + frictional unemployment (also called the full-employment rate of unemployment)

Choosing a Monetary Policy Target

the Fed can choose to target a particular level of the money supply, or particular short-term nominal interest. It concentrates on the interest rate, in part because the relationship between the money supply (M1 or M2) and real GDP growth broke down in the early 1980s (M1) and 1990s (M2). ________________________________________ There are many different interest rates in the economy; the Fed targets the FEDERAL FUND RATES: the interest rate banks charge each other for overnight loans. - the Fed DOESN'T SET the federal funds rate but rather AFFECTS the supply of bank reserves through open market operations. ---> to increase the money supply, the Fed buys those securities, the sellers deposit the sale proceeds in a checking account, and the money gets loaned out-- increasing the money supply ---> decreasing the money supply would require SELLING securities

Required reserves ratio (RR)

the MINIMUM fraction of deposits banks are required by law to keep as reserves. --> banks might choose to hold EXCESS RESERVES: reserves over the legal requirement. --> in the United States, banks keep less than 100 percent of deposits as reserves. This is known as a FRACTIONAL RESERVE BANKING SYSTEM, and is in a system shared by nearly all countries.

∆S/∆Y (marginal propensity to save)

the amount by which savings changes, when (disposable) income changes. we can rewrite the equation above as: 1+MPC +MPS ---> that is, the marginal propensity to consume plus the marginal propensity to save must equal 1. This is because part of any increase in income is consumed, and the rest is saved.

tax wedge

the difference between these is an example of a TAX WEDGE: the difference between the pretax and posttax return to an economic activity. --> a large tax wedge DISTORTS the INCENTIVES of individuals and firms to take part in economic activities, generally resulting in lower levels of economic activity-- lower real GDP

How the Fed Manages the Money Supply

the fed has 3 monetary policy tools at its disposal: 1. Open market operations (most common) 2. Discount policy 3. Reserve requirements

inflation rate

the percentage increase in the price level from one year to the next

A numerical Example of Macroeconomic Equalibrium

the table shows several hypothetical combinations of real GDP and planned aggregate expenditure. ______________________ as real GDP changes, consumption changes, but planned investment, government purchases, and net exports stay constant. Macroeconomic equilibrium can occur only at $10 billion; otherwise, the unplanned change in inventories will cause firms to change production and real GDP will change.

balanced budget

when S*public is zero, the government spends as much as it brings in; this is known as "balanced budget" -negative and positive values for S*public are known as budget deficits and budget surpluses (since the federal government funds its current deficits with borrowing (selling Treasury bonds), this takes money away available for investment spending

an increase in corporate taxes

will shift the... demand for loanable funds curve to the left causing... the real interest rate and the level of investment to decrease

An increase in expected future profits....

will shift the... demand for loanable funds curve to the right causing... the real interest rate and the level of investment to increase

An increase in the government's budget deficit

will shift the... supply of loanable funds curve to the left causing... the real interest rate to increase and investment to decrease

an increase in the desire of households to consume today

will shift the... supply of loanable funds curve to the left causing... the real interest rate to increase and investment to decrease

an increase in tax benefits for saving, such as 401k retirement accounts, which increase the incentive to save

will shift the... supply of loanable funds curve to the right causing... the real interest rate to decrease and investment to increase

Marginal propensity to save

∆Y/∆Y = ∆C/∆Y + ∆S/∆Y

In chapter, we used GDP deflator to measure price level. However, there is a more accurate way to calculate price level....

"consumer price index"

3 main sources of technological change

-Better machinery and equipment (inventions like steam engine, machine tools, electric generators, and computers have allowed faster economic growth) -Increases in human capital -better means of organizing/managing production (it managers do better job of organizing production, the labor productivity can increase.)

frictional unemployment

-Short-term unemployment that arises from the process of matching workers with jobs --> frictional unemployment occurs mostly because of job search: entering or re-entering the labor force, or being between jobs. --> it also occurs because of seasonal unemployment: some jobs fluctuate in availability due to seasonal demand

different labor groups

-The working age population is divided into those in labor force and those who are not.

structural unemployment

-Unemployment that arise from a persistent mismatch between the skills and attributes of workers and the requirements of jobs --> longer unemployment spells --> may require retraining in order to obtain "modern" job

Real vs. Nominal Interest Rate

-What is your true return when borrowing and lending money? --> nominal interest rate: the stated interest rate on a loan --> REAL interest rate: adjusted nominal rate for inflation, that is, real interest rate = nominal interest rate - inflation rate ________________________________________ You should consider the REAL interest rate when borrowing, it is a better indicator for the true cost of borrowing

to calculate the CPI in a given year, we need...

-a basket of goods -the cost to purchase the basket of goods in the base year -the prices in the current year --> the CPI in the current year is the cost to purchase the basket of goods this year, divided by the cost in the base year. By convention, we multiply this by 100, so that the CPI in the base year is 100.

property rights (how it effects labor productivity growth)

-a market system cannot function unless rights to private property are secure. Governments can aid growth by establishing independent court systems

the consumer price index (CPI)

-a measure of the average change over time in the prices that a typical urban family of four pays for the goods and services they purchase.

Rule of 70

-a useful shortcut called the "Rule of 70" can help us to determine how long it will take for an economic variable to double: Number of years to double= 70/Growth rate ...so if the growth rate is 5%, it will take about 14 years for the variable to double

While the unemployment rate returned to "normal" after the 2007-2009 recession, the employment-population ratio did not. Why?

-aging population (baby boomers reaching retirement) -long-term unemployment leading to skill deterioration -Affordable Care Act making access to health care easier

the Division of Income, 2014

-all production must be rewarded with income; so in theory, we could count either in order to calculate GDP. -in practice, data limitations make us unlikely to come up with the same number; there will always be some statistical discrepancy --> the figure illustrates the division of income as measured by the BEA in 2012

business cycle

-alternating period of economic expansion and economic recession

measuring GPD by "calculating value added"

-an alternative method to measure GDP is to measure the VALUE ADDED: the market value a firm adds to a product. --> the final selling price of a product must equal the sum of the values added to the product at each stage of production. -----> the table illustrates this method for a shirt sold on L.L Bean's website

people helped by inflation:

-borrowers- people who borrow money -a business where the price of the product increased FASTER that the price of the resources

the underground economy

-buying and selling of goods and services might be concealed from the government to avoid taxes or regulations, or because the goods and services are illegal. This constitutes the UNDERGROUND ECONOMY --> this may be 10% or more of the economy in America, and substantially more in low-income households

substitution bias

-consumers may change their purchasing habits away from goods that have increased in price

components of GDP in 2014

-consumption is the largest component of GDP; within that, services are the largest components-- almost half of GPD -American net exports are negative, since the value of our imports exceeds the value of our exports

finaical security

-document (sometimes electronic) stating the terms under which funds pass from the buyer of the security to the seller

Current Population Survey

-each month, interviewers working on a joint project of BLS and the U.S. Bureau of the Census conduct the "Current Population Survey" (aka the "household survey") and survey 68,000 households to establish the age and job market status of each member of the household

price level

-economists and policy-makers are interested in the price level: a measure of the average prices of goods and services in the economy Why? Stable prices are desirable because they allow household and firms to plan for the future appropriately.

circular flow diagram of macroeconomics

-everything that is produced and sold constitutes income for someone; so we have the choice of measuring the value of products produced and sold, of the value of incomes, and each is a valid way of measuring economic activity __________________ Firms use factors of production to produce goods and services. Households supply the factors of production to firms in exchange for income. -The circular-flow diagram allows us to trace the ways households use their income. -the circular-flow diagram shows that we can measure GDP either by calculating the total value of expenditures on final foods or services or by calculating the value of total income. We get the SAME dollar amount of GDP with either approach.

financial system

-firms often want to obtain funds for expansion via the financial system -system of financial markets and financial intermediaries through which firms acquire funds from households

financial intermediaries

-firms, such as banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers

just-in-time system

-first developed by Toyota-- involves assembling goods from parts that arrive at the factory exactly when they are needed (something that could help increase level of technology)

Growth Rates over Longer Periods

-for longer time periods, we wouldn't want to calculate each of the annual growth rates and then take annual growth rate; instead we would solve for the growth rate g, where: Previous real GDP x (1+g)^t = current real GDP --> with t as the number of time periods between the previous and current periods

Types of Unemployment

-frictional unemployment -structural unemployment -cyclical unemployment

Other measures to total production and total income

-gross national product -national income -personal income -disposable personal income

technological changes (how it effects labor productivity growth)

-improvements in capital or methods to combine inputs into outputs (new technologies) allow workers to produce more in a given period of time --> the role of entrepreneurs here is critical, in pioneering new ways to bring together the factors of production to produce better or lower-cost products --> also, government issue patents as encouragement for firms to spend money on research necessary to create new products

Outlet Bias

-increases in purchases from discount stores like Sam's Club and Costco or the internet are not incorporated in the CPI; it still uses full-retail price.

What determines the Rate of Long-Run Growth?

-increases in real GDP per capita rely on increases in LABOR PRODUCTIVITY

people hurt by inflation:

-lenders- people who lend money (at fixed interest rate) -people with fixed income -savers

the numbers of the different people in each labor group

-let's say in current economy, that there are 157.07 million people in labor force, 8.03 million people are unemployed, 149.04 million people are employed, and 251.1 million people are in working-age population. --> calculate the unemployment rate, labor force participation rate, and employment-population ratio.

capital (how it effects labor productivity growth)

-manufactured goods that are used to produce other goods and services --> the more capital a worker has available to use (including human capital, the accumulated knowledge and skills workers possess), the more productive he will be

financial markets

-markets where financial securities, such as stocks and bonds, are bought and sold.

graph that shows the measures of the national income accounts for the United states in 2014

-national income must be smaller than GDP, since it is just GDP minus depreciation -similarly, disposable personal income must be less than personal income, since it is just personal income minus taxes

GPD per capita (GPD divided by population)

-often used to represent differences in standards of living from country to country. However, even if it accurately measured total production, it would not reflect: -->the value of leisure --> pollution and other negative effects of production --> crime and other social problems --> the distribution of income ------> IN FACT, improvements in many of these will result in LOWER GDP per capita

annual rate of growth

-over periods of a few years. we can average the growth rates to find the approximate annual rate of growth

Transfer payments

-payments by the government to households for which the government does not receive a new good or service in return.

anticipated inflation

-people and firms have increased real costs of holding cash -firms have MENU COSTS: the cost to firm of changing prices. Frequently changing prices are inconvenient for firms (and consumers too!) to deal with -investors are taxed on nominal returns, rather than real returns; so this can increase the tax due

discouraged workers

-people who are available for work but have not looked for a job during previous four weeks because they believe no jobs are available for them

gross national product (GNP)

-production performed by citizens of a nation including overseas production

increase in quality bias

-products like cars and computers have become more durable and better quality over time. It is hard to isolate the PURE-INFLATION part of price increases

calculating REAL GDP

-since GDP is measured in "value" terms, we might have problems interpreting changed over time if prices change. Is an increase in GDP due to production increasing, or due to prices increasing? --> to separate these effects, the BEA calculates both NOMINAL GDP (the value of final goods/services evaluated at current-year prices), and REAL GDP (the value of final goods/services evaluated at base-year prices ----> in order to make useful comparisons, concentrate on REAL GDP rather than nominal GDP

Is the CPI an Accurate Measure of Inflation?

-some potential problems with the CPI include: --> substitution bias --> increase in quality bias --> new product bias --> outlet bias .....so, for these reasons, economists believe the CPI overstates true inflation by 0.5 to 1 percentage point.

Industrial Revolution

-the application of mechanical power to the production of goods/services which began in England around 1750

New product bias

-the basket of goods changes only every 10 years. There is a delay to including new goods like cell phones

Calculating the GDP Deflator: An Example

-the first table gives nominal and real GDP for 2013 and 2014. We can use this to calculate the GDP deflator in each year. The GDP deflator increased from 108.3 to 106.7 ((108.3-106.7)/106.7) x 100= 1.5% So we can say the price level rose by 1.5% over this period

growth rate

-the growth rate of an economic variable life real GDP or real GDP per capita is equal to the percentage change from one year to the next

trends in labor force participation

-the labor force participation rate of adult men has declined gradually since 1948, but it has increased significantly for adult women, making the overall rate higher today than it was then

Potential GDP

-the level of real GDP attained when all firms are operating at capacity. -potential GDP rises when the labor force expands, when a nation acquires more capital stock (the total amount of physical capital available in a country), or when new technologies are created. -the growth in potential GDP in the US has been relatively steady at about 3.3%; that is, the potential to produce final goods and services has been growing in the U.S. at about this rate over time. --> the recession of 2007-2009 resulted in a wider than usual gap between potential and actual GDP

Gross domestic product (GDP)

-the most common measure used by economists of overall economic activity in an economy ________________________________________________ GDP: the MARKET VALUE of all final goods and services produced in a country during a period of time, typically one year. --> to measure total output in a given year, we measure the goods and services produced only in that given year. -this avoids double-counting: if you buy a new computer in 2015. that computer counts in 2015;s GDP. If you resell it in 2016, it will not count again in 2016. -so GDP counts only NEW goods/services. USED items were previously produced and counted, so don't need to be counted again.

recession

-the period of a business cycle during which total PRODUCTION and total EMPLOYMENT are decreasing

labor productivity

-the quantity of goods and services that can be produced by one worker or by one hour of work. --> Why can the average American consume eight time as many goods and services now, than as in 1900? ----> Because the average American produces eight times as many goods and services in an hour now, than as in 1900. ____________________________________ So most of the answer to "what determines the rate of long-run growth" is the same as the answer to "what determines labor productivity growth?"

Labor force:

-the sum of employed and unemployed workers in the economy

calculating read GDP: An Example

-the table shows outputs and prices in 2009 and 2017. Calculating the total value of output in 2009 gives: $3,200+ 990 + 1350 = 5,540 --> the calculate real GDP in 2017, we use the prices from 2009. This gives real 2017 GDP in 2009 dollars of $6,680. Compare this to nominal GDP in 2017 of $7,800

Working-age population

-the total number of people aged 16 years and older, who are not in U.S> Armed Forces, in jail, hospital, or some other form of institutional care

problems with measuring the unemployment rate

-the unemployment rate measured by the BLS is not a perfect measure of joblessness. Why? --> it may UNDERstate unemployment: ----> distinguishing between people who are "unemployed" and "not in the labor force" requires judgement (should we exclude "discouraged workers"?) ----> only measures employment, not intensity of employment (full-time vs. part-time; some people are underemployed) --> it may OVERstate employment: ----> people might claim falsely to be actively looking for work ----> may claim not to be working to evade taxes or keep criminal activity unnoticed

Before an Industrial Revolution....

-there was no significant economic growth, because production of most goods had relied on human or animal power -->the use of mechanical power allowed countries-- like the United States, France, and Germany-- to begin to experience LONG RUN economic growth -->technological progress is NECESSARY for sustained increases in standards of living

Shortcomings of GDP as a measure of well-being

-two important types of production are omitted from the BEA's measurement of GDP: 1. household production 2. the underground economy

cyclical unemployment

-unemployment caused by a business cycle recession --> during an economic recession, firms find that sales are declining, so they cut production, which induces them to lay off workers. ----> when cyclical unemployment is zero, the economy is said to be at "full employment" (usually between 4-6% unemployment)

U.S. Annual Unemployment Rate over Time

-unemployment rates follow business cycles. It falls during expansion; rises during recessions --> BUT they never fall to zero. To understand why, we will examine the types of unemployment.

Unemployment Rates for Different Groups

-unemployment rates vary by ethnic group and by education level --> these two observations are statistically related --> the unemployment rate of African Americans is the highest of the four ethnic groups shown, while the unemployment rate of Asians is the lowest. --> High School dropouts have an unemployment rate that is triple the unemployment rate for college graduates.

unanticipated inflation

-unpredictable inflation makes borrowing and lending risky

Adjusting for the effects of inflation

-we can compare dollar values across different time periods (real vs. nominal) --> if you earned $25,000 in 1990, how much is it worth today? Let CPI for 1990 be 102 and CPI for 2015 by 120, then.... Value in 2015= Value in 1990 dollars x (CPI in 2015/CPI in 1990) = 25,000 x (120/102) = $29,411.76

Inflation rate

-we refer to the percentage increase in the price level from one year to the next as the inflation rate. When the price falls, we have "deflation"

Long- Run Economic Growth

-when we speak of long-run economic growth, we mean the process by which rising productivity increases the average standard of living --> the most commonly used measure of this average standard of living is "real GDP per capita"

employment

Employment: based on a survey of establishment --> monthly survey about 145,000 buisnesses and government agencies, representing about 557,000 individual worksites

national income

GDP minus the consumption of fixed capital; i.e. GDP minus depreciation

bond

a financial security promising to repay a fixed amount of funds. A bond is essentially a loan from a household to a firm.

stock

a financial security representing partial ownership of a firm

expansion

a period of a business cycle during which the total PRODUCTION and total EMPLOYMENT are increaing

The Macroeconomics of Saving and Investment

for the sake of simplicity, we will assume a closed economy, with NO exports or imports; so Y= C+I+G We can rearrange this to obtain an expression for investment: I=Y-C-G that is, investment in a closed economy is equal to income minus consumption and government purchases. Now lets examine savings. Savings is composed of private savings (by households, S*private) and public savings (by the government, S*public) S*private =Y+ TR-C-T where Y is the household income derived from the payments for factors of production, TR stands for transfer payments, C is the money spent on consumption, and T for taxes. The government "saves" whatever it brings in but does not spend (this may be negative, known as DISSAVING): S*public= T-G-TR SO, TOTAL SAVING IS: S= S*private + S*public= Y+ TR-C-T+ T-G-T R = Y-C-G

household production

household production such as childcare, cleaning, and cooking is not typically paid for with money. However such contributions are real-- if they were performed by a non-household-member, they WOULD be paid for a counted in GDP

The GDP Deflator

in order to know whether we are achieving price stability, we need to measure the price level --> one way to do this is using the GDP deflator: a measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100: GDP deflator: nominal GDP/Real GDP x100 since nominal and real GDP will be the same in the base year, the GDP deflator will be 100 in the base year.

personal income

income received by households; includes transfer payments buy excludes firm's retained earnings

disposable personal income

personal income minus personal tax payments; this measures the amount that households are able to spend or save

Inflation:

rising general level of prices: --> always reduces the purchasing power of money. In 1981, $1 got you a loaf of bread. Now you need $2.5 to get a loaf.

government purchases

spending by federal state, and local governments on goods and services (teachers' salaries, highways, and aircraft carriers) --> this does not include transfer payments, since those do not result in immediate production of new goods and services

investments

spending by firms on new factories, office buildings, and additions to inventories, plus spending by households and firms on new houses. --> the BEA measures the following categories of investments: -----> business fixed investment (machinery) -----> residential investments (spending by households for new single-family and multi-unit houses) ----->changes in business inventories (goods that have been produced but not yet sold)

consumption

spending by households on goods and services, not including spending on new houses --> in BEA statistics, consumption is further divided into expenditure on services, DURABLE goods, and nondurable goods

economic growth

the ability of an economy to produce increasing quantities of goods and services

Rel GDP per capita

the amount of production in the economy, per person, adjusted for changes in the price level. (increases in our lifespan, the amount of time we can spend on "leisure" are also important!)

microeconomics

the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices

macroeconomics

the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth --> when we want to study the overall economy-level actions of people and governments, the models and tools of macroeconomics become very useful

Is inflation good or bad?

two different types: -Unanticipated Inflation -anticipated inflation

Unemployment

unemployment: based on current population survey --> monthly survey of about 68,000 households _____________________________________________ SO, we use two different surveys to get the statistics about employment and unemployment!