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Welcome to Day 12. Principles of Macroeconomics. Chapter 6 Measuring Total Output and Income. 1. MEASURING TOTAL OUTPUT. Learning Objectives Define gross domestic product and its four major spending components and illustrate the various flows using the circular flow model.

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Welcome to day 12

Welcome to Day 12

Principles of Macroeconomics


Welcome to day 12

Chapter 6

Measuring Total Output and Income


1 measuring total output

1. MEASURING TOTAL OUTPUT

Learning Objectives

  • Define gross domestic product and its four major spending components and illustrate the various flows using the circular flow model.

  • Distinguish between measuring GDP as the sum of the values of final goods and services and as the sum of values added at each stage of production.

  • Distinguish between gross domestic product and gross national product.


1 1 the components of gdp

1.1 The Components of GDP

GDP =

consumption (C) + private investment (I) + government purchases (G) + net exports (Xn)

Or

GDP =

C + I + G + Xn

  • A flow variable is a variable that is measured over a specific period of time.

  • A stock variable is a variable that is independent of time.


1 1 the components of gdp1

1.1 The Components of GDP

  • Personal consumption is a flow variable that measures the value of goods and services purchased by households during a time period.

Personal consumption

Consumer goods and services

Households

Firms

Factors of production (labor, capital, and natural resources)

Factor incomes (wages, interest, profit, and rent)


1 1 the components of gdp2

1.1 The Components of GDP

  • Gross private domestic investment is the value of all goods produced during a period for use in the production of other goods and services.

Personal consumption

Private investment

Households

Firms

Factor incomes


1 1 the components of gdp3

1.1 The Components of GDP

  • Government purchases are the sum of purchases of goods and services from firms by government agencies plus the total value of output produced by government agencies themselves during a time period.

  • Transfer payments are payments that do not require the recipient to produce a good or service in order to receive them.


1 1 the components of gdp4

1.1 The Components of GDP

Personal consumption

Private investment

Firms

Households

Government purchases

Factor incomes

Government agencies


1 1 the components of gdp5

1.1 The Components of GDP

  • Exports are the sales of a country’s goods and services to buyers in the rest of the world during a particular time period.

  • Imports are purchases of foreign-produces goods and services by a country’s residents during a period.

  • Net Exports are exports minus imports.Exports (X) – imports (M) = net exports (Xn)

  • A trade deficit occurs when there are negative net exports.

  • A trade surplus occurs when there are positive net exports.


1 1 the components of gdp6

1.1 The Components of GDP

Personal consumption

Private investment

Firms

Households

Net

Exports

Government purchases

Factor incomes

Government agencies

Rest of the world


1 1 the components of gdp7

1.1 The Components of GDP


3 gdp and economic well being

3. GDP AND ECONOMIC WELL-BEING

Learning Objectives

  • Discuss and give examples of measurement and conceptual problems in using real GDP as a measure of economic performance and of economic well-being.

  • Explain the use of per capita real GNP or GDP to compare economic performance across countries and discuss its limitations.


3 2 conceptual problems with real gdp

3.2 Conceptual Problems with Real GDP

  • A second set of limitation or real GDP stems from problems inherent in the indicator itself.

    • Household Production

    • Underground and Illegal Production

    • Leisure

    • The GDP Accounts Ignore “Bads”(e.g. crime spending, negative externalities, environmental pollution)

  • More GDP cannot necessarily be equated with more human happiness.


3 3 international comparisons of real gdp and gnp

3.3 International Comparisons of Real GDP and GNP

  • Per capita real GNP or GDP is a country’s real GNP or GDP divided by its population.

  • Comparing one country’s output to another presents additional challenges. That said, when the data suggest huge disparities in levels of GNP per capita, for example, we observe real differences in living standards.


Welcome to day 13

Welcome to Day 13

Principles of Macroeconomics


Quiz today magic 8 ball says

Quiz today? Magic 8 ball says ….


Welcome to day 12

Chapter 7

Aggregate Demand and Aggregate Supply


Output or real gdp

Output or Real GDP

  • Potential output is the level of output an economy can achieve when labor is employed at its natural level.

    – the natural level of real GDP


Welcome to day 14

Welcome to Day 14

Principles of Macroeconomics


Quiz today magic 8 ball says1

Quiz today? Magic 8 ball says ….


1 aggregate demand

1. AGGREGATE DEMAND

Learning Objectives

  • Define potential output, also called the natural level of GDP.

  • Define aggregate demand, represent it using a hypothetical aggregate demand curve, and identify and explain the three effects that cause this curve to slope downward.

  • Distinguish between a change in the aggregate quantity of goods and services demanded and a change in aggregate demand.

  • Use examples to explain how each component of aggregate demand can be a possible aggregate demand shifter.

  • Explain what a multiplier is and tell how to calculate it.


1 1 the slope of the aggregate demand curve

1.1 The Slope of the Aggregate Demand Curve

  • Aggregate demand is the relationship between the total quantity of goods and services demanded (from all the four sources of demand) and the price level, all other determinants of spending unchanged.

  • The aggregate demand curve is a graphical representation of aggregate demand.

  • The wealth effect is the tendency for a change in the price level to affect real wealth and thus alter consumption.

  • The interest rate effect is the tendency for a change in the price level to affect the interest rate and thus to affect the quantity of investment demanded.

  • The international trade effect is the tendency for a change in the price level to affect net exports.

  • The change in the aggregate quantity of goods and services demanded refers to a movement along an aggregate demand curve.


Aggregate demand

Aggregate Demand


1 2 changes in aggregate demand

1.2 Changes in Aggregate Demand

  • A Change in aggregate demand is a change in the aggregate quantity of goods and services demanded at every price level. This can be caused by changes in…

    • Consumption,

    • Investment,

    • Government purchases,

    • Net exports.


1 2 changes in aggregate demand1

1.2 Changes in Aggregate Demand


The multiplier

The Multiplier

  • The multiplier is the ratio of the change in the quantity of real GDP demanded at each price level to the initial change in one or more components of aggregate demand that produced it.

EQUATION 1.1

Multiplier = Δ (real GDP demanded at each price level)

initial Δ (component of AD)

EQUATION 1.2

Δ (real GDP demanded at each price level) = Multiplier × initial Δ (component of AD)


The multiplier1

The Multiplier

Effect of initial increase in net exports without multiplier effect

AD2

AD1


The multiplier2

The Multiplier

Effect of initial decrease in net exports without multiplier effect

AD2

AD1


2 aggregate demand and aggregate supply the long run and the short run

2. AGGREGATE DEMAND AND AGGREGATE SUPPLY: THE LONG RUN AND THE SHORT RUN

Learning Objectives

  • Distinguish between the short run and the long run, as these terms are used in macroeconomics.

  • Draw a hypothetical long-run aggregate supply curve and explain what it shows about the natural levels of employment and output at various price levels, given changes in aggregate demand.

  • Draw a hypothetical short-run aggregate supply curve, explain why it slopes upward, and explain why it may shift; that is, distinguish between a change in the aggregate quantity of goods and services supplied and a change in short-run aggregate supply.

  • Discuss various explanations for wage and price stickiness.

  • Explain and illustrate what is meant by equilibrium in the short run and relate the equilibrium to potential output.


2 aggregate demand and aggregate supply the long run and the short run1

2. AGGREGATE DEMAND AND AGGREGATE SUPPLY: THE LONG RUN AND THE SHORT RUN

  • The short run in macroeconomic analysis, is a period in which wages and some other prices are sticky and do not respond to changes in economic conditions.

  • A sticky price is a price that is slow to adjust to its equilibrium level, creating sustained periods of shortage or surplus.

  • The long run in macroeconomic analysis, is a period in which wages and prices are flexible.


2 1 the long run

2.1 The Long Run

  • The long run aggregate supply (LRAS) curve is a graphical representation that relates the level of output produced by firms to the price level in the long run.


Long run equilibrium

Long-Run Equilibrium


Welcome to day 12

Why is the long-run aggregate supply curve (LRAS) straight up and down?Let’s believe that the more profitable something is, the more of it will be made. How do rising prices affect profits?


Welcome to day 12

Price of carCost of making car$20,000Labor $8,000 Steel $8,000Glass $4,000Total Cost of Making Car = $20,000Profit is $0. Now double the sales price and all the costs.


Welcome to day 12

Price of carCost of making car$40,000Labor $16,000 Steel $16,000Glass $8,000Total Cost of Making Car = $40,000Profit is $0. How many more cars are being made at double the sales price?


Welcome to day 12

Price of carCost of making car$22,000Labor $8,000 Steel $8,000Glass $4,000Total Cost of Making Car = $20,000Profit is $2,000. Now double the sales price and all the costs.


Welcome to day 12

Price of carCost of making car$44,000Labor $16,000 Steel $16,000Glass $8,000Total Cost of Making Car = $40,000Profit is $4,000. Is it actually more profitable to make cars now?


Welcome to day 15

Welcome to Day 15

Principles of Macroeconomics


Quiz today magic 8 ball says2

Quiz today? Magic 8 ball says ….


1 take out a piece of paper 2 write your name the day and time of the class 3 write econ 2 quiz 5

1) Take out a piece of paper.2) Write your name, the day and time of the class.3) Write Econ 2 Quiz 5


Welcome to day 12

Fill in the blanks for the following equation. Use only the domestic parts of GDP You may use the common one letter abbreviations.1) GDP = ___ + ___ + ___2) Write out what one of the abbreviations stands for.


2 2 the short run

2.2 The Short Run

  • The short run aggregate supply (SRAS) curve is a graphical representation of the relationship between production and the price level in the short run.

  • A change in the aggregate quantity of goods and services supplied is characterized by movement along the short-run aggregate supply curve.

  • A change in short-run aggregate supply is characterized by a change in the aggregate quantity of goods and services supplied at every price level in the short-run.


Welcome to day 12

Price of carCost of making car$20,000Labor $8,000 Steel $8,000Glass $4,000Total Cost of Making Car = $20,000Profit is $0. Now double the sales price and all the costs.


Welcome to day 12

Price of carCost of making car$40,000Labor $8,000 Steel $16,000Glass $8,000Total Cost of Making Car = $32,000Profit is $8,000. How many more cars are being made at double the sales price?


Deriving the short run aggregate supply curve

Deriving the Short-Run Aggregate Supply Curve


Welcome to day 12

Things that raise the cost of production shift the SRAS curve left. Things that lower the of production shift the SRAS curve right. For example, changes in:1) Resource prices2) Wages3) Cost of employer paid health insurance


Changes in short run aggregate supply

Changes in Short-Run Aggregate Supply

Shift caused by increase in price of natural resources.

SRAS3

SRAS1

SRAS2

Shift caused by decrease in price of natural resources.


Short run equilibrium

Short-Run Equilibrium

SRAS2

SRAS1

P2

Shift caused by increase in health insurance premium paid by firms

P1

AD1

Y2

Y1


Short run equilibrium1

Short-Run Equilibrium

SRAS1

Shift caused by increase in government purchases.

P2

P1

AD2

AD1

Y2

Y1


3 recessionary and inflationary gaps and long run macroeconomic equilibrium

3. RECESSIONARY AND INFLATIONARY GAPS AND LONG-RUN MACROECONOMIC EQUILIBRIUM

Learning Objectives

  • Explain and illustrate graphically recessionary and inflationary gaps and relate these gaps to what is happening in the labor market.

  • Identify the various policy choices available when an economy experiences an inflationary or recessionary gap and discuss some of the pros and cons that make these choices controversial.


3 1 recessionary and inflationary gaps

3.1 Recessionary and Inflationary Gaps

  • A recessionary gap is the gap between the level of real GDP and potential output, when real GDP is less than potential.


3 1 recessionary and inflationary gaps1

3.1 Recessionary and Inflationary Gaps

  • An inflationary gap is the gap between the level of real GDP and potential output, when real GDP is greater than potential.


Welcome to day 12

What determines exactly where Yp is?When unemployment is high, wages fall in the long-run.When unemployment is low, wages rise in the long-run.When unemployment is at the natural rate of unemployment, wages stay the same in the long-run.


Welcome to day 12

Yp is the amount of real GDP produced when unemployment is at the natural level. It is the amount of stuff we make when unemployment is such that wages do not change even in the long-run.


Welcome to day 12

When output is low, unemployment is high and wages fall. SRAS curve shifts right until output rises to Yp.When output is high, unemployment is low and wages rise. SRAS curve shifts left until output rises to Yp.


Welcome to day 16

Welcome to Day 16

Principles of Macroeconomics


Quiz today magic 8 ball says3

Quiz today? Magic 8 ball says ….


Welcome to day 17

Welcome to Day 17

Principles of Macroeconomics


Quiz today magic 8 ball says4

Quiz today? Magic 8 ball says ….


1 take out a piece of paper 2 write your name the day and time of the class 3 write econ 2 quiz 6

1) Take out a piece of paper.2) Write your name, the day and time of the class.3) Write Econ 2 Quiz 6


Welcome to day 12

In a normal one good supply and demand curve, the supply curve slopes up, showing that the businesses will produce more of the good at a higher price. Explain why the macro long-run aggregate supply curve does not slope up, but is straight up and down, showing that businesses do not produce more of the good at higher prices.


3 2 restoring long run macroeconomic equilibrium

3.2 Restoring Long-Run Macroeconomic Equilibrium

LRAS

SRAS2

SRAS1

Shift in long run as nominal wages rise.

P3

P2

Shift caused by increase in government purchases.

P1

AD1

AD2

Inflationary gap

YP

Y2


3 2 restoring long run macroeconomic equilibrium1

3.2 Restoring Long-Run Macroeconomic Equilibrium

Shift in long run as nominal wages fall.

LRAS

SRAS2

SRAS1

Shift caused by increase in insurance premiums paid by firms..

P2

P1

AD1

Recessionary gap

YP

Y2


Welcome to day 12

Chapter 9

The Nature and Creation of Money


1 what is money

1. WHAT IS MONEY?

Learning Objectives

  • Define money and discuss its three basic functions.

  • Distinguish between commodity money and fiat money, giving examples of each.

  • Define what is meant by the money supply and tell what is included in the Federal Reserve System’s two definitions of it (M1 and M2).


1 1 the functions of money

1.1 The Functions of Money

  • Money is anything that serves as a medium of exchange.

  • A medium of exchange is anything that is widely accepted as a means of payment.

  • To Barter an individual exchanges goods directly for other goods.

  • A unit of account is a consistent means of measuring the value of things.

  • A store of value is an item that holds value over time.


1 2 types of money

1.2 Types of Money

  • Commodity money is money that has value apart from its use as money.

    • E.g. Mackerel in federal prisons, gold, and silver

  • Fiat money is money that some authority, generally a government, has ordered to be accepted as a medium of exchange.

    • E.g. paper money and coins in the U.S. “this note is legal tender for all debts public and private”

  • Currency is paper money and coins.

  • Checkable deposits are balances in checking accounts.

  • A check is a written order to a bank to transfer ownership of a checkable deposit.


1 3 measuring money

1.3 Measuring Money

  • Money supply refers to the total quantity of money in the economy at any one time.

  • Liquidity is the ease with which an asset can be converted into currency.

  • M1 is the narrowest of the Fed’s money supply definitions that includes currency in circulation, checkable deposits, and traveler’s checks.

  • M2 is a broader measure of the money supply than M1 that includes M1 and other deposits.


The two m s january 2012

The two M’s: January 2012

Measured in billions


Welcome to day 18

Welcome to Day 18

Principles of Macroeconomics


Quiz today magic 8 ball says5

Quiz today? Magic 8 ball says ….


2 the banking systems and money creation

2. THE BANKING SYSTEMS AND MONEY CREATION

Learning Objectives

  • Explain what banks are, what their balance sheets look like, and what is meant by a fractional reserve banking system.

  • Describe the process of money creation (destruction), using the concept of the deposit multiplier.

  • Describe how and why banks are regulated and insured.


2 1 banks and other financial intermediaries

2.1 Banks and Other Financial Intermediaries

  • A financial intermediary is an institution that amasses funds from one group and makes them available to another.

  • A bank is a financial intermediary that accepts deposits, makes loans, and offers checking accounts.


2 2 bank finance and a fractional reserve system

2.2 Bank Finance and a Fractional reserve System

  • A balance sheet is a financial statement showing assets, liabilities, and net worth.

  • Assets are anything of value.

  • Liabilities are obligations to other parties.

  • Net worth refers to assets less liabilities.

  • Reserves are bank assets held as cash in vaults and in deposits with the Federal Reserve.

  • A fractional reserve banking system is a system in which banks hold reserves whose value is less than the sum of claims outstanding on those reserves.


The consolidated balance sheet for u s commercial banks january 2012

The Consolidated Balance Sheet for U.S. Commercial Banks, January 2012


2 3 money creation

2.3 Money Creation

  • Required reserves are the quantity of reserves banks are required to hold.

  • The required reserve ratio is the ratio of reserves to checkable deposits a bank must maintain.

  • Excess reserves are reserves in excess of the required level.

  • A bank is said to beloaned up when its excess reserves equal zero.


A balance sheet for acme bank

A Balance Sheet for ACME Bank


A balance sheet for acme bank1

A Balance Sheet for ACME Bank


A balance sheet for acme bank2

A Balance Sheet for ACME Bank


2 4 the deposit multiplier

2.4 The Deposit Multiplier

  • A deposit multiplier is the ratio of the maximum possible change in checkable deposits (ΔD) to the change in reserves (ΔR).

  • EQUATION 2.1

  • EQUATION 2.5


Welcome to day 19

Welcome to Day 19

Principles of Macroeconomics


Quiz today magic 8 ball says6

Quiz today? Magic 8 ball says ….


1 take out a piece of paper 2 write your name the day and time of the class 3 write econ 2 quiz 7

1) Take out a piece of paper.2) Write your name, the day and time of the class.3) Write Econ 2 Quiz 7


Welcome to day 12

Using the AD curve and the long run aggregate supply curve only, show the effect of an increase in AD in the long run. Mark starting price and quantity P1 and Q1, and ending price and quantity P2 and Q2. Next to the diagram, write what is happening to price and quantity (rises, falls, stays the same).


2 4 the deposit multiplier1

2.4 The Deposit Multiplier

  • A deposit multiplier is the ratio of the maximum possible change in checkable deposits (ΔD) to the change in reserves (ΔR).

  • EQUATION 2.1

  • EQUATION 2.5


3 the federal reserve system

3. THE FEDERAL RESERVE SYSTEM

Learning Objectives

  • Explain the primary functions of central banks.

  • Describe how the Federal Reserve System is structured and governed.

  • Identify and explain the tools of monetary policy.

  • Describe how the Fed creates and destroys money when it buys and sells federal government bonds.

  • A central bank is a bank that acts as a banker to the central government, acts as a banker to banks, acts as a regulator of banks, conducts monetary policy, and supports the stability of the financial system.


3 1 structure of the fed

3.1 Structure of the Fed


3 2 powers of the fed

3.2 Powers of the Fed

  • Fed sets the reserve requirements.

    What happens to the money supply if the Fed

    lowers the reserve requirement?

    What if they raise the reserve requirement?


3 2 powers of the fed1

3.2 Powers of the Fed

  • Fed sets the reserve requirements.

    What happens to the money supply if the Fed

    lowers the reserve requirement?

    - Money supply goes up.

    What if they raise the reserve requirement?

    - Money supply goes down.


3 2 powers of the fed2

3.2 Powers of the Fed

  • The discount window and other credit facilities

    • The discount rate is the interest rate changed by the Fed when it lends reserves to banks.

    • The federal funds market is a market in which banks lend reserves to one another.

    • A federal funds rate is the interest rate charged when one bank lends reserves to another.


Welcome to day 12

What happens to the money supply if the Fed raises the discount rate?What if they lower the discount rate?


Welcome to day 12

What happens to the money supply if the Fed raises the discount rate?- Lowers the money supply.What if they lower the discount rate?- Raises the money supply.


Welcome to day 12

3.2 Powers of the Fed

  • Open market operations

    • A bond is a promise by the issuer of the bond to pay the owner of the bond a payment or a series of payments on a specific date or dates.

    • Open market operations are the buying and selling of federal government bonds by the Fed.


Welcome to day 12

Open market operations are the Fed buying and selling government bonds to banks. When the Fed buys bonds from banks with newly created money, the banks have more reserves to loan out.-Money supply goes up.When the Fed sells bonds to banks, the banks have less reserves to loan out. - Money supply goes down.


Welcome to day 20

Welcome to Day 20

Principles of Macroeconomics


Quiz today magic 8 ball says7

Quiz today? Magic 8 ball says ….


1 take out a piece of paper 2 write your name the day and time of the class 3 write econ 2 quiz 8

1) Take out a piece of paper.2) Write your name, the day and time of the class.3) Write Econ 2 Quiz 8


Welcome to day 12

1. Which of the following is money as defined by M2?A) Currency inside bank vaults.B) Credit cards.C) Gold.D) None of the above.


Welcome to day 12

Chapter 10 Financial Markets and the Economy


1 the bond and foreign exchange markets

1. THE BOND AND FOREIGN EXCHANGE MARKETS

Financial markets are markets in which funds accumulated by one group are made available to another group.

  • Savers supply funds to financial markets and borrowers demand funds.


1 1 the bond market

1.1 The Bond Market

  • Bond prices and interest rates.

  • The face value of a bond is the amount the issuer of a bond will have to pay on the maturity date.

  • The maturity date is the date when a bond matures, or comes due.

  • The interest rate is the payment made for the use of money, expressed as a percentage of the amount borrowed.


1 1 the bond market1

1.1 The Bond Market

  • EQUATION 1.1

  • At a price of $950, the interest rate is 5.3%


1 1 the credit market

1.1 The Credit Market


Welcome to day 12

It is generally considered that a decrease in the interest rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.


Welcome to day 12

You can hold your money as cash for convenience of spending ORYou can put it in the bank to earn interest. The higher the interest rate, the less cash you want to hold.


2 1 the demand for money

2.1 The Demand for Money


2 1 the demand for money1

2.1 The Demand for Money

An increase in real GDP, for example, causes demand to increase. At the same interest rate the quantity of money demanded increases from M to M’.

  • Other determinants of the demand for money

    • Real GDP

    • The Price Level

    • Expectations

    • Preferences


2 2 the supply of money

2.2 The Supply of Money

  • Supply curve of money is the curve that shows the relationship between the quantity of money supplied and the market interest rate all other determinants of supply unchanged.

M


2 3 equilibrium in the market for money

2.3 Equilibrium in the Market for Money

  • Money market is the interaction among institutions through which money is supplied to individuals, firms, and other institutions that demand money.

  • Money market equilibrium is the interest rate at which the quantity of money demanded is equal to the quantity of money supplied.


2 3 equilibrium in the market for money1

2.3 Equilibrium in the Market for Money


Welcome to day 12

The Fed creates new money. 1) Banks have excess reserves.2) Interest rates fall.3) Loans increase which increases spending (AD).4) People hold onto more cash, and put less in the bank.


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