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# Welcome to Day 12 - PowerPoint PPT Presentation

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

Principles of Macroeconomics

Measuring Total Output and Income

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.

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.

• 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)

• 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

• 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.

Personal consumption

Private investment

Firms

Households

Government purchases

Factor incomes

Government agencies

• 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.

Personal consumption

Private investment

Firms

Households

Net

Exports

Government purchases

Factor incomes

Government agencies

Rest of the world

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.

• 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

• 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

Principles of Macroeconomics

Quiz today? Magic 8 ball says ….

Aggregate Demand and Aggregate Supply

• 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

Principles of Macroeconomics

Quiz today? Magic 8 ball says ….

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.

• 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.

• 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.

• 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)

EQUATION 1.2

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

Effect of initial increase in net exports without multiplier effect

Effect of initial decrease in net exports without multiplier effect

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.

• 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 THE SHORT 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 THE SHORT RUN

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?

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

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

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

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

### Welcome to Day 15 up and down?

Principles of Macroeconomics

Quiz today? up and down?Magic 8 ball says ….

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

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 domestic parts of GDP You may use the common one letter abbreviations.

• 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.

Price of car Cost of making car domestic parts of GDP You may use the common one letter abbreviations.\$20,000 Labor \$8,000 Steel \$8,000 Glass \$4,000Total Cost of Making Car = \$20,000Profit is \$0. Now double the sales price and all the costs.

Price of car Cost of making car domestic parts of GDP You may use the common one letter abbreviations.\$40,000 Labor \$8,000 Steel \$16,000 Glass \$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 domestic parts of GDP You may use the common one letter abbreviations.

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 curve left. Things that lower the of production shift the SRAS curve right. For example, changes in:

Shift caused by increase in price of natural resources.

SRAS3

SRAS1

SRAS2

Shift caused by decrease in price of natural resources.

Short-Run Equilibrium curve left. Things that lower the of production shift the SRAS curve right. For example, changes in:

SRAS2

SRAS1

P2

Shift caused by increase in health insurance premium paid by firms

P1

Y2

Y1

Short-Run Equilibrium curve left. Things that lower the of production shift the SRAS curve right. For example, changes in:

SRAS1

Shift caused by increase in government purchases.

P2

P1

Y2

Y1

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 MACROECONOMIC EQUILIBRIUM

• 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 Gaps MACROECONOMIC EQUILIBRIUM

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

What determines exactly where Y MACROECONOMIC EQUILIBRIUMp 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.

Y MACROECONOMIC EQUILIBRIUMp 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.

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 SRAS curve shifts right until output rises to Y

Principles of Macroeconomics

Quiz today? SRAS curve shifts right until output rises to YMagic 8 ball says ….

### Welcome to Day 17 SRAS curve shifts right until output rises to Y

Principles of Macroeconomics

Quiz today? SRAS curve shifts right until output rises to YMagic 8 ball says ….

1) Take out a piece of paper. SRAS curve shifts right until output rises to Y2) Write your name, the day and time of the class.3) Write Econ 2 Quiz 6

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 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.

LRAS

SRAS2

SRAS1

Shift in long run as nominal wages rise.

P3

P2

Shift caused by increase in government purchases.

P1

Inflationary gap

YP

Y2

3.2 Restoring Long-Run Macroeconomic Equilibrium 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.

Shift in long run as nominal wages fall.

LRAS

SRAS2

SRAS1

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

P2

P1

Recessionary gap

YP

Y2

Chapter 9 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.

The Nature and Creation of Money

1. WHAT IS MONEY? 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.

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 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.

• 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 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.

• 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 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.

• 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 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.’s: January 2012

Measured in billions

### Welcome to Day 18 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.

Principles of Macroeconomics

Quiz today? 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.Magic 8 ball says ….

2. THE BANKING SYSTEMS AND MONEY CREATION 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.

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 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.

• 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 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.

• 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.

2.3 Money Creation January 2012

• 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.

2.4 The Deposit Multiplier January 2012

• 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 January 2012

Principles of Macroeconomics

Quiz today? January 2012Magic 8 ball says ….

1) Take out a piece of paper. January 20122) Write your name, the day and time of the class.3) Write Econ 2 Quiz 7

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 Multiplier 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).

• 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 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).

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 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).

3.2 Powers of the Fed 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).

• 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 Fed 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).

• 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 Fed 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).

• 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.

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

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.

3.2 Powers of the Fed discount rate?

• 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.

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 government bonds to banks.

Principles of Macroeconomics

Quiz today? government bonds to banks. Magic 8 ball says ….

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

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

1. THE BOND AND FOREIGN EXCHANGE MARKETS government bonds to banks.

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 government bonds to banks.

• 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 Market government bonds to banks.

• EQUATION 1.1

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

1.1 The government bonds to banks. Credit Market

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.

You can hold your money as cash for convenience of spending rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.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 rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.

2.1 The Demand for Money rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.

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 rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.

• 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 rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.

• 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 Money rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.

The Fed creates new money. rate, ceteris paribus, will increase AD, as people will borrow more money to buy things.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.