All Formulas & Graphs Needed for Macro Exam
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M M E E = 1/MPS = 1/MPS M M T=MPC/MPS T=MPC/MPS
description
M E = 1/MPS M T=MPC/MPS. All Formulas & Graphs Needed for Macro Exam. Macroeconomic Formulas. Base year[$50/$50=1x100=100]. $46/$50x100=92[deflation of 8%]. Formulas. Price of Market Basket(2001 ) [nominal GDP] $64 - PowerPoint PPT Presentation
Transcript of All Formulas & Graphs Needed for Macro Exam
MMEE = 1/MPS = 1/MPSMMT=MPC/MPST=MPC/MPS
FormulasFormulas
$6,737$6,737[199[1994]/4]/126.1126.1[1987([1987($4,540$4,540)]x100 =)]x100 = $5,343$5,343 [[+$803.+$803.]]““RealReal GDP GDP deflatesdeflates nominal GDPnominal GDP to actual valueto actual value”[”[takes thetakes the airair out out of theof the nominal balloonnominal balloon]]
Base year[$50/$50=1x100=100]Base year[$50/$50=1x100=100] $46/$50x100=92[deflation of 8%]$46/$50x100=92[deflation of 8%]
Price of Market Basket(2001Price of Market Basket(2001) [nominal GDP][nominal GDP] $64$64GDP Price IndexGDP Price Index = = Price of samePrice of same Market Basket(1998)x100Market Basket(1998)x100;; [R[Real eal GDP] $50x100=128GDP] $50x100=128[GDP Deflator][GDP Deflator] in the base year (1998) in the base year (1998) [$64/128 x 100 = $50][$64/128 x 100 = $50]
UnemploymentUnemployment 5,655,0005,655,000Labor ForceLabor Force x 100 = x 100 = unemployment rate;unemployment rate; 140,863,000140,863,000 x 100 = 4% x 100 = 4%[Employed + unemployed[Employed + unemployed]] [[135,208,000+5,655,000] [2000]135,208,000+5,655,000] [2000]
Okun’sOkun’s LawLaw or or GDP gap GDP gap)=Unemployment Rate over 6% x 2%; 7.5%, so 1.5x2% = 33%%. Or, $3 billion GDP Gap[$100 billion nominal GDP x .03% = $3 billion].
(2000-later year) (1999-earlier year)(2000-later year) (1999-earlier year) [[**Change/original x 100]Change/original x 100] Current year’s index – last year’s indexCurrent year’s index – last year’s index 172.2-166.6(5.6)172.2-166.6(5.6)C.P.I.C.P.I. = Last year’s index(1999-earlier year) x 100; 166.6 x100 = 3.4%= Last year’s index(1999-earlier year) x 100; 166.6 x100 = 3.4%
_________________________ “ “Rule of 70”Rule of 70” = % annual rate of increase (3%) = 23 years
““Real Income”Real Income” measures the amount of goods/services nominal income will buy.[%% change in real incomechange in real income = % change in nominal income% change in nominal income - % change in PL% change in PL.] 5%5% 10%10% 5%5%
7070
Real GDPReal GDP == NominalNominal GDPGDP/Index /Index XX 100 100
$9,299.2$9,299.2[1999]/104.77[1996] x 100 =[1999]/104.77[1996] x 100 = $8,875.8$8,875.8 [So,[So, +$1,062.6+$1,062.6]]““Real GDPReal GDP deflatesdeflates nominal GDPnominal GDP to actual value” [takesto actual value” [takes the the air out air out of theof the nominal balloonnominal balloon]]
$5,250.8$5,250.8 $3,774.7$3,774.7 $5,671.8$5,671.8108.5 x 100=$_____ 108.1 x 100=$_____ 117.0 x100=$_____108.5 x 100=$_____ 108.1 x 100=$_____ 117.0 x100=$_____4,8394,839 3,4923,492 4,8484,848
1.1. Using the above formula, what is the real GDPreal GDP for 1994 if nominal GDP was $6,947 trillion and the GDP deflator was126.1? ($6,611/$5,610/$5,509) trillion.
2.2. For 1996, what would real GDPreal GDP be if nominal GDP were $7,636 trillion and the GDP deflator were 110.2?($6,929/$9,628/$6,928).
[$6,947/126.1 x 100 = $5,509 trillion[$6,947/126.1 x 100 = $5,509 trillion
[$7,636 trillion/110.2 x 100 = $6,929 trillion][$7,636 trillion/110.2 x 100 = $6,929 trillion]
““Nominal”Nominal”
““Real”Real”
UnemploymentUnemployment 5,655,0005,655,000Unemployment Rate = Unemployment Rate = Labor ForceLabor Force x 100; 4.0% = x 100; 4.0% = 140,863,000140,863,000 x 100 x 100 [Employed + unemployed] [135,208,000+5,655,000][Employed + unemployed] [135,208,000+5,655,000]
IIn n Forney, 42 Forney, 42 are are unemployed & 658unemployed & 658 are are employed. Temployed. The he unemployment runemployment rate isate is __ __%.%.
One milOne mil. are . are unemployedunemployed & & 19 mil19 mil. are . are employedemployed. The unemploy. rate is __%.. The unemploy. rate is __%.6655
1. If the total population is 280 million, 280 million, and the civilian labor forcecivilian labor force includes 129,558,000129,558,000 with jobs and with jobs and 6,739,0006,739,000 unemployed unemployed but looking for jobs, then the employment rateemployment rate would be ____%. 4.94.9
[6,739,000/136,297,000 x 100 = 4.9%][6,739,000/136,297,000 x 100 = 4.9%]
Unemployment [Let’s say that Nominal GDP is $100 billion.] [And And if it wereif it were $200 billion $200 billion?] Rate1. 7%; real unemployment is __%; % gap is ___ %; output forgone is ___ bil. 1. 7%; real unemployment is __%; % gap is ___ %; output forgone is ___ bil. 2. 8%; real unemployment is __%; % gap is ___ %; output forgone is ___ bil.2. 8%; real unemployment is __%; % gap is ___ %; output forgone is ___ bil.3. 13%; real u3. 13%; real unemploymentnemployment is __%; % gap is ___ %; output forgone is ___ bil. is __%; % gap is ___ %; output forgone is ___ bil.4. 14%; real u4. 14%; real unemploymentnemployment is __%; % gap is ___ %; output forgone is ___ bil. is __%; % gap is ___ %; output forgone is ___ bil.
6% 6% Y*FY*FYPYPYAYA
$10 tr.$10 tr.
[Frictional+Structural][Frictional+Structural]
33%%
ADAD11 ASAS
Arthur OkunArthur Okun[GDP GapGDP Gap = unemployment rate over 6% x 2unemployment rate over 6% x 2]
E2 Recessionary Gap(YRE2 Recessionary Gap(YR))Potential output ($10)Potential output ($10) exceedsexceeds actual output($9).actual output($9).Actual Actual unemploy. rateunemploy. rate(11%)(11%) exceedsexceeds Potential unemp. Potential unemp. rate(rate(6%6%).).
11%11%YRYRYAYA
$9 Tr.$9 Tr.
1%1%
ADAD22
5% Cyclical(“real”) Unempl.5% Cyclical(“real”) Unempl.10%[5%x2=10%] 10%[5%x2=10%] Negative Gap Negative Gap
[Okun’s Law][Okun’s Law]
11 22 2222 44 4477 1414 141488 1616 1616
FE GDPFE GDP “Bull’s Eye”“Bull’s Eye”
1.The CPI was 166.6 in 1999166.6 in 1999 and 172.2 in 2000172.2 in 2000. Therefore, the rate of inflation for 2000 was (2.7/3.4/4.2)% 2. If the CPI falls from 160 to 149CPI falls from 160 to 149 in a particular year, the economy has experienced (inflation/deflation) of (5/4.9/6.9)%.3. If CPI rises from 160.5 to 163.0160.5 to 163.0 in a particular year, the rate of inflation for that year is (1.6/2.0/4.0)%.
[-11/160 x 100 = -6.9%][-11/160 x 100 = -6.9%]
(2006-later year) (2005-earlier year)(2006-later year) (2005-earlier year) Current year’s index – last year’s indexCurrent year’s index – last year’s index 199.1 – 192.7 [6.7]199.1 – 192.7 [6.7]C.P.I. = Last year’s index(2006-earlier year) x 100; 192.7 x100 = 3.3%C.P.I. = Last year’s index(2006-earlier year) x 100; 192.7 x100 = 3.3%
130.7-124.0(6.7)130.7-124.0(6.7) 116-120(-4)116-120(-4) 333-300(33)333-300(33) 124.0 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____124.0 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____
[Change/Original X 100 = inflation]
5.4%5.4% -3.3%-3.3% 11%11%
[5.6/166.6 x 100 = 3.4%][5.6/166.6 x 100 = 3.4%]
So, 3.3% increase in SocialSo, 3.3% increase in SocialSecurity benefits for 2007Security benefits for 2007
Consumers in this economy buy only two goods–hot dogs & hamburgers.Step 1. Fix the basket. What percent of income is spent on each. Consumers in this economy buy a basket of:
4 hot dogs and 2 hamburgers4 hot dogs and 2 hamburgers
Step 2. Find the prices of each good in each year. YearYear Price of Hot DogsPrice of Hot Dogs Price of HamburgersPrice of Hamburgers 20012001 $1 $1 $2$2 20022002 $2 $2 $3$3
Step 3. Compute the basket cost for each year. 2001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $82001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $8 2002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $142002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14
Step 4. Choose one year as a base year (2001) and compute the CPI 2001 ($8/$8) x 100 = 1002001 ($8/$8) x 100 = 100 2002 (14/$8) x 100 = 1752002 (14/$8) x 100 = 175Step 5. Use the CPI to compute the inflation rate from previous year 2002 (175/100 x 100 = 175%) or to get actual % (175-100)/100 x 100 =75%(175-100)/100 x 100 =75%Or, Or, ChangeChange $14-$8 ($6)$14-$8 ($6) Original $8 x 100 = 75%Original $8 x 100 = 75%
(42%)(42%) 18. Suppose that a typical consumer buys the following quantities of thesebuys the following quantities of these three commodities in 2000 and 2001three commodities in 2000 and 2001.
CommodityCommodity QuantityQuantity 2000 per2000 per Unit PriceUnit Price 2001 per2001 per Unit PriceUnit PriceFood 5 units $6.00 $5.00Clothing 2 units $7.00 $9.00Shelter 3 units $12.00 $19.00
Which of the following can be concluded about the CPI for this individual from concluded about the CPI for this individual from 2000 to 20012000 to 2001? a. It remained unchanged. c. it decreased by 20% b. It decreased by 25%. d. It increased by 20% e. It increased by 25%.(Answer)(Answer) Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36,Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36,for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)]for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)]
Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57, Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57, for dollar value of $100. CPI for dollar value of $100. CPI =125 =125
ChangeChange $100-$80 [$20]$100-$80 [$20]Original = $80 x 100 = 25%; so the CPI for this individual is Original = $80 x 100 = 25%; so the CPI for this individual is 25%25%..
__________________________““Rule of 70”Rule of 70” = % annual rate of increase (3%) = 23 years
[InflationInflation (prices to double)] 70 70 70 [InvestmentsInvestments to double] 10 = ______ 12 = _____ 9 = _____ [GDPGDP (standard of living) to double] 7 7 yearsyears 6 6 yearsyears 8 8 yearsyears
70
7070
NominalNominalIncomeIncome
RealRealIncomeIncome
InflationInflationPremiumPremium
-16%16%
1010%%
66%%
[[NominalNominal income income – – inflationinflation rate rate == RealReal Income Income]]
=
11
11 APC=C/YAPC=C/Y APC = C/Y(DI)=$48,000/$50,000 = .96APC = C/Y(DI)=$48,000/$50,000 = .96 APS = S/Y(DI)= $2,000/$50,000 = .04APS = S/Y(DI)= $2,000/$50,000 = .04
APC = C/Y=$52,000/$50,000 = 1.04APC = C/Y=$52,000/$50,000 = 1.04 APS = S/Y= -$2,000/$50,000 = -.04APS = S/Y= -$2,000/$50,000 = -.04
APC - percentageAPC - percentage of of income (“Y”) consumed.income (“Y”) consumed.
AE=GDPAE=GDP
““High maintenanceHigh maintenanceEcon teacher”Econ teacher”
APS – percentageAPS – percentage of of income (“Y”) saved.income (“Y”) saved.
““Econ,Econ,Econ,Econ,
APS=S/YAPS=S/Y
APCAPC andand APSAPS
What in the What in the world is world is
AE?AE?
MPCMPC,, MPSMPS, , & the& the MMultiplierultiplier
**The The MME is the reciprocal of the MPSE is the reciprocal of the MPS..
The ““MMEE”” works like a concentric circle.
MPC - % change in Y consumed.MPC - % change in Y consumed. MPS - % change in Y saved.MPS - % change in Y saved.
MPC = C/ Y = $750/$1,000 = .75MPC = C/ Y = $750/$1,000 = .75MPS = S/ Y = $250/$1,000 = .25MPS = S/ Y = $250/$1,000 = .25MMultiplier [1/MPS]ultiplier [1/MPS]=1/.25=$1/.25 = “M=1/.25=$1/.25 = “MEE” of ” of 44[MPC is important for G in policy making decisions.][MPC is important for G in policy making decisions.]
MMEE==1/MPS1/MPS
$20 billion “G”[with ME of 4]
15 bil. 11.25 bil. 8.5 bil.
MPC MPC 1/MPS 1/MPS = = M MEE
.90.90 1/.101/.10 = = 1010
.80.80 1/.201/.20 = 5= 5
.75.75 1/.251/.25 = 4= 4
.60.60 1/.401/.40 = 2.5= 2.5
.50.50 1/.501/.50 = 2= 2
MMEE
MPCMPC --MPC/MPSMPC/MPS = = M MTT
.90.90 -MPC/.10-MPC/.10 = = -9 -9
.80.80 -MPC/.20-MPC/.20 == -4 -4
.75.75 --MPC/.25MPC/.25 == -3 -3
.60.60 --MPC/.40MPC/.40 = -1.5= -1.5 .50.50 --MPC/.50 =MPC/.50 = --11
When the When the G gives a tax cutG gives a tax cut, the , the MMTT is smaller than the is smaller than the MMEE
because because a fractiona fraction [ [MPSMPS] ] is savedis saved and and only the only the MPCMPC is is
initially spentinitially spent. So, the . So, the MMT = -T = -MPC/MPSMPC/MPS..
MMTT
TheThe MMEE,, MMTT, , && MMBBBB Multipliers MultipliersMMEE [[CC, Ig, , Ig, GG, or Xn, or Xn] ] == 1/MPS1/MPS == 1/.251/.25 == 44So, GG increase of $20 bil. increase of $20 bil. will incr Y by $80 bil.incr Y by $80 bil. [$20x4=$80$20x4=$80]And a GG decrease of decrease of $20$20 bil. bil. will decrease Y by $80 bil.decrease Y by $80 bil. [--$20x4=$20x4=--$80 bil.$80 bil.]
MMT = -T = -MPC/MPSMPC/MPS = -. = -.75/.25 = -375/.25 = -3So, TT decreasedecrease of $20 bil.of $20 bil. will incr Y by $60 bil.incr Y by $60 bil.[-$20x-3=$60-$20x-3=$60]And a TT increase of increase of $20 bil. $20 bil. will decrdecr Y Y by by $60 bil.$60 bil. [$20x-3=$20x-3=--$60$60]
MMBB = BB = 11 X X (( GG))So, an increase in increase in G&TG&T of $20 bil. of $20 bil. will incr Y by incr Y by $20$20 bil. bil. [1X$20=1X$20=$20$20]
And a decrease in G&T decrease in G&T of of $20 bil.$20 bil. will decr Y decr Y byby $20 bil. $20 bil.[1X-$20=1X-$20=--$20$20]
Any increase in expendituresincrease in expenditures x the x the M will M will increase GDPincrease GDP.Any decreasedecrease in in expendituresexpenditures x the M x the M will will decrease GDPdecrease GDP.
RRRR Excess ReservesExcess Reserves
Total (Actual) ReservesTotal (Actual) Reserves
PMC = M x ER, so 10 x .90 =$9PMC = M x ER, so 10 x .90 =$9TMS = PMC[$9] + DD[$1] = $10TMS = PMC[$9] + DD[$1] = $10[[MSMS = = CurrencyCurrency + + DDDD of of PublicPublic]]
Dennis RodmanDennis Rodman depositsdeposits $1 $1 with A with A 10% RR10% RR
.1010 90 cents90 cents
One DollarOne Dollar One bank’s loan becomesOne bank’s loan becomesanother bank’s another bank’s DDDD..
Rodman’sRodman’s
Excess ReservesExcess Reserves
Total(Actual) ReservesTotal(Actual) Reserves
PMC = M x ER, so 10 x $1 = $10PMC = M x ER, so 10 x $1 = $10TMS [$10] = PMC[$10]TMS [$10] = PMC[$10]
[[MSMS = = CurrencyCurrency + + DDDD of of PublicPublic]]
Rodman’s Bank Borrows $1 From The Fed [10% RR]Rodman’s Bank Borrows $1 From The Fed [10% RR]
RRRR
One DollarOne Dollar
Rodman’s BankRodman’s Bank
00 One DollarOne Dollar
FedFed
MULTIPLE DEPOSIT EXPANSION PROCESSMULTIPLE DEPOSIT EXPANSION PROCESSRR= 20%RR= 20%
BankBankAcquired reservesAcquired reserves
and depositsand depositsRequiredRequiredreservesreserves
ExcessExcessreservesreserves
Amount bankAmount bankcan lend - Newcan lend - Newmoney createdmoney created
AABBCCDDEEFFGGHHIIJJKKLLMMNNOther banksOther banks
$100.00$100.00 80.0080.00 64.0064.00 51.2051.20 40.9640.96 32.7732.77 26.2226.22 20.9820.98 16.7816.78 13.4213.42 10.7410.74 8.598.59 6.876.87 5.505.50 21.9721.97
$20.00$20.00 16.0016.00 12.8012.80 10.2410.24 8.198.19 6.556.55 5.245.24 4.204.20 3.363.36 2.682.68 2.152.15 1.721.72 1.371.37 1.101.10 4.404.40
$80.00$80.00 64.0064.00 51.2051.20 40.9640.96 32.7732.77 26.2226.22 20.9820.98 16.7816.78 13.4213.42 10.7410.74 8.598.59 6.876.87 5.505.50 4.404.40 17.5717.57
$80.00$80.00 64.0064.00 51.2051.20 40.9640.96 32.7732.77 26.2226.22 20.9820.98 16.7816.78 13.4213.42 10.7410.74 8.598.59 6.876.87 5.505.50 4.404.40 17.5717.57 $400.00$400.00 PP MMCC in the banking system [MxER]
TMS = $500.00TMS = $500.00
11stst 1010
$$357357ofof
the the $400$400
Paris HiltonParis Hilton
Susie RahRahSusie RahRah
Ronald McDonaldRonald McDonald
Reese WitherspoonReese Witherspoon
I’m doing I’m doing the econ the econ rap.rap.
More or better resources or better technologyMore or better resources or better technologyGGCCAAPPIITTAALL
GGOOOODDSS
40. At what letter is there unemploymentunemployment [recessionrecession]?41. What letters represent resources being used in their most productive mannermost productive manner? [full employment, full production, and best available technology]42. What letter represents an improvement in technologyimprovement in technology, therefore a new PPCnew PPC frontier line?43. The (straight line/curve) illustrates the “law of increasing cost”“law of increasing cost”??44. The (straight line/curve) illustrates the “law of constant cost.”“law of constant cost.”45. At what letter would there be the most economic growthmost economic growth in in thethe futurefuture if a country were producing there now?46. What is the opportunity costopportunity cost when moving from “C” to “D”“C” to “D”;; when moving fromwhen moving from EE to to B B; & do we have to give anything updo we have to give anything up when moving from F to DF to D?
FF
A,B,C,D,EA,B,C,D,E
GG
AACapitalCapital
ConsumerConsumernono
AABB
CC
DD
EE
FF
Consumer GoodsConsumer Goods
Y50Y50
$’s looking for Y$’s looking for Y
The Market for Dollars
Quantity of Dollars
Yen
Pri
ce o
f
Dollar
0
Y100Y100
PP
QE
SS$$DD11$$
Exchange Rate: $1 = ¥100
DD
AA
AA
DD
Appreciation of the DollarAppreciation of the DollarIncrease in taste for U.S. goodsIncrease in U.S. Interest RatesDecrease in U.S. Price LevelDecrease in U.S. Growth Rate
Depreciation of DollarDepreciation of DollarDecrease in TasteDecrease in TasteDecrease Decrease inin I In.n. Rates RatesIncrease Price LevelIncrease Price LevelIncrease Increase Growth RateGrowth Rate
DD22
Y150Y150
EE11
EE22
EE33
DecreaseDecrease in in U.S. Currency PriceU.S. Currency Price
IncreaseIncrease in in Currency PriceCurrency Price
DD33
YenYendepreciatesdepreciates
YenYenappreciatesappreciates
Y looking forY looking for $’s$’s
¥50¥50
Quantity of DollarsQuantity of Dollars
¥¥100100
Price S$$DD11$$[Exchange Rate: $1 = Y100]
DD
AA
AA
DD
DD22
¥¥150150
EE11
EE22
EE33DD33
YenYendepreciatesdepreciates
YenYenappreciatesappreciates
¥ looking for $’s
AppreciationAppreciation//DepreciationDepreciation
MM XX XX MM TTaste aste [products/assets][products/assets]
Interest RatesInterest Rates
Price LevelPrice Level
Growth RateGrowth Rate
Currency PriceCurrency Price
+ + --+ + --+ + --+ + --+ + --
++ --++ --++ --++ --++ --
$’s looking for ¥
SS$$D$$
# of Dollars# of Dollars
¥100¥100
¥150¥150
¥50¥50
SS$$
SS$$DD
AA
AA
DD
¥/$
¥/$
$1$1.50.50
# of ¥
SS11¥¥
$/¥
SS22¥¥
DD
D¥¥
AA
Japan will supplyJapan will supplymore yen for dollars.more yen for dollars.
EE22
EE22
EE22
SS22¥¥
$1.50$1.50DD
Japan will supplyJapan will supplyless yen less yen for for ddollarsollars..
AA
U.S. will supply fewer $U.S. will supply fewer $ss for ¥. for ¥.
U.S. will supply more $U.S. will supply more $ss for ¥. for ¥.
EE22
Real Domestic Output
PricePriceLevelLevel
[Production cost][Production cost]ADAD
PLePLe
YeYe
SRASSRAS [[RREEPP]][[CCIIGG--XX]]
Real Domestic Output, GDP
Pri
ce L
evel
ADAD11
[caused by [caused by “C+Ig+G+Xn”“C+Ig+G+Xn”]]
SRASSRASADAD22
YYRR
LRASLRAS
YYFF
Increase in ADIncrease in AD1.1. Increase in Increase in ConsumptionConsumption2.2. Increase in Increase in InvestmentInvestment3.3. Increase in Increase in Gov. spendingGov. spending A. On A. On military spendingmilitary spending B. On the B. On the infrastructureinfrastructure C. On C. On health carehealth care4. Increase4. Increase in in Net exports [Xn]Net exports [Xn] A. Dollar A. Dollar depreciatesdepreciates B. Trade partners B. Trade partners Y’s riseY’s rise
Real Domestic Output, GDP
Pri
ce L
evel
ADAD22
[caused by [caused by “C+Ig+G+Xn”“C+Ig+G+Xn”]]
SRASSRASADAD11
YYRR
LRASLRAS
YYFF
Decrease in ADDecrease in AD1.1. Decrease in Decrease in ConsumptionConsumption2.2. Decrease in Decrease in InvestmentInvestment3.3. DecreaseDecrease in in Gov. spendingGov. spending A. On A. On military spendingmilitary spending B. On the B. On the infrastructureinfrastructure C. On C. On health carehealth care4. Decrease4. Decrease in in NNet exportset exports [Xn] [Xn] A. Dollar A. Dollar appreciatesappreciates B. Trade partners B. Trade partners Y’s fallY’s fall
RGDP
PL
AS1
AS2
[caused by “REP”][caused by “REP”]
ADIncrease in AS [“REP”]Increase in AS [“REP”]
RResource Cost [esource Cost [domesticdomestic]] a. More land, labor, a. More land, labor, capital & entrepreneurs capital & entrepreneurs b. # of sellers increaseb. # of sellers increase RResource Cost [esource Cost [overseasoverseas]] c. Imported inputs decrease in c. Imported inputs decrease in
priceprice d. Dollar d. Dollar appreciatesappreciatesEEnvironment [legal-institutional]nvironment [legal-institutional] a. Increase in subsidiesa. Increase in subsidies b. Decrease in bus. b. Decrease in bus. regulationsregulations c. c. **Decrease in business taxesDecrease in business taxesPProductivity roductivity Increase in productivityIncrease in productivity
RGDP
PL
AS1AS3
[caused by “REP”][caused by “REP”]
ADDecrease in AS [“REP”]Decrease in AS [“REP”]
RResource Cost [esource Cost [domesticdomestic]] a. Land, labor, & capital a. Land, labor, & capital become more scarcebecome more scarce
b. Nb. Number of sellers decreaseumber of sellers decrease RResource Cost [esource Cost [overseasoverseas]]
c. Imported inputs increase c. Imported inputs increase in pricein price
d. Dollar d. Dollar depreciatesdepreciates
EEnvironment [legal-institutional]nvironment [legal-institutional]
a. Decrease in subsidiesa. Decrease in subsidiesb. Ib. Increasencrease in bus. regulationsin bus. regulationsc. *Ic. *Increase in business taxesncrease in business taxes
PProductivityroductivityDecrease in productivityDecrease in productivity
ADAD
PLPL11
AQDAQD11
[Inverse
Inverse]
PLPL AQDAQD AQDAQD22
PLPL22
AASSPLPL11
AQAQSS11
[DIRECTDIRECT ]
AQAQSS22
PLPL22
1. “Non price Level”“Non price Level” change-either CC, IIgg, GG, or XXnn2. “Whole AD curve” shifts“Whole AD curve” shifts[There is a change in AQD but it is not caused by a change in price level.]
ConsumptionConsumptionMariah Carey Mariah Carey ConcertConcert
GG
IIgg
Chevy FerrariChevy FerrariXXNN[[Exports-Imports]Exports-Imports]
CC
PLPL
AQDAQD11
ADAD22ADAD33ADAD11
RDORDO
LLetet t therehere be m be moreore military weaponsmilitary weapons
AQDAQD22AQDAQD33
Change in AChange in ASS
EEnvironmentnvironment[Legal-institutional][Legal-institutional]
1. “Non price level change”. Either R R, EE, or PP2. “Whole AS curve” shifts.3. AQS changes but is not caused by a change in PL
PLPL
AQSAQS11
ASAS33 ASAS11 ASAS22
1. Lower business taxes 2. Decrease in regulations 3. Increase in subsidies
Increase in PProductivity
You save money. We don’t You save money. We don’t require dental or medical require dental or medical insurance. You don’t have to pay insurance. You don’t have to pay us a pension and we don’t take us a pension and we don’t take sick days. And – we can dance. sick days. And – we can dance.
AQSAQS22AQSAQS33
Anything that lowersthe cost of productionwill shift AS right.
So – AS Shifters areSo – AS Shifters are
REPREP
AS Shifters(REPAS Shifters(REP))1. 1. RResource costesource cost2. 2. EEnvironment nvironment [legal-institutional [legal-institutional environment for businesses change,environment for businesses change, affecting production costsaffecting production costs
[subsidies, bus. taxes, regulations][subsidies, bus. taxes, regulations]3. 3. PProductivityroductivity
Increase in the availability of RResources
YYRR Y Y* * Real GDPReal GDP
PL
AD2
ADAD11
LRAS
YYRR Y Y* * Real GDPReal GDP
SRASSRAS
PL
SS
AEAE1[C+Ig]1[C+Ig]
AE
[C+
Ig+
G]
AE
[C+
Ig+
G]
AEAE2[C+Ig+G]2[C+Ig+G]
4545oo
PL
AD2ADAD11
LRAS
YY* * RGDPRGDP
SRASSRAS
PLPL
SSAEAE1[C+Ig1]1[C+Ig1]
AE
[C+
Ig+
G]
AE
[C+
Ig+
G]
AEAE2[C+Ig2]2[C+Ig2]
YY* * RGDPRGDPYYII YYII
Weaknesses [Limitations] of the AE ModelWeaknesses [Limitations] of the AE Model• Does Not Show Price Level ChangesPrice Level Changes• Does not show Demand-Pull InflationDemand-Pull Inflation• Does Not Deal With Cost-Push InflationCost-Push Inflation [ [StagStagflationflation]]• It ignores premature premature demand-pulldemand-pull inflationinflation [Inflation just before FE GDP]• It does not allow for “self-correction”“self-correction”
4545oo
[increase 80]
AE
AE
[[ CC ++
Ig
Ig
]] (b
illion
s o
f d
ollars
)
o45
o
CConsumptiononsumption
C + IC + Igg
IIg g = $20 = $20 BillionBillion
EquilibriumEquilibrium
370 390390 410410 430 450 470470 490 510 530 550
AE[C+Ig] [AE[C+Ig] [““BasicBasic”” or or ““SimpleSimple”” economy] economy]
C =$450 BillionC =$450 Billion+ 2
0 Ig+20
SS
GDP will increase by a “multiple” of GDP will increase by a “multiple” of 44 & & that is why it is called the “multiplier”.that is why it is called the “multiplier”.
Real GDPReal GDP
MMultiplierultiplier==44 Private -Private - ClosedClosed
+60 more
370370
390390
450450
470470
o
AE
AE [
C+
[C+
IgIg++
Xn
Xn]]
(bil
lio
ns
of
do
lla
rs)
45o
CConsumptiononsumption
C + Ig+XnC + Ig+Xn
IIg g = $20 = $20 BillionBillion
EquilibriumEquilibrium
Real domestic product, GDP (billions of dollars)
370 390390 410 430 450 470470 490 510 530 550
(C[450450] + Ig[2020] +M[1010] + X[1010] = GDPGDP [[470470]]))
C = $450 BillionC = $450 Billion
$530
510
490
470470
450450
430
410
SSPrivatePrivate OpenOpen
390390
AE
(b
illi
on
s)
o45 o
RGDPRGDP390 390 470470
ConsumptionConsumptionC + IC + Ig g + X+ Xnn
C +C + IIgg ++ XXn n ++ GGGovernmentGovernmentSpending ofSpending of$20 Billion$20 Billion
$20 Billion Government Spending & Impact on Equilibrium Y$20 Billion Government Spending & Impact on Equilibrium Y
SS
Mixed - OpenMixed - OpenPrivate-public - ROW
$20 bil. on National Defense
550550
Increases Y by $80Increases Y by $80[$20 x 4 = $80][$20 x 4 = $80]
$390$390
$470$470
$550$550
-20 x 3 = -$60-20 x 3 = -$60
Incr. T by $20 Incr. T by $20 billion billion [[MTMT = 3] Equilibrium GDP[-60] = 3] Equilibrium GDP[-60]
o45
o
Real domestic product, GDP (billions of dollars)
$550$550
C +C + IIg g + X+ Xnn ++ GG
CCaa ++ I Ig g + X+ Xnn ++ GG
$490$490
SS
Mixed-OpenMixed-Open
$20 $20 bil.bil. incr incr in in TT
$490$490
$550$550
RGDPRGDP
Re
al I
nte
res
t R
ate
, (p
erc
en
t)
Quantity of Loanable Funds
[*Use this graph if there is a chg in savings by consumers or chg in fiscal policy][*Use this graph if there is a chg in savings by consumers or chg in fiscal policy]
[*[*Use theUse the Money Market graphMoney Market graph when there is awhen there is a change in MSchange in MS]]
rr==66%%
DD11
FF11
SS
Starting from a balanced budgetbalanced budget, if theG incr spendingG incr spending or decr Tdecr T to get out ofa recessionrecession, they would now be runninga deficitdeficit and have to borrow, pushing pushing up demand in the LFMup demand in the LFM and increasing increasing the interest ratethe interest rate.
DD22
rr==88%%
FF22
EE11
EE22
Use the “real interest rate”“real interest rate” withLFMLFM, because it is long-termlong-term.Use “nominal interest rate”“nominal interest rate” withmoney marketmoney market, as it is short-termshort-term. BorrowersBorrowers LendersLenders
$$2 T2 T
GG TT
Balanced Budget [G&T=$2 Tr.]Balanced Budget [G&T=$2 Tr.]
$2.2 T$2.2 T $2 T$2 T
[*Use this graph if there is a chg in savings by consumers or chg in fiscal policy][*Use this graph if there is a chg in savings by consumers or chg in fiscal policy]
[*[*Use theUse the Money Market graphMoney Market graph when there is awhen there is a change in MSchange in MS]]
Re
al I
nte
res
t R
ate
, (p
erc
en
t)
Quantity of Loanable Funds
rr==66%%
DD11
FF11
SS11
rr==44%%
FF22
EE11
EE22
BorrowersBorrowers LendersLenders SS22
The following would cause anThe following would cause anincrease in supply in the LFMincrease in supply in the LFMand lower real interest rates:and lower real interest rates:1.1. Fed increases MSFed increases MS2.2. HH save moreHH save more3.3. Business save moreBusiness save more4.4. Government saves moreGovernment saves more5.5. Foreigners save more hereForeigners save more here
Real GDPReal GDP
PLPL SRASSRASADAD22
YYRR YYFF
[Incr G; Decr T][[Incr G; Decr T][But we getBut we get negative negative Xn]Xn]
PPL1L1
ADAD11
PLPL22
GG ADAD Y/Empl./PL;Y/Empl./PL; GG LFMLFM II.R..R.
TT DDII CC ADAD Y/Emp/PL;Y/Emp/PL; TT LFMLFM IIRR
Start from a Start from a Balanced BudgetBalanced BudgetG & T = $2 TrillionG & T = $2 Trillion
$2 tr.$2 tr.
““I can’t I can’t get a job.”get a job.”
““NNowow, , this isthis is better.”better.”
GG TT EE11EE22
LRASLRAS
DD11DD22 SS
Loanable Funds MarketLoanable Funds Market
rr=6=6%%rr=8=8%%
Rea
lR
eal
In.
Ra
te
In.
Ra
te
FF11 FF22
$2 tr.$2 tr.
$2.2 tr.$2.2 tr.
$2.2 $2.2 $2.2 $2.2
$1.8$1.8 $1.8$1.8
YYRR
DDMM
InvestmentDemand
No
min
al
Inte
res
t R
ate
88
4
0Money Market QID1QID1
MSMS11
ASASADAD11
PLPL11
8%8%
6%6%
4%4%
00
MSMS22
ADAD22
PL2
If there is a If there is a RECESSIONRECESSIONMS will beMS will beincreased.increased.
QID2QID2
DDII
Y*Y*
Buy Buy BBondsonds MSMS I.R.I.R. QIDQID ADAD YY//EEmp/mp/PLPL
Real GDPReal GDP
BuyBuy
EE11E2E2
6%6%
FedFed
PL
I want a job I want a job as a Rocketteas a Rockette
$2 T$2 T triltril..
Real Real GDPGDP
PL SRASRASSADAD22
YYIIYYFF
[Decr G; Incr T ] [Again, we get negative Xn][Decr G; Incr T ] [Again, we get negative Xn]
PPL1L1
ADAD11
PLPL22
GG ADAD Y/Empl./PL;Y/Empl./PL; GG LFMLFM I.R.I.R.
TT DDII CC ADAD Y/Emp/PL;Y/Emp/PL; TT LFMLFM IIRR
Start from a Start from a Balanced BudgetBalanced BudgetG & T = $2 TrillionG & T = $2 Trillion
$2$2 tril. tril.
GG TT
[like we have [like we have ““money trees”money trees”]]
EE11
EE22
LRASLRAS
Loanable Funds MarketLoanable Funds Market
rr=3=3%%
rr=6=6%%
DD11DD22
FF11FF22
SS
$2.2 T$2.2 T triltril..
$1.8$1.8 tril. tril...
$$1.81.8
$2.2$2.2 $2.2$2.2
$$1.81.8
Rea
lR
eal
In.
Ra
te
In.
Ra
te
10
88
66
0If there isIf there isINFLATIONINFLATION,,MS will beMS will bedecreased.decreased.
YYII
Y/EY/Empl.mpl./PL/PL
DDII
ADAD11PL
DDmmInvestment
Demand
Nom
inal In
tere
st
Rate
1010%%
8%8%
6%6%
0Money MarketMoney Market QIDQID2 2 ASADAD22
PLPL22
MSMS11
PLPL11
MSMS22
SellSell
QIDQID11
YY**
““It’s cheaper It’s cheaper to burn moneyto burn moneythan wood.”than wood.”
SellSellBondsBonds MSMS I.R.I.R. QIDQID ADAD
like““money trees”money trees”
EE11
EE22
FedFed
DDm(K)m(K)
Also, the KeynesiansKeynesians don’t think the the lower interest ratelower interest rate is asis as importantimportant as as “profit expectations.”“profit expectations.”
YYDD YY** Investment Demand
7%
55%%
11%%
0Money MarketMoney Market
QIDQID11 QIDQID22
SRASADAD11
PLPL
7%
55%%
11%%
0
MSMS22 DDI(K)I(K)
MSMS11
KKeynesian vieweynesian view is that DDMM isis flatflat [liquidity trap during a depression][liquidity trap during a depression]
and DI is is ratherrather steepsteep so monetary policy is not that strongnot that strong.
Fiscal policyFiscal policy is “ is “top bananatop banana.”.”
ThinkThink““Great Depression”Great Depression”
LRAS
1%
GDPGDP
No
min
al In
tere
st R
ate
0 500
DDmm
EE
MSMS11 MSMS22
Money MarketMoney Market
PLPL
SRASSRAS
ADAD
Liquidity TrapLiquidity Trap – in a stagnant economystagnant economy with interest rates near or at zerointerest rates near or at zero, anincrease in MSincrease in MS fails to stimulate AD, so recession or depression gets worserecession or depression gets worse.With low returns expected on financial investments, people hoard their moneypeople hoard their money.. Banks are unwilling to lend in a slack economy. Fiscal policy is needed hereFiscal policy is needed here.
YYDD
LRASLRAS
ADAD
DDm(M)m(M)
YYrr Investment DemandMoney MarketMoney Market
QIDQID11
SRASADAD11
PLPL11
ii11
MSMS22 DDI(K)I(K)MSMS11
MonetaristMonetarist view view is that DDMM is vertical is vertical [ [inelasticinelastic]] and drop I.R. very much.
DDII is is rather flat [elastic]rather flat [elastic] so monetary policy is very responsivevery responsive to decreases inthe interest rate.
LRAS
00
ii22
ii11
QIDQID22 YY**
MonetaristMonetarist view view is that the economy is relatively stableeconomy is relatively stable so increase the increase the MS only as much as the increase in real GDPMS only as much as the increase in real GDP. They are against fiscal policyagainst fiscal policy because of “crowding out.”“crowding out.”
PLPL22ii22
0
100100
L
Tax revenue (dollars)Tax revenue (dollars)
Tax
rat
e (p
erce
nt)
Tax
rat
e (p
erce
nt)
00
100100
M
L
Tax revenue (dollars)Tax revenue (dollars)
Tax
rat
e (p
erce
nt)
Tax
rat
e (p
erce
nt)
00
100100
MM
NN
L
Tax revenue (dollars)Tax revenue (dollars)
Tax
rat
e (p
erce
nt)
Tax
rat
e (p
erce
nt)
00
100100
M M
N
L
Tax revenue (dollars)Tax revenue (dollars)
Tax
rat
e (%
)T
ax r
ate
(%)
MaximumMaximumTaxTax
RevenueRevenue
10%10%
3%3%
1%1%
An
nu
al R
ate
of
Infl
atio
nA
nn
ual
Rat
e o
f In
flat
ion
1010%%
PCPC
5%5%
55% is % is YY**(F)(F) with with 33% anticipated PL.% anticipated PL.
Menu of ChoicesMenu of Choices
““More inflation”More inflation” or““more unemloyment”more unemloyment”
3%3%
UnemploymentUnemployment
Inflat.Inflat.GapGap
RRecess.ecess.
GapGap
SRASSRAS1 1
LRALRASS
Y*Y*5%5%
ADAD11
ADAD22PLPL
3%3%
10%10%
YYII
3%3%
Inflat.Inflat.GapGap
ADAD33
1%1%
YYRR
1010%%
Recess.Recess.GapGap
LRPCLRPC
Alban William Housego PhillipsAlban William Housego Phillips1914-19751914-1975
The The SRPCSRPC is almost is almostthe mirror image ofthe mirror image of
the the SRASSRAS curve curve..
The The new Phillips Curvenew Phillips Curve will will
have a have a SRPCSRPC & a & a LRPCLRPC..
SRPCSRPC
An
nu
al ra
te o
f A
nn
ual ra
te o
f in
flati
on
infl
ati
on
Unemployment rate Unemployment rate (percent)(percent)
7%
6%
55%%
4%
3%
22%%
1%
1 2 33 4 55 6 7
ASAS inflation inflation declinesdeclines...
UUnemploynemploy..increasesincreases
PPCC
3 4 5 60
3%
6%
9%
12%
15%
An
nu
al R
ate
of
Infl
atio
n (
Per
cen
t)
Unemployment Rate (Percent)
LRPC
SRPC3
SRPC2
SRPC1
a1
b1
a2
a3
b2
b3
c3
c2
Remember, anytime there is an increase in ADincrease in AD, there is a movement up movement up and to the left on the and to the left on the SRPCSRPC.Remember, any time the SRAS curve SRAS curve shifts leftshifts left the SRPC SRPC shifts rightshifts right.
Also if there is a decrease in ADdecrease in AD, there is a movement movement down and to the down and to the right on the SRPCright on the SRPC.
Also if the SRAS SRAS curve shifts rightcurve shifts right, the SRPC shifts leftSRPC shifts left.
InflationInflation
1515%%
SSRRPPCC33
SSRRPPCC11
SSRRPPCC22
There There is ais a SSRRPPCC [output prices are changing] [output prices are changing] andand aa LRPCLRPC[output [output & & input prices input prices chg afterchg after unanticipated inflation or disinflation] unanticipated inflation or disinflation]
LRPCLRPC - when unemployment = the natural rate and there is no tendency for PL to be incr/decr. PL is stable & contracts reflect it.
Let’s say that inflationinflation
has averaged averaged 99%% forthe past few years.
99% is anticipated% is anticipated.
0 0 33%% 55%% 77%%
My salary just My salary just isn’t keeping up.isn’t keeping up.
1212%%
99%%
66%%
33%%aa11
aa22
aa33
bb11
bb22
bb33
CC11
cc22
cc33
LRPCLRPC
Inflat.Inflat.GapGap
Recess.Recess.GapGap
Wow, my raise exceeds inflation.
Let’s say that inflationinflation has averagedaveraged 33%% for three years. 33% is anticipated% is anticipated..
But my salary went up by only 3%.
It can’t get any better.My raise exceeds inflation.
But when it comes time to sign But when it comes time to sign a new contract, his boss says …a new contract, his boss says …
But my raise was only 6%.
