Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year.

GDP Is Measured Using Market Values, Not Quantities

Final good or service A good or service purchased by a final user:

•Household consumption

•Business investment, including all residential construction

•Government purchases

•Exports to foreigners

• Net out goods imported from foreigners

GDP = C + I +G + NX

GDP Includes Only Current Production

Transfer payments are not included in GDP

“Underground economy” activities are not included in GDP

Household production is not included in GDP

The Value of Leisure Is Not Included in GDP

GDP Is Not Adjusted for Pollution

GDP Is Not Adjusted for Changes in Crime and Other Social Problems

GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

The GDP Deflator

$ GDP = Price Level x Real Output$Y = P x Y

P = $Y/Y

Y = $Y/P

Other Measures of Total Production and Total Income

Gross National Product (GNP)=GDP + Net Foreign Earnings of US Residents

•Compensation of employees earned abroad•Interest and profits earned abroad

Net National Product (NNP) = GNP - Capital Consumption Allowance (depreciation)

National Income (NI) = NNP - Indirect Business Taxes

Personal Income (PI) = NI + Net Transfer Payments

= Income earned from production of national product

Disposable Income (DI) = PI - Income Taxes

•Disposable Income is split between consumption and saving

Consumer price index (CPI) An average of the prices of the goods and services purchased by the typical urban family of four.

• Substitution bias.

• Increase in quality bias.

• New product bias.

• Outlet bias.

Real versus Nominal Interest Rates

Nominal interest rate: The stated interest rate on a loan.

Real interest rate: The nominal interest rate minus the inflation rate.

Real interest rate = Nominal interest rate − Inflation rate

Deflation A decline in the price level.

Potential GDP The level of real GDP attained when all firms are producing at capacity.

Business cycle ... Fluctuations around potential real GDP

The Employment Status of the Civilian Working-Age Population, April 2007

100Number of unemployed

Unemployment rateLabor force

Frictional Unemployment and Job Search

Types of Unemployment

Cyclical Unemployment

Structural Unemployment

Macroeconomic Equilibrium: Aggregate Expenditure = Output (Y)

AE = C + I + G + NX = Y

• Current disposable income• Household wealth: Assets minus liabilities

• Expected future income

• The price level

• The interest rate

• New, gotta-have styles and products

The most important variables that determine the level of C:

The Relationship between Consumption and Income,

The Slope of the Consumption Function is the Marginal Propensity to Consume

MPC = Change in Consumption in Response to a Change in Disposable Income

MPC = ΔConsumption/ΔDisposable Income = ΔC/ΔYD

When disposable income changes, ΔC = MPC x ΔYD

• Expectations of future profitability

Waves of optimism and pessimism

• Major technology changes: new products & processes

• The interest rate

• Taxes

• Cash flow Retained earnings for financing investment

• Current capacity utilization

The most important variables that determine the level of investment:

• The price level in the United States relative to the price levels in other countries

• The growth rate of GDP in the United States relative to the growth rates of GDP in other countries

• The exchange rate between the dollar and other currencies

Net Exports (NX)

The most important variables that determine the level of net exports:

Graphing Macroeconomic Equilibrium

The Multiplier Effect

Multiplier The increase in equilibrium real GDP in response to increase in autonomous expenditure, e.g. Expenditure multiplier = ΔY/ΔI

ΔY = ΔI + ΔC

Increase in output sparked by ΔI induces additional consumption,

ΔC = MPC x ΔY

MPC1

1

Aggregate demand curve A curve that shows the relationship between the price level and the level of planned aggregate expenditure, holding constant all other factors that affect aggregate expenditure.

Price up Real monetary wealth

down i up and I down + Net Exports down Output down

Aggregate demand and aggregate supply model A model that explains short-run fluctuations in real GDP and the price level.

Aggregate Supply

1 Contracts make some wages and prices “sticky.”

2 Firms are often slow to adjust wages.

3 Menu costs make some prices sticky.

The Short-Run Aggregate Supply Curve slopes upward

Why does the short-run aggregate supply curve slope upward?

Macroeconomic Equilibriumin the Long Run and the Short Run

Long-Run Macroeconomic Equilibrium

Expansion...and restoration of full employmentThe Short-Run and Long- run Effects of an Increase in Aggregate Demand:

• Prices rise along SRAS as the economy expands

• Costs increase as less productive resources are used to produce more output

• Firms increase prices to cover higher costs

• Rising wages and prices

shift SRAS inward

• Workers demand and get higher wages to offset higher prices

• Costs of production increase

• Firms increase prices to cover higher costs

Money Assets that people are generally willing to accept in exchange for goods and services or for payment of debts.

Asset Anything of value owned by a person or a firm.

What Is Money and Why Do We Need It?

The Functions of Money

• Medium of exchange: buy stuff with money

• Unit of account: post prices/keep books in money terms

• Standard of deferred payment: need money to pay debts

• Store of value

Hold money on chance prices of other assets fall

M1: The Narrowest Definition of the Money Supply

How Is Money Measured in the United States Today?

Figure 25-1

Measuring the Money Supply, July 2009

The Federal Reserve uses two different measures of the money supply: M1 and M2.M2 includes all the assets in M1, as well as the additional assets shown in panel (b).

How Banks Create Money

BANK

INCREASE IN CHECKING DEPOSITS

Wachovia $1,000

PNC + 900 (= 0.9 x $1,000)

Third Bank + 810 (= 0.9 x $900)

Fourth Bank + 729 (= 0.9 x $810)

. + •

. + •

. +

Total Change in Checking Account Deposits =$10,000

RR

1 multiplierdeposit Simple

The Functions of a Modern Central Bank

The Banker’s Bank:Lender of last resort in crises• Bank run: When many depositors rush to withdraw money at

the same time...They “run” to get to the cashier.• Silent run: Major creditors don’t turn over their loans to a

bank.

• Bank panic: Many banks experience runs at the same time.

Operates clearing system for interbank payments.Oversees financial intermediaries - ensure their soundness. - ensure public confidence

The Government's Bank:– Manages government transactions.– Controls availability of money and credit.

The Federal Reserve System

The Organization of the Federal Reserve System

Federal Reserve Districts

Federal Open Market Committee: Board of Governors + District BankPresidents meet 8 times a year to set policy. All presidents attend the FOMC meetings but they take turns voting (FRBNY guy always votes).

Board of Governors:Seven Governors nominated by Pres-ident and confirmed by Senate for 14 year terms. The Chair has a renewable 4 year term.

The Process of Securitization

(a) Securitizing a loan(b) The flow of payments on a securitized loan

The 1960s: A Policy Menu?

The Short-Run and Long-Run Phillips Curves

The Inflation Rate and the Natural Rate of Unemployment in the Long Run

Nonaccelerating inflation rate of unemployment (NAIRU) The unemployment rate at which the inflation rate has no tendency to increase or decrease.

How the Fed Fights InflationPaul Volcker and Disinflation

The Fed Tames Inflation, 1979–1989

The Balance of Payments: Linking the United States to the International Economy

• Current account records a country’s net exports, net income on investments, and net transfers... That is, payments for currently produced goods and services including labor services (paid wages) and capital services (paid “investment income”)

• Balance of merchandise trade (sometimes called “balance of trade”)

• Balance of trade in goods and service

• Net investment and labor income

• Net transfers

Balance of payments The record of a country’s trade with other countries in goods, services, and assets.

• Financial account records a country’s sales of domestic asset to foreign residents and purchase of foreign assets by domestic residents.

• Net foreign investment The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment plus net foreign portfolio investment.

Equilibrium in the Market for Foreign Exchange

Currency appreciation An increase in the market value of one currency relative to another currency.

Currency depreciation A decrease in the market value of one currency relative to another currency.

Slope on logarithmic scale= Rate of Real GDP Growth

Growth Slowdown1948-70 growth rate > 1970+ growth rate

1983 - 2007Great Moderation

The Per-Worker Production Function• Output per worker is a decreasing function of capital

per worker• There are diminishing returns to capital

Looking Across Countries – A Closer LookLooking Across Countries – A Closer Look

Conditional convergence•Human capital

•Geography and resources•Institutions: Rule-of-law/property rights/finance

What Determines How Fast Economies Grow?

• Better machinery and equipment.

• Increases in human capital.

• Better means of organizing and managing production.

There are three main sources of technological change:

• Better means of organizing and managing production.

Technology - technology - technology

What Determines How Fast Economies Grow?Technological Change: The Key to Sustaining Economic Growth