Macroeconomics Notes

MACROECONOMICS

CHAPTER 2

The measure of the aggregate output in the national income accounts is GDP: gross domestic

product. This is defined as:

1. The value of goods and services produced in an economy during a given period

2. The sum of the value added of an economy during a given period

3. The sum of incomes in an economy during a given period

The nominal GDP is the sum of the quantities of final good multiplied by their current price;

The real GDP is the sum of the quantities of final goods multiplied by their constant price

Yt – Tt Periods of positive growth are called

−1

The GDP growth equals to: Yt −1 expansions

Periods of negative growth are called

recessions

The employment (N) is the number of people in working age who has a job

The unemployment (U) is the number of people in working age who’s looking for a job

The labor is the sum of both above: L = N + U U

The unemployment rate is given by: u = . The economists care about unemployment

L

because:

I. It directly affects the welfare of unemployed

II. It’s a signal that the economy may not be using all of its resources

A fair rate of unemployment is 4%

The participation rate is given by: CPS = labor force/population of working age

The inflation is a sustained increase in the price level, on the other hand, the deflation is a

sustained decrease in the price level. The inflation could be computed by :

1. the GDP deflator (Pt) which measure the average price of output: Pt = nominal GDP/real

GDP

2. the consumer price index (CPI) which measure the cost of living

The economists care about inflation because during periods of inflation prices and wages don’t rise

proportionately leading to distortion.

CHAPTER 3

GDP = C + I + G + X – IM open economy

GDP = C + I + G Closed economy

1. CONSUMPTION C = C0 +C1 X (Y – T) is an endogenous variable and represents goods

and services purchased by consumers

C0 = what people consume. Is the intercept of the consumption function

C1 = propensity to consume

The consumption function C(Yd) is a behavioral equation because it captures the

consumers’ behavior. It could also be written as C = c0 + c1Yd where Yd is called

disposable income (income that remains after paying taxes and receiving transfers from

the government) and is given by:

Yd = Y - T

2. INVESTMENT I = I is an exogenous variable, taken as given. Is the sum of non residential

investments and residential investments. It depends on:

Level of sales (+) The higher the production the higher the

investment

Interest rate (-) The higher the interest rate the lower the

investment

3. GOVERNMENT SPENDING (G) is an exogenous variable. Together with T describes

fiscal policy

4. EXPORTS (X) are the purchases of foreign goods and services by consumers

5. IMPORTS (IM) are the purchases of national goods by consumers

X = IM Trade balance

X > IM Trade surplus

X < IM Trade deficit

The total demand for good is written as:

Z = C + I + G + X – IM In an OPEN ECONOMY

Z = C + I + G In a CLOSED ECONOMY

In a closed economy the equilibrium of the GOODS MARKET requires 2 equilibrium conditions:

1. First is that: Y = Z. The production Y must be equal to the demand Z. From that we get:

[ ]

1 – c1T

[c0+I +G ]

Y = 1−c1

[ ]

1 is the multiplier and is always positive because 0<x<1

o 1−c1

[c0 + I + G – c1T] is that part of demand that doesn’t depend on output, so it’s called

o autonomous spending

PRODUCTION depends on demand, which depends on income which is itself equal to

production so in the goods market, the demand for goods is an INCREASING

FUNCTION because an increase in demand leads to an increase in production and a

corresponding increase in income, so the result is an increase in output that is larger

than the initial shift in demand.

2. Second is that: I = S + (T – G). This condition is called the IS relation: what firms want to

invest must be equal to what people want to save. From that we get:

[ ]

1

Y = [c0 + I + G – c1T] the same result as before

1−c1

SAVING (S) is the sum of private and public savings:

1. Private saving: S = Y – T – C

2. Public saving: S = T – G

T = G Balanced budget

T > G S > 0 public saving is positive Budget surplus

T < G S < 0 public saving is negative Budget deficit

The paradox of saving is that the more people try to save, the more the output declines with

unchanged saving!

CHAPTER 4

There are two types of money:

1. Currency

2. Checkable deposits

Then there are the bonds that cannot be used for transactions.

The proportion of money/ bonds that should be hold depends on:

I. Your level of transaction

II. The interest rate on bonds

The demand for money Md = $YL(i) The higher the nominal income ($Y), the higher

the demand for money

The lower the interest rate (i), the higher the

demand for money

In FINANCIAL MARKET the equilibrium condition requires that money supply be equal to money

demand:

M = $YL(i) and thi is called LM relation.

Determination of the interest rate: must be such that the

money supply is equal to the money demand.

An increase in nominal income ($Y) leads to an increase in the

demand curve Md (shifting to the right) that correspond to an

increse in i.

An increase in the supply of money leads to a decrease of

the interest rate

The open market operations are the method Central Banks use to change the money supply in

modern economies:

If CB buys bonds Increase in money supply Ms EXPANSIONARY POLICY

If CB sells bonds Decrease in money supply Ms CONTRACTIONARY POLICY

The higher the price of the bond, the lower the interest rate: coce the CB has bought the bonds

(increasing Ms), also the demand of bonds (Md) increases and consequently their selling price and

the result is that the interest rate (i) goes down. So i is determined by the equality of Ms and

Md.

T-bills are bond issued by the US government that are repaid in 1 year or less.

SUMMARY

The interest rate is determined by the equilibrium between Md and Ms

 By changing the Ms the CB can affect the interest rate

 The CB changes the Ms through Open-market operations, which are sales or purchases of

 bonds for money

Open-market operations in which CB increases the Ms by buying bonds lead to an increace

 in the price of bonds and to a decrease in the interest rate

Open-market operations in which CB decreses the Ms by selling bonds lead to a decrease

 in the price of bond and to an increase in the interest rate

Financial Intermediaries are institutions which receive funds from people and firms and then use

these funds to buy bonds or stock or to make loans to other people. Banks keep as reserve part of

the fund that receive in 3 ways:

1. Every day some depositors withdraw cash from the bank and others deposit cash to the

bank

2. Every day some depositors of the bank write checks to depositors of other banks and, in

the same way, depositors of other banks write checks to depositors of the bank

3. Banks are subjected to reserve requirements: the actual reserve ratio in USA is about 10%

CB Balance Sheet

ASSETS LIABILITIES

Bonds CB money = reserves + currency

Bank Balance Sheet

ASSETS LIABILITIES

Reseves, loans, bonds Checkable deposits

An increase in interest rate (i) implies a lower demand of CB money because the demand for

currency and checkable deposits by people goes down (they rather hold bonds)

A bank run is a bank that run of of reserves, in order to avoid it the US governments introduced:

a) The federal deposit insurance

b) The narrow banking

When people can hold both currency and checkable deposit they have to decide how much of it

they want to hold.

Currency demand CUd = c Md

Checkable deposits demand Dd = (1 – c) Md

The larger the amount of checkable deposits, the larger the amout of reserves that the banks must

hold. The relation between reserves (R) and deposit (D) is: R = ΘD

The demand for reserves by banks is given by: Rd = Θ (1 – c) Md

The demand for CB money is equal to the sum of currency and reserves: Hd = CUd + Rd

In equilibrium the supply for CB money (H) is equal to the demand for CB money (Hd): H = Hd

In equilibrium the supply for bank reserves is equal to the demand for bank reserves: H – CUd =

Rd [ ]

1 H

The overall Ms is equal to the CB money (H) times the money multiplier: c 1 – c

( )

+Θ

High-powered money is the termi used to refect the fact that the Ms depends on H or monetary

base.

CHAPTER 5

IS relation: Y = Z



Taking into account the investment relation, the equilibrium condition becomes:

Y = C(Y – T) + I(Y,i) + G

PRODUCTION: the more the production, the more the machineries

INTEREST RATE: the higher the interest rate, the lower the investment

An increase in OUTPUT Y leads to an increase in the DEMAND

Z and a decrease in the interest rate (i)

An increase in INTEREST RATE i leads to a decrease in

DEMAND Z (and also in income/output Y, production and then

in investment I)

The downward-sloping IS CURVE describes the relation between

interest rate (i) and output (y): an increase in i implies a decrease

in Y

The factors which shifts the IS curve are G, T, and CONSUMER CONFIDENCE

LEFT SHIFT Any factor that decreases Y ↑T; ↓G; ↓C. CONFIDENCE

RIGHT SHIFT Any factor that increases Y ↓T; ↑G; ↑C. CONFIDENCE

An increase in taxes shifts the IS curve to the left

The IS curve DO NOT shift when there is a reduction in interest

rate LM relation: M = $YL(i)

 M

It becomes: = YL(i)

P

An increase in income Y leads to an increase in the demand for money Md. Given the supply of

money Ms, the increase in the demand leads to an increase in the equilibrium interest rate i. In the

financial market, an increase in income Y leads to an increase in interest rate i and that’s why the

LM curve is upward sloping.

An increase in money M/P causes the LM curve to shift down. So, in the financial market an

increase in the level of income, corresponding to an increase in the demand for money,

leads to an increase in the interest rate.

Equilibrium in the goods market states that at an increase in

interest rate corresponds a decrease in output; equilibrium in

the financial market states that at an increase in the interest rate

corresponds an increase in output. So there’s only one point (A)

at which both goods and financial markets are in equilibrium.

SHIFTS of IS of LM of AD of AS Movement Movement Trade Domestic

in output Y in interest balance demand

rate i

↑ in taxes Left / Down Down

T

↓ in taxes Ri