CH.

5 INTRO TO MACROECON

Macroeconomics
● focuses on the determinants of total national output
● Aggregate - Sums

● Aggregate Behavior
○ behavior of all households and firms together
● Sticky Prices
○ prices that do not always adjust rapidly to maintain equality between quantity
supplied and quantity demanded

3 Major Macroeconomic Concerns

1. Output Growth
2. Unemployment
3. Inflation and Deflation

1. Output Growth

● Business Cycle
○ cycle of short-term ups and downs in the economy
● Aggregate Output
○ total quantity of goods and services produced in an economy in a given period
● Recessions
○ period during which aggregate output declines
○ 2 Consecutive Quarters
○ Depression
■ prolonged and deep recession
● Expansion/Boom
○ period in the business cycle from a trough up to a peak during which output and
employment grow
● Contraction/Recession/Slump
○ period in the business cycle from a peak down to a trough during which output
and employment fall
 2. Unemployment
● Unemployment Rate
○ percentage of the labor force that is unemployed
○ unemployment rate is usually closely related to the economy’s aggregate output

3. Inflation and Deflation

● Inflation
○ increase in the overall price level
○ Hyperinflation
■ periods of very rapid increases in the overall price level
○ Deflation
■ decrease in the overall price level

4 Components of the Macroeconomy

1. Households
2. Firms
3. Government
4. Rest of the World

Circular Flow of Payments

 1. Households
a. Wages
b. also receive interest on corporate and government bonds and dividends from
firms
c. Transfer Payments
i. Social Security benefits, veterans’ benefits, and welfare payments
ii. Not in exchange of labor
d. Save
i. households receive more than they spend
e. Dissave aka Leakage
i. receive less than they spend
2. Firms
a. sell goods and services to households and the government
b. pay wages,interest, and dividends to households
c. pay taxes to the government
3. Government
a. collects taxes from households and firms
b. buys goods and services from firms, pays wages and interest to households,
and makes transfer payments to households
4. Rest of the World
a. Imports
b. Exports
5. everyone’s expenditure is someone else’s receipt

The 3 Market Arenas

1. GOODS AND SERVICES MARKET
2. LABOR MARKET
3. MONEY MARKET

1. GOODS AND SERVICES MARKET

 a. Firms supply to the goods-and-services market. Households, the government,
and firms demand from this market
2. LABOR MARKET
a. firms and the government purchase labor from households
3. MONEY MARKET
a. households purchase stocks and bonds from firms
b. Households also demand (borrow) funds from this market to finance various
purchases
c. government borrows by issuing bonds
d. Treasury bonds, notes, and bills
i. Promissory notes issued by the federal government when it borrows
money
e. Corporate Bonds
i. Promissory notes issued by firms when they borrow money
f. Shares of Stock
i. Financial instruments that give to the holder a share in the firm’s
ownership and therefore the right to share in the firm’s profits
g. Dividends
i. portion of a firm’s profits that the firm pays out each period to its
shareholders
h. Capital Gain
i. occurs whenever the value of an asset increases
ii. Realized only at sale

The Role of the Government in the Macroeconomy

● Fiscal Policy
○ Tax and Spending
○ Expansionary
■ taxes are cut and/or government spending increase
○ Contractionary
■ reverse

● Monetary Policy
○ tools used by the Federal Reserve to control the quantity of money, which in turn
affects interest rates

History of Macroecon
● GREAT DEPRESSION
○ had the largest and longest aggregate output contraction in the twentieth century
in the United States
○ John Maynard Keynes
■ governments could intervene in the economy and affect the level of
output and employment
 ○ Fine-Tuning
■ used by Walter Heller to refer to the government’s role in regulating
inflation and unemployment
○ Stagflation
■ situation of both high inflation and high unemployment, slow or negative
output growth
○ Through the late 1960s, it was believed that the government could “fine-tune”the
economy to keep it running on an even keel at all times. The poor economic
performance of the 1970s, however, showed that fine-tuning does not always
work.
○ Since 1970,the U.S.economy has seen five recessions and two periods of high
inflation.

CH. 6 MEASURING NATIONAL OUTPUT AND NATIONAL INCOME

National Income and Product Accounts

● Data collected and published by the government describing the various components of
national income and output in the economy

Gross Domestic Product (GDP)

● total market value of all final goods and services produced within a given period by
factors of production located within a country

Final Goods and Services

● Goods and services produced for final use

Intermediate Goods
● produced by one firm for use in further processing by another firm

Value Added
● difference between the value of goods as they leave a stage of production and the cost
of the goods as they entered that stage
Exclusion of used goods and paper transactions
● Old output is not counted in current GDP because it was already counted when it was
produced
● Sales of stocks and bonds are not counted in GD
○ Nothing to do with current production
○ But fee to broker is counted in GDP

Exclusion of Output produced abroad by domestically owned factors of production

● GDP is the value of output produced by factors of production located within a country.
● GROSS NATIONAL PRODUCT (GNP)
● total market value of all final goods and services produced within a given period by
factors of production owned by a country’s citizens, regardless of where the output is
produced

Calculating GDP

1. Expenditure Approach
a. method of computing GDP that measures the total amount spent on all final
goods and services during a given period (add up total amount spent)
2. Income Approach
a. measures the income—wages, rents, interest, and profits— received by all
factors of production in producing final goods and services (add up total income)

EXPENDITURE APPROACH
● GDP = C + I + G + (EX-IM)

● 4 Main Categories of Expenditure

○ Personal Consumption ( C)
■ household spending on consumer goods
○ Gross Private Domestic Investment (I)
■ spending by firms and households on new capital, that
is,plant,equipment,inventory,and new residential structures
○ Government consumption and gross investment (G)
○ Net exports (EX-IM)

● Personal Consumption Expenditures (C)

○ Durable Goods
■ Long life span
○ Nondurable Goods
■ Used up very quickly
■ Food, Clothes, Gas
○ Services
● Gross Private Domestic Investment (I)
○ Nonresidential investment
 ■ PPE
○ Residential Investment
■ Expenditures for new houses and apartment buildings
○ Change in Business Inventories
■ Inventories can be looked at as the goods that firms produce now but
intend to sell later.
■ Amount by which firms’ inventories change during a period. Inventories
are the goods that firms produce now but intend to sell later.
■ GDP = FINAL SALES + CHANGE IN BUSINESS INVENTORIES
● Gross Investment vs Net Investment
○ GDP includes newly produced capital goods but does not take account of capital
goods “consumed”in the production process.
○ DEPRECIATION
■ amount by which an asset’s value falls in a given period
○ GROSS INVESTMENT
■ total value of all newly produced capital goods (plant, equipment,
housing, and inventory) produced in a given period
○ NET INVESTMENT
■ gross investment minus depreciation
■ how much the stock of capital changes during a period
■ End Cap = Beg Cap + Net Investment
○ GOVERNMENT CONSUMPTION AND GROSS INVESTMENT (G)
■ Expenditures by federal, state, and local governments for final goods and
services
■ Does not include Transfer Payments (SSS, Stipends)
■ Because interest payments on the government debt are also counted as
transfers, they are excluded from GDP on the grounds that they are not
payments for current goods or services.
● NET EXPORTS (EX-IM)
○ Balances the overstatement of CIG on imports (expenditures on foreign goods
and services) and understatement on exports (domestic production)

INCOME APPROACH
● NATIONAL INCOME
○ income earned by the factors of production owned by a country’s citizens
○ 8 items
■ Compensation of Employees
■ Proprietor's Income
■ Rental Income
■ Corporate Profits
■ Net Interest
■ Indirect taxes - subsidiaries
■ Net business transfer payments
■ Surplus of government enterprises
● Compensation of Employees
○ Includes wages, salaries, and various supplements—employer contributions to
social insurance and pension funds
● Proprietor’s Income
○ income of unincorporated businesses
● Rental Income
○ income received by property owners in the form of rent
● Corporate Profits
○ income of corporations
● Net Interest
○ interest paid by business

● Indirect Taxes - Subsidiaries

○ Taxes such as sales taxes, customs duties, and license fees less subsidies that
the government pays for which it receives no goods or services in return
● Net Business Transfer Payments
○ Net transfer payments by businesses to others.
● Surplus of Government Enterprises
○ Income of government enterprises

● NET NATIONAL PRODUCT (NNP)

○ nation’s total product minus what is required to maintain the value of its capital
stock
○ GNP - DEPRECIATION
● STATISTICAL DISCREPANCY
○ Data measurement error

● PERSONAL INCOME
○ total income of households before paying personal income taxes.
○ Does not contain retained earnings (retained earnings are part of national income
but not personal income)
● DISPOSABLE INCOME
 ○ The amount of income that households have to spend or save is called
disposable personal income, or after-tax income.
○ It is equal to personal income minus personal income taxes.
● PERSONAL SAVING
○ The amount of disposable personal income left after total personal spending is
personal saving
● PERSONAL SAVING RATE
○ percentage of disposable personal income saved

NOMINAL VS REAL GDP

 NOMINAL GDP
o GDP measured in current dollars
 REAL GDP
o Nominal GDP adjusted for price changes
 CALCULATING REAL GDP
o Old Procedure
 Pick a base year and use prices in that year as weights to calculate real
GDP
o New Procedure
 Split the difference using geometric averages
GDP DEFLATOR

CH 7. UNEMPLOYMENT, INFLATION, AND LONG RUN GROWTH

Unemployment
 Unemployed
o a person must be 15 (16 US) years old or older
o available for work
o have made specific efforts to find work during the previous 4 weeks
 Not in the Labor Force
o not looking for work because he or she does not want a job or has given up
looking
 o full-time students, retirees, individuals in institutions, those staying home to take
care of children, and discouraged job seekers.
o 15 y/o minimum to be considered part of labor force (16 US)
 Labor Force
o Number of people employed plus the number of people unemployed

Labor Force Participation Rate

DISCOURAGED WORKER EFFECTS

 Unemployment rate underestimates the fraction of people who are involuntarily out of
work. People who stop looking for work are classified as having dropped out of the labor
force instead of being unemployed

Frictional Unemployment
 The portion of unemployment due to the normal turnover in the labor market
 The frictional unemployment rate can never be zero
 denote short-run job/skill-matching problems ,problems that last a few weeks

Structural Unemployment
 Similar to frictional
 denotes longer-run adjustment problems—those that tend to last for years

Natural Rate of Unemployment

 refer to the unemployment rate that occurs in a normal functioning economy

Cyclical Unemployment
 Any unemployment that is above frictional plus structural
INFLATION

CONSUMER PRICE INDEX

The CPI is an indicator of the change in the average retail prices of a fixed basket of goods and
services commonly purchased by households relative to a base year.

 Chained Consumer Price Index

o Uses changing weights

PRODUCER PRICE INDEX (WHOLESALE PRICE INDEX)

 These are indexes of prices that producers receive for products at all stages in the
production process,not just the final stage.The indexes are calculated separately for
various stages in the production process. The three main categories are finished goods,
intermediate materials, and crude materials,although there are subcategories within
each of these categories.
 One advantage of some of the PPIs is that they detect price increases early in the
production process. Because their movements sometimes foreshadow future changes in
consumer prices, they are considered to be leading indicators of future consumer prices.

 Output growth is the growth rate of the output of the entire economy.
 Per-capita output growth is the growth rate of output per person in the economy.
 Productivity growth is thus the growth rate of output per worker.

CH 8. AGGREGATE EXPENDITURE AND EQUILIBRIUM OUTPUT

● In any given period, there is an exact equality between aggregate output

(production) and aggregate income
● AGGREGATE OUPUT
 “Real GDP”

● AGGREGATE OUTPUT (INCOME) Y

○ GDP
○ aggregate quantity supplied

● KEYNESIAN THEORY OF CONSUMPTION

○ Consumption increases as income increases
■ Athe rise in consumption will be less than the full rise in income
○ Consumption Function
○ relationship between consumption and income

○ C = a + bY
■ C - aggregate consumption
■ Y - aggregate income
■ a - constant
● Minimum nutritional requirement/day
■ b- slope
● rise/run
● Change in consumption/Change in income
● ΔC/ ΔY

○ Curved Consumption Function

■ typical consumer spends less of the incremental income received as his
or her income rises

○ MARGINAL PROPENSITY TO CONSUME (MPC/ b)

■ Slope of consumption of function
■ fraction of a change in income that is consumed

○ AGGREGATE SAVING
■ difference between aggregate income and aggregate consumption:
■ Income is either saved or consumed.
■ Saving = Investing
■ Savings = Income - Consumption
■ S ≡ Y-C
■ ≡ (identity)
■ Aggregate Savings = Aggregate Income (Y) - Aggregate Consumption (C)
 ○ MARGINAL PROPENSITY TO SAVE (MPS)
■ fraction of a change in income that is saved
■ MPS = ΔSAVINGS/ ΔY
■ Slope of saving function

○ If consumption curve is above the 45 deg line:

● C> Y
● Savings < 0 or Negative Savings

○ If consumption curve is at the 45 degree line:

● C=Y
● Savings = Zero

○ If consumption curve is below the 45 degree:

● C<Y
● Savings > Zero

● PLANNED INVESTMENT (I)

○ GDP = C + I + G + X
■ I: Investments in Private Sector

○ Planned Investment Function

■ Fixed
■ Does not change when income changes

○ Planned Investment (I)

■ additions to capital stock and inventory that are planned by firms
○ Actual Investment
■ The actual amount of investment that takes place; it includes items such
as unplanned changes in inventories.
● DETERMINATION OF EQUILIBRIUM (OUTPUT)
○ Equilibrium: Planned Investments = Actual Investments
■ Inequilibrium: Not productive
■ Aggregate Output = Planned Aggregate Expenditures

○ Planned Aggregate Expenditure (AE) = C+ Planned Investments

■ Equilibrium: Y=AE
● Y – aggregate output
● AE – planned aggregate expenditure
■ Equilibrium: Y = C + I
■ Investments cannot materialize if there are no saving

○ Equilibrium: Y = C + Inv
■ Inventory buildup

Equilibrium
 Disequilibrium

● Find Y for equilibrium level of output

● SAVING/INVESTMENT APPROACH TO EQUILIBRIUM

○ C+S=C+I

○ S=I

● Adjustment to Equilibrium
○ When firms try to keep their inventories intact by increasing production, this will
generate more income in the economy as a whole
○ adjustment process will continue as long as output (income) is below planned
aggregate expenditure

● THE MULTIPLIER
○ ratio of the change in the equilibrium level of output to a change in some
exogenous variable

○ EXOGENOUS VARIABLE
■ variable that is assumed not to depend on the state of the economy

○ The size of the multiplier depends on the slope of the planned aggregate
expenditure line. The steeper the slope of this line, the greater the change in
output for a given change in investment
■ The greater the MPC, the greater the multiplier

○ Successive increases in income become smaller and smaller in each round of

the multiplier process, due to leakage as saving, until equilibrium is restored.
 ● MULTIPLIER EQUATION
○ Multiplier = 1/MPS

○ Multiplier = 1/1-MPC

○ change in equilibrium income (Y) is equal to the initial change in planned

investment (I) times 1/MPS
● PARADOX OF THRIFT
○ By consuming less,households have actually caused the hard times about which
they were apprehensive.

CH. 9 THE GOVERNMENT AND FISCAL POLICY

● government can affect the macroeconomy through two policy channels:
○ fiscal policy
○ monetary policy

● FISCAL POLICY
○ government’s spending and taxing behavior
■ Purchases of Goods and Services
■ Taxes
■ Transfer Payments

● MONETARY POLICY
○ Money Supply

● DISCRETIONARY FISCAL POLICY

○ Changes in taxes or spending that are the result of deliberate changes in
government policy

● GOVERNMENT PURCHASES (G), NET TAXES (T), AND DISPOSABLE INCOME (Yd)
○ Net Taxes
■ Taxes paid by firms and households to the government minus transfer
payments made to households by the government
○ Government Purchases of Goods and Services (G)

○ Disposable Income/After-Tax Income (Yd)

■ Income that ultimately gets to households

■ Yd ≡ Total Income - Net Taxes

■ Yd ≡ Y (aggregate income) - T (taxes)

■ Lump Sum Taxes - taxes that do not depend on income
 ■ Y - T ≡ C (consumption) + S (saving)
■ Y≡ C + S + T
■ AE = C + I + G

○ Budget Deficit
■ G (government spending) – T (taxes)
■ If G > T, government sells bonds or t-bills
■ A part of household saving goes to the government

● CONSUMPTION FUNCTION FOR DISPOSABLE INCOME

○ C = a + bYd
○ C = a + b(Y-T)
○ A – constant; B - slope

● DETERMINATION OF EQUILIBRIUM OUTPUT (INCOME)

○ Y=C+I+G
○ Saving/Investment Approach
■ S+T=I+G

● MULTIPLIERS
○ Government Spending Multiplier
○ Tax Multiplier
○ Balanced-budget multiplier
 ○ GOVERNMENT SPENDING MULTIPLIER ≡ 1/MPS
■ ratio of the change in the equilibrium level of output to a change in
government spending

○ TAX MULTIPLIER
■ ratio of change in the equilibrium level of output to a change in taxes
■ Tax Multiplier ≡ -(MPC/MPS)

○ BALANCED-BUDGET MULTIPLIER
■ ratio of change in the equilibrium level of output to a change in
government spending where the change in government spending is
balanced by a change in taxes so as not to create any deficit
■ balanced-budget multiplier ≡ 1

FEDERAL BUDGET
● Political Document that dispenses favors to certain groups or regions and places
burdens (taxes) on others
● Reflection of Goals the government wants to achieve
● Embodiment of some beliefs about how (if at all) the government should manage the
macroeconomy

● FEDERAL SURPLUS (+) OR DEFICIT (-)

○ Federal government receipts minus expenditures
● FEDERAL DEBT
○ Total amount owed by the federal government
● PRIVATELY HELD FEDERAL DEBT
○ privately held (non-government-owned) debt of the U.S. government

● ECONOMY’S INFLUENCE ON THE GOVERNMENT BUDGET

● Automatic Stabilizers
○ Revenue and expenditure items in the federal budget that automatically
change with the state of the economy in such a way as to stabilize GDP
● Automatic Destabilizers
○ Inflation
● Fiscal Drag
 ○ negative effect on the economy that occurs when average tax rates
increase because taxpayers have moved into higher income brackets
during an expansion
● Full-Employment Budget
○ What the federal budget would be if the economy were producing at the
full-employment level of output
● Structural Deficit
○ deficit that remains at full employment
● Cyclical Deficit
○ deficit that occurs because of a downturn in the business cycle

CH. 10 THE MONEY SUPPLY AND THE FEDERAL RESERVE SYSTEM

MONEY
● Barter
● medium of exchange, or means of payment
○ What sellers generally accept and buyers generally use to pay for goods and
services

STORE OF VALUE
● asset that can be used to transport purchasing power from one time period to another

LIQUIDITY PROPERTY OF MONEY

● portable and readily accepted and thus easily exchanged for goods

UNIT OF ACCOUNT
● standard unit that provides a consistent way of quoting prices

COMMODITY AND FIAT MONIES

● COMMODITY MONIES
○ Items used as money that also have intrinsic value in some other use

● FIAT MONEY/TOKEN MONEY

○ Items designated as money that are intrinsically worthless

● LEGAL TENDER
○ Money that a government has required to be accepted in settlement of debts

● CURRENCY DEBASEMENT
○ decrease in the value of money that occurs when its supply is increased
rapidly

Measuring the Supply of Money in the US

 ● M1: TRANSACTIONS MONEY
○ Money that can be directly used for transactions
○ M1 = currency held outside banks + demand deposits + traveler’s checks +
other checkable deposits

○ Currency in Circulation
■ Physical currency held in our pockets
○ Arranged by accessibility

● M2: BROAD MONEY

○ M1 + Savings Accounts + Money Market Accounts + other Near Monies

○ Near Monies
■ Close substitutes for transactions money, such as savings accounts and
money market accounts

PH
● M1 or Narrow Money
○ Same definition

● M2 or Broad Money
○ M1 + Peso Savings Accounts + Time Deposits (peso)

○ Money Market Accounts

○ Other near monies
● M3 or Broad Money Liabilities
○ M2 + Peso deposit substitutes

○ Peso Deposit Substitutes

■ Promissory Notes
■ Commercial Papers
● Arranged by the bank in behalf of a borrowing corporation
■ Securities other than shares included in M2

The Modern Banking System

● Assets - Liabilities = Net Worth

● Reserves
○ Deposits that a bank has at the federal reserve bank plus its cash on hand
● Required Reserve Ratio
○ percentage of its total deposits that a bank must keep as reserves at the Federal
Reserve
 ● Excess Reserves
○ difference between a bank’s actual reserves and its required reserves
○ excess reserves≡ actual reserves - required reserves

● Money Multiplier
○ Multiple by which deposits can increase for every dollar increase in reserves;
○ 1/required reserve ratio

○ An increase in bank reserves leads to a greater than oneforone increase in the

money supply

Functions of the Federal Reserve

● Lender of Last Resort

○ Fuctions of the fed
○ Provides funds to troubled banks
● Clearing interbank payments
● Regulating the banking system
● Assisting banks in financial difficulties

How Federal Reserve Controls the Money Supply

1. Changing required reserve ratio

2. Changing the discount rate
3. Engaging in open market operations

● DISCOUNT RATE
○ interest rate that banks pay to the Fed to borrow from it
● Banks raise funding through:
○ Common Stock
○ Preferred Stock
○ Bond Issuances
○ Interbank Lending or Borrowing
■ Overnight lending
○ Central Bank Borrowing or Lending

● Open Market Operations

○ BSP buying or selling bonds in the secondary market
○ Purchase and sale by the Fed of government securities in the open market; a
tool used to expand or contract the amount of reserves in the system and thus
the money supply

● BSP’s Monetary Policy

○ Inflation targeting framework
○ GDP
○ Promote and preserve monetary stability and the convertibility of the national
currency (exchange rate)

○ Repurchase Agreement