ECON

4th Quarter Notes (GDP falls because PPP decreases and people buy less)
by Yanyan Talusan and Jessie Cruz inflation – ↓PPP – less consumption
(component of GDP) – ↓GDP
Aggregate Demand
3. foreign sector substitution effect (exchange rate effect)
- the amounts of real domestic output (real GDP) which - when average price of outputs increases, consumers
domestic consumers (C), businesses (I), governments naturally begin to look for similar items produced
(G), and foreign buyers collectively (NX) will desire to abroad
purchase at each possible price level - thus, increasing imports of the economy (outflow of
- difference between aggregate demand and quantity cash, more imports, means less net export causing
demand: QD is for household (only for one product), lower GDP since imports are greater than exports)
while AD is for all good in the economy, entire economy
*NX = (x – m)
*aggregate means combined or compounded
m>x – negative NX – ↓GDP


AD CURVE
DETERMINANTS OF AD
*show shifts (determinants) and movement along the
curve (the 3 effects)
1. change in consumption
- tax hike (shift to left) or tax cuts (shift to the right)
- optimism about the future (right)
- preferences regarding consumption (right)/saving
(left) tradeoff

2. change in investment
- rate of interest (↑IR, left / ↓IR, right)
- optimism (right)/pessimism (left)
- expansion (right)

*we use price level instead of price since we’re analyzing - tax credit and tax incentives (both right)
the entire GDP, so we’re using an average of the price of
goods and services (not specific) 3. change in government expenditure
- public goods spending (right)
Components of Aggregate Demand - taxes (increase causes left) and transfer payments (right)
1. Consumption (C)
2. Investment (I) 4. change in net export
3. Government Expenditure (G) - foreign income (if economy of other countries
4. Net Export (NX) strengthens, our country shifts to right for more
exports)
Why is it sloping downward? - exchange-rate (imports decrease when currency falls
1. interest-rate effect against foreign currency)
- as average price level rises (inflation), real interest rate - consumer taste (if it’s domestic then it shifts to the
begins to rise, thus increasing the cost of borrowing right)
- firms postpone their investment and households
postpone their consumption (because price increase GRAPHING
causes people to not buy) until borrowing becomes 1. congress abolished a 10-year old tax incentive (AD
more affordable shifts to the left)
inflation – ↑IR – inflation premium – less investment and P

AD1
less consumption (components of GDP) – ↓GDP AD2

2. wealth effect
- as average price level rises, value of assets like stocks,
bonds, savings and cash on hand begins to fall Y

- higher prices reduce the quantity of output purchased
2. US exchange rate rises, based on US economy (AD shifts 7. foreign trade partners economy crashes (AD shifts to
to the right) the left)
P P

AD2 AD1
AD1 AD2

Y
Y

3. a fall in the price level increases value of assets 8. inflation forecast possible increase in consumer goods
(movement along the AD curve) (AD shifts to the left)
P P

AD1
AD
AD2

Y
Y


4. government replace sales taxes to lower rate (AD shifts 9. average price level decreased (movement along the AD
to the right) curve)
P P

AD2
AD
AD1

Y
Y

5. domestic products become more popular abroad (AD 10. government transfer payments decreased (AD shifts to
shifts to the right) the left)
P P

AD2 AD1
AD1 AD2

Y
Y


6. a decrease in price level decreases real rate of interest
Aggregate Supply
(movement along the AD curve)
P - the relationship between the average price level of all
AD domestic output (GDP) and the level of domestic output
production (AD is consumption)
- all market outputs in the economy
- difference between aggregate supply and quantity
supply: QS is for one market only while AS is for all
Y
markets in the entire economy (similar to QD
relationship with QD)





SHORT RUN VS LONG RUN AGGREGATE SUPPLY Y = output
Short Run Long Run YN = expected output (natural rate of output)
fixed cost (graph is upward variability, future, P = price level
sloping) long term (vertical) PE = expected price level
SRAS is upward sloping and P PE = P in the long run
LRAS is vertical
and Y are directly proportional
prices of input (of factors of
price of input is
production) are still not
already adjusted to
adjusted to the prices of output
the prices of output
(finished goods/services)
economy is not yet operating in economy is operating
its maximum potential, max at its maximum
labor, max output, economy potential or full

makes more and more employment
*in the long run, sticky wages, prices and misperception
will be corrected; economy will be in full employment
THEORIES
Sticky Wage Theory DETERMINANTS OF SRAS
- nominal wage is sticky (constant/not changing) in the
short-run because of contracts and expected price level
- if the nominal wage is lower than actual price level of
output, production is more profitable (cheaper labor)
thus increasing employment and AS
- if the nominal wage is greater than actual price level,
firms cut down employment thus decreasing AS
- lower production at lower price

Sticky Price Theory 1. input price
- real GDP is directly proportional to price - if input price falls, SRAS increases
- many price is sticky in the short-run because of menu - if input price increases, SRAS decreases
cost or the cost of changing prices
- firms set sticky prices to their outputs based on the 2. tax policy
expected price level - if supply-side taxes are lowered, SRAS increases
- if price level increases, firms with menu costs wait to - if supply-side taxes are increased, SRAS decreases
adjust their low price set, demand for output increases
therefore increasing AS and employment 3. deregulation
- regulation of industries cant restrict and decrease SRAS
Misperceptions Theory - less regulations can increase SRAS
- firms may confuse increasing price level as an increase - ex. straw ban
of their output’s price
- firms see it profitable, so production and employment 4. political and environmental phenomena
increase therefore increasing AS - wars and natural disasters can decrease SRAS
- firms see decreasing price level as a challenge, so it cuts - political stability can increase SRAS
down production and employment
DETERMINANTS OF LRAS
IN CONCLUSION 1. availability of resources
- a larger labor force (increase on population), larger
stock of capital (machines, funding, investments), more
widely available natural resources (discovery of new
resources) can increase the level of full employment

2. technology and productivity
- better technology raises the productivity of both capital
and labor
- a more trained and educated population increases P
LRAS1 LRAS2

productivity and LRAS over time (like K-12) SRAS

3. policy incentives
- if policy provides incentives to quickly find a job, full
employment real GDP rises Y

- if government gives tax incentives to invest in capital
and technology, full employment increases 6. discovery of new natural resources: availability of
resources (LRAS shifts to the right)
GRAPHING P
LRAS1 LRAS2
*when you graph, you need to draw both LRAS and SRAS SRAS

1. price of factors of production decrease: input price
(SRAS shifts to the right)
P
LRAS
SRAS1
Y

SRAS2

7. stricter regulation to industries: deregulation (SRAS
shifts to the left)
P
LRAS
SRAS2
Y
SRAS1

2. actual price level increased than expected price level:
sticky price theory (movement along the SRAS curve)
P
LRAS
SRAS
Y

8. abolishment of tax burden of producers: tax policy
(SRAS shifts to the right)
P
LRAS
SRAS1
Y
SRAS2

3. government removes subsidies from local production:
policy incentives (LRAS shifts to the left)
Y

9. discovery of improved and optimal technology:
technology and productivity (LRAS shifts to the right)
P
LRAS1 LRAS2
SRAS

4. unexpected hikes in the price of natural resources:
input price (SRAS shifts to the left)
P
LRAS
SRAS2
SRAS1 Y

10. increase in labor force: availability of resources (LRAS
shifts to the right)
P
LRAS1 LRAS2
Y
SRAS

5. an improved education and training of population:
technology and productivity (LRAS shifts to the right)
Y

Macroeconomic Equilibrium DECREASE IN SRAS
P
*intersection – perfect situation LRAS
SRAS2
- the quantity of real output demanded is equal to the SRAS1
quantity of real output supplied
- macroeconomic equilibrium is at the intersection of AD, P2
SRAS and LRAS P1
P
LRAS
SRAS Why is it perfect?
- there is no inflation,
AD
price is stable
P1 - producing to maximum Y
Y2 Y1
capacity, maximum
AD output - price ↑ (cost-push inflation); GDP ↓
- full employment - unemployment ↑ (left of LRAS which is full employment)
Y - this shows stagflation, a combination of inflation,
Y1
people with no jobs and low output
INCREASE IN AD
INCREASE IN SRAS
P
LRAS
SRAS P
LRAS
SRAS1

P2 SRAS2

P1
P1
AD2
P2
AD1

Y AD
Y1 Y2 Y

- price ↑ (demand-pull inflation); GDP ↑ Y1 Y2

- unemployment ↓ (right of LRAS which is full employment, - price ↓; GDP ↑
so unemployment decreases because employment is - unemployment ↓ (right of LRAS which is full
operating at beyond full employment level) employment, so unemployment decreases because
employment is operating at beyond full employment
DECREASE IN AD level)
P
- this shows expansion
LRAS
SRAS
EXAMPLES
1. Widespread optimism among consumers of an
impending expansion.
P1 P
LRAS
SRAS
P2
P
2
AD1 P
1 AD increase
AD2 AD 2
Y
Y2 Y1 AD 1

Y
- price ↓ (deflation); GDP ↓ Y Y 1 2

- unemployment ↑ (cyclical unemployment, left of LRAS
which is full employment)
- this shows recession


2. A new national tax on producers based on value added. 7. Value of currency falls
P
LRAS
P
LRAS
SRAS2 SRAS
SRAS1

P2 P2

P1
AD increase
P1
SRAS decrease
AD2

AD AD1

Y Y

Y2 Y1 Y1 Y2

3. An increase in interest rate 8. A 15 percent across-the-board increase in personal
P
income tax rates.
LRAS
SRAS P
LRAS
SRAS


P1 AD decrease AD decrease
P2
P1
P2

AD1
AD2
Y
AD1
AD2
Y2 Y1 Y
4. A major increasing in spending for education Y2 Y1
P 9. An increase in exports that exceeds an increase in
LRAS
SRAS
imports
P
LRAS

P2 SRAS

P1
AD increase
AD2 P2
AD increase
P1
AD1

Y
AD2

Y1 Y2
AD1
5. The general expectation of coming rapid inflation Y
AD increase or AD decrease Y1 Y2

P
LRAS
P
LRAS
SRAS
10. Increased spending on war preparations
SRAS
P
LRAS
SRAS
P2

P1 P1
P2
AD2
P2 AD increase
P1

AD1 AD1
AD2 AD2
Y Y
Y1 Y2 Y2 Y1 AD1
Y
6. The complete disintegration of OPEC, causing oil prices Y1 Y2
to fall by one-half. Fiscal Policy
P
LRAS
SRAS1 - it refers to deliberate changes in the government

SRAS2 spending and net tax collection to affect economic

output, unemployment and the price level
P1
SRAS increase
- it is designed to manipulate AD to 'fix' economy
P2
o there will always be a doubt since it is risky and it

AD doesn’t ensure that it will ‘fix’ the economy)

Y - government spending and taxes are adjusted by the
Y1 Y2
government to fix the economy



 Classical Economics Modern Economics Inflationary Gap
it believes that the it believes that the - the amount in which current macroequilibrium GDP
economy will soon correct economy will should have exceeds full employment GDP which is characterized by
itself in the long run stimuli for growth inflation
government should not government should - potential GDP < actual GDP
intervene with the intervene through P
LRAS

SRAS
workings of the economy spending and taxation
“in the long run, we are all must be corrected due to
P2
“Laissez Faire” – “let it be”, dead” - if you leave the bad inflation, must be
P1
“leave alone” à leave the economy alone for too slowed down with
AD2
economy alone long, we will die as contractionary fiscal policy
struggle continues AD1 to shift AD back to the left
founded by John Maynard Y
founded by Adam Smith Y1 Y2

Keynes
*the government doesn’t usually implement this since it is
EXPANSIONARY FISCAL POLICY a hard sell, lowers GDP, decreases government spending
and demand, increases taxes
- shifts AD to the right to increase gross domestic

product and reduce unemployment
o increase government spending EXAMPLES
o lowering taxes Which fiscal policy would be implemented in these
o increasing aggregate demand economic situations?
*government spending increase is better than taxation 1. government exceed the target import quota
decrease because it is not guaranteed that the money à expansionary fiscal policy
gained by consumers from not paying taxes will be spent - more imports = lower GDP
immediately - needs this policy to shift AD to the right

Recessionary Gap 2. household prefers to consume than to save
- the amount in which full employment GDP exceeds à contractionary fiscal policy
current macroequilibrium GDP - increase in demand = increase in price = inflation
- GDP which is operating below economy's maximum - needs this policy to correct inflation (shift AD left)
potential
- potential GDP > actual GDP 3. peso falls against dollar
P à contractionary fiscal policy
LRAS
SRAS
- increase in exchange rate = increase in price = inflation
needs expansionary - needs this policy to correct inflation (shift AD left)
fiscal policy to stimulate
P1
economic growth or 4. interest rate increased
P2
shift AD back to the à expansionary fiscal policy
right - increase in interest rate = decrease in demand
AD1
AD2
- needs this policy to shift AD to the right
Y
Y2 Y1
*you implement this type of policy when there is a 5. government cuts down budget appropriation
decrease in demand so that it can increase again à expansionary fiscal policy
- lesser budget appropriation = decreased gov. spending
CONTRACTIONARY FISCAL POLICY - needs this policy to increase government spending

- shifts AD to the left in order to control inflation
THE MULTIPLIER EFFECT
o decrease government spending
o increasing taxes - a change in spending and tax creates a larger change in
o decreasing aggregate demand GDP for each money used for consumption generates
more goods and services
*higher multiplier effect = increase in GDP
ex. if your classmate gives you 100 pesos, let’s say you
consume 80 pesos and save 20 pesos
 Marginal Propensity to Marginal Propensity to BALANCED MULTIPLIER
Consume (MPC) Save (MPS)
- the government both collects and spends tax revenue
the change in consumption the change in saving
- if the dollars spent is equal to the dollars collected then
caused by a change in caused by a change in the budget is balanced (government spent =
income income
government collected)
MPC =
MPS = saving ÷ income Balanced Multiplier
consumption ÷ income
à 20/100 = 0.2 (spending) (1)
à 80/100 = 0.8
MPC + MPS = 1 (always equal to 1 because every dollar
not spent is saved) Example
The government wants to spend $100 on a federal program
and pay for it by collecting $100 in additional taxes. If the
SPENDING MULTIPLIER
MPC = 0.90, how much is the increase in new GDP?
- ways to calculate the newly generated GDP caused by
Spending Taxes
the spending in the economy
initial spending by the (change in tax) (tax
- used for government expenditures (expansionary fiscal
government) (spending multiplier)
policy)
multiplier) = (100) (0.90) (1/1-0.90)
Spending Multiplier New GDP
= (100) (1/1-0.90) = -$900 (decreased
(initial spending by the
= $1000 because increase in tax)
1/MPS or 1/(1-MPC) government) (spending
new GDP = $100
multiplier)
(because 1000 was given, 900 created was taken)


Example
GENERAL PRACTICE
Suppose the government spent $100million for building
new roads and bridges with the MPC of 0.50, how much 1. Government spent P80M
additional GDP will be created by the spending? à spending multiplier
MPC Multiplier Additional GDP
new GDP = (initial spending by gov.) (spending multiplier)
= (100 million) (1/1-0.5) à $200 million 0.90 10 P800M
0.80 5 P400M
TAX MULTIPLIER 0.75 4 P320M
0.50 2 P160M
- government can induce additional GDP by changing

taxes and transfers
2. If the MPC is 0.50…
- used when the government changes tax or transfers
spends $100 gives back $100
(the cash the government gives)
*changes GDP because household has additional income spending multiplier = 2 tax multiplier = 1
with transfers, which would increase GDP, but increase in new GDP = $200 new GDP = $100
taxes will decrease GDP shows how government spending is better than
Tax Multiplier New GDP government transfers since it has a higher GDP (ex.
(MPC) (spending (change in tax) (tax Build, Build, Build program)
multiplier) multiplier)
3. Government decreased tax by P25M
Example MPS MPC Tax Multiplier Additional GDP
The MPC is 0.90 and the government transfers back tax 0.10 0.90 9 P225M
revenue to consumers by sending each taxpayer a $200 0.20 0.80 4 P100M
check. How much additional GDP is made because of this? 0.25 0.75 3 P75M
new GDP = (change in tax) (tax multiplier) 0.50 0.50 1 P25M
= (change in tax) (MPC) (spending multiplier)
= (200) (0.90) (1/0.10) = $1800 4. Government spent P25M
MPS MPC Spending Multiplier Additional GDP
0.10 0.90 10 P250M
0.20 0.80 5 P125M
0.25 0.75 4 P100M
0.50 0.50 2 P50M
*shows how the additional GDP is higher when you spend Bonds
rather than decreasing taxes (example #3) - a bond is a certificate of indebtedness
- when firms want to raise money, they can issue a
5. Assume Germany raises taxes on its citizens by €200B. corporate bond that promises the buyer of the
Assume that Germans save 25% of the change in their borrowed amount, interest rate and repayment date
disposable income. Calculate the effect of the €200B *like a certificate for safekeeping money
change in taxes on the German economy. *investing in stocks is better than buying bonds since there
taxes = (initial spending by the government) (spending is profit in investing stocks while bonds stay as is
multiplier)
= (200 billion)(0.75)(1/0.25) SUPPLY OF MONEY
new GDP = -€600 billion (decreased) - flow of money in the economy which is being measured
by its liquidity
6. Assume the Japanese spend 4/5 of their disposable - it refers to how an asset can be easily converted to cash
income. Furthermore, assume that the Japanese and be used in economic transaction
government increases its spending by ¥50 trillion and 1. M1 (most liquid)
in order to maintain a balanced budget simultaneously cash + coins + checking deposits + travelers check
increases taxes by ¥40 trillion. How much additional
GDP will be added in the Japanese economy? 2. M2
balanced = (spending)(1) M1 + savings deposits + small time deposits (less than
Spending Taxes $100,000) + money market deposits + mutual funds
spending = (initial spending taxes = (change in tax)
by the government) (tax multiplier) 3. M3 (least liquid)
(spending multiplier) = (40 trillion) (0.80) M2 + large time deposits (over $100,000)
= (50 trillion) (1/1-0.80) (1/1-0.80) *they are called large time since a bank needs to regulate
= ¥250 trillion = -¥160 trillion money supply first to avoid a bank run (bankruptcy is for
new GDP = ¥90 trillion companies)

Money DEMAND FOR MONEY
- demand for money is inversely proportional with the
- it refers to anything that is used to facilitate the
nominal interest rate
exchange of goods between buyers and sellers
- downward sloping graph
- today’s paper and coin money are called fiat money
P
because it has no intrinsic value
- the government assures us that it performs 3 general
functions
o medium of exchange interest rate money demand
o unit of account (standardized, with fixed value) or cost of
borrowing
o store of value

FINANCIAL ASSETS
- it refers to investment in the form of financial capital
which households and firms use as a place for their quantity of money per period

money

Stocks
Monetary Policy
- a share of stock represents a claim on the ownership of - this is the task of the Bangko Sentral ng Pilipinas or the
the firm central bank
- firms that wish to raise money can issue or sell stocks - it is a structured process of the increase and decrease
of their company of the money supply in order to move the economy in
- stocks are purchasable and the value of stocks changes full employment and stabilize prices
- in the stock market - money supply is adjusted to correct situations, like if
o gainers: companies with stocks that increased there is inflation, money supply is decreased
o losers: companies with stocks that decreased t
 TOOLS IN MONETARY POLICY
1. Open Market Operation
- buying and selling of government bonds
- m ↑ government buys bonds
- m ↓ government sell bonds

2. Reserve Requirement
- selling the supply of money that should stay in the
banks
- m ↑ low reserve requirement (money can now circulate
in the economy)
- m ↓ high reserve requirement (money is reserved in the
bank)

3. Discount Rate
- the interest rate charged by the Federal Reserve to the
banks for lending money
- m ↑ discount rate goes down
- m ↓ discount rate goes up

EXPANSIONARY MONETARY POLICY
- increase in money supply and decrease in interest rate
to solve low GDP and high unemployment
o buying back government bonds
o lowering reserve requirements
o decreasing discount rates
- in a Recessionary Gap – low real GDP and high
unemployment, AD must shift to the right à we need
more money supply for more consumption,
investments and more = expansion monetary policy
*where the Philippines is right now

CONTRACTIONARY MONETARY POLICY
- decrease in money supply and increase in interest rate
to solve inflation
o selling government bonds
o increasing reserve requirements
o increasing discount rates
- in an Inflationary Gap – inflation, AD must shift to the
left à we need less money supply to target inflation =
contractionary monetary policy