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Macroeconomics Lecture Notes.docx

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Bridget O' Shaughnessy

Macroeconomics: Lecture 2 What is more dangerous, a gun or a swimming pool? Why is economics difficult  Express ideas in economics: 1. English Language 2. Algebra/equations 3. Diagram/graph  Translate between each different form of communication Economics is a social science  Social = people  Science = use scientific method  Observe  Theorize  Test theory Natural experiment Microeconomics vs. Macroeconomics  Microeconomics: individual households and firms and how they interact  Macroeconomics: economy-wide phenomena such as interest rates, unemployment, money, and growth Efficiency vs. Equity  Efficiency is the size of the pie  Equity is how the pie is divided Positive vs. Normative analysis  Positive: the world “as it is”  Normative: the world “as it should be” – value judgment Model = simplification  Diagram or equations  Assumptions  Variables  Eg. Map of a city Classify Variables  Real variables vs. nominal variables (physical quantities) vs. ($)  Stock variables vs. flow variables (snapshot at point in time) vs. (time element eg. Per year) Example of a model: Circular Flow Diagram Market for goods and services Firm Household Market for factor services Macroeconomics: Lecture 3 Why doesn’t Sidney Crosby mow his own lawn? Comparative advantage exercise: Group B: Trucks Computers Canada 600 3000 Mexico 1000 1000 The Production Possibilities frontier  PPF: the combinations of output that the economy can produce given the available factors of production and production technology.  Choose a point to consume in autarky  Autarky: no trade  Feasible: a combination that lies on the PPF or inside the PPF  Infeasible: a combination that lies above the PPF  Efficient: an outcome that occurs if the economy can get all it can from its scarce resources  You are better off if you have at least the same amount of 1 good an more of the other good you are better off  You are better off if you can consume outside PPF Lecture 5: What affects your decision to go to the movies? Market  Market = group of buyers and sellers  There are 4 types of market structure:  Perfect competition – (1 buyer, 1 seller)  Monopoly  Oligopoly  Monopolistic competition Demand  Quantity Demand (Q ): the amount of a good that buyers are willing and able to purchase  The variables that influence how much buyers want to buy are: 1. Price 2. Income  Normal and inferior goods 3. Price of other goods  Substitute and complements 4. Tastes 5. Expectation  Law of Demand: other things equal (ceteris paribus), the quantity demanded of a good falls as the price of the good rises  Market Demand: the sum of individual demands  Shifts in demand ( change in demand) are caused by a change in anything other than price  Demand: anything that affects the curve  Movement along the demand curve (change in quantity demanded) is caused by a change in price  If demand increases, the curve shifts OUT  If demand decrease, the curve shifts IN LECTURE 6 – ACTIVITY Lecture 7: What will happen to Wal-Mart’s everyday low prices if there workers unionize? Supply  Quantity Supplied (Q ): the amount of a good that sellers are willing and able to sell  The variables that influence how much sellers want to sell are: 1. Price 2. Input prices  Creating ice cream – if the price of ingredients to produce ice cream increase the supply becomes more expensive and therefore less supply 3. Technology  Newly developed machines creating ice cream increases supply 4. Expectations  Law of Supply: other things equal (ceteris paribus), the quantity supplied of a good rises as the price of the good rises Supply Schedule P Q .05 400 .10 500 .15 600 .20 700 .25 800  Market Supply: the sum of individual supply curves  Shifts in supply (change in supply) are caused by a change in anything that price  Movement along the supply curve (change in quantity supplied) is caused by a change in price  If supply increases, the curve sifts OUT  If supply decreases, the curve shifts IN Lecture 9: Does doing the dishes have economic value? Gross Domestic Product Gross Domestic Product (GDP): market value of all final goods and services produced in a country in a given period of time.  It is a measure of how much stuff we make  Market Value ($) - All market transaction  Final – Avoids “double counting  Goods and services  Produced in a country  In a given period of time Three ways to calculate GDP 1. Output (basic prices) 2. Expenditure (market prices) 3. Income (market prices)  The difference between GDP at market prices and GDP at basic prices is: 1. Basic prices do not include sales tax, market prices do Canada’s 2010 GDP Equation: Y=C + I + G + NX C: Consumption – Spending by households (durable goods, non-durable goods, services) I: Investment – Purchase of new capital goods; machinery and equipment; also new housing; inventory G: Government Spending – all levels of government spending on goods and services (not transfer payments) X: Net Exports – purchases of domestically-produced goods by foreigners (exports) MINUS domestic purchases of foreign goods (imports) Gross National Product  Gross National Product (GNP): market value of all final gods and services produced by a country’s factors in a given period of time How do we calculate inflation using CPI  Consumer Price Index (CPI): measures overall cost of goods for a typical urban household  It is a measure of the price level  Steps to calculating inflation using CPI 1. Fix the basket of goods 2. CPI = Cost in current year/Cost in base year X 100 3. Inflation rate = t –t-1/t-1 100 Lecture 11: Should I Spend my Money Now? Using CPI Example: Your father earned $40, 000 in 1982. What is this salary worth in 2012 dollars? CPI1982= 61.88 CPI2012= 116.3 Answer: cross multiply Problems with CPI  There are 3 problems with CPI o Substitution Bias – Ignores consumer substitution; overstates inflation o Introduction of New Goods – CPI is based on a fix basket of goods and services; overstates inflation o Unmeasured Quality Change – Some price changes reflect quality improvements; overstates inflation CPI vs. GDP Deflator  CPI – goods and services bought by typical consumers GDP deflator – reflects prices of all goods and services produced domestically  CPI – prices change, quantities stay fixed GDP Deflator – quantities change, prices stay fixed Interest Rates Example: You have decided not to buy a pair of shoes that cost $100 and instead put the $100 into a savings account earning 5% interest per year. How many dollars do you have after 1 year?  Nominal Interest Rate: interest rate without correction for inflation - measures the increase in the number of dollars in your bank  Real Interest Rate: interest rate with correction for inflation – measures the increase in the purchasing power of the dollars in your savings account End of Information on Test 1 Lecture 12: Why are Norwegians better off than Ethiopians Productivity  Productivity: the quantity of goods and services that a worker can produce for each hour  Determinants of productivity: o Physical capital o Human capital o Natural resources – renewable, non-renewable o Technological knowledge Production Function  Production function: shows how we combine inputs to produce output  Y = A x F(K,L,H,N)  Y: output  A: Technology  K: Physical Capital  L: Labour  H: Human Capital  N: Natural resources If a production function exhibits constant returns to scale, then doubling all inputs leads to a doubling of output.  2Y = A x F(2K,2L,2H,2N)  100Y = A x F(100K,100L,100H,100N) Diminishing Marginal Product  Product: Output  Marginal Product: The extra output produced by increasing an input by 1 unit  Diminishing marginal product: the extra output produced by adding the 19 unit of labour is smaller than the extra output produced by adding the 18 unit of labour Catch-up Effect  Catch-up effect: Poor countries tend to grow fast than rich countries  Graph must have an upward slope Policies What can government policy do to raise productivity and living standards? 1. Encourage saving (K) a. Consume less and save more b. Eg. Impose a consumption 2. Allow foreign investment (K) 3. Spend on education (H) a. More educated individuals = more ideas for society b. Brain drain: emigration of highly educated people to rich countries 4. Improve property rights and reduce political instability (K,A) 5. Free Trade (A) a. Can be a substitute for technology 6. Research and Development – R&D (A)  Grants (eg. Funded research at universities)  Patent system (enhances the incentive for individuals and firms to engage in research) Lecture 13: What do the terms ‘saving’ and ‘investment’ mean to an economist? Financial Institutions: 1. Financial Markets  Bond market 1.Loan 2.Issued by large businesses, government 3.Term; risk  Stock Market 1.Ownership 2.Profit (dividends) or capital gain 3.Risk of capital loss 4.The return on stocks greater than bonds because: 1. Riskier 2. Bankruptcy laws 2. Financial Intermediaries (Indirect link between borrowers and savers)  Banks 1.Provide Loans 2.Deposits from savers  Mutual Funds 1.People with small amounts of money buy stocks together Savings and Investment National income accounting identity (GDP in a closed Economy): Y = C + I + G Private Saving: SP= Y – T – C Public Saving: SG= T – G Budget Surplus: T>G Budget deficit: G>T National Income Accounting Identity: Y = C + I + G Y – C – G = I Definition of Saving: S = Sp+ Sg SP= Y – T – C SG= T – G S = Y – T – C + T – G S = Y – C – G (national saving) S = I Market for Loanable Funds  Slope; shift curve  Demand o Negative Slope o Negative Relationship between investment and the interest rate o Firms must borrow to invest o Interest rate rises, borrowing more expensive  Supply o Positive Slope o Households: higher interest rate – every dollar saved now = more future consumption o Public saving does not depend on the interest rate o S = T – G g r S (Saving) E D (investment) Q of LF Shift Factors Demand  Anything that affects investment (other than the interest rate) Supply  Anything that affects private saving (other than the interest rate)  Anything that affects public saving In the following cases, use a market diagram to show what happens to the demand and/or supply curves. What happens to the interest rate, investment, national saving, private saving, and public saving? r S (Saving)pS + g E R1 D’ increase in investment D (investment) I1= S1 Q of LF Lecture 15: Is unemployment necessarily bad? Statistics Canada divides the non-institutional adult population into three categories: 1. Employed (Did you work last week) 2. Unemployed (Were you looking for work last week) 3. Not in labour force (If you weren’t working or looking for work last week) Unemployment rate = # of unemployed/labour force x100 LFPR = Labour force/adult population x 100 Employment rate = # of employed/adult population x 100 Thousands Labour Force 18 699 Unemployed 13 933 Employed 17 306 Adult Population 27 987 In 2011, which of the following statements is true? The unemployment rate and LFPR were both higher for men than women. Do these figures reflect reality? 1. Discourage Workers 2. Underemployment Why is there Unemployment?  There are three types of unemployment: 1. Frictional unemployment  Job search  Seasonal  Sectoral shifts 2. Structural unemployment  Quantity of factor demanded less than quantity of labour supplied 3. Cyclical unemployment  Associated with recessions/booms Employment Insurance (EI) International Comparisons Country Benefit Replacement (%) Benefit Duration (Years)Unemployment Rate (%) (2004) (2004) (2005) France 75 1.92 9.9 Germany 69 1 9.4 Italy 54 0.5 7.7 Spain 67 1.75 9.2 UK 54 0.5 4.8 US 54 0.5 5.1 Lecture 16: Would you hire a lawyer willing to work for $8 an hour? Review: Why is there unemployment?  There are three types of unemployment: 1. Frictional Unemployment 2. Structural Unemployment 3. Cyclical Unemployment Business cycles  Natural rate of unemployment  Long run, average rate 1. Minimum wage: economic theory a. Minimum wage is a price floor Unemployment Minimum Wage: Real World Minimum Wage: Market for lawyers 2. Unions Consider a small town that has one factory and many small businesses. Why would you expect the wage to be the same in both industries? Now suppose workers in the factory form a union. What happens? Factory Small Businesses w L d L L 3. Efficiency Wages  Firms operate more efficiently by increased worker productivity if wages are above equilibrium level 1. Worker Health – Only in poor countries 2. Reduce worker Turnover 3. Worker effort – Increase, Decrease - shirking 4. Worker Quality Lecture 17: Is my Mastercard an asset? Money  How much money do you make? (How would an economist ask that question? – What is your income)  Bill Gates has more money then you – More wealth (assets, or money)  Money – an asset regularly used to buy goods and services  Money Has Three Functions: 1. Medium of exchange – (credit cards is an example of method of deferring payment) 2. Unit of account 3. Store of value  Asset (something we would buy today hoping it would at least retain its value or increase, later selling it to gain wealth)  Liquidity: The ease with which an asset can be converted into the economy’s medium of exchange  When prices rise, the value of money goes down Commodity vs Fiat Money  Commodity money: money that takes the form of a commodity with intrinsic value  Fiat Money: established as money by government decree, with no intrinsic value Money in the Canadian Economy M = C+D Currency (C): Paper bills and coins in the hands of the public. Demand Deposits (D): The balances in the bank accounts that depositors can access on the demand by writing a cheque or using a debit card How do Banks Create Money? Fractional Reserve Banking  Fractional Reserve Banking: a banking system in which a bank holds only a fraction of deposits as reserves  Reserve Ratio: the fraction of total deposits that a bank holds as reserves Demonstration  This classroom is a closed economy. I have $50,000 in currency and there is no banking system  What is the current money supply? M = C+D = 50,000 + 0 = $50,000  Now I deposit my $50,000 into a bank. The reserve ratio is 50%. Money Creation using T-accounts McMaster University Bank Assets Liabilities Reserves: $100.00 Deposits: $500.00 Loans: $400.00 Question: Suppose someone deposits $100. What happens after all adjustments have taken place? McMaster University Bank Assets Liabilities Reserves: $200.00 Deposits: $600.00 Loans: $400.00 McMaster University Bank Assets Liabilities Reserves: $120.00 Deposits: $600.00 Loans: $480.00 Money Multiplier  Money Multiplier: The amount of deposits the banking system generates with each dollar of reserves. Money multiplier = 1/reserve ratio  Suppose the reserve ratio is 5%. If $100 is deposited into the banking system, what happens to total deposits? Money Multiplier = 1/0.05 = 20 If the reserve ratio is 5 percent and a bank receives a new deposit of $200, the bank must hold $10, 0.05 percent of $200, and can make $190 new deposits. Bank of Canada  Established in 1935  Bank of Canada is Canada’s central bank o Bank of England o Bank of Japan o Board of governors of the Federal Reserve system  The bank of Canada has four main areas of responsibility 1. Monetary Policy – controls the money supply 2. Currency – designs, produces, and issues currency 3. Financial System – facilitates cheque-clearing and acts as a “lender of last resort” 4. Funds Management – acts as a banker for the Canadian government Bank of Canada’s Tools of Monetary Control  The Bank of Canada controls the money supply by: 1. Open-market operations – Buying and selling government bonds 2. Changing the overnight rate – The government can change the bank rate, which equally changes the overnight rate Bank runs and the Money Supply  Depositors believe that a bank might go bankrupt  Problem for banks using the fractional-reserve banking system  Canada Insurance Corporation Lecture 19: Why is the inflation rate 2.5% in Canada but 19% in Venezuela? Classical Theory of Inflation  Price of a good
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