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Economics – March 18-28th Lecture Notes.docx

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Bridget O' Shaughnessy

Economics – March 18 , 2013th Is a government budget deficit bad for a small open economy? The Real Equilibrium in an SOE Effects of an Increase in the World Interest Rate  Does not matter value of real exchange rate  NCO is just saving minus investment  Increase in world interest rate  rwshifts up  Higher interest rates mean households want to save more and firms don’t want to borrow as much  NCO = S – I  So I increases and changes NCO Effect of an Increase in the Government Budget Deficit  Public saving will go down  Supply of loanable funds curve shifts in to the left  Excess demand for Canadian dollar  Upward pressure on value of Canadian dollar  When dollar becomes more valuable, goods/services become more expensive  Causes NX to fall Imposing an Import Quota  Import quota: limit on imported goods coming into the country  Only one trade policy that would work to influence trade balance: say no more trade (trade balance is zero)  This would be a bad idea  Work all three examples in reverse for practice th Economics – March 19 , 2013 How do aggregate demand and aggregate supply differ from demand and supply? Aggregate Demand Curve  Y = A*F(K,L,H,N)  AD: Y = C + I + G + NX  The AD curve has a negative slope for three reasons: 1. Wealth effect o If overall price level goes down, people feel wealthier (C increases) o Y increases because C increases in Y = C + I + G + NX P P1 P2 Y 1 Y 2. Interest rate effect o Liquidity preference theory (Ch. 15) o Assume: money has no interest, bonds have interest o Opportunity cost of holding money = interest rate o Price level goes down o People buy same quantity of stuff because need less money d o M decreases o Interest rate goes down o Y goes up because I goes up in Y = C + I + G + NX r Ms r1 r2 M d M 3. Real exchange rate effect o Price level goes down o eP/P* o Canadian goods are cheap relative to foreign goods o Exports go up o Imports go down o Y goes up because NX goes up in Y = C + I + G + NX Shift Factors for the AD Curve  Anything other than P that affects C, I, G or NX will cause the AD curve to shift  Ex: increase in government spending causes to shift out P AD 2 AD Y Aggregate Supply  LRAS: Y = A*F(K,L,H,N)  Slope: A, K, L, H, N do not depend on price (recall the classical dichotomy – the long run separation of real and nominal variables)  LRAS is vertical  Shift: any change in A, K, L, H or N will cause the LRAS curve to shift  natural disasters have much larger impacts in poor countries than in large countries because: buildings are less sturdy so fall down easier, have less ability to clean it up P LRAS Y Y^ Economics – March 21 , 2013 st Readings for Lectures 24-28:  L24 – p. 330-347; 367-373  L25 – p. 325-330; 347-349; 351-356  L26 – p. 349-351; 356-361  L27 – p. 373 – 374; 379-386; 390-399  L28 – p. 374-379; 386-390 Short Run Aggregate Supply:  The slope is positive for three reasons: (1)Sticky wage theory o Real wag: W/P o Labour is expensive when the price of input rises so firms cut production o P goes down resulting in a drop in Y o SRAS has a positive slope (2)Sticky price theory (3)Misperceptions theory  Shift: the SRAS curve will shift when the LRAS curve shifts or when people’s expectations of the price level changes  Y = Y^ + a(P – Pe) What are business cycles and what causes them? Business Cycles:  Economic fluctuations are irregular and unpredictable  Economic variables fluctuate together o GDP (Y) and the unemployment rate tend to move in opposite directions Real GDP Over Time  Over time GDP tends to rise Stylized Business Cycle  Going from peak to trough: recession  Going from trough to peak: expansion (boom)  Recession: (1)Two consecutive quarters of declining real GDP (2)Going from a peak to a trough in a stylized business cycle Review AD: Y = C + I + G + NX LRAS: Y = A*F(K,L,H,N) SRAS: Y = Y^ + a (P – e ) Equilibrium  The model is in equilibrium at the intersection of AD and SRAS  If this point also coincides with the LRAS curve, then the economy is in long run equilibrium Long Run Equilibrium  Changes if there is a shift in the Aggregate Demand (AD) curve  Flow varia
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