Chap 1-2 (from Sabrina) 1/17/2013 7:39:00 AM
The Focus of Macroeconomics
Macroeconomics focuses on the behavior of key macroeconomic
Since the early 1990s, the inflation rate has been in the narrow
range of 1-3% per year
- consistent with the Bank of Canada target.
3. The unemployment rate – the proportion of the labour force out of
work (Fig 1-3)
Canadian Historical Data on the UR
The UR is strangely countercyclical with GDP
o Rising in recessions and falling in expansions
Unemployment was highest in the 1930s
[during the Great Depression] and lowest in the 1940s [during
Since 1945, there has been a gradual upward trend in
unemployment, but endence in recent years suggest this trend may
4. The interest rate – the cost of borrowing and return to saving
5. The (nominal) exchange rate – the cost of one currency in terms of
Behavior of prices: tlekible (LR) & sticky (SR) D ≠ S (many not).
↪ Market clearing (equilibrium)
(ch 7-8) OMIT
Some Rule for Calculating GDP
1 1. The importance of inventories. Since we want to measure production
in a given year, we add the value of unsold goods to inventories, and
include this value in the GDP calculation.
2. We add-up the many and varied goods and services by multiplying the
quantity by the market price.
3. Exclude intermediate goods. Count the value of final goods & services
only in the GDP calculation, otherwise, double-counting will occur.
4. If goods or services don’t have a price, use an imputed value
Ex. (1) imputed rent on owner-occupied housing
(2) government services are valued at cost
Used goods (b/c been included)
Underground economy (transaction that don’t go through market)
Services of durable goods
Investment (I) (net financial investment)
i.e. Domino Pizza buying a store
Notes: Investment – the purchase of newly produced goods/services to add
to the capital stock.
Purchase made by businesses & firms
By convention, the purchase of new housing stock
The value of inventories
Government (All government levels)
Defn: Transfer Payments
Direct transfers of money from the government to individuals not in
exchange for production. (no production involved)
Net exports: NX = EX – IM
GNP everything owned by Canada
GDP everything in Canada
2 Real vs Nominal GDP
Nominal GDP – output valued at current year prices
Nominal_GDP= å Q2010 2010
Nominal GDP measures the value of goods & services produced in
can’t compare nominal GDP annually
Real GDP – output valued at constant (base year) prices
Real_GDP = å Q2010 2012
Real GDP measures the volume of goods & services produced in
GDP Deflator (price index)
Defn: The GDP deflator measures the price of output relative to its level
in the base year.
The GDP deflator is a price index which measures the overall price level.
GDP_Deflator = Nominal_GDP ´100
å Q2010 2010
GDP_Deflator = i ´100
å Q2010 2012
In this definition of the GDP Deflator, all the quantity terms will be the
same, reflecting only the relative change in prices.
Jan 15, 2013
CPI weights is fixed (csp SR) whereas GDP deflator rate is not.
Canada – (0.5% - 1%)
Flexed weight (Laspeyres) CPI
Changing weight (Paasche) GDP deflator
3 (s 48)
1. prices of capital goods (Canadian households don’t buy these
excluded from CPI)
2. price of imported (net import included in GDP)
3. basket of goods (GDP changes, because we produce different every
CPI & GDP move in the same way (not always)
Note: measuring bhlessnecs: the unemployment rate.
A well-functioning economy will use all its resources
1. unemployment may signal wasted resources
2. The costs of unemployment aren’t evenly distributed across the
Based on the Labour Force Survey of about 56,000 households, the
population [15 years+] is categorized as:
POP = employed + unemployed + not in the LF
Labour Force (LF) = employed + unemployed
Fig 2-4 p40 (Canadian Rules)
↪ This figure shows the # of people in each category in 2008
The Labour Force Survey deliberately excludes individuals in all of the
1. Persons younger than 15 years old
2. Persons residing in the Yukon, the NW territories, Nunaunt and an
3. Full-time members of the armed forces
4. Inmates in institutions. (ie. Hospitals)
4 Chapter 3 1/17/2013 7:39:00 AM
Carsian Consumption Equation
C = a + NPC (Y-I), where a =
How is GDP ALLOCATED to consumption (C), investment (I), and
government spending (G)?
Process to Equilibrium
Supply > Demand
o Implies we need more demand.
r -> I
until supply = demand.
The opposite is true
until supply = demand
The Financial Market
1. There is one financial market where loanable funds (LF) are traded.
i. This is a simplifying assumptions.
2. All investment spending by firms is financed by new borrowing.
i. This implies I(r) = LF and is inversely related to the interest
3. Any government budget deficit is financed by new borrowing which
reduces the pool of LF available to firms.
5 4. All private savings are used to make new loans to firms or to
From 3 and 4
S = (Y – T – C) + (T – G)
National Saving = Private savings + Public (dis)saving
o private means people
o S can be positive or negative
o T: tax revenue
o T-G supplus/deficit
These assumptions also imply that S = LF S
Notes: from 3, government issues bonds to borrow money to cover
deficit, this reduces private savings (C)
(s 45) loanable funds demand curve: investment
I(r) = LF
Let S = Y – C – G. This is the definition of National Savings.
From the National Accounting Identity:
Y = C + I + G
Y – C – G = I Therefore,
S = I Savings = Investment.
This is the equilibrium condition in the Financial Market.
Putting together all of our assumptions, we get:
Y -C(Y -T)-G= I(r) Therefore,
S = I(r) and,
Given the assumptions of the model, saving does not depend on the
6 We can show that financial market equilibrium eimplies goods market
Financial Market I(r) = S
I(r)=Y -C(Y -T)-G
Substitute for S
OR Demand for goods/services = Supply of goods/services
OR Goods market equilibrium condition
7 Start: in eq’m at (A).
Shock: G, T = T(bar)
At r1, S < I or LF < LF D
r quantity of LF demanded (along the demand curve).
The Effects of a Change in Fiscal Policy
Fig. 3-9 page 74
Shock: G, T=T(bar)
At r1, I>S or LF > LF
Therefore, r and I(r) until equilibrium is restored.
(We call this “crowding-out” of investment spending.)
The increase in G has no effect on the amount of output
produced by the economy which is fixed by the given supplies of
the factors of production:
Y =Y =F(K,L)
The increase in G has no effect on total expenditure on output
because the real interest rate [r] adjusts to keep Y =Y or demand =
supply in the goods market.
The composition of demand changes with investment spending
decreasing by exactly the amount by which G increased [the
crowding out effect] while consumption spending remains
T implies (Y-T)
(Y-T) implies C
S = Y – C - G
The Effects of Changes in Investment Demand
8 Fig. 3-11 page 78
In this analysis, we want to talk about exogenous changes to
For example, a technological innovation or a change in tax laws
would result in a change in investment for any interest rate.
In other words, a shift in the investment demand curve.
Note: a change in the interest rate (r) will change the quantity
demanded along the demand curve.
Model predicts: actual investment will be the same in equilibrium.
Why? In equilibrium,
I =S,S =S
Therefore, a change in investment results in a change in the
interest rate only.
The increase in investment demand has no effect on the levels of
aggregate output because the real interest rate [r] adjusts to keep
total demand for output [Y] equal to [fixed] total supply of output [
There is no change in any of the components of demand, C, I, G.
While investment demand at a given real interest rate has
increased, the actual amount of investment spending has not
changed because the equilibrium value of r has risen.
Unless “saving depends on interest rate” is specified, it does NOT hold.
An Increase in Investment Demand When Saving Depends on the
Fig. 3-13, pg. 79
Start in equilibrium at point A.
Assume there is an exogenous shock which increases investment
demand. I(r) shifts to the right.
At the initial interest rate1r , LF > LF .
The real interest rate will start to rise. As a result, the quantity of
LF demanded will along the demand curve. The quantity of LF
supplied will along the supply curve. This will continue until we
are back in equilibrium at point B.
Outcome: We have more saving which finances more investment.
10 Chap 4 1/17/2013 7:39:00 AM
Functions of Money
Medium of Exchange – emphasized that money makes exchange
easier and more efficient.
Store of Value – people will hold money only if they believe it will
continue to have value.
Unit of Account – identifies the convenience of having a widely
recognized measure for accounting and transactions.
(Jan. 24 – Lecture 6)
Control of the money supply
This is one of the most important responsibilities of Canada’s central
bank – the Bank of Canada.
Decisions regarding the size of the money supply are the responsibility of
the Governor of the Bank of Canada,
with input from the Federal Minister of Finance,
and constitute the government’s monetary policy.
The main method of control of the money supply is through open
market operations – the purchase or sale of outstanding government
bonds by the Bank of Canada.
Open Market Operations
Increase the money supply
- Bank BUYS government bonds & securities from the public, putting
money in circulation
Decrease the money supply
- Bank SELLS government bonds & securities to the public, taking money
out of acculation.
Note: money held by the Bank of Canada is not included in the money
Table 4-1 The Measures of Money
4 Measure of the money stock for Canadian Economy
Money consist of coins, bank notes, and chequable deposits.
11 1. M1 = currency (bank notes + coins) outside the banks + demand
deposits located in chartered banks (very liquid)
Demand deposits – funds in accounts that can be removed without
notice & usually pay little or no interest.
Examples: current accounts, personal chequable accounts.
2. M2 = M1 +personal savings deposits + non-personal notice deposits
located in chartered banks.
– bank deposits that typically earn a rate of return and return
a stipulated amount of notice to be withdrawn, though rarely
– deposits which have a notice requirement in the contractual
agreement with the client, although banks almost never
enforce this clause.
– bank deposits paying a market rate of return which are
deposited for a fixed term and thus have limited liquidity.
(M1 + M2 are all in chartered banks)
3. M2+ = M2 + all deposits at non-bank-taking institutions (trust,
mortgage & loan companies; credit unions and caisses populaires),
money-market mutual funds, and individual annuities at life insurance
4. M3 = M2 + chartered bank non-personal term deposits and foreign
currency deposits of Canadian residents.
Non-personal term deposits
o Deposits held by provincial and municipal governments,
corporations, and institutions, and also include deposits held
by one bank with another, known as interbank deposits.
Demand For Money (s17 - replace with notes)
Assume the amount of money people wish to hold is proportional to income:
M = kPY
(M/P) = kY
Where: M = demand for money
12 (M/P) = demand for real balance
k = a constant proportion of income
Equilibrium in the money market:
M / P = (M / P)
Supply = Demand
M / P = kY
M(1/k) = PY
Result: Money demand is equivalent to the quantity equation if:
i. V = 1/k
ii. There is equilibrium in the money market.
V = 1/k shows the link between demand for money and velocity of
When k is large, that implies velocity is small.
In other words, when people want to hold a large proportion of
money for each dollar of income, then money changes hands
Compare: MV=PV to M(1/k)=PV.
If V=1/k, then money demand is equivalent to the quantity
Y = F(k,L)
The Quantity Theory of Money
o MV = PY
Quantity Equation in Growth Rate Terms
o %DM+%DV =%DP+%DY
NOTE: since we assume V =V ,
Then %DV =0
Let ∏ denote the inflation rate.
13 %DM+%DV =%DP+%DY
Can be written as:
%DM =p +%DY
Solve for ∏:
The Quantity Theory of Money
MV = PY
The money supply determines the price level.
The growth rate of the money supply determines the inflation rate.
Definition: the revenue the government obtains by printing money.
A government can finance its deficit by:
i. increase taxes,
ii. borrowing (selling bonds),
iii. printing money ( M, then π)
M P from the Quantity Equation.
Existing money is now worth less than before because higher prices
means each dollar buys less.
This is “similar to” a tax on real balances.
Lecture 7 (Jan. 29)
Nominal Interest Rate
The costs of borrowing or the return to lending measured in
Real Interest Rate
The cost of borrowing or th