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Economics 1022A/B
Charles Middleton

Macro-Economics Monday 2:30 to 4:30; Wednesday 2:30 to 3:30 - Aggregate = Total Demand (Country) 2 ways POLICY => know how governments try to influence the economy Demand and Supply management Issues: talk about individual areas Main Issues: 1. Unemployment o Microeconomic view : Labour not employed, therefore inside the PPF and are inefficient o Measures Labour  output (measure wealth)  More unemployment  more output 2. Inflation o Sustained rise in general price index Basic Units of Economy 1. Households – people, person, family, etc. o Consume – expenditures on goods and services (Consumption) 2. Firms o Produce products 3. Governments o Function varies depending on economy (some produce products, some not, etc.) o In Canada, historically governments provide public goods (market system does not produce because they are exclusive) - What they really do: spend money = government expenditure o Tax: more they spend, more they tax 4. International o Exports and imports o X (exports) – M (imports) = Net Trade o For majority of course, assume net trade is zero  Closed economy doesn’t export or import Models - An example of an economic system - All have assumptions Circular Flow - Expenditure ($) - Products (things) - Consumption is related to income, flow of income in, provide consumption out (how much you spend) - Transfers: (No gains or losses as a group  net effect zero) o Net expenditure on G + S  Robin Hood o Normally assume that Total taxes – Transfer = Taxes Injection Leakage Exports Imports Government Expenditures Taxes Investment Savings (taken out) Expenditures + Government Expenditures + Investments = Imports + Taxes + Savings Income is broken into 2 parts = Consumption + Savings X + G + I = M + T + S Measuring the Size of the Economy - How much Is being produced o Three approaches 1. Expenditure Approach - Measure the expenditure on goods and services - What are you measuring? o GDP – Gross Domestic Product  Final level of output that is produced within Canadian borders over a specific time  Location is the important factors o GNP – Gross National Product  Final level of output that is produced by Canadians regardless of location over a specific period GDP (Expenditure Approach) - The dollar value of expenditures on final goods and services produced within Canada over a specific period - Household expenditure  called consumption - Business Expenditure  called investment - Government Expenditure  called government expenditure - Int. Expenditure = (X – M)  Net X (Net Expenditure) o X is exports o M is imports - GDP = C + G + G + (X – M) Investment a) Additions to the capital stock b) Building, houses, etc. c) Inventory accumulation o Unsold products over the time period - If gross investment increases, capital stock can increase, decrease, or stay the same Example: Calculate GDP for Chuckland 10 bikes at $50 = $500 20 pencils at $1 = $20 GDP = $520 - Only market goods are used 1) No used products 2) No black market products a. Legal goods that are not reported (tax reasons) b. Illegal goods 2. Income Approach - Any expenditure must become someone’s (or a group’s) income - We can determine total income, and from that total expenditure and therefore GDP 3. Value Added Approach - Add the value that is added at each step in the production *don’t worry about this one* Income – Expenditure Identity Total Income = Total Expenditure = GDP Y + C + I + (X-M) = GDP Size of the Population - When measure GDP, we don’t take into consideration the population - per capital GDP = GDP/ population  GDP = Y (Therefore, per capita income) GDP Over Time GDP = Sum of P x Q - can go up if prices and/or quantity increase - Nominal GDP  output in current dollars - Problem: we want to measure change in output, not the change in price. So, we want to hold prices constant o Called Constant Dollar GDP  Real GDP How? Price Index (Indices) - Base year  price index = 100 - Price Index is: Example: 2005 Item Price in $ Quantity Total Bikes 50 100 $5000 Pencils 0.5 1000 $500 Cell Phones 200 30 $6000 Totals 1130 $11,500 2009 Item Price in $ Quantity Total Bikes 65 110 7150 Pencils 0.8 1110 888 Cell Phones 300 33 $9900 1253 $17, 930 What is the percentage change? (End – Beginning) / Beginning x 100 = 55.913% ( ) ( ) ( ) What is the Price Index for 2009? 1) Consumer Price Index (C.P.I.) - Measures the prices of a “basket” of consumer goods that a typical consumer consumes over a specific time period - Monthly calculated  prices are found in the largest 64 urban centres in Canada - Basket Includes: Transportation 19.6% Shelter 25.7% Food 16.9% Recreation, Education, Reading 13% Household Operations 11.4% Clothing, shoes 5.6% Health 4.8% Alcohol, tobacco 3.1% Problems: 1) Who is typical? 2) Constant Basket Items o Substitution bias will cause an overestimate of inflation o New product bias means new products aren’t included 2) GDP Deflator - All products o Hold Q constant o Done quarterly, but released six months delayed Savings – Investment Financial Intermediation - Matching up loaners and borrowers Savers  Financial Intermediates Borrowers - Financial Intermediates are usually banks o They undertake the:  Denomination risk (e.g. need to borrow large sums)  Duration risk  Default risk Assume Two Things: 1) Firms borrow using Bonds o Bond is a debt instrument Straight Bond (Coupon Bond) - Have: o face value (dollar amount) o Maturity date (__ year bond), but doesn’t have years written on it o Coupons attached = face value x market rate (interest) at issue  Coupons are paid semi-annually o Bond Yields are equated What is a Yield? - The rate of return of a bond - Yield = Interest Rate + Capital gain (Change in price) - Every bond pays the same yield as long as the risk is the same  equated to the market rate of interest Example: Coupon Rate Current Yield Capital Gain Bond A: 2% 2% Face Value Bond B: 10% 2% Moral: Interest rate increase, bond price decreases Interest rate decreases, bond price increases 2) Government Borrow: - Bonds - Treasury bills (federal and provincial) o Short-term borrowing (30, 60, 91, 182, and 365 days) o Do not have an interest rate attached o Sold at discount End Price is the face value. - If a $1000 treasury bill that matures in 91 days sells for $995, what is the yield? - When the price of T-bill increase, yield decrease - When the price of T-bill decrease, yield increases So What? - Bank rate is ¼ of 1% above the average yield on 91-day T-bills - Rate the Bank of Canada charges charted banks for loans Saving Identities Y = C + I + G + (X – M) = GDP Assume a closed economy and no government. Y = C + I + G + (X – M) = GDP: which is: I = Y – C, and (Y – C) is savings Add government  investment = Income – Consumption – Government Expenditures - Because money that would have gone to investment now goes to government When add government, we need to include taxes: - I + t = Y – C – (G + t) o (t – G) is the government budget - Therefore, (Y – t) is the disposable income - Y d what consumption and savings are based on Loanable Fund Theory - Amount loaned must always be equal to the amount borrowed - Loans come from savings o Household supplies the money for loans from their savings  Y = C + S o If income is fixed:  When savings increase, consumption decreases  When savings decrease, consumption increases o Savings is simply future consumption so there is a trade-off between consumption and future consumption  Demand for consumption  Price of Current Consumption is the opportunity cost of future consumption  Therefore, the Opportunity Cost of future consumption is the interest rate  So, as interest rate rises, cost of consuming today increases; consumption decreases and savings increase  As interest rate decreases, cost of consuming today decreases; consumption increases, savings decrease Demand for Loans - Borrowing  businesses o Businesses borrow for investment (which is additions to capital stock) - What we want to know  profit maximizing amount of capital MR = MC - To know the effect of capital, hold Labour constant o Therefore, Marginal Cost is the additional cost of producing one more unit (the cost of adding one more machine) o Interest rate is the cost of capital - Therefore, since MR = MC, MR = and that means that - The slope depends on the MP k Version 2: - Firms borrow to pursue investment projects  have a rate of return (return on investment = productivity) - You will borrow if: ROI ≥ i - You will not borrow if: ROI < i Shifts in I d 1) Change in Productivity (MP ) k 2) Change in Price 3) Taxes See paper notes for example. Unemployment - If unemployed  produce less than potential - Over time  if the number unemployed decreases 1% and GDP increases 1%, over __ years you can double the size of the economy Types of Unemployment 1) Frictional Unemployment These two together form the Natural o Increased by E.I. Rate of Unemployment which is o Workers between jobs o Workers before first job about 6%.  Flexibility Full Employment is Q = f(k, L), where 2) Structural Unemployment Q is potential output an about 94%. o No job skills o The wrong job skills 3) Seasonal Unemployment o Seasonally adjusted numbers 4) Cyclical Unemployment o About 2% currently o Follows business cycle  Company goes bankrupt, lay-offs  Good periods cyclical unemployment drops, and vice versa Measuring - Unemployment rate - Start: All Canadians 15 years and older are the workforce o They can subtract out: voluntarily withdraw  Full-time students, retired, disabled, house spouses Workforce – voluntarily withdrawn = Labour force - Labour force is your unemployed and your employed - The Unemployment Rate is - Frictional and Structural Unemployment = Natural Rate, which is about 6% Participation Rate - People become discouraged and stop looking for a job. They are then considered withdrawn from the labour force (they go back to school, retire early, etc.) - This lowers the unemployment rate - Don’t want to look just at employment rate, but also at participation rate If Participation Rate increases, this will tend to increase unemployment rate, but new jobs are being created. If Participation Rate decreases, this will tend to decrease unemployment rate, but jobs are being lost. Natural Rate Fluctuations - Structural o Teach so that they can work - Frictional o Job search o Match-up jobs 1) Employment Insurance o Better the benefits, the longer people are between jobs  increased unemployment 2) Minimum wage (look at micro economics) 3) Efficiency Wage Theory o Firms will pay above equilibrium level of wage o Does the same thing as minimum wage 4) Unions o Opposite of monopoly  Monopsony o Restrict labour, which increases the wage  10-15% higher wages in unions o Private sector unions are slowly disappearing o Public sector is where unions are now powerful  Colleges and universities have more part-time faculty because its cheaper Money - Historical development - Three functions of money 1. Medium of Exchange - All final payments for goods and services can be made in terms of money o By decree  legal tender (eg. Canadian Dollar) - Without, it is a barter economy o Need a double coincidence of wants 2. Standard Unit of Account - All relative prices are in terms of monetary unit - Important because it makes maximization possible (know how much it costs, so you know how much to buy) 3. Store of Value - Must be able to hold part of your wealth as money o Can hold wealth as money or assets (Financial and physical) o If you don’t want to hold money you won’t want to accept it  caused by really high levels of inflation Money must be divisible Historically: - Used the Commodity Standard o Monetary unit is based on or is a commodity  Cattle, sheep, women  Not very divisible Money must be durable - Cows don’t live forever Money must be portable - Hard to carry around livestock Historically: - Money moved from commodity-based to metallic standard o Predominately gold, and then silver (Europe) o In India and China, it was silver as the more valuable metal o Relatively scarce  but gold is malleable and you can make jewellery  Women went from the monetary unit to what controls the monetary unit Start: Europe in 1300 A.D.  Today - Free gold (gold chucks) as monetary unit, so you need a weigh scale - Then to coinage, but must be issued by a central government and would have the metal content stamped on it o In Canada, quarters and dimes had serrated edges o Because of “clipping”, when people would trim the valuable edge off of the coin (debase the currency) o Quarters and dimers were made of silver until 1968: halfway through year changed into a metal alloy - In 1973, U.S. allowed the gold value to float - In 1974, a quarter was worth 25 cents as a quarter or $2.50 at a gold smith - No pre-1968 coins left th Back to Britain in 17 Century - Law called enclosure - Farms would be strips of land - In feudal system, landed Gentry owned the land, and serfs farmed it - Serfs would give a portion of the produce to the gentry as tax - Enclosure law allowed gentry to kick the serfs off and the started to use crop rotation - Crop rotation caused huge increases in agriculture production o Increased unemployment on farms  People go to the cities o Wages needed to be paid for farm workers  Often in money because they would sell crops to other countries Moral: q = f(k, L) Capital Goods Consumer Goods - Can start producing more capital o Industrial Revolution Why Britain? - People started to have money but there’s nothing to buy! - Things were also rather dangerous (no police really) o Would go to blacksmith or goldsmith who had safes to protect equipment  and they would take deposits and would charge a fee - Same time as Protestant Reformation o Catholic Church has laws against usery (no interest charged) o Jewish could lend money, but no one else could until protestants o People started to make products, went to goldsmith and blacksmith to borrow money o VIOLA! BANKING! o Gold is heavy, so started handing out I.O.U.s of gold to get the money at the blacksmith  Paper currency  and add colours and patterns so couldn’t be counterfeited o So have a gold standard: amount of paper issued depends on how much gold you can covert it to (convertible) o As economy grows, the amount of money needed grows  When money supply is directly related to your amount of gold, but when you don’t have any more gold, prices must fall o Created a non-convertible gold standard  Gold and paper no longer interchangeable and all the gold goes to the bank  Bank can print more money if wanted o Went to exchange standard  So one Indian dollar was based on a British pound, which is based on the actual gold o After 1973, everyone uses the fiat standard  Worth something because government says it is  Therefore, government can print as much as they want  Bolivia in the 1980’s had the #1 import as paper so that they could print more money Gold Standard - $1 is worth a specific amount of gold o Eg. CDN $ equals ¼ ounce - Therefore, exchange rates between currencies are stable o Eg. US $ worth 1 ounce of gold o Exchange rate = 4 CDN $ to 1 US $ - Constant exchange rates Fiat Standard – legal tender Banks and Money Creation and Money Money - Buy stuff - Store of value What is considered money? - Different measures of money o Called money supply  Determined by liquidity  Speed converted to medium of exchange  Cost of conversion  Variations in value o Eg. Stock versus Bonds  Bonds price only
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