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ECON 305 Lecture Notes

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University of Maryland
ECON 305

Macro 1/28/14 9 problem sets, 9 quizzes, drop 3 Bookmark course webpage! Start of class… In the long-run, capacity to produce goods and services (productive capacity) determines the standard of living (GDP/person) (chpt 3,4,5) GDP in the long-run depends on factors of production, amount of Labor (L) and capital (K) and technology used to turn K and L into output. (physical capital- plant/equipment). Can use this with growth rates of GDP as well. Public policy can increase GDP in the long-run only by improving productive capacity of the economy. - Increase national saving leads to larger capital stock - Increase efficiency of labor (education and increase technological progress) In the short-run, aggregate (total) demand influences the amount of goods and services that a country produces (chpt 9,10,13) -monetary and fiscal policy -shocks to the system (business gets scared of spending, less I) GDP= Consumer Spending (C) + Investments (I) +Government Spending (G) + Net Exports (NX) NX= Exports (EX)- Imports (IM) Graph, GDP vs Time (horizontal axis). Straight line F(L,K, Tech) {long run}. In the short run, economy tends to fluctuate b/c of shocks. In the long-run, the rate of money growth determines the rate of inflation, but it doesn’t affect the rate of unemployment. M=money supply. Pi= inflation= % change in price level (P)= {P(t)- P(t-1)} / P(t-1). Chapter 4 High inflation raises the nominal interest rate (real interest isn’t affected) i= nominal interest rate. i= r + pi- the fisher equation r= real interest rate want to come out 2% ahead, there is a 3% inflation rate, you will use a nominal rate of 5%. U=unemployment rate. Graph Pi vs U (x axis)- called Phillips curve, inverse relationship, high inflation is associated with low employment- IN THE SHORT RUN. The Long run Philips curve is vertical. Chapter 1 3 Major concerns of Macro. Growth of economic activity, unemployment, Inflation. Current U, 6.7%. Natural rate of U= 5%, rate when economy is at full employment (always frictional movements in the economy. Long term US growth rate of 3.3% Economic models are simplified versions of a more complex reality used to show relationships b/w variables, explain the economy’s behavior and devise policies… Mankiw’s example of new cars. Demand curve goes down, supply up. Equilibrium at middle. Market is competitive, each buyer/seller is too small to affect market price Q(d) (quanity that buyers demand. Q(s) quantity that producers supply. P= price of new cars. Y= aggregate income. P(s)= price of steel, an input. General functional notation Q(d)= F(P,Y)- quantity demanded is a function of price and income A specific functional forms shows the precise relationship D (P,Y)= 60- 10P +2Y Q(s)= F [P,P(s)] Increase in income. Will shift demand to the right. (increasing equilibrium price and quantity) Effect of steel price increase. Will shift supply curve to the left. (increasing eq price and decreasing quantity) Endogenous variables are determined in the model (quantity and price) The value of exogenous variables are determined outside the model: the model takes their values and behavior as given. (income and price of steel) 1-30 Macro No one model can really show the long run and short run. Therefore we will use dif’n models for dif’n issues.  For each new model, you should keep track of  its assumptions  which variables are endogenous, which are exogenous  the questions it can help us understand, those it cannot Market Clearing: assumption that prices are flexible, adjusting to equate supply and demand Short run, prices are sticky- adjust sluggishly in response to changes in supply or demand. Ex. Labor contracts fix nominal wage for yr or longer. If prices are sticky, demand may reduce, only changing the supply by a greater amount than eq would be, creating an excess supply (unemployment) If prices flexible (long run), markets clear and economy behaves very differently CHAPTER 2 GDP two definitions: (Expenditure=Income b/c every $ spent by a buyer becomes income to the seller)  Total expenditure on domestically-produced final goods and services.  Total income earned by domestically-located factors of production. (land labor capital entrepreneurship) Value added is the value of the output less the value of the intermediate goods used to produce the output. GDP here would be $5. Or could get it by adding the value added of each step. Value added- factor of production Wages-labor Rent- land Interest- capital Profit-entrepreneurship  consumption, C ,investment, I, government spending, G, net exports, NX An important identity: Y: value of total output, right side is aggregate expenditure Y = C + I + G + NX C- value of all goods and services bought by households including durable goods (cars, homes), nondurable goods (foods, clothes), and services [work done for consumers] (dry cleaning, air travel) I- Spending on goods bought for future use ( spending on NEW capital) (i.e., capital goods) including Business fixed investment Spending on plant and equipment Residential fixed investment Spending by consumers and landlords on housing units Inventory investment The change in the value of all firms’ inventories A stock is a quantity measured at a point in time, a low is a quantity measured per unit of time. G includes all gov’t spending on goods and services, excluding transfer payment (unemployment insurance payments, welfare benefits bc they aren’t related to the production of goods and services) NX= EX-IM- value of total exports less the value of total imports. Firm produces 10 mil worth of final goods, only sells 9 mil. No, this 1 mil not sold goes into change in inventory. Counted as inventory investment. Remember output=expenditure. GNP-total income earned by nation’s factors of production, (US citizens in Britain making money still counts) GDP-Total income earned by domestically-located factors of production, regardless of nationality GNP = GDP + factor payments from abroad minus factor payments to abroad Examples of factor payments: wages, profits, rent, interest & dividends on assets GNP>GDP- tells you they have a lot of citizens working abroad Nominal GDP measures the value of all final goods/service produced using current prices, while real GDP utilizes the prices of a base year. For real GDP, you multiply each year’s quantity by one year’s price… Changes in nominal GDP can be b/c of changes in prices and/or changes in quantities of output produced, while changes in real GDP can only be b/c of changes in quantities. Inflation rate is the % increase in overall level of prices. GDP deflator is one measure of price level. GDP deflator = 100 X Nominal GDP/Real GDP Inflation rate is change in the deflator. If your hourly wage rises 5% and you work 7% more hours, then your wage income rises approximately 12%. GDP deflator = 100  NGDP/RGDP. If NGDP rises 9% and RGDP rises 4%, then the inflation rate is approximately 5%. Consumer Price Index (CPI). Hold quantities constant and tracks price changes. 100 × Cost of basket in that month Cost of basket in base period Measure of overall level of prices published by BLS to track changes in typical household’s cost of living. It also adjust many contracts for inflation (COLAs) and allows comparisons of dollar amount over time. CPI= BLS surveys consumers to determine composition of the typical consumer’s “basket” of goods CPI may overstate inflation b/c of substitution bias (CPI uses fixed weights so it can’t show ability to substitute toward goods whose relative prices have fallen), introduction of new goods, and unmeasured changes in quality Macro 2-4 For Problem Sets, also look at previous notes Unemployed- not employed but looking for a job Labor force- amount of labor available for producing goods and services (U + employed) Not in the labor force- not employed, not looking for work Labor force participation rate, % of adult pop that is in labor force Involuntary part-time workers- individuals who would like a full-time hob but are working part time Chapter 3- the long run model\ Also need to look at Eq in goods and loanable funds market Factors of production K= capital (tools, machines, structures used in production) L= Labor Y= F(K,L) Initially Y 1 F (K , L1 1 K 2 zK an1 L = zL 2 1 Returns to scale- scale all inputs by same factor z (if z=1.2 all inputs are increased by 20%) If constant returns to scale Y = 2Y decr1asing returns to scale, Y < zY increasi2g ret1,ns to scale, Y >2zY 1 We assume tech is fixed, economy’s supply of K and L is fixed (they are all exogenous) (bar over top means its given) The distribution of national income is determined by factor prices, the price/unit firms pay for the factors of production Wage= price of L, rental rate= price of K Factor prices are determined by supply and demand in factor markets Demand for labor- assume competitive markets, firm takes W,R, P as given Firm hires each unit of labor if cost (real wage) doesn’t exceed benefit (marginal product of labor) (change in output/ change in labor) MPL- extra output the firm can produce using an additional unit of labor holding the other inputs fixed As factor input increases its marginal product fall (other things equal) 2-6 chapter 3 Labor Supply long term is a vertical line Each firm hires labor up to the point where MPL= W/P Same logic shows MPK= R/P  diminishing returns to capital: MPK  as K   The MPK curve is the firm’s demand curve for renting capital.  Firms maximize profits by choosing K such that MPK = R/P. α −α (1−α)Y α−11−α αY MPL = (1−α)AK L = MPK = α AK L = L K Neoclassical theory of Distribution says that each factor input is paid its marginal product Labor income is around 70% of total income historically Disposable Income, Y-T (t is taxes) (taxes are lump sums in this assumption) Consumption function C= C(Y-T) Shows that (Y – T )  C MPC (Marginal propensity to consume) change in C when disposable incomes increased by 1 dollar Change in C/ Change in (Y-T) G excludes transfer payments (social security benefits…) Assume G and T are exogenous Econ 2-11 Increase in immigration (increases supply) Y  =  C(Y −T ) +I (r ) +G Opposite way, plague, decreases labor supply, increasing w/p (real wage), decreasing y (output), and decreases r/p (real rental rate) demand for capital because it is less productive. Could figure this out from the formula… Equilibrium (the market for goods and services) Y>AE -> pi decrease -> I Increase (and vice versa) The loanable funds markets- simple, supply-demand model of financial system w/ one asset (loanable funds) Demand for funds: investment, supply of funds- saving, price of funds- real interest rate Demand for loanable funds comes from investment, firms borrowing to finance spending consumers borrowing to buy housing. It depends negatively on r, the price of loanable funds (cost of borrowing) The investment curve is also the demand curve for loanable funds The supply comes from savings (households making bank deposits, buying bonds), gov’t can contribute by not spending all tax revenue. A. Delta s= delta Y- MPC delta Y + MPC delta T – delta G= -100 B. 80= 0- .8 (0)+ .8(100)- 0 C. 20= 100-.8(100)+. 8(0)-0 D. 40=200-.8(200)+.8(0)-0 If T>G there is a budget surplus, T
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