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ECON 2000 Final: A Final study guide of ECON2000 going over all the key points in the exam


Department
Economics
Course Code
ECON 2000
Professor
Perry Sadorsky
Study Guide
Final

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SB ECON 2000 MACROECONOMICS FINAL NOTES BY ILAN KOGAN
Chapter 1: The Science of Macroeconomics
Macroeconomics
, the study of the economy as a whole, attempts to answer these and many related
questions.
Economists use many types of data to measure the performance of the economy, but three economic
variables are particular important:
real GDP
(measures the total income of everyone in the economy
adjusted for the level of prices),
the inflation rate
(measures how quickly prices are rising), and
the
unemployment rate
(measures the fraction of the labour force that is out of work).
The Historical Performance of the Canadian Economy
Real GDP measures the total output of the economy and real GDP per person measures the income of
the average person in the economy (in 2008 it was about 42.2 thousand dollars). Since 1900, there has
been a steady increase. Significant increases occurred during WWI, WWII (even more), a bit during the
Korean War, and a lot (most significant) after the Korean War from the mid-1950s to 1980. Significant
decreases occurred during the great depression, 1980s recession, 1990s recession, and the recent 2008-
2009 recession (periods of decreasing real GDP are called
recessions
if they are mild and
depressions
if
they are severe).
Note 1: Since GDP has increased so much, the y-axis of real GDP per person vs. year graphs is
often logarithmic which means that equal distances on the vertical axis represent equal
percentage changes.
Note 2: An increase in real GDP per person means a higher standard of living, while a decrease
means a lower standard of living.
The inflation rate varies substantially and measures the percentage change in the average level of prices
from the year before (so a negative rate means that prices are falling). Before 1945, the inflation rate
averaged about zero (but it was quite negative around 1920 after being very positive, then also negative
but less so during the depression, positive during WWII, and even more positive after wartime price
controls were removed and the Korean War occurred; they then hovered around zero until the mid-1970s
and two oil price shocks where they were quite positive, but slowly they went back to near zero until the
late 1990s when they became negative for a brief period, and negative yet again during the recession).
Periods of falling prices, called
deflation
, were almost as common as periods of rising prices. In recent
history, inflation has been the norm (this was a significant problem in the mid-1970s when prices rose at
a rate of almost 10% per year). Inflation returned to near zero in the 1990s, started creeping up again,
and then dropped during the 2008 recession.
There is always some unemployment and the amount varies from year to year. Recessions and
depressions are associated with unusually high unemployment (the highest rates of unemployment were
reached during the Great Depression of the 1930s). Since WWII, unemployment has generally increased.
In the last 15 years, this trend appears to be reversing.
Historically, unemployment falls and inflation rates rise when total spending is high (such as during WWII
or during the early 1960s), and that unemployment rises when inflation is reduced by government policy
that decreases total spending (such as during the early 1980s and 1990s). A further analysis of these
terms will allow us to evaluate the government’s fiscal policy (its changes in government spending and
taxing) and its monetary policy (changes in the growth of the nation’s money supply).
How Economists Think
Economists use
models
to understand the world and its variables. These models illustrate, often in
mathematical terms, the relationships among the variables. They dispense of irrelevant details and focus

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on underlying connections more clearly. Models have
endogenous variables
, which are the variables the
model is explaining (model’s output), and
exogenous variables
, which are the variables that a model
takes as given (model’s input). The purpose of a model is to show how exogenous variables affect the
endogenous variables.
For the standard supply and demand model, there are a few equations. Qd = D(P, Y), Qs = S(P,
Pm), and Qs = Qd. In these formulas, D( ) represents the demand function and S( ) represents
the supply function. The variables in the parentheses are correlated somehow, and this functional
notation allows us to say that the quantity demanded depends on the price and aggregate
income without having to determine the complete equation with coefficients and constants. The
demand curve, for example, shows the relationship between the price of pizza (P) and the
quantity of pizza demanded (Qd) when aggregate income (Y) is held constant. The curve slopes
downwards since a higher price of pizza encourage consumers to switch to other foods and buy
less pizza. The supply curve shows the quantity of pizza supplied (on the x-axis) and the price of
pizza (on the y-axis), holding the price of materials (Pm) constant. This curve slopes upwards
since a higher price of pizza makes selling it more profitable and firms produce more. The
equilibrium for the market is where these two curves intersect, and at the equilibrium price
consumer buy exactly how much pizzerias produce.
This model has two exogenous variables: aggregate income and the price of the materials. The
model takes them as given. The endogenous variables are the price of pizza and the quantity of
pizza exchanged; these are the variables that the model attempts to explain. The model shows
us how a change in one of the exogenous variables affects both endogenous variables (so if
aggregate income increases then the demand for pizza increases and the price of pizza does as
well).
Prices: Flexible Versus Sticky
Economists normally presume that the price of a good or a service moves quickly to bring quantity
supplied and quantity demanded into balance (they assume that markets are normally in equilibrium, so
the price of any good or service is found where the supply and demand curves intersect). This
assumption is called
market clearing
and is central to the previous model discussed. For most questions,
economists use market-clearing models.
The issue is that the assumption of continuous market clearing is not entirely realistic. For markets to
clear continuously prices must adjust instantly, but in real life many things like wages adjust slowly (e.g.
labour contracts). Although market-clearing models assume that all wages and prices are
flexible
, in the
real world some wages and prices are
sticky
. This doesn’t make the models useless, however, since
prices and wages are not stuck forever. Since the models show the equilibrium that will eventually be
reached, most macroeconomists believe that price flexibility is a good assumption for long-run issues
such as the growth of real GDP from decade to decade. This assumption is less plausible in the short-run,
such as if you are studying year-to-year fluctuations in real GDP and unemployment. In these cases, price
stickiness is a better assumption.
Microeconomic Thinking and Macroeconomic Models
Microeconomics
is the study of how households and firms make decisions and how these decision makers
interact in the marketplace. A central principle is that households and firms
optimize
they do the best
they can for themselves given their objectives and constraints. They choose purchases that maximize
their level of satisfaction, called utility, and firms make production decisions to maximize their profits.
Since aggregate variables are the sum of the variables representing many individual decisions,
macroeconomic theory inevitably rests on a microeconomic foundation.

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Internationally
G7 is Canada, US, France, Germany, Italy, UK, and Japan; these are world leaders with great wealth
created around the 1940s. BRIC(s) is Brazil, Russia, India, China, and later South Africa. These were
introduced after G7, around the 1980s, and were the countries predicted to amass lots of wealth in the
future. Canada, Australia, Russia, Brazil, and South Africa (CARBS) are countries that have a lot of
commodities (for some types they have 60-80% of them).
In the 1950s, from South America, Africa, and Southeast Asia, economists thought Africa would do the
best. However, Southeast Asia had the highest increase in GDP because saving rates were higher and so
they had more money to transform natural resources into final goods and services.
Chapter 2: The Data of Macroeconomics
GDP
The
gross domestic product
, or GDP, tells us the nation’s total income and the total expenditure on its
output of goods and services. It is generally considered to be the best measure of how well the economy
is performing and is computed by Statistics Canada every three months from administrative data
(government functions like tax and regulation) as well as statistical data (e.g. from government surveys).
The purpose is to come up with a number that summarize the total dollar value of economic activity in a
given time period.
GDP equals the (1) total value of all (2) final goods and services (3) produced within Canada during a (4)
particular year or quarter.
Since income is received from individuals owning capital equipment in other countries, GDP is not a
perfect measure of total Canadian income. GDP is total income earned domestically; it includes total
income earned domestically by foreigners but not income earned by domestic residents on foreign
ground.
For evaluating trends in the standard of living of Canadians, it is appropriate to subtract the part of our
GDP that represents income to foreigners. This figure is reported by Statistics Canada in the Balance of
International Payments accounts. The government can lower this amount by paying off debt, which
makes Canadians own more of the machines and factories that operate in our country and less income is
sent away from Canada. When this amount is subtracted from the overall GDP, the same trends are
present. Thus, we do not subtract it for much of our analysis in the book and assume that GDP measures
(a) the total output of goods and services, (b) the total income of all individuals, and (c) the total
expenditure of all individuals (this is because income must equal expenditure for the economy as a
whole).
National accounting
is the accounting system used to measure GDP and many related statistics.
Income, Expenditure, and the Circular Flow
In the circular flow model there are two flows: the flow of income and the flow of labour. Labour flows
from households to firms, and then back to households in the form of goods (e.g. bread). Income flows
from firms to households, and then back to firms in the form of expenditure (e.g. wages and profit). GDP
measures the flow of dollars in the economy, so we can compute it either as the total income from the
production of goods (wages + profit) or as the total expenditure on these goods (the flow of dollars from
households to firms). Thus, we either look at the flow of dollars from firms to households or the flow of
dollars from households to firms.
Stocks and Flows
Economists distinguish between two types of quantity variables: stocks and flows. A
stock
is a quantity
measured at a given point in time, whereas a
flow
is a quantity measured per unit of time. For example,
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