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Chapter 24

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McGill University
Economics (Arts)
ECON 209
Paul Dickinson

Chapter 19: What is macroeconomics all about? 10/01/2013 18:55:00 ← Macroeconomics is the study of how the economy behaves as a whole: • It is concerned with the determination of economic aggregates o E.g. total exports, total price investment, etc. ← ← Output and Income ← ← National product is by definition equal to national income: • To measure the total output, quantities of different goods are aggregated o Value is given to the different units of materials by multiplying the unit value by units produced o The values are then summed across all of the different goods produced  This is called the nominal national income (measured in current dollars)  Real national income is measured in constant (base- period) dollars; it only changes when quantities of goods produced change  Real national income is used to measure the changes between economies year after year ← ← Business cycle: fluctuations of national income (usually measured as GDP) around its trend value that follow a more or less wavelike pattern ← ← Potential/full-employment output (Y*): the real GDP that an economy would produce if its productive resources were employed at their normal levels of utilization (also called potential GDP) ← ← Output gap (Y-Y*): measures the difference between the actual and potential outputs ← ← Recessionary Gap (YY*): a situation in which output exceeds potential output ← ← Recession: a downturn in the level of economic activity. Often defined as precisely two consecutive quarters in which real GDP falls. ← ← Employment & the Labor Force ← ← Employment: denotes the number of adult workers (15 and over in Canada) who have jobs ← ← Unemployment: denotes the number of adult workers who are not employed but are actively searching for a job • Unemployment rate (U) = (number of people employed / number of people in labor force) x 100 percent ← ← Labor force: the total number of people who are either employed or unemployed ← ← Types of Unemployment ← ← Full employment: when the economy is at potential GDP • This does not mean that everyone in the labor force is employed ← ← Frictional unemployment: unemployment caused by the normal turnover in labor • People entering & exiting labor force; people quitting jobs & getting fired ← ← Structural unemployment: a mismatch between the structure of the supplies of labor and the demands for labor • i.e. tech bubble burst: high demand for computer specialists disappears; specialists must retrain before finding new jobs ← ← Cyclical unemployment: unemployment that changes with the ebb and flow of the business cycle ← ← Productivity ← ← Labor productivity: the amount of real GDP produced per unit of labor employed (either total # of workers or number of hours worked) • Canada’s productivity has increased almost every year since 1960 ← ← Canada’s GPD Increase: • Rising employment — larger labor force but also higher proportion of participating population • Steady increase in physical capital — buildings, factories, and machines used to produce output • Increased productivity over time ← ← Productivity is the single largest cause of rising material living standards over long periods of time • Short term changes in average real incomes are more due to the ebb and flow of the business cycle ← ← Inflation and the Price Level ← ← Price level (P): the average level of all prices in the economy • To measure this, a price index is constructed using averages of prices of various commodities based on their importance ← ← Consumer Price Index (CPI): measures the average price of the goods and services that are bought by a typical Canadian household ← ← Inflation: a general increase in prices and fall in the purchasing value of money • Anticipated inflation: households and firms can generally adjust nominal prices and wages to maintain real values • Unanticipated inflation: causes changes in the economy’s allocation of resources and real wages ← ← Rate of inflation: price level divided by the initial (base-year) price level, times 100 ← ← Purchasing power of money: the amount of goods and services that can be purchased with a given amount of money • This is negatively related to price levels ← ← Interest Rates ← ← Interest rate: the price paid per dollar borrowed per period of time (expressed as a proportion or a percentage) • Nominal: price paid per dollar borrowed per period of time • Real: nominal rate of interest adjusted for the change in the purchasing power of money o Real Rate = Nominal interest rate — rate of inflation ← ← A loan represents a flow of credit between lenders and borrows, with the interest rate representing the price of this credit. ← ← The International Economy ← ← Exchange rate: the number of units of domestic currency required to purchase one unit of foreign currency ← ← Foreign exchange: foreign currencies that are traded on the foreign- exchange market • Can be bank deposits, checks, promissory notes, etc. ← ← Depreciation: a rise in the exchange rate (more units to purchase 1 unit of foreign currency) ← ← Appreciation: a fall in the exchange rate (less units to purchase 1 unit of foreign currency) ← ← Trade-weighted exchange rate: a weighted average exchange rate between the home country and its several trading partners, where the weights reflect individual shares in the home country’s total trade ← ← ← ← ← ← ← Chapter 20: The Measurement of National Income 10/01/2013 18:55:00 ← Chapter 21: The Simplest Short-Run Macro Model 10/01/2013 18:55:00 ← Desired Aggregate Expenditure ← ← Desired Aggregate Expenditure (AE): the sum of desired or planned expenditures on domestically produced output by the following groups: • Domestic households • Firms • Governments • Foreign purchasers o Formula: AE = C + I + G + (X – IM) ← ← NOTE: national income accounts measure actual expenditures in each of the four expenditure categories. National income theory deals with desired expenditures in each of these four categories. ← ← Autonomous Expenditure: elements of expenditure that do not change systematically with national income (have no dependence on national income) ← ← Induced Expenditure: components of aggregate expenditure that are subject to systematic changes in response to changes in national income ← ← Consumption is typically between 55 and 60% of GDP and is the largest component of aggregate expenditure. Investment usually counts for about 20%. ← ← Closed Economy: an economy that has no foreign trade in goods, services, or assets ← ← Disposable Income: the amount of income household goods receive after deducting tax-money and adding transfer money • By definition, there are only two possible uses of disposable income, saving and consumption ← ← Saving: all disposable income that is not spent on consumption ← ← Consumption Function: relates the total desired consumption expenditures of all households to the several factors that determine it: • Disposable income • Wealth • Interest rates • Expectations about the future ← ← Average Propensity to Consume (APC): desired consumption expenditure divided by disposable income • APC = C/YD ← Mar
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