Markets 9/17-handout
1. and their role
Product1. Determine Prices of Products 2. Ration (Allocate) Products
.
Markets (using the forces of S & D)
2. Demand from Buyers Demand Schedule Demand-a schedule which shows the various amounts of a product which consumers are willing and able to purchase at each specific price in a set of possible prices during some specific period of time An individual Buyer's Demand for Corn (hypothetical data)
Price per bushel $5 4 3 2 1 Quantity demanded per week 10 15 Now buy more b/c let`s say 20 25 income increases shift Dc 35 40 55 60 80 85
Resource 1. Determine Price of Resources 2. Ration (Allocate) Resources
Note: high price=few units sold; low price=more units sold; inverse relationship However if Price es from $5 to $4 there has been a in quantity demanded, i.e. you are now exercising your option to consume more b/c P Law of Demand: price and quantity are inversely related (graph)
Determinants of Demand (Determines Location of Demand Curve) 1. tastes or preferences of individuals 2. # of consumers (market Demand) 3. money income 4. price of related goods 5. consumer expectations Note: 1-4=individual Dc & 5=Market Dc Change in Demand change in one or more of the 5 determinants thus shifting the whole demand schedule D rightward shift (i.e. D1 to D2) D leftward shift (i.e. D1 to D3)
(graph)
Change in Quantity Demanded a change in the price of the product and results in a movement along the curve (e.g. $4--20, $3--35) Market Demand Market demand for corn, three buyers (hypothetical data)
Price Quantity Quantity Quantity Total per demanded demanded demanded Quantity bushel first buyer second buyer third buyer per week $5 10 +12 +8 =30 4 20 +23 +17 =60 3 35 +39 +26 =100 2 55 +60 +39 =154 1 80 +87 +54 =221 Market Demand=(individual Dc`s) the sum of individual demands for a product market (graphs)
Market demand for corn, 200 buyers (hypothetical data)__________________________
(1) Price per bushel $5 4 3 2 1 (2) Quantity demanded per week, single buyer 10 20 35 55 80 (3) # of buyers in the market X200 X200 X200 X200 X200 (4) Total quantity demanded per week =2,000 =4,000 =7,000 =11,000 =16,000
3. Supply from Sellers Supply Schedule Supply- a schedule which shows the various amounts of a product which a producer is willing and able to produce and make available for sale in the market at each specific price in a set of prices during some specific period of time Law of Supply: price of quantity are positively related An individual producer's supply of corn (hypothetical data) (graph)
Price per bushel Quantity supplied per week $5 60 4 50 3 35 2 20 1 5 Note: direct relationship between P & Q; gov`t rationing: ex. low income housing
Determinants of Supply (i.e. Location of Supply Curve) 1. techniques of production 2. prices of resources & taxes 3. prices of other products 4. price expectations 5. # of sellers on the market 6. change in the # of sellers in the market Note: 1-4=individual Sc Change in Supplychange in one or more of the 6 determinants thus shifting the whole supply schedule S rightward shift (i.e S1 to S2) S leftward shift (i.e S1 to S3) Change in Quantity Supplied a change in the price of the product resulting in a movement along the curve (e.g. $4--50, 3--35) Marked Supply Market supply of corn 200 producers (hypothetical data)__________________
(1) Price per bushel $5 4 3 2 1 (2) quantity supplied per week, single producer 60 50 35 20 5 (3) # of sellers in the market x200 x200 x200 x200 x200 (4) total quantity supplied per week =12,000 =10,000 =7,000 =4,000 =1,000
(graph)
(graph)
4. Market Equilibrium (QD-QS) -where QS =QD and there is no shortage or surplus Market supply and demand for corn (hypothetical data)_______________
(1) Total quantity supplied per week 12,000 10,000 7,000 4,000 1,000 (2) Price per bushel $5 4 3 2 1 (3) total quantity demanded per week 2,000 4,000 7,000 11,000 16,000 (4) surplus (+) or shortage (-) (arrows indicate effect on price) +10,000 +6,000 0 (market equilibrium) -7,000 -15,000
(graph)
5. Price System : Provides a Rationing Function QD > QS Shortages P QD < QS Surpluses P
6. Demand & Supply Applications (P and Q Results) Eight Specific Cases
9/25 (cont.)
Foreign Exchange Rate- the price of one nation`s currency in terms of an other nation`s currency (e.g. $1=100 yen, thus 1 yen=$0.01) exchange rates are determined by the forces of supply and demand in the foreign exchange market (graph) Appreciated: if the $ buys more yen Depreciated: if the $ buys less yen Currency Appreciation-when the value of a currency decreases;-if the value of $decreasesU.S. goods become less expensive for other nations to buy thus U.S. goods become less expensive for other nations to buy thus U.S. Xs increaseother nation`s good become more expensive for U.S. buyers thus U.S. Ms decrease balance of trade improves (Xs & Ms) Definition of Globalization -is the integration of international economies -it is the integration of trade, capital, technology, information, & people across national borders, in a way that is creating a single global market & to some degree a global village. *trade-exchange of goods and services *capital-flows (foreign direct investment) *diffusion of technology worldwide * information flows almost instantaneously (internet) *people move across borders; -globalization is having important cultural, social, environmental, and political impacts
Ch.4 Important Terms Functional distribution of income: the manner in which national income is divided among the functions performed to earn it (or the kinds of resources provided to earn it); the division of national income into wages & salaries, proprietors` income, corporate profits, interest, & rent Personal Distribution of income: the manner in which the economy`s personal or disposable income is divided among different income classes or different households or families Durable Goods: a consumer good w/ an expected life/use of 3 or more years Nondurable Goods: a consumer good w/ an expected life/use of less than 3 years Services: an (intangible) act or use for which a consumer, firm or gov`t is willing to pay Plant: a physical establishment that performs one or more functions in the production, fabrication, & distribution of goods & services firm: an organization that employs resources to produce a good or service for profit & owns & operates one or more plants Industry: a group of (one or more) firms that produce identical or similar products Sole proprietorship: an unincorporated firm owned & operated by one person Partnership: an unincorporated firm owned & operated by 2 or more persons Corporation: a legal entity (person) chartered by a state or the Federal gov`t that is distinct & separate from the individuals who own it Stock: an ownership share in a corporation Bond: a financial device through which a borrower (a firm/gov`t) is obligated to pay the principle & interest on a loan at a specific date in the future Limited Liability: restriction of the maximum loss to a predetermined amount for the owners (stockholders) of a corporation; the maximum loss is the amount they paid for their shares of stock Principal-agent problem: a conflict of interest that occurs when agents (workers or managers) pursue their own objectives to the detriment of the principals (stockholders`) goals Monopoly: a market structure in which the # of sellers is so small that a seller is able to influence the total supply & the price of the good or service (i.e pure monopoly) Externality: a cost or benefit from production or consumption, occurring w/o compensation to some other than the buyers & seller of the product (can be negative or positive) Negative externality: a cost imposed w/o compensation on third parties by the production or consumption of sellers or buyers; ex.: a manufacturer dumps toxic chemicals into a river, killing the fish sough by sports fishers; an external cost or spillover cost Positive externality: a benefit obtained w/o compensation on third parties by the production or consumption of sellers or buyers; ex.:a beekeeper benefits when a neighboring farmer plants clover; an external benefit or spillover benefit Public goods: a good or service that is characterized by non-rivalry & non-excludability; a good or service w/ these characteristics provided by gov`t Free-Rider Problem: the inability of potential providers of an economically desirable good or service to obtain payment from those who benefit, b/c of nonexcludability Quasi-public goods: a good or service to which excludability could apply but that has a large positive externality that gov`t sponsors its production to prevent an under allocation of resources Gov`t purchases: expenditures by gov`t for goods & services that gov`t consumes in providing goods & services for public (or social) capital that has a long lifetime; the expenditures of all gov`ts in the economy for those final goods & services Transfer payments: a payment of money (or goods & services) by a gov`t to a household or firm for which the payer receives no good or service directly in return Personal income tax: a tax levied on the taxable income of individuals, households & unincorporated firms Marginal tax rate: the tax rate paid on ea. additional dollar of income Average tax rate: total tax paid divided by total (taxable) income, as a percentage Payroll taxes a tax levied on employers of labor equal to a percentage of all or part of the wages & salaries paid by them & on employees equal to a percentage of all or part of the wages & salaries received by them Corporate income tax: a tax levied on the next income (accounting profit) or corporations Property Taxes: a tax on the value of property (capital, land, stocks, & bonds, & other assets) owned by firms & households
(graph/notes)
9/26
1.Specialization & Comparative Advantage Specialization in resource use-where an individual, firm, region, or nation uses its resources to produce what it can do best Comparative Advantage-where there exists a lower relative cost in production from another producer Terms of Trade-the rate at which units of one product can be exchanged for units of another Gains from Specialization & Trade-the extra output trading partners obtain through specialization of production & exchange Note: in our examples of the gains from specialization we assume complete specialization occurs--in practice complete specialization is not likely to happen 2. Trade Protectionism Protective Tariffs-excise taxes or duties placed on imported goods Improved Quotas-limits on the quantities or total value of goods that may be imported Non-tariff Barriers-restrictions on imports resulting from licensing requirements, quality standards, bureaucratic red ta[e Export Subsidies-gov`t payments to domestic producer of export goods (decreased costs of production allowing more sales in world markets) *Reasons for Protectionism Misunderstanding of the gains from trade: -exports=employment of domestic labor, thus are good -imports=displace domestic labor, thus are bad -the point is that trade brings an overall increase in output obtained through specialization & exchange ~Smoot-Hawley Tariff (1930)-highest rate at 60%; backlash: Reciprocal Trade Agreement Act (1934)-encourages other nations to lower their tariffs
*now tariff level is about 5%
(graph)
Political Considerations -special interest groups
10/01
Circular Flow Model: injection & withdrawals
(graph)
1. Simlified-Two Sector Circular flow model of the economy 1) circle flow reps the size of GDP 2) it also reps the level of income & employment (output) 3) it is total spending that creates total output; -i.e. the more spending the more output 4) the level of toal spending must be just right if we are to have full employment & stable prices; -if total spending is too low we have unemployment then recession, then maybe even depression; -if spending is too highwe may have shortages of good & upward pressure on prices (i.e. inflation) Two, Three, & Four Sector Models Who are the Spendors? C + I = GDP (Two Sector) [(cons) (bus)] C + I + G = GDP (Three Sector) closed economy [(gov`t) (not realistic)] C + I +G + (X-M)= GDP (Four Sector-open economy) (net exports) NX=X-M; X > M + NX (surplus); X < M -NX (deficit) Money income denied from producing this year`s output Amount spent to purchase this year`s output GDP GDP Upper Loop Lower Loop
Y E Income Approach Expenditure Approach (wages + rents + interests + profits) (C + I + G + (X-M)] GDP-yardstick of economic performance; -used mostly as a measure of how well the economy is doing; =total value of goods & services produced in the domestic economy during a calendar year (graph)
Injections: anything that adds to the size of the economic circular flow; ex.: gov`t purchases from households Withdrawals: anything that subtracts from the size of the economic circular flow; ex.:business savings, personal income taxes, business taxes
(graph)
Ch.6 Important Terms
National Income Accounting: the techniques used to measure the overall production of the economy & other related variables for the nation as a whole Gross Domestic Product (GDP): the total market value of all final goods & services produced annually within the boundaries of the U.S.; whether by U.S. or foreign-supplied resources Intermediate goods: products that are purchased for final use & not for resale or further processing or manufacturing Final Goods: goods that have been purchased for final use & not for resale or further processing or manufacturing Multiply Counting: wrongly including the value of intermediate goods in the GDP; counting the same good or service more than once Value Added: the value of products sold by a firm less the value of products (materials) purchased & used by the firm to produce the product Expenditures Approach: the method that adds all expenditures made for final goods & services to measure GDP Income Approach: the method that adds all the income generated by the production of final goods & services to measure GDP Personal Consumption Expenditures: the expenditures of households for durable & nondurable consumer goods & services Gross Private Domestic Investment (Ig): expenditures for newly produced capital goods (such as machinery, equipment, tools, & buildings) & for additions to inventories Net Private Domestic Investment: gross private domestic investment less consumption of fixed capital; the addition to the nation`s stock of capital during a year Gov`t Purchases: (G) expenditures by gov`t for goods & services that gov`t consumes in providing public goods & for public (or social) capital that has a long lifetime; the expenditures of all gov`ts in the economy for those final goods & services Net Exports: (Xn) exports minus imports Taxes on production & imports: a national income accounting category that includes such taxes as sales, excise, business property taxes, & tariffs which firms treat as costs of producing a product & pass on (in whole or in part) to buyers by charging a high price National Income (NI): total income earned by resource suppliers for their contributions to GDP plus taxes on production & imports; the sum of wages & salaries, rent, interest, profit, proprietors` income, & such taxes Consumption of Fixed Capital (depreciation): an estimate of the amount of capital worn out or used up (consumed) in producing the GDP Net Domestic Product (NDP): GDP less the part of the year`s output that is needed to replace the capital goods worn out in producing the output; the nation`s total output available for consumption or additions to the capital stock Personal Income (PeI): the earned & unearned income available to resource suppliers & others before the payment of personal taxes Disposable Income (DI): PI less personal taxes; income available for personal consumption expenditures & personal saving Nominal GDP: the GDP measured in terms of the price levels at the time of measurement (unadjusted for inflation) Real GDP: GDP adjusted for inflation; GDP in a year divided by GDP price index for that year, the index expressed as a decimal Price Index (PI): an index # that shows how the weighted-average price of a market basket of goods changes over time
10/05
Measuring National Output & Income 1. Macro & GDP National Income Accounting-the techniques employed to measure (estimate) the overall production of the economy-as well as-other related variables that are part of GDP Macro Equation-a macro. Equation that profiles the U.S. economy (i.e. #1-18 of flap of textbook) & (pg.111 to 114 of text) Pg. 108 (expenditure approach) & pg. 111 (income approach); GDP: 388 billion 2. GDP-a monetary measure Money GDP: (also called nominal or current GDP) is calculated by taking current price X quantity of products sold & then summing the value of all goods & services produced in a given period CPI-Consumer Price Index-measures the general increase in prices over time from some benchmark period (uses a basket of 300 item) Real GDP-money GDP adjusted for changed in the price level; -calculated as follows: *real GDP=( $GDP/CPI) X100 Take the actual ex. from the back flap of the textbook for yr. 2005 Given : $GDP in 05=$12,455.8 (item #1); CPI=112.736 (CPI in 00=100) Real GDP`05=($GPD`05 / CPI`05) X100 = $11,0408.6 (item #8) Thus, the $GDP in `05 of $12,455.80 when adjusted for price changes, of 12.736% over the period for $11,048.60 3. Price Level Measures Price Index (PI)-an index # which shows how the weighted average price of a market basket of goods/services changes over time CPI-an index that measures the prices of a fixed market basket of some 300 goods/services bought by a typical consumer PI (given year)=(Price of market basket in specific year/price of same market basket in base year) X100 -means a basket of goods costing $100 in `92 would cost $112.40 in `97 or in `97 prices have increase by 12.4% over `92 i.e. ((112.4-100)/100) X100= 12.4% 4. $GDP: Price component + Real goods component $GDP=Price component (i.e. some is due to in prices) + real component (i.e. some is due to real quantity goods & services) (see Fig. 7.2) GI (Gross Investment)=NPDI + CCA (net private domestic investment) NPDI = GI CCA (a) expanding production of capacity CCA < GI NPDI is positive (i.e. adds to capital stock) (b) static production capacity CCA = GI NPDI = 0 (i.e. capital stock remains the same) (c) declining production capacity CCA > GI NPDI is negative (i.e. uses up part of capital stock) (see Figure 6.3-U.S. domestic output & the flows of expenditure & income)
10/08
Nominal vs. Real GDP: Applications 1. The 10 orange economy-cherry sheet 2. Application: Converting $GDP to Real GDP: #11, pg. 122 in text 3. Economic Indicators Journal Four Websites (1) www.biz.yahoo.com/c/e.html #1-9, & 11 (2) www.whitehouse.gov/news #10, 13, 14, & 15 (3) www.census.gov/mtis/www/mtis.html #12 (4) www.conference-board.org/economics/schedule.cfm #16
10/09
Business Cycles: Description, Phases, & Economic Growth 1. Reviewing what determines spending: C + I + G + Nx 2. Basic goals of the economy Primary Goals: 1) Full Employment of Resources in the Economy (95/96% of Labor Force) 2) Stable Prices (Low Inflation-less than 3%) 3) Economic Growth of Output (3 to 4%) Other Major Goals 4) X=M (i.e. approximately for favorable balance of trade) 5) Equitable Distribution of Income (Reasonable) 6) Economic Freedom to make decisions 7) Economic Security 8) Economic Efficiency 3. Potential vs. Actual GDP Potential GDP-the real output an economy can produce if it employs its available resources Actual GDP-the output the economy actually produces in a given period
GDP Gap-the amount by which actual GDP falls below potential GDP (it equals foregone output)
(graphs-2)
Note: A larger unemployment rate bigger gap for GDP (see Table 7.2-check about recessions) The Business Cycle-the ups & downs in the level of economic activity (Figure 7.1-graph)
4. Phases of the Business Cycle Peak: characterized by high employment & high output-sometimes inflationary pressures & shortages Recession-characterized by employment & output both declining (i.e. a decrease in economic activity) Trough-where output & employment bottom out (i.e. substantial unused capacity or large GDP gap) Recovery-where output & employment expand toward full employment (i.e. achieve the growth trend goal) Depression-severe & prolonged recession (i.e. 1933, 25% unemployment, 40$ excess capacity in plants) 5. Non-cyclical Fluctuations -fluctuations in economic activity not related to the business cycle Seasonal Variations-increase & decreases in the level of economic activity within a single year, caused by a chance in the season; (e.g. preChristmas & pre-Easter sales) Secular Trends-a long-term tendency towards change in some variety over a very long period of the years (e.g. capitalism has exhibited a long run trend towards expansion)
10/12
Business Cycles: unemployment & inflation 1. Modeling Output: employment & inflation (the spending, output, income, & employment graph) Inflation (Figure 7.4) The Spending, Output, Income, & Employment Graph (graphs-2)
Aggregated Demand (AD) = C + I + G + Nx (spending) Aggregated Supply (AS) = physical output goods/services What happens in: Range 1: don`t want to be here (trough) Range 2: we want to be here (equilibrium) Range 3: don`t want to be here (pure price ) 2. Three Types of Movement in GDP Range 1-is where there is unemployment but stable prices; increase in spending decreases unemployment & prices remain stable until full employment is approached; real GDP & $GDP are the same Range 2-is where the economy approaches full employment the price level begins to rise b/c of shortages in some industries; this means that part of any increase in spending will be used up in price rises lessening the impact of expenditures on output & unemployment; here $GDP is rising faster than real GDP Range 3-is where once full employment is reached further increase in spending will simply push up prices & cause pure demand pull inflation (pt. 4 on the graph); here real GDP is rising not at only $GDP (graph)
3. Inflation-a rise in the general level of prices in the economy; -measures by changes in the consumer price index (CPI) e.g. `78 CPI=195.5 & `79 CPI=217.4; %CPIinflation rate Inflation Rate`79=(CPI`79-CPI`78) / CPI`78 X100=(217.4-195.4) / 195.4 x100=11.2% Nominal vs. Real Inflation Rate nominal-not adjusted for inflation/price rate, real-adjusted for price changes (see Figure 7.4-on inflation) 4. Types of Inflation Demand Pull(pt. A)-inflation which is the result of an in aggregate demand (spending= C + I + G) at near or full employment (range 3) Cost Push or Market Power (pt. B)-inflation that results from increases in wages, prices of raw materials, or profits, in the absence of excess demand (range 2 but high) Stagnation (pt. C)-both high unemployment & inflation occurring at the same time in the economy--WORSE! (graph)
Figure 7.2: the labor force consists of persons 16 years or older who are not in institutions & who are employed or unemployed 5. Types of Unemployment Full Employment-where 95 or 96% of the labor force, willing & able to work Thus our unemployment goal=4 to 5 % Unemployment measure= # unemployed / total labor force `79 = 6 million / 102.9 million = 5.8% Frictional Unemployment-unemployment due to being between jobs Structural Unemployment-unemployment due to technological change making workers` skill obsolete Cyclical Unemployment-unemployment due to deficient aggregate demand [ C + I + G + (X-M)] or total spending caused by the business cycle Natural Rate of Employment-the sum of friction & structural unemployment (graph)
Economic Costs Unemployment 1. GDP gap labor unemployment 2. unequal burdens Employment
10/15
1. Income buys less 2. value assets worth less (retirement savings) 3. arbitrary redistribution of wealth & income
Social Costs 1. Delinquent taxes 2. Crime 3. Family break-ups 4. Revolution 1. Dissension 2. Mistrust 3. Can`t maintain standard of living
Households & Consumption Spending 1. Classical Economics (1800) vs. Keynesian Economics (1936) 1) Classical Economics-that body of macroeconomic theory accepted by most economists prior to the 1930s-conclusion was that a capitalistic economy would tend to employ its resources fully, i.e., it would tend towards YF 2) Keynesian Economics-that body of macroeconomic theory which today (w/ slight modifications) is accepted by most (but not all) economics as the basis for understanding how the macro. economy works. It developed in the 1930s specifically when Keynes published his book: The General Theory of Income & Employment in 1936. The conclusion was/is that a capitalistic economy does not always tend to employ its resources fully & that the gov`t needs to play a role in promoting full employment. Keynes advocated the use of fiscal policy or monetary policy to promote full employment-resulted in the Full Employment Act of `40 requiring the federal gov`t to actively intervene in the economy to promote full employment 2. Preliminary Assumption of the Aggregate Expenditures Model -revert back to our 2 sector model: 1) start w/ a closed economy with no Xs & Ms 2) start w/ no gov`t sector 3) focus on household savings (i.e. no business saving) 4) to simplify we assume that depreciation & net foreign fact income equal zero Derive Keynesian Income Graph from Circular Flow Model (Aggregate Expenditure Model) (graph)
(see Fig. 8-1)
4. Major Determents of Consumption C=f (Yd) Yd = C + S S = Yd S (see Table 8.12) (ave. propensity consumed) APC = C / Yd (ave. propensity saved) APS= S / Yd or 1-APC (marginal propensity to consume) MPC = C / Yd or 1-MPS (marginal propensity to save) MPS = S / Yd or 1-MPC Note: MPC + MPS = 1
Ch. 7 Important Terms
Economic growth: (1) an outward shift in the production possibilities curve that results from an increase in resource supplies or quality or an improvement in technology; (2) an increase of real output (GDP) or real output per capita Real GDP per capita: inflation-adjusted output per person; real GDP/pop. Rule of 70: a method for determining the # of years it will take for some measure to double, given its annual percentage increase; ex.: to determine the # of years it will take for the price level to double, divide 70 by the annual rate of inflation Productivity: a measure of ave. output or real output per unit of input; ex.: the prod. of labor is determined by dividing real output by hours of work Business Cycle: recurring increases & decrease in the level of economic activity over periods of years; consists of peak, recession, trough & expansion phases Peak: the point in the business cycle at which business activity has reached a temporary maximum; the economy is near or at fully employment & the level of real output is at or very close to the economy`s capacity Recession: a period of declining deal GDP, accompanied by lower real income & higher employment Trough: where output & employment bottom out Expansion: a phase of the business cycle in which real GDP, income, & employment rise Labor Force (LF): persons 16 years of age or older who are not in institutions & who are employed or unemployed and seeking work Unemployment Rate: the percentage of LF unemployed at any time Discouraged Workers: employees who have left eh LF b/c they have not been able to find employment Frictional Unemployment: a type of unemployment cause by workers voluntarily changing jobs & by temporary layoffs; unemployed workers between jobs Structural Unemployment: unemployment of workers whose skills are not demanded by employers, who lack sufficient skills to obtain employment, or who can`t easily move to locations where jobs are available Cyclical Unemployment: a type of unemployment caused by insufficient total spending (or by insufficient aggregate demand) Full-Employment Rate of Unemployment: the unemployment rate at which there is no cyclical unemployment; the unemployment rate at which there is no cyclical unemployment of the LF; equal to between 4 & 5% in the U.S. b/c some friction & structural unemployment is unavoidable Natural Rate of Unemployment (NRU): the full-employment rate of unemployment; the unemployment rate occurring when there is no cyclical unemployment & the economy is achieving its potential output; the unemployment rate at which actual inflation equal expected inflation Potential Output (PO): the real output (GDP) an economy can produce when it fully employs its available resources GDP Gap: actual GDP--PO; may be either a positive amount (a positive GDP gap) or a negative amount (a negative GDP gap) Okun`s Law: the generalization that any one percentage point rise in the unemployment rate above the full-employment unemployment rate will increase the GDP gap by 2% of the PO (GDP) of the economy Inflation: a rise in the general level of prices in an economy Consumer Price Index (CPI): an index that measures the prices of a fixed market basket of some 300 goods & services bought by a typical consumer Demand-Pull Inflation: increases in the price levels (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand Cost-Push Inflation: changes in the PI (inflation) resulting from an increase in resource costs (for ex.: raw-material prices) & hence in per-unit production costs; inflation caused by reductions in aggregate supply Per-Unit Production Costs: the ave. production cost of a particular level of output; total input cost divided by units of output Nominal Income: the # of dollars received by an individual or group for its resources during some period of time Real Income: the amount of goods & services a worker can purchase w/ his/her income during some period of time; nominal income adjusted for inflation Anticipated Inflation: increases in the price level (inflation) that occur at the expected rate Unanticipated Inflation: changes in the price level (inflation) at a rate greater than expected
Cost-of-Living Adjustments (COLAs): An automatic increase in the incomes (wages) or workers when inflation occurs; guaranteed by a collective bargaining contract between firms & workers Real Interest Rate: the interest rate expressed in dollars of constant value (adjusted for inflation) & equal to the nominal interest rate less the expected rate of inflation Deflation: a decline in the economy`s price level Hyperinflation: a very rapid rise in the price level; an extremely high rate of inflation
10/16
Investment Spending (Capital Formation-i.e. what determines investment levels) 1. Def. of Investment -expenditures in the economy on capital goods (i.e. new plant, equipment, machinery--things we use to make other things) -Gross Investment is the total investment spending in the economy during a special period GI or just I = NPDI + CCA (ex. 2057.4 = 452.6 + 1604.8) *if GI > CCA NPDI > 0 (or it is positive & means the economy is likely expanding) *if GI < CCA NPDI < 0 (or it is negative & means the economy is likely declining) *if GI = CCA NPDI = 0 (means the economy is static GI helps determine a nation`s GDP : GDP = C + I + G + Nx (ex. 12,455.59 = 8,742.4 + 2,057.4 + 2,372.8 716.7) 2. Determining the Level of Investment -is determined by the expected return to be obtained from the investment project in relation to the interest rate (i.e. cost of capital) Expected return=percent return on the investment (e.g 12%) Interest rate=cost of capital (e.g. 10%) Example: Return Rate Project A 12% > 10% Positive Return = 2% Project B 20% < 10% Greater Return = 10% Other Things Equal: (more investment in project B) Summarize the Decision to Invest 1) expected return > interest rate invest 2) expected return < interest rate don`t invest 3) expected return = interest rate indifferent Those projects w/ the highest return i.e. 1) from above will be undertaken first 3. The Investment Demand Schedule/Curve -a curve or schedule which shows rates of interest (along vertical axis) & the amount of investment (along horizontal axis) the businesses on aggregate want to make at each rate of interest Expected Return Value Investment Projects Investment Demand 16% 0 0 14 5 5 12 5 10 10 5 15 8 5 20 6 5 25 4 5 30 Investment Demand (column 3) at any interest rate = (of value of projects) with that expected interest rate or above (see Fig. 8.5) (see Fig. 8.6) (see Fig. 8.7)
10/17
Aggregate Expenditure Model: Two-Sector Equilibrium 1. Concept of Equilibrium Income in the Economy (income & output) Equilibrium=a position form which there is no tendency to move the eq. income--the income & output level where AD = AS where Injections = withdrawals 2 sector I=S 3 sector I+G=S+T 4 sector X+I+G=S+T+M Two Approaches to Finding Equilibrium 1) AD = AS approach (i.e. E = Y approach) *[see handout] 2) S = I Equ. income agg. A = agg. S (E = Y) No tendency to move away If AD > AS Y If AS < As Y (see Table 9-2) (see Fig. 9-2) (see Fig. 9-9)
Ch.8 Important Terms
45-degree line: a line along which the value of GDP (measured horizontally) is equal to the value of aggregate expenditures (measured vertically) Consumption schedule: a schedule showing the amounts households plan to spend for consumer goods at different levels of disposable income Saving schedule: a schedule that shows the amounts households plan to save (plan not to spend for consumer goods), at different levels of disposable income Break-even income: the level of disposable income at which households plan to consume (spend) all their income & to save none of it; also, in an income transfer program, the local earned income at which subsidy payments become zero Average Propensity to Save (APS): fraction (or percentage) of disposable income that households save; saving divided by disposable income Average Propensity to Consume (APC): fraction (or percentage) of disposable income that households plan to spend for consumer goods & services; consumption divided by disposable income Marginal Propensity to Save (MPS): the fraction of any change in DI that households save; equal to change in saving divided by change in disposable income Marginal Propensity to Consume (MPS): the fraction of any change in DI spent for consume goods & services; consumption divided by change in disposable income Wealth Effect: the tendency for people to increase their consumption spending when the value of their financial & real assets rises & do decrease their consumption spending when the value of those asserts fall Expected Rate of Return: the increase in profit a firm anticipates it will obtain by purchasing capital (or engaging in research & development) expressed as a percentage of the total cost of the Investment (or R & D) activity Investment Demand Curve: a curve that shows the amounts of investment demanded by an economy at a series of real interest rates Multiplier: the ratio of change in the equilibrium GDP to the change in investment or in any other component of aggregate expenditures or aggregate demand; the # by which a change in the equilibrium GDP
10/19
The Multiplier Theory: Inflationary & Deflationary Gaps 1. Changes in Equilibrium Income & the Multiplier (See Table 8-3) Y = K x I K = 1 / 1-MPC or 1 / MPS 2. Multiplier-measures re-spending effect (K); the # by which a change in expenditure must be multiplied to get the resulting Y; i.e. K x exp. = Y Calculated as follows: *K = 1 / 1-MPC or C/ Y (e.g if the MPC=.75, then K1= 1 / 1-.75 = 4) so the re-spending effect is 4X any change in original spending 3. Actual YE vs. desired YF Income Level (graph) Actual = current YE Desired YF the desired level of income Full-employment non-inflationary level of income 4. Recessionary Gap (i.e deflationary gap) is the amount by which AD or spending must increase to achieve YF ; i.e. YE < YF 5. Inflationary Gap the amount by which AD (spending) must decrease to achieve full-employment non-inflationary level or income; i.e. YE > YF
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Ch.9 Important Terms
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Planned Investment: the amount that firms plan or intent to invest Investment Schedule: A curve or schedule that shows the amounts firms plan to invest at various possible values of real GDP Aggregate Expenditures Schedule: a schedule or curve showing the total amount spent for final goods & services at different levels of real GDP Equilibrium GDP: (see equilibrium real domestic output)-the GDP at which the total quantity of final goods & services purchased (aggregated expenditures) is equal to the total quantity of final goods & services produced (the real domestic output); the real domestic output at which the aggregate demand curve intersects the aggregate supply curve Leakage: (1) a withdrawal of potential spending form the income-expenditures stream via saving, tax payments, or imports; (2) a withdrawal that reduces the lending potential of the banking system Injection: an addition of spending to the income-expenditure stream: investment, gov`t purchases & net exports Unplanned Changes in Inventories: changes in inventories that firms did not anticipate; changes in inventories that occur b/c of an unexpected increase or decrease of aggregate spending (of aggregate expenditures) Net Exports (Nx) exports minus imports Lump-Sum Tax: a tax that is a constant amount (the tax revenue of gov`t is the same) at all levels of GDP Recessionary Expenditures Gap: the amount by which the aggregate expenditures schedule must shift upward to increase the real GDP to its full-employment, non-inflationary level Inflationary Expenditure Gap: the amount by which the aggregate expenditures schedule must shift downward to decrease the nominal GDP to its full-employment non-inflationary level
10/24
Three Sector Model Analysis & Application 1. Adding Gov`t & Equilibrium Income -means we now have a 3 sector economy -AD now = C + I + G + Nx -G is a political decision by society`s control group (Congress & the president) -G is an injection, thus GDP will increase -even though we included Xs & MS, Nx=0 (i.e., for now the international sector is a wash) -continue to use: 1) AD = AS approach 2) withdrawals =injections approach: S + M + T = I + X + G (see table 9.4 in textbook) Y = 80 Y = K x G (see Fig.9.5)
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2. Policy Measures (Fiscal Policy) Multiplier Concept Equation Y (horizontal axis of graph) = K (responding effect) x Exp.(vertical axis of k-graph) Analysis & Applications (1) solving for Y : Y = K x Exp.
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(2) Solving for K: K= Y / Exp. (3) Solving for Exp.: Exp.= Y / K *use the most 3. Taxation & Equilibrium Income Yd = Y T Nx=0 taxes are a withdrawal YE (Table 9.5) lump-sum tax Equal changes (Table 9.4-consumption spending is $375) (Table9.5-consumption spending is $360) goes b/c taxes were added for table 9.5 Note: equal changes in in G & T are expansionary (so G=20 & T=20 changes Y to by 20 Why? Of T of 20 = 15 cons. & 5 savings graph
10/26
In-class project Macro Analysis & Applications 1. AS = AD YE = C + I + G + (X-M) or injections =withdrawals, I = S, so I + G + X = S + T + M 2. K = 1 / 1-MPC or 1 / MPS = C/ Y 3. Y = K x Exp. 4. If YE < YF = deflationary gap If YE > YF = inflationary gap
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10/29
Aggregate Demand & Applications
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No way to analyze price, thus use AD & Ad modelgraph #5
1. AD-shows the amount of goods & services--the real amount of rational output, which will be purchased at each possible price level
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2. AS- amount of goods & services--the real amount of rational output, which will be produced at each possible price level
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3. Equilibrium Output Prices The intersection of AD & AS helps: 1) determine the general level of prices (PE) & level of income & output (YE), i.e., the health of the economy (a measure of inflation & unemployment in the economy) 2) useful in adopting policies to deal w/ inflation & unemployment 3) involves use of both demand management policies & supply management policies--both types of policies have their limitations & problems 4) demand management policies shifts AP right or left 5) supply management policies shifts the AS right or left (graph)
4. Shifts in AD (see pg. 190)
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What if consumer wealth causes spending to ? Shifts AD schedule in Fig.11-4 upward & AD curve in Fig. 11-3 to the right 5. Shifts in AD (see pg. 194)
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1) An in resource prices shifts as leftward, i.e. AS1 to AS3 -A in resource prices shifts AS rightward, i.e. AS1 to AS2 2) What about productivity changes? What about changes in legal-institutional environment?
10/30
Equilibrium: Real Output & the Price Level (see Pg. 190 & 194) 1. Equilibrium & Different Ranges Changes in Equilibrium due to changes in AD, i.e. shift AD, PL=price level
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(See Fig. 10-7: an in AD that causes demand-pull inflation)
(Fig.10-8: A in AD that causes a recession)
(Fig. 10-9: a in AS that causes a cost-push inflation)
(Fig.10-10: growth, full employment & relative price stability)
(Fig. 10-6: graph for a through j)
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Steps: (look over problems) 1) assume partial equilibrium analysis 2) assume all other things remain constant 3)*determine if event impacts demand or supply side (pg.190 7 194) 4) implement shift in graph 5) read off results on price & output, compared to original equilibrium--show what happens to price & output
10/31
Fiscal Policy: The Gov`t Sector
1. Legislative Mandates Employment Act of `46: -a landmark in U.S. socioeconomic legislation b/c it commits the Federal Gov`t to take action through monetary & fiscal policy to maintain economic stability -CEAs a 3 member council that advises the president of the U.S. on economic policy matters -JEC of Congress investigates different economic issues for Congress -Purpose of all the above is to flatten the business cycle (i.e. provides stabilization) (graph)
2. Fiscal Policy & Budget Philosophies (1) Budget Philosophies: G + T determines budget; if G > T Budget Deficit (injections > withdrawals) if G < T Budget Surplus (injections < withdrawals) if G = T Budget Balance (injections = withdrawals) Y (2) Fiscal Policy: is an attempt by gov`t to use spending (G) & taxation (T) policies to achieve a YF non-inflationary level of income
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3. Discretionary Fiscal Policy A deliberate attempt to change spending (G) or taxation (T) to compensate for too little or too much spending (i.e. flatten the business cycle) Expansionary Fiscal Policy (used to close a deflationary gap) (spending) involved (1) G -works by G & thus AD specific (2) T -works by T Y goes to T policy tools (3) some combo. -thus more available for C AD
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Contractionary Fiscal Policy (used to close inflationary gap) (spending) Involves: (1) G -works by G & thus AD (2) T -works by T more Y goes to T (3) some combo. -thus less available for C AD 4. Fiscal Policy to Close a Deflationary Gap YE < YF Deflationary Gap expansionary fiscal policy (i.e G or T, thus G > T Budget Deficit)
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5. Fiscal Policy to Close an Inflationary Gap If YE > YF inflationary gap contractionary fiscal policy (i.e. G or T, thus G < T Budget Surplus) -to eliminate cycles you need a cyclically balanced budget (i.e. G = T annually would not provide for stabilization) 6. Financing Deficits & Disposing of Surplus -two ways for gov't to finance a deficit Borrowing in the money market; means gov`t competes w/ private sector for funds; added borrowing may drive up interest rates; added borrowing may crowd out private spending; expansionary impact about the same its just that gov`t is sending instead of the private sector Money Creation sometimes referred to as primary new money; there is no crowding out of private spending; more expansionary but more inflationary -two ways to dispose of surplus
Debt Retirement pay down the national debt of some $8 trillion; does this by buying back its gov`t securities; puts funds back into the money market of the private sector; may reduce interest rate as more funds become available; may reduce the anti-inflationary impact of surplus Impounding means the gov`t just allows surplus to stand idle; realize a great anti-inflationary effect; the gov`t is withholding purchasing power from the economy; more anti-inflationary than debt retirement
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