Class 21 Revised 11-7-2011 Foundation of Aggregate Economics

Class 21 Revised 11-7-2011 Foundation of Aggregate Economics

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Class 21 Foundations of Aggregate Economic or Macro Analysis This discussion is essential to all that follows in the rest of the course. The main issues that will now be addressed are: a.i.1.a.i.1. Employment a.i.1.a.i.2. Inflation a.i.1.a.i.3. Growth a.i.1.a.i.4. Stability We will do this in the context of the economy as an exchange—stock & flow—system mediated with money. Main Flow variables AD ≡ Aggregate Demand or Aggregate Expenditures will be viewed from both a spending perspective and from a money perspective. SRAS ≡ Short run aggregate supply (output) defined as the quantity of gross domestic product currently being produced at current inflation expectations LRAS ≡ Long run aggregate supply (output) defined as full employment gdp—potential gdp or gdp that is sustainable and desirable—a goal of policy. Main Stock Variables: Employment, Unemployment, Capital Stock and Money Stock are “stock” variables. Regulator variables: Interest rates and inflation (price level) are the main regulator variables of the economy. I. Define the following symbols: M = money stock v = velocity of money circulation—how fast money changes hands y = real GDP P = price level π = inflation Nominal GDP = P*y = Y, which is the measure usually stated in publically quoted statistics. See WEB sites below to glance at the data: FRED database we examined in the first week http://research.stlouisfed.org/fred2/ CPI Price index: http://research.stlouisfed.org/fred2/series/CPIAUCNS?cid=9 GDP price index ( called an implicit price deflator because it is used to remove the effects of inflation from nominal gdp. http://research.stlouisfed.org/fred2/series/GDPDEF?cid=21
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II. Discussion of Aggregate Demand. a. First examine AD from Money perspective. Equation of exchange: Mv = Py http://www.federalreserve.gov/releases/h6/ Values for P are found at: Manipulation of the equation of exchange yields: y d = and is called the money profile of AD. = means that as M increases at given prices or expected, AD increases. Since is never zero, the text makes and interesting change from = to = by substituting for P. This allows the AD curve to be expressed as quantity being a relation with rather than P as is the usual understanding of demand. The advantage is since we are mostly concerned with inflation rather than the price level, the analysis deals with inflation directly. Therefore we graph AD with inflation on the vertical axis and Y or GDP demanded or aggregate demand on the horizontal axis as below. At π e , point 1 indicates the output that would be demanded in the economy. What happens if the quantity of money M increased? Show on the graph What happens if the quantity of money M decreased? Show on the graph.
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This response is the basic idea behind monetary policy and influencing the economy! Changes in the quantity of money change aggregate demand. The policy question is which change and how
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Class 21 Revised 11-7-2011 Foundation of Aggregate Economics

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