ECON 102 UBC Gateman M1

macroeconomics

study of behaviour and performance of economy as a whole AKA behaviour of econ aggregates and averages and how they are influenced by gvmt policy

what happens when aggregate output increases

people's incomes and output of commodities rise

what happens when unemployment rate rises

workers' income falls

what happens when there are disruptions in the credit market

interest rates rise

short run

- variables: output, employment, inflation

- short term fluctuations ---> business cycle

long run

study of short run variables but on path of aggregate output

- econ growth

- investment and tech change

why is the long run growth more important than short term fluctuations

bc it affects our material living standards over time

value of national income is AKA

value of national product

- total value of all goods and services

nominal national income vs real national income

whats another name for both

1) changes in physical quantities or prices aka current dollar national income

2) measures VALUE of individual inputs, not at current price but at a set of prices that prevailed at some base period -- shows changes in QUANTITY of output aka content dollar national income

features of gross domestic product (2)

what are they called together

1) long term economic growth

2) short term fluctuations

--> business cycle

national output

what the economy actually produces

potential output

level of output economy would produce if all resources were fully employed (there can be differing estimations of this)

output gap

difference between potential output and actual output

Y-Y*

if Y

economy's resources are not fully employed --> recessionary gap ---> unemployment and lost output

if Y<>Y*

market value of production in excess of what economy can produce on sustained basis ex people working longer or factories running extra shifts

--> inflationary gap ---> gvmt will try to reduce this

why doesn't growth in income per person mean that everyone is better off

because economic growth means shifts in production ex from agriculture to industry

if output increases, what 2 things could have happened to employment

1) more workers - rise in employment (mostly only this in SR)

2) existing workers producing more AKA rise in productivity (this and #1 both exist in the LR)

employment

number of adult works who have jobs

unemployment

number of adult workers who are not working but are actively looking for work

labour force

total number of people who are either employed or unemployed

unemployment rate

# of ppl unemployed / # of ppl in labour force

what should happen to employment if economy is at potential GDP? why doesn't this actually happen (2)?

there should be full employment but this doesn't happen bc

1) there is constant turnover in jobs and change in job opportunities --> there will always be unemployment due to normal labour turnovers - frictional unemployment

2) economy is constantly adapting to various shocks - there will be a mismatch in characteristics of labour force and available work - structural unemployment

frictional unemployment

unemployment that occurs when people take time to find a job

structural unemployment

unemployment that occurs when workers' skills do not match the jobs that are available

cyclical unemployment

because of ups and downs of business cycle

seasonal fluctuations in employment

occur yearly so they are easy to predict

why does unemployment matter (2)

1) economic waste: this is especially important when there is a loss of potential output but also not enough output to satisfy everyone's needs - if it goes on for a very long time then even social safety nets ex UI will run out

2) human suffering

productivity, why does it matter

amount of output produced per one unit of labour - CAN lead to rise in living standards

labour productivity

amount of real GDP produced per init of labour employed

inflation

a rise in the average level of all prices

rate of inflation

rate at which price level is rising

P2-P1/P1 x 100

price level

average level of all prices in economy (P)

consumer price index

measures average price of goods and services bought by Canadians household , doesn't have units bc its relative measurement

why does inflation matter

it reduces the real value of anything with nominal value + reduces the purchasing power of money

purchasing power of money

amount of goods and serves that can be purchased with a unit of money

types of inflation (2)

1) anticipated : households and firms can adjust nominal prices and wages so there are fewer real effects on economy

2) unanticipated : more changes in real value of prices and wages

** the reality is usually somewhere in between these two

interest rate

price paid to borrow money over a stated period of time

two important types of interest rates

1) prime interest rate : IR that banks charge to their best customers - if this changes most other interest rates will change in the same direction

2) bank rate : rate bank of canada (central bank) charges on short term loans to commercial banks ex BMO RBC

nominal vs real interest rate

- which does the burden of borrowing rely on

1) price paid per dollar borrowed per period of time 2) nominal interest rate adjusted for the change in purchasing power of money

- burden of borrowing relies on the real IR

credit in the economy

banks will act as intermediates and regulate the flow of credit (IR is the price of credit)

why does interest rate matter

because it affects standard of living + willingness for firms to invest

exchange rate

# of units of domestic currency needed to purchase one unit of foreign currency

foreign exchange

foreign money needed to carry out international transactions, exchanges on the foreign exchange market

foreign exchange market

market in which foreign exchange is traded at price expressed by exchange rate

depreciation of domestic currency

rise in exchange rate

appreciation of domestic currency

fall in exchange rate

trade weighted exchange rate

weighted exchange rate between home country and trading partners in which the weights reflect partner's share in the home country's total trade

net exports

also know as?

difference between exports and imports AKA trade balance

long term options for econ policy (2)

1) gvmt should keep inflation low to have stability and econ growth

2) moderate inflation is more conducive to growth

how can the gvmt encourage growth through spending in the LR

if it spends less than it makes in tax revenue AKA there is a budget surplus --> IR down ---> investment up ----> growth

how can government stimulate econ activity in the SR

increase spending and reduce taxes

double counting

counting all outputs in GDP not considering that some firms' outputs are inputs for others

intermediate goods

goods used in the production of final goods

final goods

goods and services that have been purchased for final use AKA consumption, investment, gvmt use or export

value added

sales revenue - cost of intermediate goods (no other gvmt costs)

- payment that is owed to firm's factors of production

- correct measure of firm's contributions to total output

what are two things that are equal to value added

- value of expenditure on that output

- total income claims generated by production of that output

injections and withdrawals in circular flow diagram

- injections: exports, investment, gvmt purchases

- withdrawals: imports, savings, taxes

how to calculate GDP from expenditure side

1) consumption expenditures (C)

2) investment expenditures (I)

3) government purchases (G) not including transfer payments

4) net exports (Y-IM)

so,

GDP=C+I+g+(X-IM)

consumption expenditures, letter

C

household expenditures on all goods and services

investment expenditures, letter, types (3)

I

expenditure on production of goods not for present consumption

1) changes in inventories a) accumulation is investment b) decumulation is disinvestment

2) new plants and equipment : creating new capital stock

3) new residential housing

inventory

stock of raw materials, goods in process, finished goods -- all held by firms

capital stock

aggregate quantity of capital goods

gross investment

total investment that occurs in the economy

replacement investment

replacement of capital lost due to depreciation

net investment

gross inv - depreciation

exports

(y) value of all domestically produced goods and services sold to gvmt/households/firms in other countries

imports

(IM) value of all goods and services purchased from gvmts/firms/households in other countries

net exports

(Y-IM)=NX

how to calculate GDP from income side

1) factor incomes

2) non factor payments

GDP= factors of income + (indirect taxes-subsidies) + depreciation

factor incomes (3)

1) wages and salaries

2) intrest

3) business profits (dividends and retained earnings)

non-factor payments (2)

1) indirect taxes + subsidies

2) depreciation

nominal GDP vs real GDP

value at current vs base price

-- if they change differently over a period of time that means there has been a change in price

GDP deflator

an index that measures the average change of price of all items in GDP

nom GDP/ real GDP x 100

why do GDP deflator and CPI not change the same way

because not all goods consumed by the canadian household is a canadian output

omissions from GDP (4)

1) illegal activities ( although some times illegal income is declared under the guise of other legal income)

2) underground economy: the transactions are legal but they are not declared for taxes

3) home production/non-market activities/leisure : ex home renovations/volunteer/lost work hours is lost income

4) economic bans ex pollution

why is it ok that we dont include omissions from GDP (3)

1) it is very hard to quantify them and adjust them in

2) change in GDP is still valid even if specific GDP levels aren't accurate

3) policymakers use GDP to make policy off of. if these activities that policy has no control over are considered it makes the predictions and thus policies inaccurate

desired aggregate expenditure (AE)

sum of desired/planned spending on domestic output by households/firms/gvmt/foreigners (out of resources they actually have, is not unlimited desire)

I vs Ia

I is desired investment and Ia is actual inventment

autonomous vs induced expenditure

expenditure elements that dont vs do change systematically with national income

3 assumptions of simplified econ model

1) no trade with other countries aka closed economy

2) no gvmt so no taxes

3) price level constant

disposable income

amount o income household receives after taxes, in simple macro model Yd = Y bc there are no taxes

savings

all disposable income that is not spent on consumption

consumption function, variables

relationship bc desired consumption expenditure and all the variables that determine it ex disposable income, wealth, interest rates, expectations about the future

average propensity to consume

desired consumption/level of disposable income

APC=C/Yd

marginal propensity to consume

change in desired consumption/change in disposable income that brought it about

MPC=deltaC/deltaYd

what is the slope of the consumption function

MPC

where is the break even level of consumption

what happens before - after this point

when the consumption function and 45 degree line meet

before : - desired savings

after: + desired savings

average propensity to save

APS=S/Yd

marginal propensity to save, also known as

MPS=deltaS/deltaYd

AKA z

shifts in consumption function

1) change in household wealth (accumulated assets-debts): household wealth UP, consumption function shifts UP, savings function shifts DOWN

2) change in interest rates: IR UP desired aggregate consumption UP consumption function shifts UP

(this is bc we want to buy more durable goods that we'd have to borrow money for when the interest rate is low)

3) change in expectations:

-optimistic : spend more, shift UP

-pessimistic: spend less, shift DOWN

Durable vs non-durable goods

D- intended to last for 3+ years

ND- not intended to last for 3+ years

examples of household assets and debts

- assets: savings accounts, mutual funds, stocks and bonds, RRSPs, ownership of houses and cars

- debts: mortgages, car loans, outstanding line of credits from banks

factors that influence desired investment (3)

1) real interest rate: as IR goes up the opportunity cost of holding inventory goes up an desired investment goes down

- inventory : opp cost

- residential construction: people don't want to buy houses when IR is high

- new plants and equipment: if you have to borrow to buy you won bc IR is high if you already have money then its better to loan it out

2) changes in sales: level of sales up desired stock of inventory (aka investment in inventory) up

3) business confidence: will invest if optimistic

is desired investment autonomous, why

yes its not affected by Y

horizontal line

- simplification but also reflects that investment has to do with what happens in the future more than the current Y

aggregate expenditure function

AE = C + I

desire consumption + desired investment

slope of AE function

MPS

equilibrium national income, what is the assumption

when AE = Y

AKA where AE function intersects 45 degree line

firms are able to produce at any output demanded

if AE>Y

if AE

there will be pressure for Y to go up

there will be pressure for Y to go down

shifts in AE function, how will this effect equilibrium national income

will shift with shifts in consumption or investment functions (note: if shift is change in expenditure that is equal at all levels then the shift will be parallel, if it is change in MPS then it will be a change in slope)

- shift upwards --> equilibrium national income goes up

- shift downwards --> equilibrium national income goes down

multiplier, how is it in the simple macro model , why

change in equilibrium national income/change in the autonomous expenditure that brought it about

greater than 1 bc there is an extra induced increase in expenditure (more than the same amount of increase in Y)