September 7th 1. INTRODUCTION Text - Ch Inputs (factors of production) and outputs (goods and services) in economics.

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1 September 7th 1. INTRODUCTION Text - Ch. 1 - Key concepts from the Microeconomics: Production Possibility Frontier (PPF) and demand-supply analysis. - What is economics and what is economic theory? - Inputs (factors of production) and outputs (goods and services) in economics. - Labor, Land and Capital. - Three problems of economic organization: What? How? For Whom? - Economic organization: Market Economy, Command Economy, Mixed Economies. - Production Possibilities Frontier. (1) Economics [chapter 1, p. 4] (2) Productive Efficiency [chapter 1, p. 13] (3) Production-Possibility Frontier [chapter 1, p. 11] (4) Opportunity Cost [chapter 1, p. 13] - Adam Smith ( ) - Key Concepts of Macroeconomics. - John Keynes ( ) September 9th 2. OVERVIEW OF ECONOMICS Text - Ch. 4 - Short-run fluctuations (business cycles) and Long-term trends (economic growth). - Objectives of Macroeconomics: Output Employment Price Stability - Instruments of Macroeconomics: Monetary Policy Fiscal Policy International Trade Regulations - The Market System. - Aggregate Supply and Demand and Market Equilibrium. 1

2 (5) Macroeconomics [chapter 4, p. 65] (6) Gross Domestic Product (GDP) [chapter 4, p. 68] (7) Nominal and Real GDP [chapter 4, p. 68] (8) Potential GDP [chapter 4, p. 68] (9) Unemployment Rate [chapter 4, p. 69] (10) Rate of Inflation [chapter 4, p. 70] (11) Fiscal Policy [chapter 4, p. 72] (12) Monetary Policy [chapter 4, p. 73] (13) Aggregate Supply [chapter 4, p. 75] (14) Aggregate Demand [chapter 4, p.76] - Gross Domestic Product. - Two Measure of National Output: Goods Flow + Consumption (C) + Gross Private Investment (I) + Government Purchases (G) + Net Exports (X) Earnings Flow + Compensation of Employees) + Proprietors Income + Rental Income + Net Interest + Corporate Profits + Depreciation + Production Taxes - Double Counting and Value Added. September 12th 3. MEASURING ECONOMIC ACTIVITY Text - Ch. 5 - GDP Price Deflator, Nominal GDP, Real GDP. (15) Gross Domestic Product GDP [chapter 5, p. 84] (16) Account [chapter 5, p. 86] (17) Intermediate Goods [chapter 5, p. 87] (18) Value Added [chapter 5, p. 88] (19) GDP Price Deflator [chapter 5, p. 89] (20) Nominal and Real GDP [chapter 5, p ] (21) Depreciation [chapter 5, p. 92] (22) Transfer Payments [chapter 5, p. 93] (23) Net Exports [chapter 5, p.94] (24) Net Investment [chapter 5, p. 93] 2

3 GDP = C + I + G + X (1) Q = real GDP = nominal GDP GDP price deflator = P Q P (2) X = N et Exports = Exports Imports (3) N et Investment = Gross Investment Depreciation (4) September 14th 4. NATIONAL ACCOUNTS Text - Ch. 5 - Net Domestic Product (NDP) and Gross National Product. - National Income (NI) and Disposable Income (DI). - Savings (S) and Investment (I): Measured savings are exactly equal to the measured investment. (a) With no government and closed economy (no foreign trade) G and X disappear from the GDP equation and what is left is GDP = C +I, and I = GDP C. Household savings is a part of the disposable income and in this case disposable income is equal to the national income DI = NI = GDP D since there is no government and thus no taxes and transfers. Thus households savings are equal to DI C = GDP D C. Business savings are equal to the total product produced GDP minus what was consumed by households (C) and minus what was saved by the households DI C, therefore business savings are equal to GDP C DI + C = GDP DI = D. Total private savings (S P ) are equal to business savings (D) plus households savings (GDP D C). Thus S P = GDP C = I, or S P = I. (b) In a more general case there is a government and foreign trade. Thus, GDP = C + I + G + X. Government savings (S G ) is a difference between government revenues (taxes, T ) and government purchases (G) and transfers it makes to the public (T r): S G = T (G + T r). Private savings are equal to the sum of households savings (DI C) and business savings (D). In this case disposable income is equal to the national income (NI = GDP D) minus taxes and plus transfers form the government, DI = GDP D T +T r. Thus households savings are DI C = GDP D T +T r C. If you add business savings (D) to households savings you will get total private savings: S P = D + GDP D T + T r C = GDP T + T r C. To get total savings in the economy just sum private and government savings: S T = S G + S P = T (G+T r)+gdp T +T r C = GDP C G. But because GDP = C +I +G+X it is the case that S T = I + X = I T, or total savings within the economy is exactly the same as total investment I T = I + X. - Price Indexes and Inflation. Consumer Price Index (CPI) Producer Price Index (PPI) GDP Price Index 3

4 (25) Disposable Income [chapter 5, p. 96] (26) Net Domestic Product [chapter 5, p. 94] (27) Gross National Product [chapter 5, p. 94] (28) National Income [chapter 5, p. 96] (29) Price Index, Inflation [chapter 5, p. 99] N DP = GDP Depreciation (5) N I = GDP Depreciation (6) Rate of Inflation = P t P t 1 P t 1 (7) September 16th 5. FOUNDATIONS OF THE AGGREGATE DEMAND Introduction to Supply and Demand Text - Ch. 3, 4B, 7B - Introduction to supply and demand, market equilibrium. Law of Downward Sloping Demand Substitution Effect Income Effect - Aggregate Demand (AD): Downward-Sloping Aggregate Demand. Components of the Aggregate Demand: C, G, I, X Determinants of the Aggregate Demand and the Impact of: I. Policy variables controlled by the government. II. Exogenous Shocks. (30) Market Demand[chapter 3, p. 46] (31) Law of Downward-Sloping Demand [chapter 3, p. 47] (32) Market Supply [chapter 3, p. 51] (33) Market Equilibrium [chapter 3, p. 54] (34) Aggregate Demand Schedule [chapter 4, p. 76] (35) Aggregate Demand [chapter 7, p. 133] September 19th 6. FOUNDATIONS OF THE AGGREGATE SUPPLY - Aggregate Supply (AS): Keynesian vs. Classical Schools: Text - Ch. 4B, 15A, 17A 4

5 - Sticky Prices and Wages in the Short-run - Long-run Adjustment Factors Affecting: - Long-run Aggregate Supply - Short-run Aggregate Supply (36) Aggregate Supply Curve [chapter 15, p. 306] (37) Short-run and Long-run Aggregate Supply Schedules [chapter 15, p. 306] (38) Potential Output [chapter 15, p. 306] (39) Classical Approach [chapter 17, p. 351, 352] September 21st 7. CONSUMPTION, INCOME AND SAVINGS Text - Ch. 6A - Consumption (C) and Savings (S) - Consumption and Savings Functions: 45 0 line Break-even point Dissaving vs. Saving - Marginal Propensities to Consume (MPC) and Save (MPS). - Determinants of the National Consumption Behavior: Current Disposable Income Permanent Income and The Life Cycle Model Wealth (40) Personal Saving [chapter 6, p. 108] (41) Personal Saving Rate (s) [chapter 6, p. 109] (42) Break-even point [chapter 6, p. 109] (43) Consumption Function [chapter 6, p. 110] (44) Savings Function [chapter 6, p. 110] (45) Marginal Propensity to Consume (MPC) [chapter 6, p. 112] (46) Marginal Propensity to Save (MPS) [chapter 6, p. 112] S = DI C (8) s = S DI MP C = C DI (9) (10) 5

6 MP S = S (11) DI MP C + MP S = 1 (12) where stands for the incremental change in the variable; for example, DI t = DI t DI t 1. - Determinants of Investment (I): Revenues Costs Expectations - Investment Demand Curve. Demand for Investment Schedule Shifts in the Investment Demand Curve September 23d 8. INVESTMENT Text - Ch. 6B (47) Gross Private Domestic Investment [chapter 6, p. 119] (48) Investment Demand Curve [chapter 6, p. 120] September 26th 9. THE MULTIPLIER MODEL Text - Ch. 8A - Multiplier Model: GDP = C + I Assumptions: fixed wages and prices, unemployment Model studies short-run fluctuations - Output Determination: Savings and Investment S = I Total Expenditure T E = C + I = GDP Equilibrium Adjustment Mechanism - Multiplier: Graphical Illustration of the Multiplier - Multiplier Model and AS-AD Model (49) Multiplier (M) [chapter 8, p. 146] (50) Exogenous Variable [chapter 8, p. 142] (51) Equilibrium Level of GDP [chapter 8, p. 144] (52) Exogenous Variable [chapter 8, p. 142] 6

7 M = GDP I 1 M = 1 MP C = 1 MP S GDP = 1 M I = 1 MP C 1 + MP C + MP C 2 + MP C = 1 1 MP C September 28th - September 30th 10. FISCAL POLICY IN THE MULTIPLIER MODEL Text - Ch. 8B - Redistributive and Stabilizing Functions of the Fiscal Policy. - Keynesian Approach to Macroeconomic Policy. - Instruments of the Fiscal Policy: Government Purchases (G) Taxes (T) Transfers - Multiplier Model with the Government: GDP = C + I + G - The Impact of Government Policies on Output and Aggregate Demand: Government Purchases: T E = G Taxes: T E = MP C T - Fiscal Policy Multipliers: Expenditure Multiplier M E Tax Multiplier M T (53) Expenditure Multiplier [chapter 8, p. 153] (54) Tax Multiplier [chapter 8, p. 156] (55) Net Taxes [chapter 8, p. 152, footnote 4] (13) (14) I (15) (16) MP C + MP C 2 + MP C = MP C 1 MP C (17) M E = GDP G = 1 1 MP C (18) M T = GDP = MP C T 1 MP C (19) M T = M E MP C (20) 7 M T < M E (21)

8 October 03d 11. OPEN ECONOMY - FOREIGN TRADE - Open Economy and Foreign Trade: Marginal Propensity to Import (M P m) Imports, Exports, Net Exports Total Domestic Output: GDP=C+I+G+X - Determinants of Trade and Net Export: Domestic Income and Output Foreign Exchange Rate Text - Ch. 14B - Open Economy and the Multiplier Model: T E = C + I + G + X Imports and Net Export as a function of GDP Output Determination in the Open Economy - Fiscal Policy in the Open Economy: Open-Economy Expenditure Multiplier (M O E ) (56) Open-economy Macroeconomics [chapter 14, p. 279] (57) Marginal Propensity to Import [chapter 14, p. 282] (57) Open-Economy Multiplier [chapter 14, p. 284] M O E = MP m = Im DI M O E = 1 MP S + MP m < M E = 1 MP S 1 1 (MP C MP m) = 1 MP S + MP m (22) (23) (24) 8

9 TE Adjustment Mechanism in the Multiplier Model TE=C+I+ΔI+G+X TE1 TEC TEA A C B D E1 TE=C+I+G+X TE0 E0 ΔI MPC*ΔI Q0 QB QD Q1 GDP Initially the economy is in equilibrium at point E0, where aggregate demand is equal to the aggregate supply: TE0=Q0 There is a shock to aggregate demand (TE): (i) either investment changes ΔTE=ΔI (as it is the case on the graph) (ii) or government uses fiscal policy: government purchases: ΔTE=ΔG taxes ΔTE=-MPC*ΔT As a result at point E0 demand increase to TEA=TE0+ΔI Yet, since at point E0 firms are still producing Q0 they are willing to expand output to QB=TEA to meet this additional demand ΔI To increase output they hire workers who increase production from Q0 to QB. The income these workers earn is equal to the additional output they produce, that is ΔI Yet as workers' income increases with ΔDI=ΔI they are spending more at the market ΔC=MPC*ΔDI=ΔTE. (As a result demand jumps from TEA to TEC and is higher than the amount of the goods produced in the economy QB - we have excess supply.) Firms are willing to expand output to QD=TEC to meet this additional demand they higher workers to produce more output. As a result the disposable income of these workers increases: ΔDI=(QD-QB)=MPC*ΔI ΔDI =MPC*ΔI This circle repeats until ΔDI=0

10 October 12th 12. GLOBAL ECONOMY Text - Ch. 13A, B (p ), Ch. 14B (p ) - The Balance of International Payments: Current Account, Financial Account - The Determination of the Foreign Exchange Rates: The Foreign Exchange Market Demand and Supply of the Foreign Currency Exchange Rate and the Balance of Payments - Investment and Saving in the Open Economy: Open-Economy Savings, World Interest Rate Net Exports = Private Saving + Government Saving - Domestic Investment (1) Balance of International Payments [chapter 13, p. 261] (2) Balance on Current Account [chapter 13, p. 261] (3) Foreign Exchange Rate [chapter 13, p. 264] (4) Foreign Exchange Rate Depreciation (Appreciation) [chapter 13, p. 266] I T = I + X = S + (T G) (1) X = S + (T G) I (2) - Financial System: Functions of the Financial System Financial Assets Interest Rates and Present Value October 14th 13. MONEY DEMAND Text - Ch. 9A, B (p ) - The Case of Money: Modern Money and the Components of the Money Supply Narrow and Broad Money - The Demand for Money: Money s Functions The Cost of Holding Money Two Sources of Money Demand (5) Financial Markets and Financial Intermediaries [chapter 9, p. 163] (6) Financial Assets [chapter9 13, p. 164] (7) Interest Rate [chapter 9, p. 165] 1

11 (8) Present Value [chapter 9, p. 166] (9) Real and Nominal Interest Rates [chapter 9, p. 168] (10) Present Value [chapter 9, p. 166] (11) Money [chapter 9, p. 171] (12) Narrow (transaction) Money (M1) and Broad Money (M2) [chapter 9, p. 173] r - Real Interest Rate, π - Inflation, i - Nominal Interest rate. r = i π (3) - The Supply of Money: Balance Sheet of the Commercial Banks Commercial Banks Reserves The Process of Deposit Creation Financial System Equilibrium - The Federal Reserve System. October 17th 14. MONEY SUPPLY Text - Ch. 9C (p ), Ch. 10A (p ) (13) Bank Reserves, Excess Reserves, Required Reserves [chapter 9, p. 175] - Money Supply Multiplier: Multiple Expansion of Bank Deposits Money Supply Multiplier October 19th 15. MONEY SUPPLY MULTIPLIER Text - Ch. 9C (p ) (14) Money Supply Multiplier [chapter 9, p. 179] M - Money Supply Multiplier, RR - Reserve Requirement Ratio. M = 1 RR (4) 2

12 - The Fed Operations: Open Market Operations Discount-Rate Policies Reserve-Requirements Policies - The Fed Balance Sheet. October 21st 16. MONETARY POLICY Text - Ch. 10A, B (p , ) - Monetary Policy: The Effect of Monetary Policy Instruments on The Balance Sheets of the Fed and Commercial Banks. - The Effect of Money on Output and Prices: Monetary Transmission Mechanism The Money Market Monetary Policy in AD-AS Framework (15) Open Market Operations, Discount-Rate Policies, Reserve-Requirements Policies [chapter 10, p. 195] (16) Federal Funds Rate [chapter 10, p. 197] (17) Borrowed Reserves [chapter 10, p. 197] (18) Discount Rate [chapter 10, p. 198] (19) Money Market [chapter 10, p. 204] M - Money Supply, i - Interest Rate, I, C, X - Consumption, Investment, Net Exports, AD - Aggregate Demand, GDP - Output, P - Price Level, - up, - down. M i I, C, X AD GDP, P (5) - Feature of The Business Cycle: Recessions and Expansions October 24th 17. BUSINESS FLUCTUATIONS Text - Ch. 7A (p ), Ch. 15A (p ) 3

13 - Business Cycle Theories: Exogenous and Internal Cycles Multiplier-Accelerator Theory Demand Induced Cycles (20) Business Cycle, Recession [chapter 7, p. 128] (21) Multiplier-Accelerator Theory [chapter 7, p. 130] (22) Six Theories of Business Cycles [chapter 7, p. 131] M - Money Supply Multiplier, RR - Reserve Requirement Ratio. M = 1 RR (6) October 26th 18. UNEMPLOYMENT Text - Ch. 15B (p ) - Measuring Unemployment: Employed, Unemployed, Labor Force, not in the Labor Force - Impact of Unemployment: Economic Impact Social Impact - Economic Interpretation of Unemployment: Three Kinds of Unemployment Voluntary vs. Involuntary Unemployment Graphical Analysis of Unemployment (23) Structural, Frictional and Cyclical Unemployment [chapter 15, p ] (24) Voluntary Unemployment [chapter 15, p. 315] (25) Involuntary Unemployment [chapter 15, p. 317] E - Employed People, U - Unemployed People, L - Labor Force, UR - Unemployment Rate. L = E + U (7) UR = U L = U (8) U + E 4

14 October 28th 19. ECONOMIC IMPACT OF UNEMPLOYMENT Text - Ch. 15B (p ) - Measuring The Cost of Unemployment: Okun s Law - for every 2% that GDP falls relative to potential GDP, the unemployment rate rises about 1%. Unemployment will decline if actual output grows faster than the potential output - Labor Market Issues: Sources of Wage Inflexibility (26) Okun s Law [chapter 15, p. 313] October 31st 20. INFLATION Text - Ch. 16A (p ) - Definition of Inflation: Three Magnitudes of Inflation Anticipated(Expected) and Unanticipated inflation - The Economic Cost of Inflation: Wealth Redistribution Effects Distortional Effects on the Relative Prices Effect on the Real Incomes and Wealth Optimal Inflation Rate? (27) Rate of Inflation [chapter 16, p. 328] (28) Anticipated Inflation [chapter 16, p. 332] P t - Price Level (year t), π t - Rate of Inflation in (year t). π t = P t P t 1 P t (9) November 2nd 21. PHILLIPS CURVE Text - Ch. 16B (p ) - Modern Inflation Theory: Inertial Inflation Demand-Pull and Cost-Push (Supply-Pull) Inflation Expectations and Inertial Inflation (Graphical Analysis) 5

15 - Phillips Curve: Short-Run Phillips Curve - The Tradeoff Between Unemployment and Inflation Nonaccelerating Inflation Rate of Unemployment (NAIRU) Long-Run Phillips Curve From Short-Run to Long-Run - A Revision of Inflationary Expectations (29) Inertial Inflation [chapter 16, p. 336] (30) Demand-Pull Inflation [chapter 16, p. 336] (31) Cost-Push Inflation [chapter 16, p. 337] (32) Phillips Curve [chapter 16, p. 338] (33) NAIRU [chapter 16, p. 340] November 4th 22. STABILIZING THE ECONOMY Text - Ch. 16B (p ), Ch. 18B (p ) - The Role of Fiscal and Monetary Policy to Stabilize the Economy: Objectives of the Government Available Policy Instruments to Manage Aggregate Demand Recognition, Response and Efficiency Lags of Fiscal and Monetary Policies - Fiscal-Monetary Policy Mix. - Rules and Discretion in Policy Making. - Inflation Targeting. (34) Demand Management [chapter 18, p. 378] (35) Fiscal-Monetary Mix [chapter 18, p. 380] (36) Inflation Targeting [chapter 18, p. 383] November 7th 23. BUDGET DEFICIT AND THE PUBLIC DEBT Text - Ch. 18A (p , p. 374) - The Economics of The Government Dept: Budget, Surplus/Deficit, Government Debt Budget Policy, External and Internal Government Debt (37) Budget, Surplus/Deficit, Government Debt [chapter 18, p. 370] (38) External and Internal Government Debt [chapter 18, p. 374] 6

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