Lecture Macroeconomics: Lecture 28 - Prof. Dr.Qaisar Abbas

This chapter presents the following content: The science of macroeconomics; the data of macroeconomics- GDP, unemployment & inflation; national income: where it comes from and where it goes; economic growth; money and inflation;...

Review of the previous lecture The Fed can control the money supply with § open market operations § the reserve requirement § the discount rate Portfolio theories of money demand § stress the store of value function § posit that money demand depends on risk/return of money & alternative assets Review of the previous lecture The Baumol-Tobin model § is an example of the transactions theories of money demand, stresses “medium of exchange” function § money demand depends positively on spending, negatively on the interest rate, and positively on the cost of converting nonmonetary assets to money Lecture 28 Review of the previous lectures Instructor: Prof Dr Qaisar Abbas The Science of Macroeconomics • • Macroeconomics is the study of the economy as a whole, including • growth in incomes • changes in the overall level of prices • the unemployment rate Macroeconomists attempt to explain the economy and to devise policies to improve its performance The Science of Macroeconomics • Economists use different models to examine different issues • Models with flexible prices describe the economy in the long run; models with sticky prices describe economy in the short run • Macroeconomic events and performance arise from many microeconomic transactions, so macroeconomics uses many of the tools of microeconomics The data of Macroeconomics- GDP, Unemployment & inflation • Gross Domestic Product (GDP) measures both total income and total expenditure on the economy’s output of goods & services • Nominal GDP values output at current prices; real GDP values output at constant prices Changes in output affect both measures, but changes in prices only affect nominal GDP • GDP is the sum of consumption, investment, government purchases, and net exports The data of Macroeconomics- GDP, Unemployment & inflation • The overall level of prices can be measured by either the Consumer Price Index (CPI), the price of a fixed basket of goods purchased by the typical consumer the GDP deflator, the ratio of nominal to real GDP • The unemployment rate is the fraction of the labor force that is not employed • When unemployment rises, the growth rate of real GDP falls National Income: Where it Comes From and Where it Goes • Total output is determined by • how much capital and labor the economy has • the level of technology • Competitive firms hire each factor until its marginal product equals its price • If the production function has constant returns to scale, then labor income plus capital income equals total income (output) National Income: Where it Comes From and Where it Goes • The economy’s output is used for • consumption (which depends on disposable income) • investment (depends on the real interest rate) • government spending (exogenous) • The real interest rate adjusts to equate the demand for and supply of • goods and services • loanable funds • A decrease in national saving causes the interest rate to rise and investment to fall Economic Growth • • The Solow growth model shows that, in the long run, a country’s standard of living depends • positively on its saving rate • negatively on its population growth rate An increase in the saving rate leads to § higher output in the long run § faster growth temporarily § but not faster steady state growth Investment • All types of investment depend negatively on the real interest rate • Things that shift the investment function: § Technological improvements raise MPK and raise business fixed investment § Increase in population raises demand for, price of housing and raises residential investment § Economic policies (corporate income tax, investment tax credit) alter incentives to invest Investment • Investment is the most volatile component of GDP over the business cycle § Fluctuations in employment affect the MPK and the incentive for business fixed investment § Fluctuations in income affect demand for, price of housing and the incentive for residential investment § Fluctuations in output affect planned & unplanned inventory investment Money Supply and Money Demand • Fractional reserve banking creates money because each dollar of reserves generates many dollars of demand deposits • The money supply depends on the § monetary base § currency-deposit ratio § reserve ratio Money Supply and Money Demand • • The Fed can control the money supply with § open market operations § the reserve requirement § the discount rate Portfolio theories of money demand § stress the store of value function § posit that money demand depends on risk/return of money & alternative assets Money Supply and Money Demand • The Baumol-Tobin model § is an example of the transactions theories of money demand, stresses “medium of exchange” function § money demand depends positively on spending, negatively on the interest rate, and positively on the cost of converting nonmonetary assets to money ... positively on the cost of converting nonmonetary assets to money Lecture 28 Review of the previous lectures Instructor: Prof Dr Qaisar Abbas The Science of Macroeconomics • • Macroeconomics is the... Aggregate Supply • Three models of aggregate supply in the short run: § sticky-wage model § imperfect-information model Đ sticky-price model ã All three models imply that output rises above its natural... demand for real money balances with supply IS-LM model § Intersection of IS and LM curves shows the unique point (Y, r ) that Aggregate Demand ã IS-LM model Đ a theory of aggregate demand § exogenous: