Macroeconomics: EC102

Lecture 1: 9/04/2024
●​ Microeconomics vs. Macroeconomics
○​ Microeconomics
■​ Economic decisions of individual
●​ Individual consumers (households)
●​ Individual firms
●​ Individual markets
○​ Macroeconomics
■​ The economy as a whole
●​ All consumers
●​ All firms
●​ All markets
●​ Characteristics of Macroeconomics
○​ Time frame masters
■​ Short run vs. long run
○​ The Long Run
■​ Economic Growth
○​ The Short Run
■​ Business Cycle Fluctuations
■​ Aggregate demand
■​ Demand management
●​ Monetary policy
●​ Fiscal policy
○​ Expectations matter
○​ Greater complexity – more complex math
○​ Highly empirical emphasis on data
○​ Policy-driven
Gross Domestic Product (GDP)
●​ Definition
○​ GDP is the market value of all final goods and services produced within a country
in a year
FINAL goods and services
●​ The cost of wheat to miller is $.50
●​ The cost of flour to the baker $1.50
●​ The cost of the loaf to the retailer $2.00
●​ The price of bread on the shelf is $2.50
●​ TOTAL = 6.50
○​ *this is not the contribution of the loaf to the GDP
○​ You do not count multiple times
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○​ MV of the FINAL which is 2.50 (the last time the good is created in any form)
●​ USED GOODS DO NOT COUNT

Lecture 2: 9/06/2024
Measuring GDP
●​ Process called
○​ “National Income Accounting”
■​ Calculated by the Bureau of Economic Analysis–a division of the Dept. of
Commerce
■​ Issue the “NIPA”--National Income and Product Account
●​ The Expenditure Method
○​ Calculates GDP by adding up the value of expenditures of all final goods and
services in the economy
●​ Final Goods and Services
○​ Cost of wheat to miller $.50
○​ Cost of flour to baker $1.50
○​ Cost of loaf to retailer $2.00
○​ Price of bread on shelf $ 2.50
○​ 6.50
US Nominal GDP and Components 2023 (in Billions of Dollars)

An important identity
Y = C + I + G + NX
Y = GDP = value of total output
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C = consumption
I = investment
G = government purchases
NX = net exports
●​ Aggregate expenditure
GDP and National Income
●​ GDP = National income
○​ To measure overall economic activity, the BEA measures the amount of money
that households, firms, the government and foreigners spend on goods and
services.
○​ But that amount is equal to the amount of wages, interest payments, rents and
profits received by households and firms, i.e. national income.
○​ Therefore, we can use the terms “GDP” and “National Income” interchangeably

Potential GDP
●​ Potential GDP is an estimate of what GDP would have been if all factors of production
(e.g. labor and capital) had been used at their “normal” rates.
●​ It is a measure of the economy’s capacity to produce, not it’s actual production
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Lecture 3: 9/09/2024
Nominal GDP
1960-2023
●​ 542.4B → 27.4T
○​ Did we produce 51 times more stuff in 2023 than in 1960
■​ Prices were a lot higher
○​ Get rid of the effects of inflation
○​ We want to calculate the GDP without the process of inflation
Real vs. Nominal GDP
●​ Nominal GDP is the value of all goods and services measured at current prices
○​ It values the output of all good and services in 2023 AT the prices set in 2023
■​ Assume there are N goods produce in the economy
1 1 2 2
●​ 2023 Nominal GDP = 𝑃 23
𝑄 23
+ 𝑃 23
𝑄 23
●​ REAL GDP is the value of all goods and services measured at a constant price level
○​ Currently the government uses 2017 as a base
1 1 2 2
●​ 2023 Real GDP = 𝑃 17
𝑄 23
+𝑃 17
𝑄 23
■​ In 2023 US Real GDP
●​ Real GDP
○​ Uses the prices of goods and services in the base year to calculate the value of
goods in all other years
○​ Separates price changes from quantity changes
Notation for the Rest of the Course
Y = Real GDP
P = Price level
P×Y = Nominal

Measures of the Price Level (P)

●​ The GDP Deflator
○​ Ratio of nominal to real GDP times 100

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
GDP Deflator = 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
× 100
2023 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
GDP Deflator = 2023 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
× 100
27.4T/22.4T * 100 = 1.22 * 100 = 122
Index number like 122 ARE HELPFUL FOR CALCULATE INFLATION FOR DEFLATOR

●​ When would the deflator be equal to 100

○​ When Nominal GDP = Real GDP
■​ In the base year
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●​ 2017
Price Level vs. Inflation
●​ P stands for the price level (measured by the GDP deflator or the CPI
●​ Inflation = percentage change in P
○​ =%∆𝑃

Measurers of the Price level

●​ The GDP deflator
○​ Ratio of nominal GDP to real GDP times 100
■​ Measures changes in the prices of ALL goods and services that make up
GDP
●​ The GDP deflator
○​ Ratio of nominal GDP to real GDP, times 100
○​ Measures changes in the prices of all goods and services that make up GDP
○​ Measures changes in the prices of things that an average consumer buys
○​ The most closely watched indicator of what is happening to prices
■​ Release of a new CPI number can have a big impact on financial
markets
●​ Calculated and published by the Bureau of Labor Statistics (BLS)
●​ CPI number is released in the middle of each month
●​ Uses:
○​ Tracks changes in the typical household’s ​
cost of living
○​ Used to adjust many contracts for inflation (“COLAs”)
○​ Allows comparisons of dollar amounts over time
How the BLS constructs the CPI
1.​ Survey consumers to determine composition of the typical consumer’s “basket” of
goods.
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2.​ Every month, collect data on prices of all items in the basket; compute cost of
basket
3.​ Choose a base period (currently an average. of prices from 1982 – 1984)
4.​ Calculate the CPI in a given month as follows:

Calculating the CPI

Year PPizza PCDs Cost of CPI

Basket

2013 $10 $15 $350

2014 $11 $15 $370

2015 $12 $16 $400

2016 $13 $15 $410

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Calculating the Inflation Rate with CPI

Year CPI
Inflation Rate Calculation

2013 100 --

2014 105.7

2015 114.3

2016 117.1

Lecture 4: 9/11/2024
Measures of the Price level (cont.)
●​ My Econ Lab
○​ Problem sets are called Quizzes but aren’t quizzes – all questions are worth one
point
○​ Do not click Submit until you are ready to have your problem set graded. After
you click submit, you cannot change your answer.
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○​ After the due date you will be bale to see your answers as well as the correct
answer. Just click review next to the problem set name
●​ Calculating inflation with the CPI
○​ Index numbers are meaningless unless you compare months’ number – thereby
you can calculate the percentage change in prices.
Inflation = P in later year - P in earlier year/ P in earlier year * 100
Inflation between two years
= P in later year - P in earlier year/ P in earlier year * 100
Successive years creates the inflation rate

●​ Inflation, disinflation and deflation

○​ Disinflation is when inflation in going down…so prices are still increasing just
not as fast
○​ Deflation means prices are going down
●​ CPI vs. the GDP deflator
●​ CPI
○​ Includes only goods typically bought by consumers
○​ Includes imported goods
○​ Uses a fixed basket of goods
●​ GDP deflator
○​ Includes all goods
○​ Includes only domestic good
○​ Uses a changing basket of goods
●​ Real vs. Nominal Interest Rates
○​ Nominal interest rat e= i
○​ Real interest rate = r
○​ Inflation rate = π
●​ i=r+ π
●​ r=i–π
○​ So if i=4%, π = 3%, then r = 1%
3
○​ If forecasting, use π , expected inflation
𝑒
■​ I = r + π
𝑒
■​ Bank wants r=5% and π = 3% sets i at 8%
●​ All of the ones you'll hear in your life are NOMINAL interest rate
●​ ∆𝑃 𝑎𝑛𝑑 ∆𝑖
○​ i=r+ π
○​ As p goes up pi goes up
○​ As pi goes up i goes up
●​ Converting a past amount into a current amount
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○​ Value in later year dollars
𝐶𝑃𝐼
■​ = value in earlier year dollars 𝐶𝑃𝐼
𝐿𝑎𝑡𝑒𝑟

𝐸𝑎𝑟𝑙𝑖𝑒𝑟

○​ In 1969 the salary of the POTUS was raised to 200K. What would that salary be
in july 2024 dollars
○​ CPI in May 1969 = 36.4
○​ CPI in July 2024 = 314.54
○​ Value of 200K now = was 1.7m in 1969
●​ In 2009 the federal minimum wage was raised in 7.25 what would the minimum wage be
if it kept up with inflation
𝐶𝑃𝐼 314.53
●​ = 7.25 * 𝐶𝑃𝐼
𝑗𝑢𝑙2024
= 7.25 * 215.949
= 10. 56
2009

●​ Note the Biden Administration wants to raise

1980 in BU tuition to 8120
What would that be in 2024
●​ CPI in 1980 = 82.7
●​ 314.54
●​ 8120 * 314.54/82/7
○​ 30,883
○​ 87122
○​ Bu tuition has risen almost 3 times faster than inflation

Lecture 5: 9/13/2024
●​ Why is Inflation Bad?: The Costs of Inflation
○​ Distributional effects: Some workers’ incomes will not keep up with inflation
○​ “Shoeleather costs”: the resources wasted when inflation encourages people to
reduce their money holdings
■​ Includes the time and transportation costs of more frequent bank
withdrawals
○​ Menu costs” the cost of changing prices
■​ Printing new menus, mailing new catalogs, etc.
○​ Confusion & inconvenience: inflation changes the yardstick we use to measure
transactions.
■​ Complicates long rate planning and the comparison of dollar amounts over
time.
○​ Tax distortions
■​ Inflation makes nominal income grow faster than real income
■​ Taxes are based on nominal income, and some are not adjusted for
inflation
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■​ So inflation causes people to pay more taxes even when their real incomes
don’t increase

No Inflation Adjustment
●​ Nominal return before tax
●​ 5.0%Reduction in return due to 30% tax - 1.5%
●​ Nominal return after tax 3.5%
●​ Inflation rate - 3.5%
●​ Real return after tax and inflation 0.0%
Inflation Adjusted Tax
●​ Nominal return before tax 5.0%
●​ Inflation rate - 3.5%
●​ Real return before tax 1.5%
●​ Reduction in return due to 30% tax - 0.45%
●​ Real return after tax and inflation 1.05%
●​ Arbitrary redistributions of wealth
○​ Higher-than-expected inflation transfers purchasing power from creditors to
debtors: Debtors get to repay their debt with dollars that aren’t worth as much.
○​ Lower-than-expected inflation transfers purchasing power from debtors to
creditors.
○​ High inflation is more variable and less predictable than low inflation.
○​ So, these arbitrary redistributions are frequent when inflation is high.
●​ EXAMPLE
○​ Auto loan of $30,000
○​ Bank wants a real return (return after inflation) on the loan of 5%
○​ Bank forecasts inflation to be 3%
○​ So, the bank will charge a nominal rate of 3% + 5% = 8% on the loan.
●​ EXAMPLE 2
○​ Auto loan of $30,000
○​ Nominal interest rate is 8%
○​ Suppose actual inflation is only 1% instead of 3%.
○​ Bank’s real return on the loan is
○​ ​ ​ r = i – π = 8% − 1% = 7%
○​ In real terms, the borrower is now paying an interest rate of 7%, instead of 5%!
■​ Unexpectedly low inflation benefits creditors, and hurts borrowers
Unemployment
○​ Definition and measurement
■​ Employed– worked, even part time, in the
last week
●​ June 2024 = 161,774,000
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■​ Unemployed–did not work in the last week, but did look for a job over the
last month
●​ June 2024 = 7.23 million

●​ Types of unemployment
○​ Frictional
○​ Structural
○​ =natural rate of unemployment
●​
●​ The natural rate of unemployment
○​ Factors which influence the natural rate of unemployment
○​ Government Policies
■​ Training Programs
●​ Can reduce structural unemployment
●​ Example: Trade Adjustment Assistance Program
■​ Unemployment Compensation
●​ Tends to increase frictional unemployment
●​ Reduces the opportunity cost of unemployment
●​ In U.S., equals about half the average wage for 6 mos.
○​ Higher in Canada and Europe—70% - 80% of wage for
12+ mos.
■​ Labor Market Policies
●​ Legal restrictions on hours, vacations, retirement, and esp. firing;
especially restrictive in
Europe
■​ Government Policies (cont.)
●​ Minimum Wage Laws
○​ Currently $7.25
nationally—higher
in some states
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○​ Forces the wage to remain above equilibrium
○​ Quantity of labor supplied > Quantity of labor demanded
■​ Labor Unions
●​ Bargain with employers over wages, benefits, working conditions
●​ Important in airlines, autos, steel and telecom
●​ Can keep wages above equilibrium in unionized industries, leading
to unemployment
■​ Only 9% of private workforce is unionized
●​ Much higher for government sector
■​ Overall, probably little effect on national unemployment rate
●​ Efficiency Wages: Henry Ford and the 5 day wage
○​ Henry Ford - founder of Ford Motor Company
■​ Introduced modern techniques of production
■​ Built cars on assembly lines
●​ Unskilled workers were taught to perform the same simple tasks
over and over again
○​ 1914—Ford increased daily wage to $5
■​ Twice the going wage
■​ Worker turnover and absenteeism fell
■​ Productivity rose
■​ Ford’s costs decreased, profits increased, despite higher wage
●​ Types of Unemployment
○​ Cyclical
●​ Identifying unemployment
●​ Natural rate of unemployment
○​ Normal rate of unemployment
○​ Rate around which the unemployment rate fluctuates
●​ Cyclical unemployment
○​ Deviation of unemployment from its natural rate

Lecture 6: 9/16/2024
Introduction to Economic Growth
●​ Growth Rate of Real Gdp
○​ Growth is the change in real GDP over time
○​ Growth rate = the annual percentage change in real GDP
■​ %∆𝑌
●​ But…what we really care about is the change in real per capita GDP
○​ It is the growth rate of real per capita GDP that correlates most closely with
improvement in living standards
○​ Growth Calculations: Example
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●​ The Rule of 70
○​ Years to double
■​ = 70/ growth rate
○​ Growth Rate: divide by the number not the decimal of the percentage
■​ 70/2 = 35
○​
●​ Growth Rate of Per Capita GDP
■​ While US GDP growth has been 3.6 percent
per year in the post-war era, the U.S>
population has grown at about 1.6 percent

●​ The importance of growth

○​ Economic growth is the ultimate determinant of
such variables as….
■​ Nutrition
●​ Do people in a given country
have enough to eat
■​ Literacy
●​ How many people can read and write in a country
■​ Infant mortality
●​ How many children survive past infancy
■​ Life expectancy
●​ How long in a given country are people expected to live
●​ Growth over time and across countries
○​ Example: India
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■​ 1945-1995 average annual growth rate = 1.3%
■​ At the rate it would have taken Indian per capita GDP about 200 years to
reach the current U.S. level
■​ Since 1995, average annual growth rate = 6%
○​ Growth in one country or region over time
●​ Human welfare in the short and long run
○​ In a rescission like the recession of 2007–2009, real GDP per capita in the U.S>
falls by just one or two percentage points relative to the level of potential GDP
○​ Even small difference in growth rates – differences of 1 or 2 percentage
points–can lead over time to huge reductions in real per capita GDP of 20% or
more below potential GDP
●​ Growth difference across countries
○​ Since growth rates vary, the country rankings can change over time:
■​ Poor countries are not necessarily doomed to poverty forever – e.g.,
Singapore, incomes were low in 1960 and are quite high now.
■​ Rich countries can’t take their status for granted: They may be overtaken
by poorer but faster-growing countries.

Lecture 7: 9/18/2024
The Basic Growth Model
●​ The Importance of of Productivity
○​ A country’s standard of living depends on its ability to produce goods and
services
■​ This ability depends on productivity, the average quantity of goods and
services produced per hour of labor input
○​ Y = real GDP = quantity of output produced ​
L = person hours
○​ The Key to Growth
○​ Productivity
■​ The quantity of goods and services that can be produced by one hour of
work
●​ Ex: Country produces 10B of GDP with 1B person hours of labor
●​ Country B produces 25B of GDP with 5B person hours of labor
●​ Productivity in Country A $10B/$1B person hrs. = $10 per person
hr.
●​ Productivity in Country B 25B/5B person hours = $5 per person hr.
○​ Why Productivity is So Important
○​ When a nation’s workers are very productive real GDP is large and incomes are
high
○​ When productivity grows rapidly, so do living standards
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○​ What , then, determines productivity and its growth rate?
■​ Capital - physical capital - machines, tools, equipment, commercial
buildings
●​ What Caused the Productivity Slowdown from 1973-1994
○​ No universally agreed answer – several hypotheses
■​ Rising oil prices and new environmental requirements made exisiting
machines prematurely obsolete
■​ Deterioration of the US education system
■​ Productivity didn’t really slow down. It only appeared to slow down due
to measurement problems:
●​ Difficulty measuring productivity in the production of services
which became a bigger part of the economy in the 1970s
●​ Difficulty measuring improvements in health and safety
●​ Productivity in the US
○​ Can the United States Maintain High Rates of Productivity Growth?
■​ Some economists argue that the development of a “new economy” based
on information technology caused the higher productivity growth that
began in the mid-1990s and many expect it to continue
●​ Others are skeptical, arguing that by the early 2000s, innovations
in information and communications technology were having a
greater effect on consumer products than on labor productivity.

●​ Determinants of Productivity
●​ The Per Worker Production Function:
○​ L denotes the number of labor hours worked
○​ Output per Labor Hour (Y/L)
○​ Capital per Labor Hour (K/L)
●​ Capital per labor hour
■​ Productivity is higher when the
average worker has more capital
(machines, equipment, etc.).
■​ Ie. an increase in K/L causes an
increase in Y/L
■​ As K/L increases Y/L increases
●​ The Per Worker Production Function
○​ Per-worker production function: The
relationship between real GDP per hour
worked and capital per hour worked,
holding the level of technology constant
●​ Not linear
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■​ Human Capital
●​ The knowledge and skills workers acquire through education,
training, and experience
●​ Productivity is higher when the average worker has more human
capital
■​ Diminishing Marginal Product of Capital
●​ Technological Change: The Basis of Sustainable Growth
○​ Technology: processes a firm uses to turn inputs into outputs
○​ Technological change is an increase in the quantity of output firms can produce
with a given quantity of inputs
●​ Three Sources of Technological Change
○​ Better machinery and equipment
■​ Computers, software machines tools, electronics
○​ Increases in human capital
■​ Education, training, experience
○​ Better organization and management of production
■​ Just in time system
●​ Technological change helps
economies overcome
diminishing marginal returns of
capital

Lecture 8: 9/20/2024
Growth cont.
●​ New Growth Theory
○​ A model of long-run economic growth that emphasizes that technological change
is influenced by economic incentives and so is determined by the working of the
market system
○​ Key to economic growth – accumulation of knowledge capital
○​ Physical capital is subject to decreasing returns
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○​ Knowledge capital is subject to increasing returns
●​ Human capital vs. knowledge capital
○​ Human capital is the skills, education, experience, capacity, and attributes of
workers that determine their productive capacity and earning power
○​ Knowledge capital is the totality of the collective scientific and engineering
knowledge possessed by society
●​ New Growth Theory cont.
○​ Government policy can help increase the accumulation of knowledge capital in
three ways
■​ They are protecting intellectual property with patents and copyrights.
●​ Patent: the exclusive right to produce a product for a period of 20
years from the date the product is invented
■​ Subsidizing research and development
■​ Subsidizing education
●​ Convergence
○​ Poor countries will grow faster than richer countries and eventually catch up in
terms of GDP per capita
○​ Why would we expect convergence
■​ Technology transfer
■​ Another implication of diminishing marginal product of capital
●​ Low K stock → high 𝑀𝑃𝑘 → high returns to investment → higher
domestic saving and higher investment by foreigners
●​ Example of the Catch-Up Effect
○​ Over 1960-1990, the U.S> and South Korean devoted a similar share of GDP to
investment so you might expect they wuld have similar growth performance
○​ But growth was >6% in Korean and only 2% in the U.S.
○​ Explanation: the catch-up effect. In 1960, K/L was far smaller in KOrea than in
the U.S., hence Korea grew faster
●​ Absolute convergence vs. contingent convergence
●​ Absolute convergence – the view that the forces promoting convergence are so strong
that poor countries will inevitably catch up to richer countries, regardless of other factors
●​ contingent convergence– the view that the poor countries can catch up, but it is not
inevitable. Instead, growing fast enough to catch up depends primarily on other factors.

Lecture 9: 9/23/2024
Convergence (Review)
●​ Why would we expect convergence
○​ 1. Technology transfer
■​ Reverse engineering: product
○​ 2. Poorer countries can attract more capital
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●​ Absolute vs. Contingent Convergence
Three Alternative approaches to development
●​ Environmental approach
○​ Geography
○​ Climate
○​ Endemic disease
■​ Malaria
○​ Inaccessibility of trade routes (landlocked countries)
○​ Lack of natural resources
○​ Policy implications
●​ International trade approach
○​ Two dimensions of integration into the world economy
■​ Trade in goods and services
●​ Problems with import-substituting industrialization
■​ Capital inflows
●​ Financial capital
●​ FDI: foreign direct investment
○​ A foreign company establishes a direct presence in another
country.
●​ Institutional approach
○​ Legal system
○​ Political system
○​ Monetary stability
○​ Corruption

Lecture 10: 9/25/2024

●​ The Three Approaches to Development (Review)
●​ Growth in China
○​ Some Facts and Figures
○​ Chinese Economic History
○​ The Chinese Growth Miracle
○​ Recent Developments
■​ Necessary reforms
■​ Coronavirus
●​ Three Approaches to Development
○​ Environmental Approach
○​ International Trade Approach
○​ Institutional Approach
●​ Some Development Success Stories
○​ China
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■​ Some facts and figures
■​ Area: 3.7M Sq. Mi. (4th largest in the world)
■​ Population: 1.4B (2024 est.) (largest in the world)
■​ Population growth rate: 0.23% per year (avg.)
■​ GDP: $31.2T (2023 est. based on PPP)
■​ (PPP stands for “Purchasing Power Parity.” We’ll study it after the
midterm.)
■​ Per capita GDP: $22,100 (2023 est. based on PPP)
China: Facts and Figures
●​ Real GDP Growth Rate:

China Some Economic History

●​ How is a command economy different from a market economy?
○​ Market economy:
■​ Entrepreneurs
■​ Market signals and forces
■​ Dumb ideas are not profitable – will die out
●​ Command economy:
■​ State planners and agents with different incentives
■​ No information from prices
■​ Very effective at concentrating resources …
■​ … but prone to waste and unchecked inefficiency
●​ Mao’s “Great Leap Forward”
○​ Coal and agriculture:
■​ Bad technology & bad incentives
●​ Deng Xiaoping: Freezing the plan
○​ Keeping the command economy intact…
○​ …but adding a market economy on top.
FDI and Exports
●​ FDI:
○​ Not just foreign capital
○​ Also knowledge, quality standards, “productivity”
○​ Diaspora / Special Economic Zones
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●​ Foreign trade:
○​ Using China’s biggest resource: Labor
Weaknesses
●​ The Stimulus Package & Stock Market Crash
●​ A command economy at heart:
○​ Export-dependent
○​ Investment-driven
○​ Restrictive capital markets
○​ Politically motivated credit markets
○​ Few investment options for household savings
●​ The Stimulus Program:
○​ Global Financial Crisis:
○​ Demand for exports and capital flows to China dry up
●​ Government response to keep growth rates high:
○​ Direct spending: Infrastructure
○​ Easier financing conditions for companies
●​ The Market Crash:
○​ Growth slowdown (statistics reliable?)
○​ Very high levels of indebtedness, real estate bubble
○​ Reason for the boom: household stock buying
Recent Developments
●​ Ending of most public health restrictions (lockdowns) in December, ’22
●​ Designed to stimulate the economy and restore rapid economic growth
●​ Potential problems:
○​ Falling demand for Chinese exports due to economic slowdown in US and Europe
○​ Low consumer confidence among Chinese consumers
○​ Demographic changes—an aging population
■​ The population shrank in 2022 for the first time since the 1960s—down by
850,000 to 1.412 billion
■​ Push for automation and robotics to make up for a smaller workforce, and
increase the productivity of remaining workers
●​ Fragile financial sector
●​ Increased geopolitical tensions

Lecture 11: 9/30/2024

Midterm 1 Topics
●​ GDP: is the market value of all final goods and services produced within a country in a
year
○​ Definition and measurement
○​ Components
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●​ Price level and Inflation
○​ GDP deflator
○​ CPI
○​ Measuring inflation
○​ Converting a past amount into current dollars
●​ Unemployment
○​ Unemployment rate
○​ Labor force participation rate
○​ types of unemployment
●​ Economic growth
●​ Per labor hour production function
●​ Convergence
●​ Three approaches to development
Articles
Note: 3 questions
●​ Poor and the rich
●​ Unlocking growth in Africa
●​ Why poor countries are poor
●​ Institutions matter, but not for everything

Lecture 12: 10/09/2024

The Fundamental Macro Equation
●​ GDP = Aggregate Expedniture (AE)
Y=C+I+G+N+X
Y = REAL GDP
C = Consumption
I = investment = residential investment
G = government PURCHASES
​ TRANSFER PAYMENTS ARE NOT PURCHASES
Determinants of Consumption
●​ Current Disposable Income
○​ Total current income (GDP) after taxes are taken out and transfer payments are
added. Y -T + TR
●​ Consumption Function
○​ Consumption Function: relationship between disposable income and consumption
spending
Maginal propensity to Consume (MPC): the slope of the consumption function. The amount by
which consumption spending changes when disposable income changes
Macroeconomics: EC102

MPC = Change in Consumption

∆𝐶
—---—-----—------------------------------- = 𝐷
∆𝑌

Change in disposable Income

Marginal Propensity to Save = 1 - MPC

●​ The change in saving divided by the change in disposable income
●​ Expected Future Disposable Income
●​ Real Interest Rate
○​ Higher interest rate = more incentive to Save (decline in consumption spending)
■​ Debt costs more
■​ More incentive to save
●​ Household Wealth
○​ Household Wealth = Household assets - Household Liabilities
○​ Assets: Value of home, car, financial investments
○​ More wealth = more consumption spending
●​ Price Level
○​ Higher inflation = lower real consumption
●​ Income is the amount of earnings households receive in the current period
Lecture 12: 10/09/2024
●​ Where Do Firms Get the Money to Invest
●​ An important identity
○​ Y = C + I + G + NX → aggregate expenditure
○​ Y = value of total output
●​ The Fundamental Macro Equations
●​ GDP = Aggregate Expenditure (AE)
○​ Y = C + I + G + NX
●​ What Economists Mean by Investment
○​ Not what we mean in ordinary language
■​ For example, “investment” does not include:
●​ Buying a stock
●​ Opening a savings account
●​ Buying a share in a small business
●​ Buying rare coins
○​ None of these activities are directly involved in the production of goods and
services
■​ None of them add to GDP
●​ Investment
○​ What is Investment?
■​ Plant and equipment (Commercial buildings, offices, software, patents,
copyrights) also called Nonresidential Fixed Investment
Macroeconomics: EC102
●​ 81% of all investment in 2023
■​ Housing (residential, change in private inventories)
●​ (about 18% of all investment in 2023)
■​ Change in Inventories
●​ (about 1% of all investment in 2023)
●​ What are inventories?
○​ Finished goods, that haven’t been sold yet
○​ Raw materials, that haven’t been used yet
○​ Goods that aren’t finished yet, and are still in that middle of
the production process
●​ But it isn’t inventories that count in the investment part of GDP,
it’s the change in inventories!
■​ What Do We Mean By “Change in Inventories”?
●​ If firms add $500 B to their inventories
○​ Stuff firms have produced but not yet sold
○​ Stock of raw materials firms have bought but not yet used
○​ Products still in the production processes
●​ Firms sell, use or finish 400 billion worth of stuff
●​ Net change in inventories
○​ = $500 B - $ 400 B = +100B
●​ Change in finished goods not yet sold
●​ Change in raw materials not yet used
●​ Change in unfinished goods still in the production process
■​ Investment is the most volatile component of aggregate expenditure
■​ Investment is vital to economic growth
●​ Why Productivity Is So Important
○​ When a nation’s workers are very productive, real GDP is large and incomes are
high.
○​ When productivity grows rapidly, so do living standards
○​ What, then, determines productivity and its growth rate?
■​ Technological change
■​ Capital
○​ Why is it Important?
■​ Investment = change in capital = ∆𝐾
●​ Determinants of Investment
●​ Expectations of future profitability
○​ Optimism or pessimism
●​ Taxes
○​ Corporate income tax
○​ Investment tax credits
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●​ Cash flow
○​ Real interest rate
●​ r and Investment
●​ r↑ → I↓
○​ As r goes up, it is more expensive for firms to borrow to buy equipment and build
factories and office buildings
○​ As r goes up, it is more expensive for families to borrow to buy houses and
condos
●​ r↓ → I↑
●​ Financing Alternatives
○​ What are firm’s financing alternatives?
○​ What percentage of total capital raised is represented by each alternative?
●​ Borrow the Money
○​ Bank Loans​ 15%
○​ Bonds​ ​ 7.5%
●​ Sell Ownership Shares in the Company
○​ Stocks​​ 2.5%
●​ Use Their Own Savings
○​ Retained Earnings​ 75% → Internal Funds

Lecture 13: 10/11/2024

Net Exports of goods and services
●​ In most recessions net exports goes up (mostly everything else goes down, imports go
way down therefore net export is actually positive)
●​ Nominal Exchange Rate (E): price of one currency in terms of another currency
○​ Number of units of foreign currency per unit of domestic currency
○​ Depreciation: currency got cheaper
○​ Appreciation: currency got more valuable
○​ Exporters want currency to be as cheap as possible
●​ Exchange Rates
○​ The current yen/dollar exchange rate is about 142.6
○​ The price of $1 is ¥142.6
○​ So E = the number of yen per dollar = 142.6
○​ In January, 2023, E = 130, It took 130 yen to buy $1
■​ So, since then, the dollar has appreciated
●​ The price of $1 used to be ¥130
●​ Now the price of $1 has gone up to ¥142.6
○​ It can be expressed as
■​ Units of foreign currency per dollar
■​ ¥142.6/ $1 7 yuan / $1
●​ or as
○​ Dollars per unit of foreign currency
■​ ¥142.6/$1 = $.007 / ¥1
Macroeconomics: EC102
■​ 7 RMB / $1 = $.14 / 1 yuan
○​ Recently E = ¥142.6/$1
○​ The Lexus LS costs about ¥8.4 Million = $58,906
○​ What if the yen depreciated to ¥200 = $1
■​ ¥8.4 M/200 = $42,000
○​ What if the yen appreciated to ¥90 = $1
■​ ¥8.4 M/90 = $93,333
●​ Equilibrium
●​ Equilibrium in foreign exchange market (determinants of price of one currency vs
another)
○​ Determined by supply and demand

1.​ Foreign firms and households wanting to buy U.S. goods and services
2.​ Foreign Firms and households wanting to invest in U.S. physical or financial asset
3.​ Currency traders believe the value of the $US will rise
a.​ Biggest Determinant!!!
4.​ CHECK SLIDES
●​ Unlike in markets for goods and services, the supply of $US is caused by just the same
elements as causes the demand for $US, only in
reverse: firms, households, and speculators
wanting to obtain (say) Japanese yen and pay for
them with U.S. dollars.
●​ The equilibrium exchange rate is the rate at which
the quantity of dollars supplied equals the amount
of dollars demanded.

●​ If the exchange rate is too high, more people will

want to sell $US for yen than want to buy
them—a surplus.
●​ The exchange rate will depreciate: the value of the
$US will fall, relative to the value of the yen.
●​ An exchange rate that is too low will cause the
$US to appreciate: an increase in market value relative
to the yen (or generally any other currency).
Changes in the Demand for and Supply of Foreign Exchange
●​ Anything (apart from the exchange rate itself) affecting
the demand for foreign exchange will shift the demand
curve—to the right for an increase in demand, to the
left for a decrease.
○​ This might result from:
1.​ Changes in the demand for U.S.-produced goods and
services relative to foreign-produced goods and
services
2.​ Changes in the desire to invest in the U.S. relative to
foreign countries
Macroeconomics: EC102
3.​ Changes in the expectations of currency traders about the likely future value of $US
relative to foreign currencies
○​ The supply of $US for yen is the same as the demand for yen with $US, so the
same factors that change demand also change supply.
What Causes E to Fluctuate?
●​ As of 2023, the volume of international currency transactions was
○​ $1 Trillion per day
●​ International trade accounted for only
○​ 2% – 5% of this daily volume
●​ What accounts for the other 95% - 98%
○​ World-wide trade in assets
○​ Speculation
1.​ Real interest rate
○​ If interest rates in the US go up relative to the world, increase demand for
us assets
○​ Demand for dollar increases = price of dollar increases
●​ rus ↑ (rel. to r in the rest of the world)
→ Demand for $-denominated assets ↑

→ Demand for $ ↑

→ Price of a dollar ↑

i.e. E ↑

Lecture 14: 10/15/2024

Net Exports (cont.)
Nominal Exchange Rate: price of one country in terms of another country
●​ Number of units in foreign currency per unit of domestic currency
●​ E
Real exchange rate = the price of goods in one country in terms of the price of goods in some
other country
●​ Need to know nominal exchange rate
●​ e

(Domestic Price) X (nominal exchange rate)

—---------------------------------------------------
(Foreign price)

Purchasing power parity: same good should cost the same wherever in the world its sold
●​ If this is true, real exchange rate = 1
●​ Nominal exchange rate = foreign price / domestic price
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Arbitrage: taking advantage of differences in prices

Big Mac Index:

●​ If real exchange rate > 1, domestic currency is overvalued and foreign currency is
undervalued
●​ If real exchange rate < 1, domestic currency is undervalued and foreign currency is
overvalued

Limitations of the PPP Theory: two reasons why exchange rates do not always adjust to
equalize prices across countries:​

1.​ Many goods cannot easily be traded

a.​ EX: haircuts, going to the movies, price differences on such goods cant be
arbitraged away
2.​ Foreign, domestic goods are not perfect substitutes
a.​ Price differences reflect taste differences

●​ Trade deficit: excess of imports over exports

●​ Trade Surplus: an excess of exports over imports

●​ Balanced Trade: Exports = Imports

●​ Determinants of Exports:
1.​ Real Exchange Rate (e)
2.​ GDP of our trading Partners (Y foreign)
a.​ CHECK REVIEW SLIDES
3.​ Tastes and preferences of people abroad for our goods and services
4.​ Trade Policies (tariffs)

●​ If real exchange rate is higher, Domestic goods are more expensive for foreign buyers,
and exports go down
●​ If real exchange rate is lower, Domestic goods are cheaper for foreign buyers, and
exports go up
Increase in foreign GDP is good for exports
Foreign GDP Lower = exports go down

●​ Determinants of Imports

1.​ Real exchange rate

2.​ Domestic gdp
a.​ Higher domestic GDP = more imports
b.​ Lower Domestic GDP = less imports
3.​ Domestic tastes and preferences for foreign goods
4.​ Trade policies
Macroeconomics: EC102
●​ Real exchange rate goes up, foreign goods are cheaper for domestic buyers, therefor
imports go up, net exports go down
●​ Lower Real Exchange rate, domestic goods are cheaper for foreign buys, lower imports,
net exports go up
●​ Strong dollar bad for exports, good for imports
●​ Foreign GDP has no influence on imports,
●​ Froeig

Net Exports Affected By:

1.​ Real exchange rate

2.​ Foreign GDP
3.​ Domestic GDP
4.​ Tastes
5.​ Trade policies

●​ Strong Dollar Always hurts net exports

●​ Real Exchange rate going up makes exports go down and imports go up,
○​ Therefor net exports goes down
●​ Real exchange rate goes down makes exports go up and imports go down
○​ Therefor net exports go up

●​ Foreign GDP is high = exports are higher, therefor net exports is higher
●​ Foreign GDP is lower = exports go down, therefor net exports are lower

●​ Domestic GDP is higher = imports go up, so net exports go down

●​ Domestic GDP is lower = imports go down, so net exports go up

●​ Higher Interest Rate in the US

1.​ greater demand for dollar denominated assets (assets priced in US Dollars)
2.​ Demand for Dollars goes Up
3.​ Nominal Exchange Rate Goes UP
4.​ Real Exchange Rate Goes UP
5.​ Exports Go Down
6.​ Imports Go Up
7.​ Net Exports goes down

Lecture 15: 10/18/2024

Aggregate Expenditure

SLIDES UNTIL AGGREGATE DEMAND CURVE

Aggregate Expenditure vs Aggregate Demand

Macroeconomics: EC102
●​ Expenditure refers to specific point on demand curve (total spending at particular price
level)
●​ Demand refers to the curve, every price level

●​ Increase in aggregate Expenditure: movement along aggregate demand curve

●​ Inverse Relationship

3 Effects why Aggregate Demand Curve Slope Down

​ **Come into effect when there's a change in the price level**
1.​ Wealth Effect
a.​ When Wealth goes up, purchasing power of household wealth goes down,
consumption spending goes down
i.​ The price lvl goes up, AG goes down
2.​ Interest Rate Effect
a.​ When interest rate goes up, consumption spending goes down, investment goes
down, net exports goes down
i.​ The price lvl goes up, AG goes down
3.​ International Trade Effect
a.​
i.​ The price lvl goes up, AG goes down

Price lvl = vertical Axis

Lvl of total Spending = Horizontal Axis

Lecture 16: 10/21/2024

●​ Review of Aggregate Demand Curve Slope Down?
●​ An important identity
a.​ Y = C + I + G + NX
●​ AD Curve
a.​ The AD curve relates to the price level to aggregate expenditure on the economy’s
goods and services
●​ AD Curve
​ INSERT PHOTO
Y = aggregate expenditure a point on the aggregate demand curve
P = price level
(12T, 130)
(13T, 120)
(110, 14T)
You trace out the aggregate demand curve
Downward slowing?
1.​ Wealth Effect
Macroeconomics: EC102
a.​ When the Price level goes up, the purchasing power of household wealth goes
down, and consumption spending goes down
i.​ Savings bonds → purchasing power
ii.​ Consumption goes does, so the largest component, Aggregate expenditure
goes down
2.​ Interest Rate Effect
a.​ When the price level goes up → interest rate goes up, consumption spending goes
down, investment goes down, net exports go down
i.​ With higher interest rates consumption goes down
1.​ Auto loan, credit card debt
a.​ It costs more to finance consumption as a buyer
b.​ Either way, consumption will go down
c.​ Investment spending goes down
i.​ The way the firms get the money for investment
1.​ By borrowing
ii.​ When interest rates are higher borrowing is higher
iii.​ Residential investments go down – a lot of families
cannot afford it
d.​ Net exports go down
i.​ Lead to higher exchange rates (real exchange rate)
ii.​ Exports go down
iii.​ Foreign goods are cheaper to domestic
1.​ Exports go down
e.​ THEREFORE AE goes down
3.​ International Trade Effect
a.​ As the Price level goes up, the real exchange rate goes up, imports go up, exports
go down – net exports go down – AE goes down
WORKS IN THE OPPOSITE - AE will go up in the opposite direction
Change in Aggregate Expenditure vs. Change in Aggregate Demand
●​ Increase in AE
○​ Lower price level, higher AE
○​ Move down along the AD curve
○​ A movement along the ADC
●​ Increase in AD
○​ This means that there will be a higher level of AE at EVERY price level, not just
at one
○​ The rightward shift of the entire AD curve
○​ At the same price level, the demand shifts higher
■​ Regardless of the price level, with an increase in AD, there is a higher
level of Aggregate expenditure
●​ Decrease in AE
○​ A movement along the AD c: a decrease in AE
●​ Decrease in AD
○​ The entire curve shifts to the left
○​ Lower AE at every price level
Macroeconomics: EC102

●​ What Shifts the Aggregate Demand Curve?

a.​ government policies
■​ Monetary policy - policies which affect interest rates ®
■​ done by the Federal Reserve
■​ When the Fed raises:
●​ Higher interest rates→ Consumption spending goes down,
investment spending goes down, NX goes down because exchange
rates rise – AD shifts left
■​ When fed lowers
●​ Lower interest rates:
○​ DO NOT GET CONFUSED with the r effect
■​ Remember what starts the IR effect → which is
ALL ABOUT PRICE LEVEL
■​ Fiscal policy – policies which affect G and/or T
●​ Government SPENDING
●​ Changes in government purchases
●​ Changes in transfer payments
●​ Changes in taxes
●​ Done by Congress, White House, treasury dept
●​ G raised AD → AD shifts right
●​ G lowered AD → AD shifts left
●​ T raised → C and I goes down → AD shifts left
●​ T lowers → C and I go up → AD shifts rights
b.​ Change in expectations of households and firms
■​ Based on what people believe will happen in the future
■​ C = f((Y-t), (Y-T)^e, r, wealth, price level)
■​ If consumers are optimistic – they will consume more - AD shifts right
■​ If consumers are gloomy – they will consume less - AD shifts left
c.​ Change in foreign variables
d.​ NX = f(e,Y^for, Y^dom, tastes, trade policies
■​ nominal exchange rate lowers, the real exchange rate goes down, Imports
are more expensive – AD shifts right
■​ Nominal exchange rate rises, real exchange rate goes up, net exports go
down → shifts left
■​ Domestic GDP rises, IM goes up, Net exports go down –AD shifts left
(NX is a component)
■​ Domestic GDP is down, IM goes down, net exports go up – AD shifts
right
■​ Foreign GDP rises, X goes up, NX goes up, → AD shifts right
Macroeconomics: EC102
■​ Foreign GDP lowers, X goes down, NX goes down
Lecture 17: 10/23/2024
●​ Long Run Aggregate Supply Curve (LRAS)
○​ When the economy is along the LRAS line unemployment will be at the natural
rate
■​ Frictional - in between job
■​ structural unemployment - their skills don't match the job
○​ Will always be vertical but not stationary
■​ When the economy/productive capacity grows – LRAS will shift right
●​ Short Run Aggregate Supply Curve (SRAS)
○​ Why Does SRAS Slope UP?
■​ Contracts make some wages and prices sticky
■​ Firms are often slow to adjust wages
■​ Menu costs make some prices sticky
●​ Less significant because of the internet
○​ What causes the SRAS Curve to Shift
■​ Changes that shift BOTH LRAS and SRAS
●​ Increases in the labor force and capital stock
●​ Technological change
■​ Changes that shift only SRAS
●​ Expected changes in the future price level
●​ Adjustments of workers and firms to errors in past
expectations about the price level
○​ Negative Supply Shocks (up)
■​ When it shifts up
■​ This means that the short SRAS shifts up and moves left upward shift
●​ Communicates that prices are going up
●​ Every level of GDP/output – will produced only at a higher price
level
●​
○​ Positive Supply Shocks (down)
■​ This means that the short SRAS shifts down and moves right, with a
downward shift
●​ Due to the internet – every level of output could be produced at
lower price levels
Lecture 18: 10/25/2024
Macroeconomic Equilibrium
●​ Shifts in the AD Curve (Review)
●​ Supply Shocks (Review)
●​ Macroeconomic Equilibrium
Macroeconomics: EC102
○​ Long Run Macroeconomic Equilibrium
■​ When we’re on the LRAS line, the natural unemployment rate
■​ When the SRAS, AD, SRAS,
●​ Equilibrium occurs
○​ The Short Run
○​ Short equilibrium occurs when the AD curve changes
■​ Inflationary Gap
●​ GDP is higher/above long run/potential GDP
●​ Price level is higher at SR - inflation
●​ Unemployment is below the natural rate
●​ This is an inflationary gap,
○​ 1. GDP is above its long-run/potential level
○​ 2. Higher price level, more inflation
○​ 3. Unemployment is below the natural rate
○​ Transition to the Long Run
■​ Upward shift of LRAS
●​ Much higher price levels, more inflation
○​ Long run dynamics out of an
inflationary gap
■​ Recessionary Gap
■​ 1. GDP is below its long run/potential level
■​ 2. Unemployment is above the natural rate – cyclical unemployment
●​ SRAS downward shift as prices fall
●​ Transition to the Long Run
○​ ELR2 – GDP is back up
○​ The price level is even lower
○​ How long is this gonna take?
○​ SRAS curve shifts right

Lecture 18: 10/28/2024

Review: Recessionary Gap
●​ Y Actual < Y Potential t
●​ Unemployment > natural rate
Review: Inflationary Gap
●​ Y actual > y potential
●​ Price level goes up
●​ Unemployment < natural rate
Relationship Between Inflation and Unemployment
●​ Recessionary Gap
○​ Y^Actual < YPotential
Macroeconomics: EC102
○​ Price Level Goes Down
○​ Unemployment > Natural Rate
●​ Inflationary Gap
○​ Y Actual > YPotential
○​ Price Level Goes Up
○​ Unemployment < Natural Rate
The Trade-off between inflation and unemployment
●​ The Phillips curve
●​ Illustrates a negative association between the inflation rate and the unemployment rate.
At point A, inflation is low, and unemployment is high. At point B, inflation is high, and
unemployment is low
○​ Vertical axis - Inflation rate
○​ Horizontal axis - unemployment
●​ A Policy Menu?
○​ Since fiscal and monetary policy affect aggregate demand, the PC appeared to
offer policymakers a menu of choices:
■​ Low unemployment with high inflation
■​ Low inflation with high unemployment
■​ Anything in between
○​ 1960s: U.S. data supported the Phillips curve.
○​ Many believed the PC was stable and reliable
The Vertical Long Run Phillips Curve
●​ 1968: Milton Friedman and Edmund Phelps argued that tradeoff was temporary
●​ Natural rate hypothesis: the claim that unemployment eventually returns to its normal or
“natural” rate, regardless of the inflation rate
●​ Based on the vertical LRAS curve
●​ If the LRAS is vertical, it must be the case that, in the long run, the Phillips curve is
vertical
Reconciling Theory and Evidence
●​ Phillips Curve is vertical in the long run. (Friedman and Phelps)
●​ But..in the short run, the Phillips curve clearly slopes downward
●​ To bridge the gap between the short run and the long run, Friedman and Phelps
introduced a new variable: expected inflation – a measure of how much people expect the
price level to change
The Phillips Curve Equation
●​ Short run
○​ Monetary policy can reduce u-rate below the natural u-rate by making inflation
greater than expected.
●​ Long run
Macroeconomics: EC102
○​ Expectations catch up to reality; the unemployment rate goes back to the natural
rate, whether inflation is high or low.
How Expected Inflation Shifts the PC
●​ Initially, expected & actual inflation = 3%, unemployment = natural rate (5%)
●​ Govt. policy shifts AD right, making inflation 3% higher than expected, u-rate falls to
4%.
●​ In the long run, expected inflation increases to 6%, PC shifts upward, and unemployment
returns to the natural rate.
●​ If the govt. is determined to keep unemployment at 4%, they can enact policies to shift
AD to the right again, lowering unemployment to 4%, but increasing inflation to 9%,
higher than the 6% people were expecting. So we go from point C to D on PC2
●​ But in the long run, expectations catch up to reality, the expected inflation rate goes to
9%, PC2 shifts up to PC3, and unemployment returns to the natural rate at point E.
●​ Expected & actual inflation = 3%
●​ Unemployment = Natural Rate (NAIRU) (5%)
●​ Inflation will stay at 3% unless some govt. policy tries to reduce unemployment below
the natural rate
The Natural Rate of Unemployment is also called “NAIRU”
●​ Nonaccelerating inflation rate of unemployment
○​ The unemployment rate at which the inflation rate ahs no tendency to increase or
decrease
Key Points About the Phillips Curve
1.​ The Long-run Phillips Curve is vertical at the natural rate of unemployment
2.​ The Short-run Phillips Curve is downward sloping
3.​ Everywhere along a given Short-run Phillips Curve, expected inflation is the same
4.​ Where the Long-run and Short-run Phillips Curves intersect, actual inflation = expected
inflation

Lecture 19: 11/01/2024

Money and Banking
●​ Some Facts About Banks
○​ Ten Largest U.S. Banks,
1.​ JP Morgan Chase
2.​ BofA
3.​ Wells Fargo
4.​ Citibank
5.​ US Bank
6.​ PNC Bank
7.​ Goldman Sachs
8.​ Truist Bank
9.​ Capital One
Macroeconomics: EC102
10.​TD Bank

Ten Largest Banks in the World 2023

1.​ Industrial and Commercial Bank of China
2.​ China Construction Bank
3.​ Agricultural Bank of China
4.​ Bank of China
5.​ JP Morgan Chase
6.​ BNP Paribas
7.​ China Development Bank
8.​ Bank of America
9.​ MUFG Bank
10.​Credit Agricole

Depository Institutions
●​ Economic Functions
○​ Creating Liquidity
■​ Borrowing “short” and lending “long”
○​ Minimizing the Cost of Borrowing
○​ Minimizing the Cost of Monitoring Borrowers
○​ Pooling Risk
Bank balance sheet

Assets (A) Liabilities (L)

Reserverse Deposits
●​ Vault Cash ●​ Savings deposits
●​ Deposits with the Fed ●​ Time deposits
●​ Loans ●​ Checking deposits
●​ Bonds ●​ Other liabilities
●​ Other assets ●​ Bank Capital (= A - L)

●​ How Do Banks Work?

○​ Basic of Bank Accounting — Balance Sheets
○​ Some Bank Accounting Exercises
●​ Economies of scale
●​ Economies of scope
●​ Loan diversification
Macroeconomics: EC102
Lecture 19: 11/13/2024
Functions of Money
1.​ Medium of Exchange (buying items)
2.​ Unit of account (measures value of stuff)
3.​ Stores value
4.​ Standard of deferred payment (borrowing lending)

●​ Barter requires Double coincidence of wants: i have what you want, you have what i
want
●​ Barter economy only trades goods for other goods (no money)

Liquidity: cash, checking deposits, saving deposits, time deposits, stocks and bonds, real estate,
fine art

Measures of Money
1.​ M1
a.​ Currency and travelrs checks
i.​ Cash in the hands of the public
b.​ Checking Desposits
c.​ Savings Deposits
2.​ M2
a.​ M1 (changes in M1 changes M2)
b.​ Time Deposits (CDs)
c.​ Money market mutual funds and other deposits

What isn’t money

1.​ Checks
a.​ Checks arent money but cheking deposits are
2.​ Credit cards

Depository Institutions:
1.​ Essential activity: take deposits and make loans
2.​ Commercial banks
3.​ Thrift Institutions
a.​ Savings and loan associations
b.​ Savings banks
c.​ Credit unions
4.​ Money Market Mutual Funds

Money is not Wealth!

●​ Wealth: net worth
○​ Assets - Liabilities
●​ Money
○​ Cash, checking deposits, saving accounts
Macroeconomics: EC102

Bank Balance Sheet

●​ Assets
○​ Reserves Most Liquid
■​ Vault cash
■​ Deposits with the Fed
○​ Loans Most Important
○​ Bonds
○​ Other assets
●​ Liabilities
Macroeconomics: EC102
○​ Deposits
■​ Saving deposits
■​ Checking deposits
○​ Bank Capital

Bank Capital = Assets - Liabilities

Assets = Liabilities + Bank Capital

Where Does Money Come From?

1.​ Change in total Deposits
2.​ Change in the money supply
3.​ The Reverse Money Multiplier Process

Examples of Changes in Bank Balance Sheet

1.​ Someone Deposits $500 Cash

a.​ Reserves + 500
b.​ Checking Deposits + 500
2.​ Bank Buys $1000 in Bonds
a.​ Reserves -1000, Bonds + 1000
3.​ Bank Loans $500 Cash
a.​ Reserves -500, Loans + 500
4.​ Bank Loans $500 by crediting a deposit account for the borrower
a.​ Reserves -500, Loans +500
b.​ Checking Deposits +500, Checking Deposits -500
5.​ Bank is robbed of 500
a.​ Reserves -500
6.​ Customer Makes a Loan Payment of 1000 ($800 interest + $200 Principal)
a.​ Reserves +1000, Loans -200
7.​ A $1M Loan Default
a.​ Loans -1M

Money Multiplier (somebody deposits money into bank) (deposit → Loan)

1.​ Add to reserves and checking deposits
2.​ Leaves 10% of total in Reserves, 90% in Loans

Reverse Money Multiplier (withdrawl from the bank)

Banks required to keep 10% of total deposits on reserve

​ ​ ​ ​ ​ ​ 1
Change in Total Deposits = (Initial Deposits) —--
​ ​ ​ ​ ​ ​ R
Macroeconomics: EC102
​ ​ ​ ​ ​ ​ 1
Change in Total Deposits = (Initial Deposit) —------
​ ​ ​ ​ ​ ​ R+E

1
—--- is called “money multiplier”
R+E

Change in Money Supply = (Change in total deposits) + (change in cash held by the public)

R goes down: Change in total deposits, and change in money supply goes up

Money supply = Total Deposits

Lecture 20: 11/15/2024 and Lecture 21: 11/18/2024

The Federal Reserve System

●​ Many americans opposed idea of central bank

●​ 12 federal reserve district
●​ 2 federal reserves in missouri

Federal Reserve Functions

1.​ Clears checks
2.​ Issue new currency and remove damaged currency
3.​ Evaluate Bank Mergers and Expansions
4.​ Lender to member banks
5.​ Liaison between local community and the federal Reserve System
6.​ Perform Bank Examinatiosn
7.​ Conduct Monetary Policy

Fed Monetary Policy Tools

1.​ Set the Reserve Requirement (R)
a.​ Currently R=0%
2.​ Set the Discount Rate
a.​ The rate that banks have to pay if they borrow from the Fed
3.​ Conduct Open Market Operations (Most Important)

Monetary Policy
1.​ Expansionary Monetary Policy
a.​ Actions which increase the money Supply
Macroeconomics: EC102
2.​ Contractionary Monetary Policy
a.​ Actions which decrease the money supply

Tools of the Fed

1.​ Open Market Operations
a.​ The Fed Buys or Sells T-Bonds
2.​ Changing the Reserve Requirement
3.​ Reserve Lending from the “discount Window”
a.​ Role as “Lender of Last Resort”

Fed Buys 1 M Bond

●​ T-Bonds - $1M, Deposits +1M
●​ Deposits +1M

Expansionary Monetary Policy

●​ Buying Bonds

Fed Buys Bonds (inflationary gap)

●​ I goes down
●​ Consumption goes up
●​ Investment goes up
●​ Net Exports goes up
●​ Ag goes up
●​ National Income goes up
●​ Unemployment goes down
●​ Inflation goes Up

Fed Sells 1M Bonds

●​ T-Bonds +1M, Deposits -1M
●​ Deposits -1M

Contractionary Monetary Policy

●​ Selling bonds

Fed Sells Bonds (recessionary gap)

●​ I goes up
●​ Consumption goes down
●​ Investment goes down
●​ Net exports goes down
●​ Ag demand down
●​ National income down
●​ Unemployment goes up
●​ Inflation goes DOWN - why they do it
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Money Supply Curve (Money by interest Rates)
●​ Vertical line
●​ If fed buys bonds Shifts to right when money supply goes up
●​ If fed sells bonds money supply curve goes left
●​ Where two lines interest = equilibrium

Money Demand Curve

●​ Slopes down
●​ Interests rate high = up on money demand curve
●​ Interests low = low on money demand curve
●​ Increase in Nominal GDP shifts demand to the right
●​ Decrease in Nominal GDP shifts demand to the left

FOMC Meetings
●​ Feds meet to decide on interest rates
●​ 8 times per year
●​ Triggers a chain of events unemployment, output, prices of goods and services

Federal Reserve
●​ Targets “Federal Funds Rate”
○​ Rate that banks charge each other to borrow reserves
○​ Banks have incentive to do this
○​ Stays close to target
○​ Controls rate by conducting open market operations
○​ The Fed can increase the federal funds rate selling Treasury bonds, which
decreases bank reserves.
●​ Discount Rate
○​ Banks borrows directly from the Fed

Why Feds Target I instead of M

●​ i is easier to control
●​ More closely related to economic variables

●​ Fed wants to undertake expansionary policy only in recessionary gap

○​ Fed will shift short run upwards
○​ Lowers interest rate
●​ Fed wants to undertake contractionary policy during inflationary gap
○​ Fed will shift short run down
○​ Raises interest rate
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Monetary Neutrality:
●​ When the bank changes money supply, it doesn’t change anything else besides price lvl
(inflation) in the long run
●​ In the short run if you increase money supply, AD shifts right
○​ Y goes up, unemployment down
●​ Long run, SRAS shifts up, overall price lvl goes up

Faster money growth moves AD up

Phillips Curve Equation

●​ Short Run
○​ Monetary policy can reduce unemploymtent rate below natural rate by making
inflation greater
●​ Long Run
○​ Expectations can catch up, unemployment tate goes back up to natrual rate

Quantity Equation:

​ ​ ​ Nominal GDP​​ ​ ​ P*Y

Velocity (of M1) = —--------------------- =​ —---------------------
​ ​ ​ M1 Money Stock​ ​ ​ ​ M

​ ​ ​ ​ Nominal GDP
Velocity (of M2) = ​ —-------------------------
​ ​ ​ M2 Money Stock

Velocity = average number of times each dollar in the money supply is used to purchase goods
and services

Rearrange Equation gets Levels Form

MV = PY

%ΔM + %ΔV = %ΔP + %ΔY

Two Assumptions Quantity Theory

1.​ In the Long run %ΔV = 0, but V isn’t 0
2.​ In the long run, %ΔM does not affect %ΔY
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%ΔP = %ΔM - %ΔY
(says inflation is result of growing money supply faster than economy is growing)

●​ Hyperinflation
○​ Inflation exceeding %50 a month
○​ Price level - increases more than a hundredfold over the course year
○​ Caused by Exccessive growth in the money supply

Random:

●​ When the Federal Reserve purchases Treasury securities in the open​market, the sellers of
such securities deposit the funds in their banks and bank reserves increase.

●​ When the Federal Reserve sells Treasury securities in the open​market, the buyers of
these securities pay for them with checks and bank reserves fall.

Fiscal Policy
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Fiscal Policy:
●​ Changes in government Spending
○​ Government purchases (fed, state, local lvl)
○​ Transfer Payments (most importantly, about half), (where gove moves money
around)
●​ Changes in Taxes
●​ Decided by the Treasury Dept at legislative or executive Branch
●​ Changes in gov spending, taxes, or transfer payments

Monetary Policy:
●​ Only done by the Fed
●​ Affects money supply and interest rate

Federal Government Revenue:

●​ Individual income taxes, 46%
●​ Social Insurance taxes, 38%

Expansionary Fiscal Policy

●​ An expansionary fiscal policy involves increasing spending or cutting taxes to prevent or
end a recession or depression.
●​ Government spending goes up
●​ TR goes up
●​ Taxes go down
●​ Inflation goes up (look at price lvl)
●​ Shift Demand curve to Right

●​ Crowding Out of investment: gov spending increase in i

○​ Decreases private investment
○​ Ad curve goes left after expansionary fiscal policy
○​ AD goes up
○​ P X Y goes up
○​ Money Demand Goes up

Contractionary Fiscal Policy

●​ A contractionary fiscal policy involves cutting spending or raising taxes to slow down
unsustainable economic growth.
●​ Government spending goes down
●​ Transfer payments goes down
●​ Taxes go Up
●​ Shift demand curve to left

Budget Balance =
●​ T - G - TR
●​ T - (G + TR)
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●​ T > (G + TR) → Budget Surplus
●​ T = (G + TR) → Balanced Budget
●​ T < (G + TR) → Budget Deficit

The federal government debt is the accumulation of all past deficits.

●​ When someone Reaches 62, they can start recieving social security
●​ If they wait longer they get the most (70)
●​ 65 = medicare

Government Policies the AD Curve

●​ Taxes increase, Transfer payments decrease, AD shifts left
●​ Taxes Decrease, Transfer Payments increase, AD shifts right

Gov Spending Multiplier:

​ 1
ΔY = —----------- (Δ G)
1 - MPC

Tax Multiplier:
-MPC
ΔY = —------------ (ΔT)
​ 1 - MPC

●​ Change in i: change in quantity of money demanded

○​ i increases: smaller quantity of money demanded
○​ i decreases: larger quantity of money demanded

Lags in Stabilization Policy:

●​ Recognition Lag
●​ Decision Lag
○​ Monetary Policy: short
○​ Fiscal Policy: long
●​ Impact Lag
○​ Monetary Policy: long
○​ Fiscal Policy: short

Automatic Stabilizers:
●​ Programs which stabilize demand by expanding or shrinking with the economy
○​ Income tax
○​ Unemployment compensation
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○​ Welfare payments
○​ food stamps

Focus on slides and notes

Review all the problem sets (the ones without answers)
-​ Attempt practice final last

List of Topics
●​ GDP
○​ definition ; measurement
○​ Potential GDP; per capita GDP
○​ Nominal vs. real GDP
●​ Measures of price level
○​ GDP deflator, inflation calculations
○​ CPI; inflation calculations
○​ Costs of inflation (why inflation is bad)
○​ Disinflationvs. Deflation
○​ Nominal vs. real interest rates
○​ Converting a past amount into present dollars
●​ Unemployment
○​ Definition
○​ Unemployment rate labor force participation rate
○​ Types of unemployment
○​ Factors that influence the natural rate
●​ Economic growth
○​ Calculation of a growth rate
○​ Rule of 70
○​ Per capita GDP growth rate
○​ Why growth is important
○​ Productivity determinants
○​ Human capital
○​ Sources of technological change
○​ Per worker production function
■​ Diminishing returns to capital
■​ Technological change
○​ New growth theory
○​ Convergence
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■​ Two reasons why we would expect convergence
■​ Evidence on convergence; the catch-up line
■​ Three approaches to growth