GDP- the total market (monetary) value of final goods and services newly produced within a country’s borders over a given time period.- Value added approach: value of output- value of intermediate inputso Avoids double-counting- Three approaches to accounting for GDPo Add up total expenditureso Add up the value of total productiono Add up the value of income- GDP is represented by Yo Y=C+I+G+(X-M) Consumption: by households and private institutions Investment: in physical capital (plant, equipment, etc). Gross investment.- Gross investment- the amount spent on capital goods in a given time period- Net investment- gross investment less depreciation- Depreciation- the amount of capital that wears out or becomes obsolete Government expenditures Net Exports= Exports minus imports- Nominal GDP- expressed in current dollars- Real GDP- adjusted for inflation expressed in dollars for a particular base yearo Converting nominal to real GDP: Real GDP=Nominal GDP/Price Index- GDP is often used as a measurement of well-beingo GDP per capita: GDP divided by the population is used as an indicator of average living standards Doesn’t account for:- Health status and life expectancy- A clean, sustainable environment- A more educated population- Subjective well-being- The value of leisure time- Unpaid work (household labor)***GDP includes the time and money spent cleaning up an environmental disaster, the unhealthy products, and travel costs associated with inefficient commutes and poor transport systems even though they have a questionable impact on well-being. Extraction of natural resources adds to GDP however depletion of environmental resources is not counted- Alternative approaches to GDP: o Capabilitieso Human Development Indexo Third-party criterionGNP- the total market value of final goods and services newly produced by the citizens of a country (and their assets) over a given time period.BUSINESS CYCLES- Ups and downs of GDP growth - Recession- the level of real GDP fallsINFLATION- Rate of inflations can be calculated from price indiceso GDP deflatoro CPI (most common method)SAVINGS AND INVESTMENT- GDP=C+I+G+(X-M)o GDP=C+G+I+GI+(X-M)o Income-C-GC=I+GI+(X-M)- Savings=Investment + Net ExportsEX ANTE AND EX POST- Ex Ante-before the adjustment to equilibrium. “Planned”. “Desired” consumption, saving, and/or investment- Ex Post-after the adjustment to equilibrium. o Ex Ante: savings < investmento Ex Post: savings = investment To adjust to the ex post you must change income (Y) or interest rates (r)AGGREGATE DEMAND-How much firms and households intend to spend on consumption and investment (Ex ante concept)- Y>C+I: insufficient aggregate demando Leakages>injection- Y<C+I: excess aggregate demando Leakages<Injections- Classical Solution of Aggregate Demando Supply of savings: Willingness to save increases with the interest rate because you get a higher return on savings o Investment demand: Demand for investment (or funds to finance investment) falls as interest rate rises since the costs of investment increases with interest rates Opportunity cost- what else can you do with the money? Investment opportunities less attractiveo If Savings> Investment, interest rates fall until Savings=Investment Lower interest rates reduce savings and increase investmento If Savings<Investment, interest rates rise until Savings=Investment Higher interest rates reduce investment and encourage savingso Interest rates always adjust so that Savings=Investment but firms can also decide to invest less.  Interest rates will fall as a result and if there is less savings due to the lower interest rate, there is more consumption causing the economy to automatically brought back to the full-employment level of outputo Output does not change, only prices change- Keynesian model of aggregate demando Consumption depends on income Only a fraction of additional income is spent on consumption, the rest is saved The fraction of additional income spent on consumption is called the “marginal propensity to consume” (mpc)- Marginal propensity to save (mps)= 1-mpc- Output Multipliero 1/(1-mpc)o Can have less than full employment in equilibrium If there is too little aggregate demand, firms cannot sell all they produce so output falls until Y=C+IIS CURVE- Investment = Savings: IS Curve- Consumption and savings depends on the level of income/output Y- Suppose the level of investment depends on the real interest rate (r).o A higher r reduces demand for investmento A lower r increases investment demand- IS curve is the combination of income levels (Y) and interest rates (r) at which investment equals saving- Movement along the curve:o Changes in r (which determines investment) and Y (which determines consumption/savings)- Shifts in curves:o Government spending (increase shifts IS right as well as AD)o Exports- increase shifts IS righto Imports- increase shifts IS leftMONEY SUPPLY- M1 includes:o Currency in circulationo Checking accounts and demand deposits- Liquidity-ease at which an asset can be turned into or used as money - Liquidity demand= demand for money- M2 includes:o Savings accountso Money market mutual fundso Time deposits- M3 includes:o Large time depositso Money market fundso Repurchase agreements- Monetary policy is controlled by central bank- Real balances refer to the purchasing power of the money supplyo Real balances= money supply divided by the price level (M/P)o Higher prices reduce the purchasing power of the money supply- Interest rates:o Nominal interest rates- actual market rateo Real interest rate= nominal interest rate-inflation- Demand for money depends on income and interest rate- Transactions demand for moneyo When output/income increases, so does the demand for money- Opportunity cost of holding moneyo The interest rate represents the opportunity cost of holding money-since money does not earn interest- In equilibrium, the supply of money must equal the demand for moneyLM CURVE- Liquidity Demand Equals Money Supply- Descries the values of Y and r where money demand equals money supplyo Higher Y- excess demand for money Equilibrium requires higher interest rateso Lower Y-surplus supply of money Equilibrium requires lower interest rates- Movement along the LM curve:o Changes in money demand due to changes in income/output (Y) or interest rates (r)- Shifts in the LM curve:o Primarily due to changes in the money supply and /or real balanceso Changes