MACROECONOMICS STUDY SHEET Copyright 1997 Roger E Wehr Equilibrium GDP Y S T M I G X Three Main Variables in Macroeconomics 1 Output C a bY GOP GNP where a autonomous b MPC 2 Prices CPI PPI GOP deflator GDP deflator Nominal GDP I Real GDP 3 Unemployment Unemployment S a 1 b Y where a autonomous dissaving 1 b MPS APC CIY APS SIY APC APS 1 MPC AC AY MPS AS AY MPC MPS 1 1 b Structural c Cyclical The natural rate of unemployment is approximately equal to the sum of frictional and structural unemployment Approach to GDP controversial Y C S T MULTIJ LIERS 1 Investment Multiplier This mu iplier tells us how much equilibrium income changes when investment changes Gross Domestic Product GDP Depreciation Indirect Business Taxes Rent Wages Interest Profit Net Domestic Product A Y 1 GDP DepreciatiOn Indirect Business Taxes Rent Wages Interest Profit AI 1 MPC 2 Government Multiplier This mu iplier tells us how much equilibrium income changes when govemment spending changes National Income GDP Depreciation Indirect Business Taxes Rent Wages Interest Profit AY Trnnsfer Payments Social Security Contributions Undistributed COI JOIateProfits Y Y T Expenditures Appro80h to GDP Y C I G X M Income Approach to GDP Y C S T Formula for the 45 degree line Y AE NOTE The intersection of the 45 degree line with the AE function will determine the equilibrium level of output Y Leakages Injections Approach to 1 AG 1 MPC 3 Tax Multiplier This mu iplier tells us how much equilibrium income changes when Penonal Income Personal Taxes is a function of disposable income Also note saving is a function of disposable income 2 0 MPC 1 The Marginal Propensity to Consume is some number between zero and one 3 If Y increases then APC falls As Income rises the Average Propensity to Consume falls The third conjecture is the most a Frictional Disposable Income Y Penonallncome C f yd Consumption Types of Unemployment Nationallnoome Three Keynesian Conjectures Regarding Consumption Rate UI L whereL U E hi me consumption BuDding the Keynesian Expenditures Model Stage 1 Consumption AE1 C To solve for yo set Y C NOTE When Y AE the level of savings will equal zero 5 0 Stage 2 Investment AE2 C 1 To solve for Y set Y C 1 NOTE When Y AE the level of savings will equal the level of investment 5 1 Stage 3 Government AE3 C I G To solve for yo set Y C I G NOTE When Y AE the level of savings will equal the level of investment plus govemment spending 5 I G Stage 4 Taxes AE4 C Y T I G To solve for Y set Y C Y T I G NOTE When Y AE the level of savings taxes Leakages will equal the level of investment government T spending Injections Stage 5 Net Exports Aft C Y T I G X M To solve for yo set Y C I G XM NOTE When Y AE the level of savings taxes imports Leakages investment will equal the level of govemment spending taxes changes AY MPC exports Injections AT 5 T M 1 MPC 4 Money Multiplier This mu iplier tells us how much the money supply could grow potentially with an initial deposit Note If the Required Reserve Ratio is small then the money mu iplier will be large and vice versa 1 I Required reserve ratio 8 In G I G X Three Funotio of Money 1 Medium of exchange Barter requlrea a double colne dence of wants 2 Store of Value 3 Unit of Account MACROECONOMICS STUDY SHEET Rule of 72 To determine how fast an item doubles divide the nmnber 72 by the rate For example if inflation grows at an annual rate of 12 then it will take approximately 6 years for the inflation rate to double Four Tools of the Fed Copyrightl997 4 Correlation does not mean Causation the erroneous notion that when items are correlated that one item must cause the other 5 Reverse causation the erroneous notion that A causes B when in fact B causes A I Reserve Requirements NOTE Ockham s Razor the model with the fewest variables is preferred 10 a model which If RR increases then Ms decreases explains a situation equally well with a Contraetionary Fiscal Policy a decrease in government spending and or an increase in taxes Cost pusb Inflation inflation which is caused bY a leflward shift of AS Crowding Out a condition in which an increase in government spending forces out some private investment from the economy larger number of variablcs 2 Discount Rate If the discount rate increases then Ms decreases Classical versus Keynesian Macroeconomy 3 Open Market Classical The economy is inherently stable government intervention is destabilizing Operations If the Fed buys bonds then the Ms increases If the Fed sells bonds then the Ms decreases 4 Moral Suasion a k a Open Mouth Operations The Equation of Exchange MV PY AM RogerE Wehr Economic Definitions AV AP AY where M money supply V velocity P price level and Y income output Three Keynesian Motives for Holding Money AS is vertical Views of the Note Prices are flexible Demand pull Inflation inflation which is caused bY a rightward shift of AD Elasticity a measure of responsiveness the percentage change in quantity divided bY the percentage change in the variable of interest Keynesian The economy is inherently unstable government intervention is stabilizing Expansionary Fiscal Policy an increase in government spending and or a decrease in taxes AS is horizontal Fiscal Policy a change in government spending and or a change in taxes Note Prices are sticky National Debt v Bpdget Deficit National Debt stock concept 5 trillion Budget Deficit flow concept 150 250 billion per year Economic Laws Flow the quantity which occurs over a period of time Keynesian Cross the intersection of the 45 degree and AE lines Inflation an increase in the overall price level TI 1 Transactions Demand posKlvely related to Income Law of Supply As the price of a good increases the quantity supplied increases 2 Speculative Demand negatively related to the Interest rate Law of Demand As the price of a good increases the quantity demanded decreases Misery Index the sum of the inflation rate and the unemployment rate Say s Law Classical its own demand Monetary Policy a change in the Money supply 3 Precautionary related to Income Demand positively Economic Warnings Supply creates I Post Hoc Ergo Propter Hoc Fallacy Gresham s Law Bad money drives because of this therefore because of this good money out of circulation the erroneous notion that because A precedes B that A causes B 2 Fallacy of Composition the erroneous notion that what holds true for the individual must also hold true for the group as a whole 3 Violation of ceteris paribus all other things being equal the error in