Master Macroeconomics: Insights into National Income & Policies

School

Concordia University**We aren't endorsed by this school

Course

ECON 203

Subject

Economics

Date

Dec 12, 2024

Pages

225

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Econ203-FTamjidDohaChowdhur

1CONCORDIA UNIVERSITY Department of Economics ECON 203/4 SECTIONS D, E, F, G and EC INTRODUCTION TO MACROECONOMICS1WINTER 2023 SECTION D SECTION E SECTION F Instructor: Fatina Siblini Maria Da Palma David Desjardins Email: fatina.siblini@concordia.camaria.dapalma@concordia.cadavid.desjardins@concordia.caOffice Hours: TuTh 13:00 – 14:00 (H 1155.33) M 18:00 – 19:00 (H 1150) F 12:30 – 14:30 (H 1150) Lecture Hours: TuTh 14:45 – 16:05 (MB 1.210) Sa 11:45 – 14:30 (H 110) F 14:45 – 17:30 (H 110) SECTION G SECTION EC Instructor: Maria Da Palma Xintong Han Email: maria.dapalma@concordia.ca xintong.han@concordia.ca Office Hours: M 18:00 – 19:00 (H 1150) Tu 10:00 – 11:30 (H 1155.15) Lecture Hours: MW 16:15 – 17:30 (MB 1.210) Online (Asynchronous) Course Description: A university-level introduction to national income determination, short- and long-run macroeconomic models, money and banking, fiscal and monetary policies, exchange rates and the balance of payments. Course Prerequisite: None. Course Objectives: This objective of this course is to give students insight into the dynamics of the modern macroeconomy, making them better-informed citizens and allowing them to follow the media’s coverage of economic policy debates and issues. At the end of this course, students should understand the various measures of a macroeconomy’s wellbeing (eg, GDP, and unemployment, inflation, interest and exchange rates), monetary and fiscal policies, and the modern fractional reserve banking system. Required Textbook and Lab Component: Ragan, C. Macroeconomics, 17thCanadian Edition. Pearson, 2022. §To purchase access to the e-text and MyLab, click on the MyLab and Masteringicon on Moodle. Course Assessment: COMPONENT WEIGHT DESCRIPTION Labs (10) 20 percent Due Sundays before 11:59pm starting January 29 Midterm 1 20 percent Chapters 4 – 8 (Sunday, February 26, 13:15 – 14:30 Eastern) Midterm 2 20 percent Chapters 9 – 13 (Sunday, April 2, 13:15 – 14:30 Eastern) Final Exam 40 percent Chapters 4 – 16, 19 (Date and Time To Be Determined) Coordination:ECON 203 is coordinated across all sections in terms of course content, pace of coverage, labs and exams. 1Every effort has been made to ensure the accuracy of the information contained in this course outline. In the event of extraordinary circumstances and pursuant to the Academic Regulations, the University and/or instructor may modify the delivery, content, structure, forum, location and/or evaluation scheme. In such an event, students will be informed.

2Lectures:§Lectures (except for section EC) take place in person. Attendance is not required, but lectures are not recorded so you are responsible for any material covered in class (see Tentative Lecture Schedule and Assigned Readingson page 6). §For section EC only, lectures are pre-recorded and posted on Moodle for asynchronous delivery. These lectures should be watched according to a traditional in-class semester schedule to ensure deadlines are met and exams are not missed (see Tentative Lecture Schedule and Assigned Readingson page 6). §While the lectures (for all sections) focus overwhelmingly on what is in the textbook, you are ultimately responsible for familiarity with the content covered in the textbook but not in the lectures and the content covered in the lectures but not in the textbook. Office Hours: §Office hours are not recorded, optional and take place in person (see banner on page 1). §Office hours are offered on a first-come, first-served basis and not by appointment. §If you use office hours, you are expected to “arrive” prepared (ie, with your questions ready) and to be efficient so that the maximum number of students can make use of the available time. §If you are unable to attend office hours because of scheduling conflicts, you can email your questions with attached audio, video and/or pictures. The more precise the information you provide, the faster and more precise the instructor can respond. Labs:§There are ten (10) MyLab labs, each worth two percent. These labs are very similar to more traditional, hardcopy assignments that students would submit to instructors. The purposes of the labs are to: (1) reinforce material covered in class; (2) teach material for which there is insufficient time in class; (3) keep students on track with course learning objectives; and, (4) provide students with immediate evaluation and feedback. §Labs are always accessible (except during exams) by clicking on the MyLab and Masteringicon on Moodle after purchasing the access code and registering in the appropriate section. Do NOT register by going directly to MyLab’s website as you will be asked for a course ID and you are not provided with one.§The grade on your FIRST attempt for each question (if it is before the deadline) is the one that is recorded. After the deadline, a copy of each lab is available for you to practice as much as you like. Grades from those attempts do not count. §Labs are due Sundays at 11:59pm Eastern (see Tentative Lecture Schedule and Assigned Readingson page 6). The time is based on MyLab’s clock. The best way to avoid missing deadlines is to do the labs ahead of time, not just prior to the deadline. §You may ask for a 48-hour extension for any ONE of the ten labs. No documentation and no reason are required, but you should use the extension opportunity judiciously and not use it without legitimate reason because a second extension will not be provided. §If Pearson makes MyLab unavailable for an unscheduled reason (eg, a technical error on its part) and the instructordetermines that this makes it impossible for you to complete your lab by the assigned deadline, then you may request an extension, without penalty, equal to the time that MyLab was unavailable. Note that this does not apply when you experience technical difficulties on your part. §Each lab consists of some multiple-choice, graphical, numerical and conceptual questions. Evaluation and feedback are provided immediately. §Some MyLab questions are based on computer algorithms. This means that every time a lab is attempted, some parameters (eg, numbers, wording) of the questions may differ. §Labs do not have a preset amount of time to finish, but inactivity for extended periods could result in MyLab automatically logging you out. §Address technical problems and questions directly to Pearson (https://support.pearson.com/getsupport).

3 Exams:§There are two midterms written outside of class time (Sunday, February 26 and Sunday, April 2) that cover the first- and second-thirds of the course, respectively, and a cumulative final written during the final exam period. (See Course Assessmenton page 1 and Tentative Lecture Schedule and Assigned Readingson page 6 for more details about the contents and weights.) §You are responsible for knowing the date, time and location of the final exam and can find the information posted in multiple places around the Concordia campus and online. §The format, content and delivery of the midterm and final exams are identical across all sections (including section EC): closed book, multiple choice and in person. §The weight of a missed midterm, for any reason (eg, illness, religious, work obligation, exam scheduling conflict, etc.), is shifted automatically to the final. There are NO MAKEUP, ALTERNATE OR DEFERRED MIDTERMS under any circumstances, nor may they be written early. §If you miss, or cannot write, the final, you must request a deferred exam according to the process described here. Final exam accommodations are almost never approved for reasons relating to personal/family travel/events. §You may use a non-programmable calculator and scrap paper that is provided to you by the instructor to assist you, but you may NOT use any other additional materials (eg, formula sheets, dictionaries, etc.). If you fail to follow any of these instructions, you will receive a grade of zero for the exam and will face academic misconduct proceedings in accordance with Concordia’s policies on academic integrity. If you are unsure if what you are doing is acceptable, ask first. §You must use pencil and fill out the student number on the Scantron correctly. You must also write the exam in the classroom to which you are assigned (your instructor will provide room assignments closer to the midterm dates). If you fail to follow any of these instructions, you will receive a grade of zero for the exam without the opportunity to shift the weight to the final. No exceptions. §Do NOT underestimate the difficulty of the exams. The style of the exams is to ensure timely feedback; you should not interpret that the exam is easy because it is multiple choice. §Questions involve algebra, definitions, interpretations and multi-part questions where the answer to one multiple-choice question may lead to another. §If you require university-approved special accommodations (eg, 30 min/hr extra writing time), you must secure the necessary approval from the Concordia Access Centre for Students with Disabilities (ACSD) and notify the instructor at least one week prior to the exam to receive it. §You may reviewyour exam during in-person office hours. During that time, you may not take notes, pictures, etc. of the exam contents. Intellectual property laws protect the contents of the exam. Correspondence: If you need to email the instructor, it mustoriginate from your Concordia email address. Any email from anyother address will be treated as spam and will be neither read nor answered. This policy protects confidentiality and confirms the student’s identity. If you have not activated your address already, follow the instructions at www.concordia.ca/it/services/email-for-students-office-365.html. Drop-In Centre: In place of the traditional in-class tutorials, graduate students in the department of economics provide a “drop-in centre” both on campus and on Zoom, where students can seek clarification on course-related materials. These drop-in centre hours are not recorded and are optional. The centre begins in week 3 and continues until the final exam. Hours may change week to week with extra hours provided before the midterms and final if there is insufficient time within the existing hours. Information will be posted on Moodle when it is available.

4 Discussion Board: Graduate students manage a discussion board on Moodle for those looking to post course-related questions. Students can expect responses within 24 – 48 hours depending on the day of the week and the volume of questions posted. This, rather than the instructor, should be used as a point of first contact for course-related questions, comments and issues. Study Group Sessions: The Student Success Centre organises study groups for students enrolled in ECON 203. Students attending the groups can review course content, work on sample problems together and review prerequisite material needed to succeed in economics. Students who have had previous success in the courses run these groups. Schedules are available on Moodle. Grade Criterion: A+ 90 – 100 4.3 B+ 77 – 79 3.3 C+ 67 – 69 2.3 D+ 57 – 59 1.3 FNS 00 – 49 0.0 A 85 – 89 4.0 B 73 – 76 3.0 C 63 – 66 2.0 D 53 – 56 1.0 DNW A- 80 – 84 3.7 B- 70 - 72 2.7 C- 60 – 62 1.7 D- 50 – 52 0.7 NR Grade Distribution: It is the policy of the Department of Economics that courses at the 200-level should not have more than half of the class receiving grades of A’s and B’s without “serious reflection”. In the event that the actual distribution differs from department policy, department policy takes priority and adjusting the thresholds listed in Grade Criterionmay be necessary to ensure compliance. This adjustment (up or down) will not be considered as grounds for appealing a final grade. Copyright of Lectures:Content belonging to instructors shared in courses, including, but not limited to, online or in-person lectures, course notes, exams and video/audio recordings of classes remain the intellectual property of the faculty member. It may not be distributed, published or broadcast, in whole or in part, without the expressed permission of the faculty member. Students are also forbidden to use their own means of recording any elements of an online class or lecture without express permission of the instructor. Any unauthorised sharing of course content may constitute a breach of Concordia University’s Academic Code of Conduct and/or Code of Rights and Responsibilities as well as The Canadian Copyright Act. As specified in the Policy on Intellectual Property, the University does not claim any ownership of or interest in any student IP. All university members retain copyright over their work. Third-Party Software:Students are advised that an external website is used in the course and students will be asked to submit or consent to the submission of personal information (eg, name and email) to register and to the submission of their work for evaluation. Students are responsible for reading and deciding whether to agree to any applicable terms of use. Use of this external website is voluntary. Students who do not give their consent should identify themselves to the course instructor as soon as possible, and in all cases before the DNE deadline, to discuss alternate modes of participation. Students are advised that the University cannot guarantee the protection of intellectual property rights or personal information provided to any external website. Intellectual property and personal information held in foreign jurisdictions are subject to the laws of such jurisdictions.

5 Private Tutors: Students are advised that the Department of Economics does not support and cannot guarantee the quality of any private tutoring service offered by outside institutions. Students are encouraged to use caution and should be aware that they enrol in such services at their own risk. Student Responsibilities: Students are expected to be aware of their academic responsibilities as outlined in the Code of Rights and Responsibilities. Student Services: Access Centre for Students with DisabilitiesDepartment of Economics Academic AdvisingStudent Success CentreCounselling and Psychological ServicesHealth Services Financial Aid and Awards Academic Integrity Dean of Students Office International Students Office Student Hub Sexual Assault Resource Centre Concordia Student Union Academic Calendar Third-Party Educational Software or Services Important University Dates: DATE EVENT January 9 Classes begin and Moodle page available January 23 Deadline to add winter-term courses January 23 Deadline for withdrawal with tuition refund (DNE) from fall‑term courses February 27 – March 5 Reading Week – no classes March 1 Deadline to apply for admission to Fall 2023 undergraduate programs and degree transfer March 17 Last day to register with ACSD to receive accommodations for winter-term finals April 6 Last day for instructor-scheduled exams April 7 – 10 Easter – university closed April 17 Last day of classes April 18 Last day for academic withdrawal (DISC) from fall-term courses April 18 Make-up day for classes scheduled on April 7 and April 8 April 20 – May 2 Final exam period (date, time and location posted on campus and online)

6 Tentative Lecture Schedule and Assigned Readings (Section F): DATE EVENT COVERAGE January 13 Introduction What Macroeconomics Is All About –– Chapter 4 January 20 The Measurement of National Income Chapter 5 January 27 The Simplest Short-Run Macro Model Chapter 6 January 29 LAB 1 DUE Chapters 4 – 5 February 3 Adding Government and Trade to the Simple Macro Model Chapter 7 February 5 LAB 2 DUE Chapter 6 February 10 Real GDP and the Price Level in the Short Run Chapter 8 February 12 LAB 3 DUE Chapter 7 February 17 From the Short to the Long Run: The Adjustment of Factor Prices Chapter 9 February 19 LAB 4 DUE Chapter 8 February 24 Long-Run Economic Growth Chapter 10 February 26 MIDTERM 1 (13:15 – 14:30) Chapters 4 – 8 March 10 Money and Banking Chapter 11 March 12 LAB 5 DUE Chapters 9 – 10 March 17 Money, Interest Rates and Economic Activity Chapter 12 March 19 LAB 6 DUE Chapter 11 March 24 Monetary Policy in Canada Inflation and Disinflation Chapter 13 Chapter 14 March 26 LAB 7 DUE Chapters 12 – 13 March 31 Unemployment Fluctuations and the NAIRU Chapter 15 April 2 MIDTERM 2 (13:15 – 14:30) Chapters 9 – 13 April 9 LAB 8 DUE Chapter 14 April 14 Government Debt and Deficits Chapter 16 April 16 LAB 9 DUE Chapters 15 – 16 April 18 Exchange Rates and the Balance of Payments Chapter 19 April 23 LAB 10 DUE Chapter 19 TBD FINAL EXAM Chapters 4 – 16, 19

Copyright © 2023 Pearson Canada Inc.4 -2Chapter Outline/Learning ObjectivesSectionLearning ObjectivesBlankAfter studying this chapter, you will be able to4.1 Key Macroeconomic Variables1.define the key macroeconomic variables: national income, unemployment, productivity, inflation, interest rates, exchange rates, and net exports.4.2 Growth Versus Fluctuations2.understand that most macroeconomic issues are about either long-run trends or short-run fluctuations, and that government policy is relevant for both.

Copyright © 2023 Pearson Canada Inc.4 -34.1 Key Macroeconomic Variables (1 of 4)•National Product and National Income•The production of output generates income.•The meaning of aggregation–This gives nominal national income, which is total national income measured in currentdollars.•Real national income is national income measured in constant(base-period) dollars. It changes only when quantities change.

Copyright © 2023 Pearson Canada Inc.4 -44.1 Key Macroeconomic Variables (2 of 4)•One of the most commonly used measures of national income is called gross domestic product (GDP).•GDP can be measured in real or nominal terms.•The major movement of real GDP is a positive trend that increased real output by almost four times since 1975. This is referred to as long-term economic growth.•Real GDP also shows short-term fluctuations around the trend.

Copyright © 2023 Pearson Canada Inc.4 -5Figure 4-1 Growth and Fluctuations in Real GDP, 1975–2020Real GDP measures the quantity of total output produced by the nation’s economy during a year. Real GDP is plotted in part (i). With only a few interruptions, it has risen steadily since 1975, demonstrating the long-term growth of theCanadian economy. Short-term fluctuations are obscured by the long-term trend in part (i) but are highlighted in part (ii). The growth rate fluctuates considerably from year to year. The long-term upward trend in part (i) reflects the positive average annual growth rate of 2.4 percent in part (ii), shown by the dashed line.(Source: Based on Statistics Canada, Table 36-10-0369-01.)

Copyright © 2023 Pearson Canada Inc.4 -74.1 Key Macroeconomic Variables (4 of 4)•Potential output (Y*) •The output gap measures the difference between potential output and actual output. Output Gap = Y− Y*•When Y< Y*, the output gap is a recessionary gap.•When Y> Y*, the output gap is an inflationary gap.

Copyright © 2023 Pearson Canada Inc.4 -8Figure 4-2 Potential GDP and the Output Gap, 1985–2020Potential and actual GDP both display an upward trend. The output gap measures the difference between an economy’s potential output and its actual output; the gap is expressed here as a percentage of potential output. Since 1985, potential and actual GDP have almost doubled. The output gap in part (ii) shows clear fluctuations. Shaded areas show inflationary and recessionary gaps.(Source: Real GDP based on Statistics Canada, Table 36-10-0369-01; output gap based on www.bankofcanada.ca.)

Copyright © 2023 Pearson Canada Inc.4 -9Why National Income Matters•National income is an important measure of economic performance•Recessions are associated with unemployment and lost output•Booms can bring inflation•The long-run trend in real per capita is an important determinant of standard of living.•Economics grow doesn’t make everyonebetter off

Copyright © 2023 Pearson Canada Inc.4 -10Employment, Unemployment, and the Labour Force (1 of 3)•Employment •Unemployment •Labour force•Unemployment rateNumber of people unemployedUnemployment rate100Number of people in the labour force

Copyright © 2023 Pearson Canada Inc.4 -11Employment, Unemployment, and the Labour Force (2 of 3)•Potential GDP ‒ fullemployment. •Even when the economy is at full employment, some unemployment exists because of natural turnover in the labour market (frictional unemployment)and the mismatch between jobs and workers (structural unemployment).•When real GDP is less than potential GDP, there is cyclical unemployment.

Copyright © 2023 Pearson Canada Inc.4 -12Figure 4-3Labour Force, Employment, and Unemployment, 1976–2020The labour force and employment have grown since 1976 with only a few interruptions. The unemployment rateresponds to the cyclical behaviour of the economy. Both the labour force and the level of employment in Canada haveapproximately doubled since 1976. Booms are associated with a low unemployment rate and slumps with a highunemployment rate.(Source: Based on data from Statistics Canada, Table 14-10-0327-01.)

Copyright © 2023 Pearson Canada Inc.4 -13Employment, Unemployment, and the Labour Force (3 of 3)•Employment has grown roughly in line with the growth in the labour force.•The data also shows that the short-term fluctuations in the unemployment rate have been substantial.•The unemployment rate has been as low as 5.7 percent in 2019 and as high as 12 percent during the deep recession of 1982. •During the COVID-19 pandemic, the unemployment rate increased to a high of 13.7 percent, and then gradually fell throughout 2020.

Copyright © 2023 Pearson Canada Inc.4 -14Why Unemployment Matters•Enormous social significance•Loss of income •Loss of output•Crime, mental illness, and general social unrest tend to be associated with long-term unemployment

Copyright © 2023 Pearson Canada Inc.4 -15Productivity•Productivity is a measure of the amount of output that the economy produces per unit of input.•Labour productivity is the level of real GDP divided by the level of employment (or total hours worked).•There has been a significant increase in labourproductivity over the past half-century .•Productivity growth is the single largest cause of rising material living standards over long periods of time.

Copyright © 2023 Pearson Canada Inc.4 -16Figure 4-4Canadian Labour Productivity, 1976–2020(Source: Based on data from Statistics Canada. Real GDP: Table 36-10-0369-01. Hours worked: Table 14-10-0043-01.Employment: Table 14-10-0327-01.)

Copyright © 2023 Pearson Canada Inc.4 -17Inflation and Price Level•The price level is the average level of all prices in the economy expressed as an index number. •Inflation•The Consumer Price Index (CPI) •Rate of inflation calculation with CPI data

Copyright © 2023 Pearson Canada Inc.4 -18Why Inflation Matters (1 of 2)•We value money not for itself but for what we can purchase with it.•The purchasing power of money is the amount of goods and services that can be purchased with a unit of money.•Inflation reduces the purchasing power of money. It also reduces the real value of any sum fixed in nominal (dollar) terms.

Copyright © 2023 Pearson Canada Inc.4 -19Why Inflation Matters (2 of 2)•If households and firms fully anticipate inflation over the coming year, they will be able to adjust many nominal prices and wages to maintain their real values.•Unanticipated inflation generally leads to more changes in the real value of prices and wages.•In reality, inflation is rarely fully anticipated or fully anticipated.•As a result, some adjustments in wages and prices are made but not all the adjustments that would be required to leave the economy’s allocation of resources unaffected.

Copyright © 2023 Pearson Canada Inc.4 -20Figure 4-5 The Price Level and the Inflation Rate, 1960–2020The rate of inflation measures the annual rate of increase in the price level. The trend in the price level has been upward over the past half-century. The rate of inflation has varied from almost 0 to more than 12 percent since 1960.(Source: Based on data from Statistics Canada, Table 18-10-0004-01. The figures shown are annual averages of the monthly data.)

Copyright © 2023 Pearson Canada Inc.4 -21Interest Rates•The interest rate is the price paid per dollar borrowed per period of time, expressed either as a proportion (e.g., 0.06) or as a percentage (e.g., 6 percent)•Compare the prime interest rate to the bank rate•Nominal interest rate vs. real interest rate •Why do interest rates matter? –Compare effects on savers to that on borrowers–Impact on investment plans•Interest rates and credit flows

Copyright © 2023 Pearson Canada Inc.4 -22Figure 4-6 Real and Nominal Interest Rates, 1965–2020(Source: Nominal interest rate: 3-month Treasury bill rate, Statistics Canada, Table 10-10-0122-01. Real interest rate is based on Statistics Canada, Table 18-10-0005-01.)

Copyright © 2023 Pearson Canada Inc.4 -23Exchange Rates and Trade Flows (1 of 3)•In June 2021 you could buy 0.68 euros for each dollar that you gave up. Or you could buy 1 euro for 1.47 dollars.•The exchange rate•Foreign currency •The foreign-exchange market•Appreciation vs. depreciation

Copyright © 2023 Pearson Canada Inc.4 -24Figure 4-7 Canadian–U.S. Dollar Exchange Rate, 1975–2020The Canadian–U.S. exchange rate has been quite volatile over the past five decades. The Canadian-dollar price of one U.S. dollar increased from just over $1 in the early 1970s to over $1.55 in 2002, a long-term depreciation of the Canadian dollar. By 2012 the Canadian dollar had appreciated and it again cost about $1 to purchase one U.S. dollar. Between 2012 and 2020, the Canadian dollar depreciated against the U.S. dollar again, by about 30 percent. (Source: Based on annual average of monthly data, Statistics Canada, Table 33-10-0163-01.)

Copyright © 2023 Pearson Canada Inc.4 -25Exchange Rates and Trade Flows (2 of 3)•In Canada, the path of the trade-weighted exchange rate is virtually identical to the Canadian–U.S. exchange rate shown in Figure 4-7, reflecting the very large proportion of total Canadian trade with the United States.•Two notable periods: –Depreciation of CDN$ in the late1990s–Appreciation of CDN$ during the 2002‒2012 period

Copyright © 2023 Pearson Canada Inc.4 -26Exchange Rates and Trade Flows (3 of 3)•Canada has long been a trading nation•Compare the history of the relative size of exportsto imports•Net exports are the difference between exports and imports and are often called the trade balance.•Canada’s exports and imports have increased fairly closely in step with each other over the past 40 years.•The trade balance has fluctuated mildly over the years, but it has stayed relatively small, as a proportion of total GDP.

Copyright © 2023 Pearson Canada Inc.4 -27Figure 4-8Canadian Imports, Exports, and Net Exports, 1980–2020Though imports and exports have increased dramatically over the past four decades, the trade balance has remained roughly in balance. The nominal values of imports and exports rose steadily over the past few decades because of both price increases and quantity increases. The growth of trade increased noticeably after the early 1990s. The trade balance—net exports—is usually close to zero.(Source: Based on Statistics Canada, Table 36-10-0104-01.)

Copyright © 2023 Pearson Canada Inc.4 -284.2 Growth Versus Fluctuations•Long-Term Economic Growth–Long-term trends of rising total output and output per person have meant rising average living standards.–Long-term growth receives less attention in the media but has more importance for a society’s living standards from generation to generation.–There is considerable debate regarding the ability of government policy to influence the economy’s long-run rate of growth.

Copyright © 2023 Pearson Canada Inc.4 -29Short-Term Fluctuations•Short-term fluctuations lead economists to study business cycles.•Economists debate the effectiveness of monetary and fiscal policy in influencing these fluctuations.•Some economists argue that despite the power of policy to affect the economy, governments should not attempt to “fine-tune” the economy by making frequent changes in spending and taxing.

Chapter4:WhatMacroisallabout(FP)1.FiscalPolicy-Gov'sabilitytospendandtax(MP)2.MonetaryPolicy-Centralbank'sabilitytocontrolthemoneysupply.3.IncomePolicy-Controlofwages/prices4.SupplySidePolicy-AffectGDPthroughtaxation.keyvariables(GDP)1.NationalOutput(GrossDomesticProduct)⊥Real-Adjustedforprice⊥Nominal-Today'smoney.GDP(Goesup)RecessionRecovery~PeakTroughtime

⊥Potentialoutput-GDPIfallressoncesusedtocapacityOG>O-YnflationaryG~DOGLO-DRecessionaryG⊥outputGap(OG):Y-YpG.Employment(andunemployment)⊥Employed:15+yearsandworkingforpay/profit⊥unemployed:upfrontwork,butlooking(generally4weeks)outoflaborforce(LF)⊥EmployedandUnemployed.workingagepopulation(WAP):⊥15+yearsandavailabletoworkUnemploymentrate:oemployedx100LF

Labourforceparticipation:px100Typesofunemployment:1.Frictional(Laidoff)2.Structural3.Seasonal4.Cyclical.wheny=YP(output=potentialoutput)Isfullemployment⊥frictional/structuralseasonal.INAIRU:Non-AccelaratingInflationRateofUnemployment.

3.InflationandPriceLevel⊥Pricelevel-AveragePrices⊥ConsumerPriceIndex(CPI)⊥looksatvalueofconsumerbasketofgoods.CPI=veofBasketincurrentyrx100valueofBasketinBaseYrEx:CPI,g=133.8CP117=130.4%D=woldx 10%.D=13 3.8-130.4 x 100130.4=2.6%->lossinpurchasingpower.4.InterestratesImoundpaid/$$BorrowedNominalvsReal?i=M+He-+FisherEquation

5.ExchangeRates(e)e=Se-Dif e=appreciation$OSDforCDN5)1.33CDN=irsifeM=depreciationife X=depreciatione=$OSD-Dife*-appreciatione$CDN$ICDN=50.75USDthevalueof1interferersanother?if$CDNdepreciates:exportsimports

Copyright © 2023 Pearson Canada Inc.5 -2Chapter Outline/Learning ObjectivesSectionLearning ObjectivesBlankAfter studying this chapter, you will be able to5.1 National Output and ValueAdded1.see how the concept of value added solves the problem of “double counting” when measuring national income.5.2 National Income Accounting:The Basics2.explain how GDP is measured from the expenditure side and from the income side.5.3 National Income Accounting:Some Further Issues3.explain the difference between real and nominal GDP.4.discuss the many important omissions from official measures of GDP.5.understand why real per capita GDP is a good measure of average material living standards but an incomplete measure of overall well-being.

Copyright © 2023 Pearson Canada Inc.5 -35.1 National Output and Value Added (1 of 2)•Production occurs in stages.•Some firms produce outputs that are used as inputs by other firms, and these firms, in turn, produce outputs that are used as inputs by yet other firms.•The error that would arise in estimating the nation’s output by adding all sales of all firms is called double counting.•Compare intermediate goods to final goods

Copyright © 2023 Pearson Canada Inc.5 -45.1 National Output and Value Added (2 of 2)•To avoid double counting, use the concept of value added. Value added = Sales rev. − Cost of intermediate goodsandValue added = Payments owed to the firm’s factors of production•The sum of all values added in an economy is a measure of the economy’s total output.

Copyright © 2023 Pearson Canada Inc.5 -65.2 National Income Accounting: The Basics•Three different ways of measuring national income.1.The concept of value added.2.Sum the total flow of expenditure on final domestic output.3.Sum the total flow of income generated by the flow of domestic production.•All three measures yield the same total, grossdomestic product (GDP), which is the total value of goods and services produced in the economy during a given period.

Copyright © 2023 Pearson Canada Inc.5 -8GDP from the Expenditure Side (1 of 4)•GDP for a given year is calculated from the expenditure side by adding up the expenditures needed to purchase the final output produced in that year.1.Consumption ExpenditureHousehold expenditure on all goods and services.2.Investment ExpenditureExpenditure on the production of goods not for present consumption.

Copyright © 2023 Pearson Canada Inc.5 -9GDP from the Expenditure Side (2 of 4)•Investment expenditure also includes inventories.•Investment expenditure also includes capital goods and residential housing.•The economy’s total quantity of capital goods is called the capital stock.•Creating new capital goods is called fixed investment.

Copyright © 2023 Pearson Canada Inc.5 -10GDP from the Expenditure Side (3 of 4)•Net investment = Gross investment – Depreciation•The total amount of investment in any given year is the sum of the changes in inventories, the additions to the stock of plant and equipment, and the new construction of residential housing units.3.Government PurchasesGovernment purchases –Expenditure on currently produced goods and services, exclusive of government transfer payments.

Copyright © 2023 Pearson Canada Inc.5 -11GDP from the Expenditure Side (4 of 4)4.Net ExportsNet exports = Exports – ImportsMeasured from the expenditure side, GDP is equal to the total expenditure on domestically produced output.GDP = Ca+ Ia+ Ga+ NXa

Copyright © 2023 Pearson Canada Inc.5 -12Table 5-1 GDP from the Expenditure Side, 2020 (1 of 2)CategoryBillions of DollarsPercent of GDPConsumption (C)BlankBlankDurable goods164.5BlankSemi-durable goods84.1 BlankNon-durable goods317.8 BlankServices699.2 BlankBlank1265.6 57.4Investment (I)BlankBlankPlant and equipment185.8 BlankResidential structures185.2 BlankInventories19.8 BlankOther41.4 BlankBlank392.6 17.8

Copyright © 2023 Pearson Canada Inc.5 -13Table 5-1 GDP from the Expenditure Side, 2020 (2 of 2)•GDP measured from the expenditure side of the national accounts gives the size of the major components of aggregate expenditure.•(Source:Based on Statistics Canada, “Gross Domestic Product, Expenditure based, Table 36-10-0104-01.)CategoryBillions of DollarsPercent of GDPGovernment Purchases (G)BlankBlankCurrent expenditure498.7 BlankInvestment94.2 BlankBlank592.926.9Net Exports (X − IM)BlankBlankExports of goods and services638.4BlankImports of goods and services683.7BlankBlank45.32.1Statistical Discrepancy0.90.0Total GDP2204.9100.0

Copyright © 2023 Pearson Canada Inc.5 -14GDP from the Income Side (1 of 3)•Involves adding up factor incomes and other claims on the value of output until all of that value is accounted for.1.Factor IncomesThree main components of factor incomes: wages and salaries, interest, and business profits.2.Non-factor PaymentsIndirect taxes are taxes on the production and sale of goods and services. Subsidies act like negative taxes. They are payments from the government to firms.

Copyright © 2023 Pearson Canada Inc.5 -15GDP from the Income Side (2 of 3)•Some portion of current output replaces worn out physical capital—depreciation.•So from the income side, GDP is the sum of factor incomes plusindirect taxes (net of subsidies) plusdepreciation.

Copyright © 2023 Pearson Canada Inc.5 -16GDP from the Income Side (3 of 3)•When we calculate GDP from the income side, we include a “fudge factor”, called statistical discrepancy.•Statistical discrepancy makes sure that the independent measures of income and expenditure come to the same total.•Although national income and national expenditure are conceptually identical, in practice both are measured with slight error.

Copyright © 2023 Pearson Canada Inc.5 -17Table 5-2 GDP from the Income Side, 2020•GDP measured from the income side of the national accounts gives the sizes of the major components of the income generated by producing the nation’s output.•(Source:Based on Statistics Canada, “Gross Domestic Product, Income based, Table 36-10-0430-01.)CategoryBillions of DollarsPercent of GDPFactor IncomesBlankBlankWages, salaries, and supplementary income1157.252.5Interest and other investment income210.39.5Business profits (including rent)279.512.7Net Domestic Income at Factor Cost1647.074.7Non-factor PaymentsBlankDepreciation388.917.6Indirect taxes less subsidies168.17.6Statistical Discrepancy0.90.0Total2204.9100.0

Copyright © 2023 Pearson Canada Inc.5 -185.3 National Income Accounting: Some Further Issues•Real and Nominal GDP–Total GDP valued at current prices is called nominal GDP.–GDP valued at base-period prices is called real GDP.•The GDP Deflator–If nominal and real GDP change by different amounts over a given time period, then prices must have changed over that period.

Copyright © 2023 Pearson Canada Inc.5 -19GDP from the Income Side•We compare what has happened to nominal GDP and real GDP by calculating the GDP deflator.•The GDP deflatoris an index number derived by dividing nominal GDP by real GDP.•Its change measures the average change in price of all the items in GDP.Nominal GDPGDP Deflator100Real GDP

Copyright © 2023 Pearson Canada Inc.5 -20Figure 5-2 Nominal and Real GDP in Canada, 1985–2020 (billions of dollars)Nominal GDP tells us about the money value of output; real GDP tells us about the quantity of physical output.Nominal GDP gives the total value of output in any year, valued at the prices of that year. Real GDP gives the totalvalue of output in any year, valued at prices from some base year, in this case 2012. The comparison of real and nominalGDP implicitly defines a price index, changes in which reveal changes in the (average) prices of goods produceddomestically. Note that in 2012, nominal GDP equals real GDP (measured in 2012 prices), and thus the GDP deflatorequals 100.(Source: Based on Statistics Canada, Table 36-10-0104-01.)

Copyright © 2023 Pearson Canada Inc.5 -21GDP Deflator versus the CPI•The GDP deflator does not necessarily change in line with changes in the CPI.•The two price indices are measuring different things.•Movements in the CPI measure the change in the average price of consumer goods.•Movements in the GDP deflator reflect the change in the average price of goods produced in Canada.

Copyright © 2023 Pearson Canada Inc.5 -22Omissions from GDP•GDP is an excellent measure of the flow of economic activity in organized markets in a given year.•But much economic activity takes place outside the marketsthat the national income accountants survey.•These activities include:–Illegal Activities (Cannabis now formally included)–The Underground Economy–Home Production, Volunteering, and Leisure–Free Products in the Digital World –Economic “Bads”

Copyright © 2023 Pearson Canada Inc.5 -23Do the Omissions Matter?•The current approach to measuring GDP is useful because:1.It would be difficult to correct the major omissions.2.The levelof GDP may be inaccurate but the changein GDP is a good indication of the changes in economic activity.3.To design policies to control inflation it is necessary to know the flow of money payments made to produce and purchase Canadian output. Modified measures that included non-market activities would distort these figures and likely lead to policy errors.

Copyright © 2023 Pearson Canada Inc.5 -24GDP and Living Standards•To what extent does GDP provide a useful measure of our living standards?•Changes in real per capita income are a good measure of average material living standards.•But material living standards are only part of what most people consider their overall well-being.

1%GDP:LDPGDPxO⊥worksforNominalandrealGDPGDPdeflator:AmeasureofaggregatepriceGDPdeflatorDX100%DGDPDEF=GDPDEFyn-CDPDEFy,x100GDPDEFy,ConsumerPriceindex(CPD)⊥anothermeasureofaggregatepriceCP1=ValueofVirtualBasketinCurrentyeX100ValueofBasketinBaseyo

QQ2PIPeCopie10132023Pizza2023 2527Coffee5834Muffins91223valueofbasketvalueofbasketinyinY2P,xQ1=733P2XQ2=817CPIy,=vey,x100=33x100=100%basevalueIy2-y1⊥ioverstated⊥Substitutionbias⊥New-Comerbias

Limitations1.IllegalActivities2.UndergroundEconomy3.Homeproduction4.Economics"Bad"5.FreestuffGDP/Capitalation

Income=Expenditure=IncomeCalculatingGDP1.valueaddedapproach·2.Expenditureapproach3.Incomeapproachvalueadded⊥whatyoupayforandwhatyouchargefor⊥Salesrevenue-Costofinputs·AvoidsdoublecountingMilkProductionStagesofProd.valueofSalesValieadd.1.Rawmilk$0.700.to$0.702.Processing$1.00$0.303.Shipping$)1.20-D$0.204.RetailSale$1.50-$30total$1.50

Expenditureapproach⊥5broadcategoriesi)Consumption((a)ii)Investment(Fa)(TotalIa/Grossnetinv=Gross-depreciationI?inv↓-PlantisEquipmentreplacementsInventory-Newhousingiii)Gov.expense(Ga)iv)exports(Xa)v)Imports([Ma)GDP=C+I+G+(X-IM)-metExport(NX)

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Copyright © 2023 Pearson Canada Inc.6 -2Chapter Outline/Learning ObjectivesSectionLearning ObjectivesBlankAfter studying this chapter, you will be able to6.1 Desired Aggregate Expenditure1.explain the difference between desired and actual expenditure.2.identify the determinants of desired consumption and desired investment.6.2 Equilibrium National Income3.understand the meaning of equilibrium national income.6.3 Changes in EquilibriumNational Income4.explain how a change in desired expenditure affects equilibrium income through the “simple multiplier.”

Copyright © 2023 Pearson Canada Inc.6 -36.1 Desired Aggregate Expenditure (1 of 4)•The actual values of the various categories of expenditure are indicated by Ca, Ia, Ga, and (Xa− IMa).•Economists use the same letters without the subscript “a” to indicate the desired expenditure in the same categories:–desired consumption, C–desired investment, I–desired government purchases, G–desired net exports, (X–IM)

Copyright © 2023 Pearson Canada Inc.6 -46.1 Desired Aggregate Expenditure (2 of 4)•What Does “Desired” Really Mean?–“Desired” expenditure is not just a list of what consumers and firms would buy if they had no constraints on their spending—it is much more realistic than that. –Desired expenditure is what consumers and firms would like to purchase, given their real-world constraints of income and market prices.

Copyright © 2023 Pearson Canada Inc.6 -56.1 Desired Aggregate Expenditure (3 of 4)•The sum of desired or planned spending on domestic output by households, firms, governments, and foreigners is desired aggregate expenditure.AE= C+ I+ G+ (X− IM)•Elements of aggregate expenditure that do not change systematically with national income are called autonomous expenditures.•Components of aggregate expenditure that do change systematically in response to changes in national income are called induced expenditures.

Copyright © 2023 Pearson Canada Inc.6 -66.1 Desired Aggregate Expenditure (4 of 4)•Assumptions of the simplest short-run macro model:–there is no trade with other countries—that is, the economy we are studying is a closed economy; –there is no government—and hence no taxes; and–the price level is constant.•By simplifying the model we are better able to understand its structure and therefore how more complex versions of the model work.

Copyright © 2023 Pearson Canada Inc.6 -7Desired Consumption Expenditure (1 of 3)•Disposable income= household income ‒ taxes•Saving‒ disposable income not spend on consumption.•The Consumption Function–The consumption functionis the relationship between desired consumption expenditure and all the variables that determine it.–Desired consumption is determined by: disposable income, wealth, interest rates, and expectations about the future.

Copyright © 2023 Pearson Canada Inc.6 -10Desired Consumption Expenditure (2 of 3)Disposable Income (YD)Desired Consumption (C)Desired Saving (S)APC = C/YDΔYDΔCMPC = ΔC/ΔYD030−30—30240.83054−241.80120960.815015001.001501200.8300270300.901501200.8450390600.8775600.8525450750.8675600.8600510900.85BlankBlankBlank

Copyright © 2023 Pearson Canada Inc.6 -11Desired Consumption Expenditure (3 of 3)•Average propensity to consume (APC) APC= C / YD–Note that APCfalls as disposable income rises.•Marginal propensity to consume (MPC)MPC= C / YD–The MPCis the slope of the consumption function.–The constant slope of the consumption function shows that the MPCis the same at any level of disposable income.

Copyright © 2023 Pearson Canada Inc.6 -12The Saving Function (1 of 2)•Households decide how much to consume and how much to save.•Average propensity to save (APS):APS= S / YD•Marginal propensity to save (MPS):MPS= S / YD

Copyright © 2023 Pearson Canada Inc.6 -13The Saving Function (2 of 2)•Because all disposable income is either spent or saved, it follows that the fractions of income consumed and saved must account for all income: APC+ APS= 1•It also follows that the fractions of any increment to income consumed and saved must account for all of that increment: MPC+ MPS= 1

Copyright © 2023 Pearson Canada Inc.6 -14Figure 6-3(i) Shifts in the Consumption Function (1 of 2)(i) The consumption function shifts upward with an increase in wealth, a decrease in interest rates, or an increase in optimism about the future•The consumption function shifts upward with an increase in wealth, a decrease in interest rates, or an increase in optimism about the future.

Copyright © 2023 Pearson Canada Inc.6 -15Figure 6-3(ii) Shifts in the Consumption Function (2 of 2)(ii) The saving function shifts downward with an increase in wealth, a decrease in interest rates, or an increase in optimismabout the future•The saving function shifts downward with an increase in wealth, a decrease in interest rates, or an increase in optimism about the future.

Copyright © 2023 Pearson Canada Inc.6 -16Desired Investment Expenditure (1 of 2)•The three categories of investment are inventory accumulation, residential construction, and new plant and equipment.•Investment expenditure is (1) the most volatile component of GDP, and (2) strongly associated with aggregate economic fluctuations.•Determinants of desired investment expenditure are (1) the real interest rate, (2) changes in the level of sales, and (3) business confidence.•The current level of real GDP is not an important determinant of current desired investment.

Copyright © 2023 Pearson Canada Inc.6 -17Figure 6-4 The Volatility of Private-Sector Investment, 1981–2020The major components of private-sector investment fluctuate considerably as a share of GDP. The recessions of 1982, 1991, 2009, and 2020 are evident from the reductions in investment. These data exclude investment by governmentand non-profit institutions, which combined are quite stable and amount to about 4 percent of GDP. Note that thecategory “plant and equipment” includes investment in intellectual property (IP) products, which result from researchand development (R&D) activities.(Source: Based on author’s calculations using data from Statistics Canada, Table 36-10-0104-01.)

Copyright © 2023 Pearson Canada Inc.6 -19The Aggregate Expenditure Function (1 of 2)•The aggregate expenditure (AE) function relates the level of desired aggregate expenditure to the level of actual national income.•In the absence of government and international trade, desired aggregate expenditure is equal to desired consumption plus desired investment:AE= C+ I

Copyright © 2023 Pearson Canada Inc.6 -20The Aggregate Expenditure Function (2 of 2)•Example:•The consumption function is: C= 30 + (0.8)Y•The investment function is: I = 75•The AEfunction is: AE= C+ I= 30 + (0.8)Y+ 75= 105 + (0.8)Y

Copyright © 2023 Pearson Canada Inc.6 -21Figure 6-6 The Aggregate Expenditure Function•The slope of the AEfunction is the marginal propensity to spend, which in this simple model, is just the marginal propensity to consume.The aggregate expenditure function relates desired aggregate expenditure to actual national income. The curve AE in the figure plots the data from the first and last columns of the accompanying table. Its intercept, which in this case is $105 billion, shows the sum of autonomous consumption and autonomous investment. The slope of AE is equal to the marginal propensity to spend, which in this simple economy is just the marginal propensity to consume.

Copyright © 2023 Pearson Canada Inc.6 -226.2 Equilibrium National Income•If desired aggregate expenditure exceeds actual income, inventories are falling and there is pressure for actual national income to rise.•If desired aggregate expenditure is less than actual income, inventories are rising and there is pressure for actual national income to fall.•The equilibrium level of national income occurs when desired aggregate expenditure equals actual national income.

Copyright © 2023 Pearson Canada Inc.6 -23Table 6-1 Equilibrium National IncomeActual National Income (Y)Desired Aggregate Expenditure (AE = C + I)Effect30129150225Inventories are falling; firms increase output300345450465525525Equilibrium income600585900825Inventories are rising; firms reduce output•National income is in equilibrium when desired aggregate expenditure equal actual national income. The data are from Figure 6-6.

Copyright © 2023 Pearson Canada Inc.6 -24Figure 6-7 Equilibrium National Income(1 of 2)•The equilibrium condition occurs when AE = Y.•If actual Y< Y0, desired AEwill exceed national income, and output will rise.Equilibrium national income is that level of national income where desired aggregate expenditure equals actual national income. If actual national income is below Y0, desired aggregate expenditure will exceed national income, and output will rise. If actual national income is above Y0, desired aggregate expenditure will be less than national income, and production will fall. Only when national income is equal to Y0will the economy be in equilibrium, as shown at E0.

Copyright © 2023 Pearson Canada Inc.6 -25Figure 6-7 Equilibrium National Income(2 of 2)•If actual Y> Y0, desired AEwill be less than national income, and production will fall.•Only when Y= Y0will the economy be in equilibrium, (E0).Equilibrium national income is that level of national income where desired aggregate expenditure equals actual national income. If actual national income is below Y0, desired aggregate expenditure will exceed national income, and output will rise. If actual national income is above Y0, desired aggregate expenditure will be less than national income, and production will fall. Only when national income is equal to Y0will the economy be in equilibrium, as shown at E0.

Copyright © 2023 Pearson Canada Inc.6 -266.3 Changes in Equilibrium National Income•One shift is when the AEfunction shifts parallel to itself.•Another possible shift is when there is a change in the slope of the AEfunction.Figure 6-8Shifts in the Aggregate Expenditure Function

Copyright © 2023 Pearson Canada Inc.6 -27The Multiplier•What determines the size of the change in national income?–The simple multiplier is the ratio of the change in equilibrium national income to the change in autonomous expenditure that brought it about, calculated for a constant price level.–In the simple macro model, the multiplier is greater than 1.

Copyright © 2023 Pearson Canada Inc.6 -28Figure 6-9 The Simple Multiplier•zis the marginal propensity to spend out of national income •Ais the change in autonomous expenditure11YSimple multiplierAz

Copyright © 2023 Pearson Canada Inc.6 -30Economic Fluctuations as Self-Fulfilling Prophecies (1 of 2)•Households’ and firms’ expectations about the future state of the economy influence desired consumption and desired investment.•Changes in desired aggregate expenditure will, through the multiplier process, lead to changes in national income.•This link between expectations and national income suggests that expectations about a healthy economy can actually produce a healthy economy—what economists call a self-fulfillingprophecy.

Copyright © 2023 Pearson Canada Inc.6 -31Economic Fluctuations as Self-Fulfilling Prophecies (2 of 2)•Imagine that firms begin to feel optimist about future economic prospects.•This optimism may lead them to increase their desired investment, which shifts up the economy’s AEfunction.•The upward shift in the AEfunction increases national income.•If enough firms are optimistic and take actions based on that optimism, their actions will create the economic situation that they expected.

Chapter6:Thesimplestshort-runmacromodelAssume:notradenogovernmentnopricesarefixedNote:Y=C+Sincome=consumption+saving)aggregatedDesiredConsumptionExpenditurefactorsaffectingC2+ IYYep(a)3)Int.rates(i)-iP--C4)Expectationsabtfuture--CorkCCassumethatIislinear,though

C=ax+b=>C=a+bYdYd=disposableincomea-yintercept(Yd=0)b-slope.(eAbeofA)ex:C=30+0,84difYdAby19,-+CibyasopNB:A?=0,80=slopeofMarginalpropensitytoconsume(MPC):factionofadditionalydspentonadditionaldesiredconsumptionMPC=*=Slopeofconsumption0[MPC11APC:Averagepropensitytoconsume:ProportionofYospentonCAPC=

Thesavingfunction(S)S=Yd-2S=a+(1-b)Yd3YinterseptC=30+0,84dthenS=-30+0,24d)MPS:MarginalPropensitytoSave:factionofadditionalYdspentonadditionalSMPS=A=Slopeof aAPS(Averagepropensitytosave):fractionofYdspentonSAPS=SYd

CCYdC=YaC3204-C=atbydCC=YdC=o+1Yd·YoCYd-S=0S70S=0(45'libre)(45ifC=30+0,84d150YoS=-30+0,2Solve--30/0,2=yd=150forYdS3570·Ya310150otherfactorsaffectingeands·wealthCP-DSyCr-g9wh,ib,exp?wp,iP--~IntratesshiftsCshiftspl·Expectations3"1:""M

aP(//Shift)c=YdCCCoYdC#b(RotationofCurveup)C=Yd2,F:Yd

Plannedinvestment1.allnewCapitalexpendituresi)Inventoryzaffectedii)Residentialconstruction-realintrateiii)NewplantandequipementDinSalesaconfidenceIisautonomousAE=C+1AC=A+ZY

Copyright © 2023 Pearson Canada Inc.7 -2Chapter Outline/Learning ObjectivesSectionLearning ObjectivesBlankAfter studying this chapter, you will be able to7.1 Introducing Government1.describe how government purchases and tax revenues relate to national income.7.2 Introducing Foreign Trade2.describe how exports and imports relate to national income.7.3 Equilibrium National Income3.determine equilibrium in our macro model with government and foreign trade.7.4 Changes in Equilibrium National Income4.explain why the introduction of government and foreign trade in the macro model reduces the value of the simple multiplier.5.describe how government can use fiscal policy to influence the level of national income.7.5 Demand-Determined Output6.understand why output is demand determined in our simple macro model.

Copyright © 2023 Pearson Canada Inc.7 -37.1 Introducing Government•Fiscal policyis the use of the government’s tax and spending policies to achieve government objectives.•Government Purchases–Desired government purchases, G, are part of aggregate desired expenditures.–We make the assumption that the level of government purchases is autonomous with respect to the level of national income.

Copyright © 2023 Pearson Canada Inc.7 -4Net Tax Revenues (1 of 2)•Net tax revenue is total tax revenue minus transfer payments, denoted T.T= tY•Where Yis GDP and tis the net tax rate—the increase in net tax revenue generated when national income rises by $1.

Copyright © 2023 Pearson Canada Inc.7 -5Net Tax Revenues(2 of 2)•In the presence of government taxes and transfers, there is an important distinction between national income (Y) and disposable income (YD), the amount household receive after taxes are paid and transfers are received.YD= Y− T = Y – tY = (1 - t)Y

Copyright © 2023 Pearson Canada Inc.7 -6The Budget Balance•The budget balance is the difference between total government revenue and total government expenditure. It equals net tax revenue minus government purchases, T – G.•When net revenues exceed purchases, the government has a budget surplus.•When purchases exceed net revenues, the government has a budget deficit.•When the two amounts are equal, the government has a balanced budget.

Copyright © 2023 Pearson Canada Inc.7 -7Provincial and Municipal Governments•When measuring the overall contribution of government to desired AE, all levels of government must be included.•To summarize:1.All levels of government add directly to desired aggregate expenditure through their purchases of goods and services, G.2.Governments collect tax revenue and make transfer payments. Net tax revenues (T) are positively related to national income.•Twill enter the AEfunction indirectly, through its effect on disposable income (YD) and consumption.

Copyright © 2023 Pearson Canada Inc.7 -87.2 Introducing Foreign Trade•Net Exports–Exports depend on spending decisions made by foreign households and firms that purchase Canadian products.–Typically, exports will not change as a result of changes in Canadian national income.–So we treat exports as autonomous expenditure.

Copyright © 2023 Pearson Canada Inc.7 -9Net Exports (1 of 2)•The marginal propensity to import (m) is the increase in import expenditures induced by a $1 increase in national income. IM = mY•Net exports is given byNX = X – mY•Exports are autonomous with respect to Ybut imports are positively related to Y, so net exports are negatively related to national income.

Copyright © 2023 Pearson Canada Inc.7 -10The Net Export Function (1 of 2)•Marginal propensity to import ‒ slope•The slope of the net export function in part (ii) is the negative of the marginal propensity to import.Actual National Income (Y)Exports (X)Imports (IM = 0.1Y)Net Exports (NX = X − IM)072072300723042600726012720727209007290–18

Copyright © 2023 Pearson Canada Inc.7 -12Shifts in the Net Export Function (1 of 3)•Changes in Foreign Income–An increase in foreign income, other things being equal, increases the quantity of Canadian goods demanded by foreign countries. –The Xcurve shifts upward and the NXfunction also shifts upward, parallel to its original position.

Copyright © 2023 Pearson Canada Inc.7 -13Shifts in the Net Export Function (2 of 3)•Changes in International Relative Prices–A rise in Canadian prices (relative to other countries) decreases Canadian exports.–The Xcurve will shift downward.–Canadians will see imports from foreign countries become cheaper relative to the prices of Canadian-made goods.–The marginal propensity to import will rise, and the IMcurve will rotate up.

Copyright © 2023 Pearson Canada Inc.7 -14Shifts in the Net Export Function (3 of 3)•A rise in Canadian prices (relative to other countries) reduces Canadian net exports at any level of national income.•A fall in Canadian prices increases net exports at any level of national income.•The most important cause of a change in international relative prices is a change in the exchange rate.•A depreciationof the CDN$ means that foreigners must pay less of their money to buy one CDN$, and Canadian residents must pay more CDN$ to buy foreign currency.

Copyright © 2023 Pearson Canada Inc.7 -15Figure 7-2 The Net Export Function and a Change in International Relative Prices•A rise in Canadian prices relative to foreign prices lowers exports from Xto X’ and raises the import function from IMto IM’.•This shifts the net export function downward to NX’.

Copyright © 2023 Pearson Canada Inc.7 -167.3 Equilibrium National Income•Adding Taxes to the Consumption FunctionYD= Y− TIf T= (0.1)Y, then YD= (0.9)YC= 30 + (0.8)YDC= 30 + (0.8)(0.9)YC= 30 + (0.72)YIn the presence of taxes, the marginal propensity to consume out of nationalincome (0.72) is less than the marginal propensity to consume out of disposable income (0.8).

Copyright © 2023 Pearson Canada Inc.7 -17The AEFunction•The AEfunction is given byAE= C+ I+ G+ (X–IM)•Recall that the slope of the AEfunction is the marginal propensity to spend out of national income—z.•In this model, z= MPC(1 –t) –m

Copyright © 2023 Pearson Canada Inc.7 -18Figure 7-3 The Aggregate Expenditure Function(1 of 2)PointActual National Income (Y)Desired Cons.(C = 30 + 0.72Y)Desired Investment Expenditure(I = 75)Desired Government Expenditure (G = 51)Desired Net Export Expenditure(X − IM =72 − 0.1Y)Desired Aggregate Expenditure (AE = C +I + G + X − IM)A030755172228B150138755157321C300246755142414D600462755112600E9006787551−18786

Copyright © 2023 Pearson Canada Inc.7 -19Figure 7-3 The Aggregate Expenditure Function(2 of 2)•Slope of AEis the marginal propensity to spend on domestic output. •The equilibrium level of national income is $600 billion.

Copyright © 2023 Pearson Canada Inc.7 -20Equilibrium National Income•Suppose national income is less than equilibrium •Some of the desired expenditure must either be frustrated or take the form of purchases of inventories of goods that were produced in the past.•As firms see their inventories being depleted, they increase production, which increases national income.•The opposite sequence of events occurs when national income is greater than its equilibrium amount.•Only when national income is equal to desired aggregate expenditure is there no pressure for output to change.

Copyright © 2023 Pearson Canada Inc.7 -217.4 Changes in Equilibrium National Income•The Multiplier with Taxes and Imports–The presence of imports and taxes reduces the marginal propensity to spend out of national income and reduces the value of the simple multiplier.–The simple multiplier equals 1/(1 –z), where z= MPC(1 –t) –m.•In Canada, if MPC= 0.8, t= 0.25, and m= 0.35, how large is Canada’s simple multiplier?

Copyright © 2023 Pearson Canada Inc.7 -22Net Exports (2 of 2)•If the net export function shifts upward, the AEfunction will also shift upward and equilibrium national income will rise.•If the net export function shifts downward, so too will the AEfunction and equilibrium national income will fall.•Exports are autonomous with respect to domestic national income.•If exports increase by $1b, then equilibrium national income will increase by $1b times the simple multiplier.

Copyright © 2023 Pearson Canada Inc.7 -23Fiscal Policy•Stabilization policy— designed to reduce the economy’s cyclical fluctuations and stabilize national income is. •In our model, there are two fiscal policy tools available to government policymakers — the net tax rate (t) and government purchases (G).•A reduction in the net tax rate or an increase in government purchases shifts the AEcurve upward, setting in motion the multiplier process that tends to increase equilibrium national income.

Copyright © 2023 Pearson Canada Inc.7 -24Figure 7-4(i)The Effects of Fiscal Policy on Equilibrium GDPi.Change in gov’t purchases–Increase in Gshifts AEupward–AE0to AE1–Equilibrium income equals ∆Gtimes the simple multiplier.

Copyright © 2023 Pearson Canada Inc.7 -25Figure 7-4(ii) The Effects of Fiscal Policy on Equilibrium GDPii.Change in net tax rate–A reduction in the net tax rate rotates AE–The new curve has a steeper slope.–Equilibrium income increases.

Copyright © 2023 Pearson Canada Inc.7 -267.5 Demand-Determined Output•Equilibrium National Income–The equilibrium level of national income is the level at which desired aggregate expenditures equals actual national income (AE = Y).–If actual national income exceeds desired expenditure, firms will eventually reduce production, causing national income to fall.–If actual national income is less than desired expenditure, firms will eventually increase production, causing national income to rise.

Copyright © 2023 Pearson Canada Inc.7 -27The Simple Multiplier•The simple multiplier measures the change in equilibrium national income that results from a change in the autonomouspart of desired aggregate expenditure.•The simple multiplier is equal to 1/(1 − z), where zis the marginal propensity to spend out of national income.•In a closed economy with no government, z= MPC.•In an open economy with government, z= MPC(1 − t) − m.

Chapter7:AdditionGov.tothesimplemodal~privateConsumptionAE=C+1⊥AggregateExpenditures-Investmenty*=[b(a+1)⊥PotentialOutputGov.autonomousexpendituresNettaxerevenue=totaltax-transfersrevenueorT=To+-taxrate↓autonomoustaxationBudgetBalance(BB)BB=T-G->Gov..Expenditures⊥NettaxrevenueBBTOsurplusBBLOdeficitBB=obalancedBudget

t=2+1=>AE=C+1+GandequilibriumisstillatAE=yExample:C=100+0,84 T=50+0.1yI=100Yd=Y-IG=200Y=C+I+G(EquilibriC=a+bYdAE=?I:fixedAf=C+1+GG:fixed=100+0,8yd+100+200Yd:Y-T=400+0,84dT:To+ty=400+0.8(y-t)y=C+I+G=400+0,8(y-(50+0,14))&It)(a+1+G-bl)=400+0,8y-40-0,05yy=AE=360+0,72YAE=360+0,72yFooEo=y=360+0,77ySolvefory=y*k=1Y-0,72y=360(45"1-2y=1286

FPandMultiplierEffectMultiplier:y=k=ASIGAE=A+zYAAifGPby100=>AEFEG+DGDY=KDAAE1=AG+DGAE,=360+0,72y+100DY=(100)=357[AE,=460+0,72Y]Y*new=Y*+BYi+Yp=1700DG?DYSY-ypisrecessionary)=1286+357&=1643BY=1DGz=MPC(1-t)-m⊥disposable⊥net⊥M.P.taxtoimport.Missincoerate.

NX(NetexportfunctionNX=X-IM-PDesiredimporto(mY)IDesiredExportsf(x)=ax-bIM=motmiY*Y=D 495IM=mo+0.45Y95=mo+0.45(100)95-45=moPublicSaving=T-GS+T-G=I+(X=1M)1257/100-150 (T-G=I+(X-M)-S

T=to++,Y*=355555=to+0.4 (100)55-40=toAE=a+(b(1-t))y+I+G(x-IM)=a+(b(1-t))y+F+G+X-my=a+b(1-t)y+I+G+x-mY=a+b(1-t-m)y+I+G+xAE=Y[b(1-t)-my+I+G+a+XinY=AEAIY=Y(b(1-t)-mJ+A--Y=

Copyright © 2023 Pearson Canada Inc.8 -2Chapter Outline/Learning ObjectivesSectionLearning ObjectivesBlankAfter studying this chapter, you will be able to8.1 The Demand Side of the Economy1.explain why an exogenous change in the price level shifts the AE curve and changes the equilibrium level of real GDP.2.derive the aggregate demand (AD) curve and understand what causes it to shift.8.2 The Supply Side of the Economy3.describe the aggregate supply (AS) curve and understand why it shifts when technology or factor prices change.8.3 Macroeconomic Equilibrium4.explain how AD and AS shocks affect equilibrium real GDP and the price level.

Copyright © 2023 Pearson Canada Inc.8 -38.1 The Demand Side of the Economy•Exogenous Changes in the Price Level–Changes in ConsumptionMuch of the private sector’s total wealth is held in the form of assets with a fixed nominal value.The most obvious example is money.What this money can buy—its real value—depends on the price level.A rise in the price level lowers the real value of money held by the private sector, and a fall in the price level raises the real value of money held by the private sector.

Copyright © 2023 Pearson Canada Inc.8 -4Changes in Consumption•Changes in the price level change the wealth of bondholders and bond issuers, but because the changes offset each other, there is no change in aggregate wealth.•In summary, a rise in the price level leads to a reduction in the real value of the private sector’s wealth.•A reduction in wealth leads to a decrease in autonomous desired consumption and to a downward shift in the AEfunction.•A fall in the price level leads to a rise in wealth and desired consumption and to an upward shift in the AEfunction.

Copyright © 2023 Pearson Canada Inc.8 -5Changes in Net Exports (1 of 2)•When the domestic price level rises (and the exchange rate remains unchanged), Canadian goods become more expensive relative to foreign goods.•Canadian consumers reduce their purchases of Canadian-made goods and increase their purchases of foreign goods.•Consumers in other countries reduce their purchases of Canadian-made goods.

Copyright © 2023 Pearson Canada Inc.8 -6Changes in Net Exports (2 of 2)•A rise in the domestic price level (with a constant exchange rate) shifts the net export function downward, which causes a downward shift in the AEcurve.•A fall in the domestic price level shifts the net export function upward and the AEcurve upward.

Copyright © 2023 Pearson Canada Inc.8 -7Changes in Equilibrium GDP•An exogenous increase in the price level causes AE0to shift downward from to AE1.•The equilibrium changes from E0to E1and real GDP falls from Y0to Y1.Figure 8-1Desired Aggregate Expenditure and the Price Level

Copyright © 2023 Pearson Canada Inc.8 -8The Aggregate Demand Curve•The aggregate demand (AD) curveis a curve showing combinations of real GDP and the price level that make desired aggregate expenditure equal to actual national income.•A rise in the price level causes the AEcurve to shift downward and leads to a movement upward and to the left along the ADcurve, reflecting a fall in the equilibrium level of GDP.•A fall in the price level causes the AEcurve to shift upward and leads to a movement downward and to the right along the ADcurve, reflecting a rise in the equilibrium level of GDP.

Copyright © 2023 Pearson Canada Inc.8 -9Figure 8-2 Derivation of the ADCurve•As the price level rises from P0to P1to P2, the AEcurve shifts downward from AE0to AE1to AE2.•In the bottom graph, a movement occurs up along the ADcurve.•A change in the price level causes a shift of the AEcurve but a movement along the ADcurve.

Copyright © 2023 Pearson Canada Inc.8 -10Shifts in the ADCurve•Any change that causes the AEcurve to shift will also cause the ADcurve to shift.•Such a shift is called an aggregate demand shock.•An increase in autonomous aggregate expenditure shifts the AEcurve upward and the ADcurve to the right.•A fall in autonomous aggregate expenditure shifts the AEcurve downward and the ADcurve to the left.•The simple multiplier measures the horizontal shift in the ADcurve in response to a change in autonomous desired expenditure.

Copyright © 2023 Pearson Canada Inc.8 -11Figure 8-3 The Simple Multiplier and Shifts in the ADCurve•An increase in autonomous expenditure shifts AE0to AE1.•The size of the horizontal shift of the AD curve is equal to the simple multiplier times the increase in autonomous expenditure.

Copyright © 2023 Pearson Canada Inc.8 -128.2 The Supply Side of the Economy•The Aggregate Supply Curve•The aggregate supply (AS)curve is a curve showing the relation between the price level and the quantity of aggregate output supplied, for given technology and factor prices.•As output increases, less efficient standby plants may have to be used, and less efficient workers may have to be hired, while existing workers may have to be paid overtime rates for additional work.•For these reasons, unit cost, which is cost per unit of output, increases.

Copyright © 2023 Pearson Canada Inc.8 -13Figure 8-4 The Aggregate Supply Curve•The AScurve is positively sloped.•The higher is the level of output, the faster unit costs tend to rise, so the AS curve becomes steeper as output rises.

Copyright © 2023 Pearson Canada Inc.8 -14Shifts in the ASCurve•Shifts in the AScurve caused by exogenous forces are called aggregate supply shocks.•A rise in factor prices causes the AScurve to shift leftward.•A fall in factor prices causes the AScurve to shift rightward.•An improvement in technology causes the AScurve to shift rightward.•A deterioration in technology causes the AScurve to shift leftward.

Copyright © 2023 Pearson Canada Inc.8 -168.3 Macroeconomic Equilibrium•Demand behaviouris consistent with supply behaviouronly at the intersection of the ASand ADcurves.•E0is the macroeconomic equilibrium.Figure 8-6Macroeconomic Equilibrium

Copyright © 2023 Pearson Canada Inc.8 -17Changes in Macroeconomic Equilibrium•A shift in the ADcurve is called an aggregate demand shock.•A shift in the AScurve is called an aggregate supply shock.•Aggregate demand and aggregate supply shocks are labelled according to their effect on real GDP.•Positive shocks increase equilibrium GDP; negative shocks reduce equilibrium GDP.

Copyright © 2023 Pearson Canada Inc.8 -18Figure 8-7 Aggregate Demand Shocks •Aggregate demand shocks cause the price level and real GDP to change in the same direction.•Both rise with an increase in aggregate demand, and both fall with a decrease in aggregate demand.

Copyright © 2023 Pearson Canada Inc.8 -19Figure 8-8 The Multiplier When the Price Level Varies•An increase in autonomous expenditure causes the AEcurve to shift upward, but the rise in the price level causes it to shift part of the way down again.

Copyright © 2023 Pearson Canada Inc.8 -20Figure 8-9 The Effects of Increases in Aggregate Demand •The effect of any given shift in ADwill be divided between a change in Yand a change in P.•The steeper the AScurve, the greater the price effect and the smaller the output effect.

Copyright © 2023 Pearson Canada Inc.8 -21Figure 8-10 Aggregate Supply Shocks •ASshocks cause Pand Y to change in opposite directions.•A negative supply shock shifts the AScurve leftward, and the rise in the price level shifts the AE curve downward.

Copyright © 2023 Pearson Canada Inc.8 -22Analyzing the 2020 Pandemic Recession with the AD/ASModel (1 of 2)•The combined effect of the negative AS shock and the negative ADshock from the COVID-19 pandemic was a sharp reduction in output and employment. •The economy’s ability to combine land, labour and capital to produce output was severely reduced. There was a large leftward shift in the AScurve, and real GDP declined. •For both businesses and households, the pandemic led to a significant reduction in demand even for an unchanged level of income. There was a large leftward shift of the ADcurve, and real GDP fell.

Copyright © 2023 Pearson Canada Inc.8 -23Analyzing the 2020 Pandemic Recession with the AD/AS Model (2 of 2)•By the middle of 2021, vaccines for COVID-19 were becoming available in many countries and most economies were beginning to recover.•Once individuals are able to safely return to their workplaces, the ASshock will reverse relatively quickly. •Once stores, restaurants, airlines, and hotels are able to safely conduct business, households and firms will return to their normal level of demand. The ADshock will reverse relatively quickly.

Copyright © 2023 Pearson Canada Inc.8 -24A Word of Warning •Many economic events ‒ especially changes in the world price of raw materials ‒ cause both aggregate demand and aggregate supply shocks in the same economy.•The overall effect on real GDP in that economy depends on the relative importance of the demand-side and supply-side effects.

Copyright © 2023 Pearson Canada Inc.9 -2Chapter Outline/Learning ObjectivesSectionLearning ObjectivesBlankAfter studying this chapter, you will be able to9.1 Three Economic States1.describe the three different macroeconomic states, and the underlying assumptions for each one.9.2 The Adjustment Process2.explain why output gaps cause wages and other factor prices to change.3.describe how changes in factor prices affect firms’ costs and shift the AS curve.9.3 Aggregate Demand and Supply Shocks4.explain why real GDP gradually returns to potential output following an AD or AS shock.9.4 Fiscal Stabilization Policy5.understand why lags and uncertainty place limitations on the use of fiscal stabilization policy.

Copyright © 2023 Pearson Canada Inc.9 -39.1 Three Macroeconomic States•The Short Run–The assumptions of the model in the short run are:Factor prices are assumed to be exogenous; they may change, but any change is not explained within the model.Technology and factor supplies are assumed to be constant (and therefore Y*is constant).

Copyright © 2023 Pearson Canada Inc.9 -4The Adjustment of Factor Prices•The assumptions of the theory of the adjustment process are:–Factor prices are assumed to adjust in response to output gaps.–Technology and factor supplies are assumed to be constant (and therefore Y*is constant).

Copyright © 2023 Pearson Canada Inc.9 -5The Long Run•The assumptions of the model in the long run are:–Factor prices are assumed to have fully adjusted to any output gap.–Technology and factor supplies are assumed to be changing.

Copyright © 2023 Pearson Canada Inc.9 -6Table 9-1 Three Macroeconomic StatesBlankThe Short RunThe Adjustment ProcessThe Long RunKey AssumptionsFactor prices are exogenous.Factor prices are flexible/endogenous.Factor prices are fully adjusted/endogenous.Technology and factor supplies (and thus Y*) are constant/exogenous.Technology and factor supplies (and thus Y*) are constant/exogenous.Technology and factor supplies (and thus Y*) are changing.What HappensReal GDP (Y) is determined by aggregate demand and aggregate supply.Factor prices adjust to output gaps; real GDP eventually returns to Y*.Potential GDP (Y*) grows over the long run.Why We Study This StateTo show the effects of AD and AS shocks on real GDP.To see how output gaps cause factor prices to change and why real GDP tends to return to Y*.To understand the nature of long-run economic growth.

Copyright © 2023 Pearson Canada Inc.9 -8Factor Prices and the Output Gap•Output Above Potential, Y> Y*–Because firms are producing beyond their normal capacity output, there is an excess demand for all factor inputs.–Workers will find that they have considerable bargaining power, and they will put upward pressure on wages.–The boom that is associated with an inflationary gap generates conditions ‒ high profits for firms and an excess demand for labour ‒ that tends to cause wages to rise.

Copyright © 2023 Pearson Canada Inc.9 -9Output Below Potential, Y < Y*•Because firms are producing below their normal capacity output, there is an excess supply of all factor inputs, including labour.•Firms will have below-normal sales and not only will resist upward pressures on wages but also may seek reductions in wages.•The slump that is associated with a recessionary gap generates conditions ‒ low profits for firms and an excess supply of labour ‒ that tends to cause wages to fall.

Copyright © 2023 Pearson Canada Inc.9 -10Downward Wage Stickiness•Both upward and downward adjustments to wages and unit costs do occur, but there are differences in the speed at which they typically operate.•Booms can cause wages to rise rapidly.•Recessions usually cause wages to fall only slowly.

Copyright © 2023 Pearson Canada Inc.9 -11The Phillips Curve•A.W. Philips observed that wages tended to fall in periods of high unemploymentand rise in periods of low unemployment.•The resulting negative relationship betweenunemployment and the rate of change in wageshas been called the Phillipscurve ever since.

Copyright © 2023 Pearson Canada Inc.9 -12Potential Output as an “Anchor”•Following an ADor ASshock, the short-run equilibrium level of output may be different from potential output.•Any output gap is assumed to cause wages and other factor prices to adjust, eventually bringing the equilibrium level of output back to potential.•The level of potential output therefore acts like an “anchor” for the economy.

Copyright © 2023 Pearson Canada Inc.9 -16Long-Run Equilibrium•Following any ADor ASshocks, the adjustment of factor prices continues until real GDP returns to Y*.•The economy is in long-run equilibriumwhen this adjustment process is complete and there is no longer an output gap.•So the economy is in long-run equilibrium when the intersection of the ADand AScurves occurs at Y*.

Copyright © 2023 Pearson Canada Inc.9 -17Figure 9-5 Changes in Long-Run Equilibrium •In part (i), a shift in the ADcurve raises the price level but leaves real GDP unchanged in the long run.•In part (ii), an increase in potential output raises real GDP and lowers the price level.

Copyright © 2023 Pearson Canada Inc.9 -18The Canadian Wage-Adjustment Process: Empirical Evidence •Canadian data confirm that positive output gaps tend to drive wages and costs upward.•Negative output gaps tend to drive wages and costs downward. Figure 9-6The Canadian Phillips Curve, 1991–2018(Source: Author’s calculations using data from the Bank of Canada and Statistics Canada.)

Copyright © 2023 Pearson Canada Inc.9 -199.4 Fiscal Stabilization Policy•The government may use various fiscal tools to try to push real GDP back towards potential output.•The alternatives to using fiscal stabilization policy are to wait for the recovery of private-sector demand (a shift in the ADcurve) or to wait for the economy’s adjustmentprocess (a shift in the AScurve).•Examples of fiscal effects: WWII/Recession 2008

Copyright © 2023 Pearson Canada Inc.9 -20The Basic Theory of Fiscal Stabilization(1 of 2)•The effect of any given shift in ADwill be divided between a change in Yand a change in P.•The steeper the AScurve, the greater the price effect and the smaller the output effect.Figure 9-7The Closing of a Recessionary Gap

Copyright © 2023 Pearson Canada Inc.9 -21The Basic Theory of Fiscal Stabilization(2 of 2)•AS shocks cause P and Y to change in opposite directions.•A negative supply shock shifts the AScurve leftward, and the rise in the price level shifts the AE curve downward.Figure 9-8The Closing of an Inflationary Gap

Copyright © 2023 Pearson Canada Inc.9 -22Short Run Versus Long Run•The paradox of thrift—the idea that an increase in saving reduces the level of real GDP—is true only in the short run.•In the long run, the path of real GDP is determined by the path of potential output.•The increase in saving has the long-run effect of increasing investment and therefore increasing potential output.

Copyright © 2023 Pearson Canada Inc.9 -23Automatic Fiscal Stabilizers (1 of 2)•Suppose a shock shifts ADright and increases short-run real GDP.•As real GDP increases, government tax revenues also increase.•With fewer low-income households and unemployed persons requiring assistance, governments transfers fall. •The rise in net tax revenues dampens the overall increase in real GDP caused by the initial shock.•The tax-and-transfer system reduces the value of the multiplier and acts as an automatic stabilizer for the economy.

Copyright © 2023 Pearson Canada Inc.9 -24Automatic Fiscal Stabilizers (2 of 2)•The marginal propensity to spend on national income is:z= MPC(1 –t) –m•The simple multiplier is:Simple multiplier = 1/ (1 –z)•The lower the net tax rate (t), the larger the simple multiplier and thus the less stable is real GDP in response to shocks to autonomous spending.

Copyright © 2023 Pearson Canada Inc.9 -26Fiscal Policy and Growth•If an increase in government purchasesleads to an increase in potential output (or its growth rate), the negative effects from the crowding out of private investment will be reduced.•Reductions in tax ratesgenerate a short-run demand stimulus and may also generate a longer-run increase in the level and growth rate of potential output.

Chapter9:FromtheshortruntothelongRun-TheadjustmentoffactorpricesShortRen:↑(outsidefactors!-Factorprices-Exogenous-TechnologyandfactorsuppliesareconstantLongRun:i)Factorpricesassumedtorespondtooutputgaps:/Y<Ypory>Yp)ii)Technologyandfactorsuppliesareest.PLRASLRAS:Long-Run⊥aggregatesupply->onlymovesAnchorwhenwe⊥Pointwherechangesassumptionswewanttoget.IYP/y*)YAtpotentialoutput.

FactorPricesandtheoutputgapadjustmenty-YP33YPRecessionarygapoInflationnarygapASoElAs,ASAdd-DAsoprices/P1=8---EirigeP--...:--CL"ADJPYShortRunEquil:ADASatSREquil:AD=Asata·Since>YpthereLongRenEquil:isasignificantPD·SinceY/YpthereisXSininputmarketscapacity,andXssupplyof·Asaresult,upwardfactorinputsAsaresult,thereisapressureoninputprices·SinceswagesinputsdownwardpresenceoninputpricesareP=Shiftprices.·ContinuesY<YP·ContinuesasSinceswages&inputprices~b=AsbeginsshiftrightlongasY>YP

Notes:1)Wagesarestickyii)PhilipsCurveTrackoffbetweenwagesandUnempiii)Y>Yp=DPricesgoupYcYp=-Pricesfall(Disinflation(not(deflationsShort-Run=AD=AS=DPoYoLong Run=AD=Yp(LRAS)=AS=* P*y*atYpADshocks?ShockgrouaD)⊥fiscalpolicy

Assume+shockPASASo-Ez·PEgAD,ADO-DYPY/YCLR)inEquilatEowyp*=PoY*=YPAD=AS=Yp(LRAS)ifGP=PAD-DAD,(Shifright)Short-run:YPtoy,**10 P,Long-Run:Sincey>Yp,upwardpressureonpricesAscurveshiftleftaslongasy>YporY=Ypagainat22:Y*=YpPE=P2

-ADShockAsoADAszPo---EElaADg⊥At2YYP·AtEsinShort-Run-Gy=DAD,lefttoADo=>E,whereAD=As-ER:SinceY<Yp=1input pfull=Asshifnight

+Asshock-AsshockAsoAs4)El-D-PP.----SoIPo-----oPo----Eop.--- -E,"!ADADOYpY,YY,Y·SR:Wagesy=As to A,(Right)·SR:WDAstrAslet=DAs,:AD=P,Yl·LR:Sincey>Yp=AnputCostB·LR:Y<Yp=DUnexpectedlyInputCosty=DShiftsleftunhlDownwardpressureYp=Yagainbackto50onwagesandinputpricesAsshiftsRight

Asibe!ingeneralypisPPAso-At30inLRequil-31-ifypP= Dyp-D=Recession·EoLR:SinceYcYp=DinputpricesIandADOAsshiftsrightYPY'pYGovernmentintervention·RecessionaryGap(y<yp)DAso(Right)&·E,-ifGP=-ADtoAD,itb)20%-----.!AD,ADYPY

InflationaryGapAs-/nequilatEo-Sincey>yp: DG%.----So(tP)toADtoAD,P,!=Pp,YADpA=P,;Y*=YPYpYoLimitationsondiscretionaryfiscalpolicyi)Decision&executionlags.ii)TemporaryvsPermanenttopchanges??ii)FinetuningusGrossTuningFiscalPolicy&Growthi)Gii)bt

↑PricelevelAE=3000+0.64+0.25(M/P)M=24,000⊥PrivatesectorM/PAEnominalwealthP=a(4000123000+0.64+2.25(240002)3""134""145""156""16

Chapter11

OriginsofMoney?Currencyiswhat1.Metallicmoneythegov.owes.⊥problem?⊥Greshan'slaw⊥Badmoneydrives.1.PaperMoney⊥Promisetopaylater(Promissory(3.FiatMoney⊥It'smoneybecausewebelievesoDefinitionsofthemoneysupply(MP)M=Currency+Demanddeposits(TD,SectiaincirculationatchartenedBanks⊥The"BigSix"#notentitletobuy4-scheduleAbanksinv.property.ScheduleBbanks⊥morerelax

M2=M'+NoticedepositsatchartenedBanksCND)ND-SavingActDP-Nointerest-ChequableSavings-Chequable-allotherDeposits-Charge-payableonDemandM2+=M2+allotherdepositsatallDeposittakinginstitutions.-NotjusttheBigSix.M2++=M2++CanadaSavings+non-monla-aryinstitutions.M3=MS=Currency+BankDeposits

BankofCanadaBMO-EastSPrRoyalBankofCanada-west-19351935-IndependantofGovt?ItYes,ifGovagreeswithBank⊥whathappensiftheydon'tagre⊥MinisterofFinanceorderpresidentofBanktolistenorquit.Functions1.BankertoCommercialBanks2.BankertoFederalGov't3.RegulatorofthemoneysupplyMSgoesintoMoney-BogC-MSBof CEMoney-MSP

HowdoesBoCcontroltheMS?1.OpenmarketoperationsLiBuying?SellingCDNgov'tbondsBofCsellsbonds=>M'LBogCbuysbonds=>MSP2.Gov'ttransfersBank-BofC=DMSBofC->Bank=>MSPBank->Bank=DNochange3.BankRate/OvernightRate(ONR)4.75Bankrate-RateBofCcharges+.25Banks4.5OR-RateBankschargeeachother4.25DepositsRate-RateBankDepositsatBankofCanada=ONRP=Tightmoney=MsONRy=Easymoney=MSP

=-1000.2

BankA(AfterDeposit)AssetsviabilitiesXSReservesCashRes.100Deposits1000ActualReserveLoangoo100TargetReserve=200=0.1/11001100Too=90litesSincethe$90bearsnointrest.MotgainingoBankAloansouttosomeone(Deadweight)bycreatingaDemandDeposit(DD).ThatsomeonethendrawsdownonthedepositandputsitintoBankB.

BankAAssetsLiabilitiesCashRes.200Deposits1000ToBank-90+90PD3BIoan900-sowithdrawal+90BankBAssumeallBanksAssetsLiabilitieshavesamestarting s.-BankBgetsanewCashRes.10Deposits1000Depositof$90foraLoan900-NBXSreseve=0100g1000BankBAssetsLiabilitiesXSReserves=CashRes.10Deposits1000190-0.1/1090)+90+98loan900=Si$100g1000S1$-Dloanouttosomeone-sputsina

BankBAssetsLiabilitiesCashRes.10Deposits1000-81+S1YontoBankCloan900-81IRepeatwithD..)+8110901090overallfortheBankingSystem-BankINewDepositNewloan.Add,toRes.A1009010B90L81IC81L72.908.10D72.90/65.617.29::::1000900-ioo

IfnoistheTargetReserveRatio(TRR)1%&inDeposit=.NewCashdeposit=money.XDReservesmultipler=of(100)=1000&Loans=DinDeposits-DReserves=1000-100=900whatifthereisaCashDrain?⊥Consumerskeep10%oftheirloanADeposits=MoneyXDReservesmultiplierme=TRR(10%)=mYNewCashdepositC=CD (10%)=ato,x100=5005007900Couldbereversed⊥less⊥Bankscallinaloan.

FormulasTargetReserves=ActualReserves-ExcessTargetReservesRatio=TargetReservestExcessReserves:&DepositsfoCashDepositse+Vv*=v+ExcessRes·*Deposits=NewCashDepositsC+vXReserves=v*·Deposits.AReserves=:NewCashDeposits

Chapter12:Money,InterestRate,and-simplificatioconomicActivity.Bonds:anyinterestbearingasset-usuallyapromisetoacertainamount/principle)overaspecifiedperiod(terms+interest(i)"Money:anythingthatisamediumofexchange.Presentvalue(PV)=ThevalueoftodayofoneormorepaymentstobereceivedinthefutureIfweget$100inoneyearandthei=5%FV=PV(H+i)Ifweget$100inoneyearat5%,howmuchshouldwepayforthistoday?FV=PV((+i)PV=

Asequenceoffuturepayments-FV=PV(I+i)SupposePV=100i=0.05Yr1:FV=100(1+0.05)=105Yv2:Fv=105(1+0.05)=100(I+i)(l+i)=100(1+1)Yv3:Fv=110.25)(+0.05)=100 (1+i)((+i)(l+i)=100(GeneralRule:FV=Pv(i+i) n,PV=isnExample:Bondpromisestopay10%interestayear(Couponrate)andfindfacevalueof$1,000attheyearendof3years.Howmuchisitworthtodayifmarketrateis7%↑V=Y=D PV=0733PV=1078.73Ifyoupay$1000areyouhapp?⊥Yes,

IngeneralPV=/+2+3+...RipaymentsatmaturingTwhatifinterestis9%instead?PV=09)1+092+30433=1025.31(/fmarketRateP,PVt)=dyfiP,PVit,PVBPVandMarketpriceofBond?$)1000bondpayingat8%foryearPV= E==92Ifsellingprice7926-+buyerstillgetsloo=Dlessthan8%returnIfsellingprice<926-*buyergets$1000butcouldborrow$900andbuythebondandpaytheloaninstantly

Generally:PriceofBond=PVofincomestreamPB=PVQ:Ifi=9%inmarketratecanyouselbondfor$1000-1000·0.08=1080PV=F=8009inoneyearyouget=$991FV-PV1080-9914-9%overallDpBImportantaMarketpriceBondyiel (in%)=V=P(1+x>2 - pmaluit⊥facevalueyield=y=(1+x)=-1=x

Demandformoney(MP)Rate1.Speculativemotive-takeadvantageofint'opp.2.TransactionsMotive-Buystuff3.Precautionary-JustinCasewhatdetermineMP1.TheinterestRate(i)⊥i=MP⊥iy=MPq2.RealGDP(Y)⊥weneedmorefortransactions⊥>yY=>MPP;y=>MP3.Pricelevel(P)⊥AnyDPaffectsthe $valueoftransactions⊥PB=MPPPy=DMPl

MouvementalongtheMPcurveAnyD(Change)iniNi10-----A'~i...--1.-..BImim,,moneyShiftinMDYP,p9=MPPshiftrightY6,Pp=MPbshiftleft

NiOY1>YoOP,>Po&Y2Yo&MP,(Y1,P,)P2YoMPo(Yo,PolMP(Y2,Pes->moneyMDP--Pricelevel(Priceoroutput&)MS-D

EquilibriuminthemoneymarketaMSNB:PMSDShiftRighti-BuyBondsI=XSDemand=SEMS-D""leftExcess-supplyMS=MP=Di(Equilibriu1ifiDemandi-------ifiisupply-------Eoi,--------o----ExcessDemandMP(Yc,40⊥2People↓byGetmoneymon as awantmoney=1sellbonds=XSbS= P=iP

whathappensifMSorMPchange?MsP(b)psMP-atFoMS=MP=Ditim-MSP=DMStoMS,=MS=MP=Di*,iit-------Overall:MSEgiLi---E,MP(Yo,Po)>MD↑(b)money·Ms-MDP=+MPotoMP,M(P,44)-M4=MS=i*i*j---EOverall:IM(Y,,40)MPD:itis.-------- M4(Y0,Po)MPP=iS-->XSDemand

MoneymarketandchangesinAD?Usuallyifichanges=ithereisachangeinIMoMS,inincoopportunitieiy=*IPiP=DIpMELY-i---->->moneyIoIfIP=DAEl=YPthroughmultipliesprocess

#All3marketshavetobeinE↑MSonAPSMS,ay=AEMAE,(o)#Edi?EI-FM!![45)[oY,YnequilatEowithPaADIIIIi=i*P=4 YY=YoII-XfMSPM8toMP=Dibtoi*II-Sinceit=/P,aP,ex=N----i --AsO-=>AE=C+I+G+(x-X,M)IPP2I=DAEotoAE,↑=YPto y,throughmultiplierYo"AD=>Po,Y,isanewpointonanewAD=DAD,ShifttoAD,

InGeneral↑MS-Di b-+[P,a P,NXP->AEP-DyP(AD-D)(XP,[Mb]!↓MS -piP-+[b,ab,Nb-*AEb-PYl(ADY⊥TransmissionmechanismNote:BecauseoftheinterdependanceofPY,i,themultiplierissmaller

Moneyisneutralinthelong-Run.LRASASIMASoPFl-LRequilAD=AS=LRAS---⑨El-YMS=DADtoright----Po------oEo'--toAD,I=ADI=AS!AD,SRequilADO(Y1P,)>YpYYYo-LR:SinceYYp=DinputcostsriseunexpectedlySincenoBinY=DMoneyisneutral