Macroeconomics Principles: Chapters 7-12
Chapter 7: Business Cycles and Unemployment
Business Cycle
The business cycle consists of four phases: expansion, peak, recession (contraction), and trough.
Unemployment Rate
The unemployment rate is calculated as the number of unemployed individuals divided by the number of individuals in the labor force. It’s important to note that this calculation does not include discouraged workers or those working in the underground economy.
Labor Force Requirements
Important: Discouraged workers are not included in the labor force.
Types of Unemployment
- Seasonal: Unemployment that is usually short-term and occurs because workers and employers need to find each other.
- Frictional: Unemployment related to recent graduates or individuals seeking new jobs. It is typically short-term and arises as workers and employers search for suitable matches.
- Structural: Unemployment caused by technological advancements or a mismatch between employee skills and job requirements. It can also result from a permanent decrease in demand for an industry’s output.
- Cyclical: Unemployment associated with economic recessions. Cyclical unemployment rises during recessions and falls during periods of economic growth.
Real Interest Rate
The real interest rate is the nominal interest rate adjusted for inflation.
GDP Gap
The GDP gap is the difference between potential real GDP (excluding cyclical unemployment) and actual real GDP (observed).
Types of Inflation
- Hyperinflation: An extremely high rate of inflation.
- Demand-Pull Inflation: Inflation caused by an excess of aggregate demand over aggregate supply.
- Cost-Push Inflation: Inflation caused by rising resource prices (e.g., oil), particularly when major input prices increase significantly.
Chapter 8: Aggregate Demand and Aggregate Supply
Definitions
- Aggregate Demand (AD): Total spending at different price levels.
- Aggregate Supply (AS): Total output at different price levels.
Effects of Changes in AD/AS
Changes in aggregate demand and aggregate supply lead to changes in the equilibrium price level and real GDP, resulting in business cycles.
Factors Affecting AD/AS
- Consumption: Influenced by income, wealth, expectations, demographics, and taxation.
- Investment: Affected by interest rates, technology, the cost of capital goods, and capacity utilization.
- Government Spending: Includes government expenditures on goods and services.
- Net Exports: Influenced by domestic and foreign income, domestic and foreign prices, exchange rates, and government policies.
Aggregate Supply Equation
AS = C + I + G + X
Downward Slope of the Aggregate Demand Curve
The aggregate demand curve slopes downward due to the following price-level effects: the wealth effect, the interest rate effect, and the international trade effect.
Impact of Inflation on the Economy
Question: How does inflation affect the economy?
Answer: When prices increase for energy, food, commodities, and other goods and services, the entire economy is affected. Rising prices, known as inflation, impact the cost of living, the cost of doing business, borrowing money, mortgages, corporate and government bond yields, and every other facet of the economy.
Chapter 9: Components of Aggregate Expenditures
Components of Aggregate Expenditures
Y = AE = C + I + G + X
Consumption
- Disposable Income: Household income after taxes.
- Wealth: Increases in wealth tend to increase consumption and decrease current saving.
- Expectations: Consumer confidence, a measure of consumer opinion regarding the economy’s future, can influence consumption.
- Demographics: Economists generally expect consumption to rise with population growth, all else being equal.
Investment
- Interest Rate: Capital expenditures are often financed, making interest rates a key factor.
- Profit Expectations: Decision-makers compare financing costs to the expected returns from new capital. Favorable comparisons lead to investment.
- Technological Change: Technological advancements can drive investment.
- Cost of Capital Goods: The price of capital goods affects investment decisions.
- Capacity Utilization: The extent to which firms are using their existing capacity can influence investment.
Government Spending
The US government spends over $2 trillion annually on goods and services.
Net Exports
- Surplus: Occurs when net exports are positive (exports exceed imports).
- Deficit: Occurs when net exports are negative (imports exceed exports).
Marginal Propensities
- Marginal Propensity to Consume (MPC): The change in consumption divided by the change in disposable income.
- Marginal Propensity to Save (MPS): The change in savings divided by the change in income.
- Marginal Propensity to Imports (MPI): The change in imports divided by the change in income.
Chapter 10: Equilibrium Real GDP
Two Methods for Finding Equilibrium Real GDP
- When Aggregate Expenditures (AE) equal Real GDP.
- When Total Leakages equal Total Injections.
Leakages and Injections
Leakages in the flow from domestic income to spending include saving, taxes, and imports. Injections include investment, government spending, and exports.
Computing the Spending Multiplier
The spending multiplier is used to determine the change in real GDP resulting from a change in autonomous spending.
Formula: Multiplier = 1 / Leakages = 1 / (MPS + MPI)
Leakages: Savings, taxes, imports
The Keynesian Model
The Keynesian model is a fixed-price model. It assumes that the supply of goods and services always adjusts to aggregate expenditures without requiring price changes.
Chapter 11: Financing Government Spending
Financing Government Spending
Government spending must be financed through a combination of taxation, borrowing, and creating money. It can be financed by tax increases or borrowing (debt), although borrowing can reduce consumption and investment.
Chapter 12: Banking and the Money Supply
Required Reserves
Required reserves are the reserves that banks must keep on deposit with the Federal Reserve to comply with reserve requirements.
Excess Reserves
Excess reserves are cash reserves held by banks beyond the required amount. These reserves can be loaned out. If a bank has zero excess reserves, it cannot make new loans.
Calculating Maximum Loan Amount
Banks can calculate the maximum amount they are allowed to loan, considering both required reserves and excess reserves.
Midterm 2 Formula Sheet
Rate of Unemployment
[Formula not provided in the original text]
GDP Gap
GDP gap = potential real GDP – actual GDP
MPC
MPC = Change in consumption ÷ change in disposable income
MPS
MPS = Change in saving ÷ change in disposable income
MPC + MPS
MPC + MPS = 1
MPI
MPI = change in imports ÷ change in income
Spending Multiplier
[Formula not provided in the original text]
Recessionary Gap
[Formula not provided in the original text]