Gross domestic product ( GDP ) The market value of all final goods and services produced in a country during a

1. Gross domestic product (GDP) The market value of all final goods and services produced in a country during a period of time, typically one year. GDP Is Measured Using Market Values, Not Quantities GDP Includes Only Current Production • Final good or service A good or service purchased by a final user: • Household consumption • Business investment, including all residential construction • Government purchases • Exports to foreigners • Net out goods imported from foreigners • GDP = C + I +G + NX

2. Transfer payments are not included in GDP “Underground economy” activities are not included in GDP Household production is not included in GDP The Value of Leisure Is Not Included in GDP GDP Is Not Adjusted for Pollution GDP Is Not Adjusted for Changes in Crime and Other Social Problems GDP Measures the Size of the Pie but Not How the Pie Is Divided Up

3. The GDP Deflator $ GDP = Price Level x Real Output $Y = P x Y P = $Y/Y Y = $Y/P

4. Other Measures of Total Production and Total Income • Gross National Product (GNP) • =GDP + Net Foreign Earnings of US Residents • Compensation of employees earned abroad • Interest and profits earned abroad Net National Product (NNP) = GNP - Capital Consumption Allowance (depreciation) National Income (NI) = NNP - Indirect Business Taxes = Income earned from production of national product Personal Income (PI) = NI + Net Transfer Payments Disposable Income (DI) = PI - Income Taxes • Disposable Income is split between consumption and saving

5. Consumer price index (CPI) An average of the prices of the goods and services purchased by the typical urban family of four. • Substitution bias. • Increase in quality bias. • New product bias. • Outlet bias.

6. Real versus Nominal Interest Rates Nominal interest rate: The stated interest rate on a loan. Real interest rate: The nominal interest rate minus the inflation rate. Real interest rate = Nominal interest rate − Inflation rate Deflation A decline in the price level.

7. Potential GDP The level of real GDP attained when all firms are producing at capacity. Business cycle ... Fluctuations around potential real GDP

8. The Employment Status of the Civilian Working-Age Population, April 2007

9. Types of Unemployment Frictional Unemployment and Job Search Structural Unemployment Cyclical Unemployment

10. Macroeconomic Equilibrium: Aggregate Expenditure = Output (Y) AE = C + I + G + NX = Y

11. The most important variables that determine the level of C: • • Current disposable income • • Household wealth: Assets minus liabilities • • Expected future income • • The price level • • The interest rate • New, gotta-have styles and products The Relationship between Consumption and Income, The Slope of the Consumption Function is the Marginal Propensity to Consume MPC = Change in Consumption in Response to a Change in Disposable Income MPC = ΔConsumption/ΔDisposable Income = ΔC/ΔYD When disposable income changes, ΔC= MPC x ΔYD

12. The most important variables that determine the level of investment: • • Expectations of future profitability • Waves of optimism and pessimism • • Major technology changes: new products & processes • The interest rate • • Taxes • • Cash flow  Retained earnings for financing investment • Current capacity utilization

13. Net Exports (NX) The most important variables that determine the level of net exports: • The price level in the United States relative to the price levels in other countries • The growth rate of GDP in the United States relative to the growth rates of GDP in other countries • The exchange rate between the dollar and other currencies

14. Graphing Macroeconomic Equilibrium

15. The Multiplier Effect Multiplier The increase in equilibrium real GDP in response to increase in autonomous expenditure, e.g. Expenditure multiplier = ΔY/ΔI ΔY = ΔI + ΔC Increase in output sparked by ΔI induces additional consumption, ΔC = MPC x ΔY

16. Aggregate demand curve A curve that shows the relationship between the price level and the level of planned aggregate expenditure, holding constant all other factors that affect aggregate expenditure. • Price up • Real monetary wealth • down •  i up and I down • + Net Exports down •  Output down

17. Aggregate demand and aggregate supply model A model that explains short-run fluctuations in real GDP and the price level.

18. The Short-Run Aggregate Supply Curve slopes upward Aggregate Supply Why does the short-run aggregate supply curve slope upward? 1Contracts make some wages and prices “sticky.” 2 Firms are often slow to adjust wages. 3 Menu costs make some prices sticky.

19. Macroeconomic Equilibriumin the Long Run and the Short Run Long-Run Macroeconomic Equilibrium

20. Expansion...and restoration of full employment • The Short-Run and Long- run Effects of an Increase in Aggregate Demand: • Prices rise alongSRAS as the economy expands • Costs increase as less productive resources are used to produce more output • Firms increase prices to cover higher costs • Rising wages and prices shiftSRAS inward • Workers demand and get higher wages to offset higher prices • Costs of production increase • Firms increase prices to cover higher costs

21. What Is Money and Why Do We Need It? Money Assets that people are generally willing to accept in exchange for goods and services or for payment of debts. Asset Anything of value owned by a person or a firm. The Functions of Money • • Medium of exchange: buy stuff with money • • Unit of account: post prices/keep books in money terms • • Standard of deferred payment: need money to pay debts • Store of value • Hold money on chance prices of other assets fall

22. How Is Money Measured in the United States Today? M1: The Narrowest Definition of the Money Supply Figure 25-1 Measuring the Money Supply, July 2009 The Federal Reserve uses two different measures of the money supply: M1 and M2.M2 includes all the assets in M1, as well as the additional assets shown in panel (b).

23. How Banks Create Money

24. The Functions of a Modern Central Bank

25. Board of Governors: Seven Governors nominated by Pres- ident and confirmed by Senate for 14 year terms. The Chair has a renewable 4 year term. The Federal Reserve System The Organization of the Federal Reserve System Federal Reserve Districts Federal Open Market Committee: Board of Governors + District Bank Presidents meet 8 times a year to set policy. All presidents attend the FOMC meetings but they take turns voting (FRBNY guy always votes).

26. The Process of Securitization (a) Securitizing a loan (b) The flow of payments on a securitized loan

28. The 1960s: A Policy Menu?

29. The Short-Run and Long-Run Phillips Curves The Inflation Rate and the Natural Rate of Unemployment in the Long Run Nonaccelerating inflation rate of unemployment (NAIRU) The unemployment rate at which the inflation rate has no tendency to increase or decrease.

30. How the Fed Fights Inflation Paul Volcker and Disinflation The Fed Tames Inflation, 1979–1989

31. The Balance of Payments: Linking the United States to the International Economy Balance of payments The record of a country’s trade with other countries in goods, services, and assets. • Current accountrecords a country’s net exports, net income on investments, and net transfers... That is, payments for currently produced goods and services including labor services (paid wages) and capital services (paid “investment income”) • Balance of merchandise trade (sometimes called “balance of trade”) • Balance of trade in goods and service • Net investment and labor income • Net transfers • Financial account records a country’s sales of domestic asset to foreign residents and purchase of foreign assets by domestic residents. • Net foreign investment The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment plus net foreign portfolio investment.

32. Equilibrium in the Market for Foreign Exchange Currency appreciation An increase in the market value of one currency relative to another currency. Currency depreciation A decrease in the market value of one currency relative to another currency.

33. Slope on logarithmic scale = Rate of Real GDP Growth 1983 - 2007 Great Moderation Growth Slowdown 1948-70 growth rate > 1970+ growth rate

34. The Per-Worker Production Function • Output per worker is a decreasing function of capital per worker • There are diminishing returns to capital

35. Looking Across Countries – A Closer Look Conditional convergence • Human capital • Geography and resources • Institutions: Rule-of-law/property rights/finance

36. What Determines How Fast Economies Grow? Technology- technology- technology There are three main sources of technological change: • • Better machinery and equipment. • • Increases in human capital. • Better means of organizing and managing production. • Better means of organizing and managing production.

37. What Determines How Fast Economies Grow? Technological Change: The Key to Sustaining Economic Growth