Snmek 1

1
what do we know?

• class 1 description
• real x nominal GDP, 3 ways to measure GDP
• deflator x CPI
• unemployment rate, participation rate
• class 2 AD goods and financial markets
• multiplicative effects of autonomous
  components of demand its size depends on
  how sensitive is the demand to income
• role of progressive taxation (T depends on Y)
  automatic stabilizers
• money demand (transaction and liquidity
  purposes, role of IR via opportunity cost)
• alternatively quantity theory of money (with
  constant velocity)
• link between the supply of monetary base and
  money supply money multiplier, says how
  powerful the money creation process is

today continue with our study of fluctuations
ec210, class 3
Milan Lisicky
2
economy in the short-run perspective how do
shocks to AD affect economy

• How do fluctuations happen?
• AD is major source of fluctuations, namely
  fiscal policy and monetary policy

• What is AD?
• equilibrium output of final goods at each level
  of P

what is level of output, Y, is demanded (and
produced) for given P and IR goods market
what level of nominal IR can exist for given P
and Y financial market
markets are interconnected
IR affects the level of output at the goods
market ltISgt
Y affects the level of IR at the financial
market ltLMgt
Milan Lisicky
ec210, class 2
3
aggregate demand goods market derivation of the
IS curve

• Assumptions
• A1 Firms have free capacities gtgt demand, Z,
  determines Y
• A2 Demand depends on Y gtgt Z(Y)
• From definitions of GDP follows that the economy
  must be in
• expenditure ( production) income (45 line) gtgt
  Z(Y) Y
• The role of IR
• from our basic investment theory, I d0 d1Y
  d2 IR
• solving Z(Y) Y gives Y 1 / (1 - c1 - d1)
  c0 - c1 Td0 - d2 IR G
• IS curve depicts Y that prevails for a given
  level of IR ?IR ... ?I ... ? Y

Q1, back
Milan Lisicky
ec210, class 2
4
aggregate demand financial market derivation of
the LM curve

• Assumptions
• all wealth is held either in money or bonds, only
  bonds bear IR
• money is held either in cash or deposits Md c
  Md (1-c) Md
• Demand for money
• Md PY L(IR), or explicitly Md / P m0 m1
  Y m2 IR
• Supply of money (derived from the inter-bank
  money market)
• Ms Hs c ? (1-c)
• The role of Y
• from our money demand theory, Md / P m0 m1
  Y m2 IR
• solving Md Ms gives IR 1 / m2 (m0 m1 Y
  M / P)
• LM curve gives IR that prevails for a given level
  of Y ?Y ... ?Md ... ?IR

Q2, back
Milan Lisicky
ec210, class 2
5
economy in the short-run perspective how do
shocks to AD affect economy
Markets are interconnected fiscal and monetary
policy affect both IR and Y

• Transmission mechanism of fiscal policy (Q3, c)
• ?G...?Z...?Y...?Md...?IR...?I...?Z...?Y
• mult. m1-
  d2-
• note financial crowding out of private
  investment

• Transmission mechanism of monetary policy (Q3,
  d)
• ?Hs...?Ms... (?Bonds,?IR,?Md)...?I...?Z...?Y..
  .(?Md,?IR)
• MM
  m2- d2
  mult. m1-

Milan Lisicky
ec210, class 2