Review

1
Review

• Chapters 19 - 25

2
Chapter 19 Key Concepts

• Long run growth vs. the Business Cycle
• Potential Output and the Output Gap
• Employment, Unemployment and the Labour Force
• Inflation and the Price Level
• Exchange Rates and Balance of Payments

3
Real GDP fluctuates around a rising trend. The
trend shows long-run economic growth. The
short-run fluctuations show the business cycle.
Potential (full employment) national income
measures what the economy could produce if all
resources were employed at their normal levels of
utilization.
The output gap measures the difference between
potential output and actual output. Output Gap
Y - Y
4
Recessionary Gap
Peak
Recovery
Actual GDP
Recession
Real GDP
Potential GDP
Peak
Trough
Inflationary Gap
Time
When actual income (output) is less than
potential income, there is said to be a
recessionary gap.
When actual income (output) exceeds potential
income, there is said to be an inflationary gap.
5
Employment is the number of adult workers (15 and
over) who hold jobs.
Unemployment is the number of individuals who are
not employed but who are actively searching for a
job.
The labour force is the total number of people
who are either employed or unemployed.
Number of people unemployed
Unemployment Rate

X 100
Number of people in the labour force
When the economy is at full employment (Y Y),
the unemployment that exists is frictional
and/or structural.
6
The unemployment rate that occurs when the
economy is at full employment (YY) is called
the natural rate of unemployment.
During recessions, unemployment rises above its
full-employment level (the natural rate of
unemployment). During booms, unemployment falls
below this level. When unemployment is greater
than the full-employment level, there is cyclical
unemployment.
7

• In a country with a working-age population of 150
  million, 100 million workers are employed and 15
  million workers are unemployed. The size of the
  labour force is
• 150 million
• 100 million
• 115 million
• 15 million

Labour force Employed Unemployed 100 15
115 million

• What is the unemployment rate?
• 15
• 10
• 13
• 66.7

8

• You notice that over the last year the
  unemployment rate has gone from 8.2 percent to
  6.2 percent and growth in real GDP has increased.
  Hence over this year the economy is likely
• in a recession
• at the trough of a business cycle
• in an expansion
• at the peak of a business cycle

9
The price level refers to the average level of
all prices in the economy. Inflation is the rate
at which the price level is changing.
Consumer Price Index (CPI) measures the price
level and is based on the price of a typical
consumption basket. It then expresses that
price as a ratio of the price in some base period.
Inflation erodes the purchasing power of money
and adds to the uncertainty of economic life.
10

• Which of the following is a stock?
• Income
• Depreciation
• Investment
• Government Debt

• At the end of last year, the CPI equaled 120. At
  the end of this year, the CPI equals 132. What is
  the inflation rate over this year?
• 6
• 10
• 12

11
The exchange rate is the number of Canadian
dollars required to purchase one unit of foreign
currency. A depreciation of the Canadian dollar
means the exchange rate has increased. An
appreciation of the Canadian dollar means the
exchange rate has decreased.
The balance of payments accounts record all
international payments that are made in the
course of international transactions of goods,
services, and assets.
The trade balance is the difference between the
value of exports and the value of imports.
12
Chapter 20 National Income

• Measuring National Income
• The Expenditure Approach
• The Factor Incomes Approach
• Real vs. Nominal GDP
• GDP per capita
• GDP and welfare

13
Gross Domestic Product (GDP) is the total value
added produced in the economy. GDP is a measure
of all final output that is produced in the
economy.
GDP is also equal to the total flow of
expenditure on domestic output. Adding up the
total flow of income generated by domestic
production also gives us GDP.
14
The Expenditure Side

• C Consumption expenditure on final goods
• I Gross Investment Expenditure (inventories,
  plant and equipment, residential housing) Net
  Investment Depreciation.
• G Government Purchases of goods and services
  (does not include transfer payments)
• NX Net Exports Exports Imports
• X Exports purchases of Canadian goods and
  services by foreignors
• IM Imports purchases of foreign produced
  goods by Canadians

GDP C I G NX
15
The Income Side

• GDP is the sum of factor incomes and other claims
  on the value of output.
• Net Domestic Income at factor cost
• Wages Rent Interest Profits

GDP Net Domestic Income at factor cost
(Indirect Taxes Subsidies) Depreciation
The difference between measured GDP from the
income approach and the expenditure approach is
called the statistical discrepancy.
16
Real vs. Nominal National Income
Nominal national income is GDP valued at current
prices.
Real national income is GDP that is valued at
constant base-period prices.
GDP at current prices
GDP Deflator
x 100
GDP at base-year prices
Per capita output is the amount of output per
person
Economists use real GDP as opposed to nominal GDP
to compare the economys output between two
different time periods.
17
Chapters 21-22 Overview

• Simple Macro Model
• Adding Government
• Adding International Trade
• The Simple Multiplier

18
Closed Economy without Government
AE C I
C autonomous consumption (MPC x Disposable
Income) C a bYD where YD is disposable income
I investment (autonomous) Autonomous
Expenditure a I Induced Expenditure bYD The
marginal propensity to spend, z MPC b
The simple multiplier 1/(1-z)
19
Adding Government
G Government Purchases T Net Tax Revenues T
G Government budget balance/Public Saving
Tax Function T tY where t is the tax rate
With taxes, disposable income is less than
national income YD Y T Y tY (1 - t)Y
This changes the consumption function C a
bYD a b(1 t)Y
20
Adding International Trade
Imports Function IM mY where m is the marginal
propensity to import.
Net Exports Function NX X IM X - mY
Changes in foreign incomes, the relative prices
of Canadian products and exchange rates will
shift the net exports function.
21
AE Function
AE C I G NX
AE C I G (X IM) AE a b(1-t)Y I
G (X mY) AE a I G X b(1-t) mY
Autonomous Expenditure, A
Induced Expenditure
Marginal Propensity to Spend, z
AE A zY
22
Equilibrium National Income
Equilibrium condition Y AE
When Y lt AE, firms find that their inventories
are lower than desired and increase production.
When Y gt AE, firms find that their inventories
are piling up higher than desired and reduce
production.
23
Suppose there is a change in autonomous
expenditure, A. A a I G X
The resulting change in equilibrium national
income
24
If the simple multiplier is 4, what is the
marginal propensity to spend out of national
income?

• 0.1
• 0.2
• 0.75
• 0.5

25
Practice Question
26
Chapter 23 AD AS

• Deriving AD from AE
• Short Run Macroeconomic Equilibrium
• Demand and Supply Shocks

27
Deriving AD from AE
28
Short Run Macroeconomic Equilibriumwith price
adjustment
Aggregate Demand
Aggregate Supply
Equilibrium Condition
29
AD AS Supply Shocks

• Expansionary shocks cause real GDP to increase
  (AD and/or AS shift to the right)
• Contractionary shocks cause real GDP to decrease
  (AD and/or AS shift to the left)
• Some events will cause both AD AS curves to
  shift.

30

• Shifts AD
• Changes in C, I, G, X, IM

Shifts AS Changes in Factor prices Factor
supply Technology Prices of raw materials Unit
costs Productivity
Shifts Y, Potential Output Changes in Factor
supply Technology Productivity
31
Which of the following does NOT shift potential
GDP?

• A decrease in nominal wages
• Technological innovation
• Labour force growth due to increased immigration
• An increase in the nations capital stock due to
  investment

32
Chapter 24 Short Run to Long Run

• Defining the short-run
• The Adjustment Process
• Fiscal Policy

33
Short-run vs. The Long Run

• Short-run
• Factor prices, factor supply and technology are
  assumed to be constant.
• The Adjustment process
• Factor prices adjust to close output gaps, factor
  supply and technology are assumed to be constant.
• The Long-run
• Factor prices have fully adjusted, technology and
  factor supply are assumed to be changing.

34
The Adjustment Process

• After a demand or supply shock leading to an
  output gap in the short run, factor prices will
  adjust in order to bring real GDP back to
  potential output in the long run.
• Inflationary Gap Excess Demand in Economy.
  Factor Prices rise. AS shifts to the left to
  close gap. Price level rises.
• Recessionary Gap Excess Supply in the Economy.
  Factor Prices fall. AS shifts to the right. Price
  level falls.

35
In the long run, the multiplier

• is the same as in the short run.
• is larger than in the short run.
• is greater than 1.0.
• is equal to 0 because output returns to potential
  GDP.

36
Fiscal Policy

• This is the use of the government budget to
  affect aggregate demand (AD).
• Contractionary Fiscal Policy Appropriate for
  closing inflationary gaps involves reducing
  government purchases and/or increasing tax rates.
  AD shifts left.
• Expansionary Fiscal Policy Appropriate for
  closing recessionary gaps involves increasing
  government purchases and/or reducing tax rates.
  AD shifts right.

37
Chapter 25 GDP Accounting
Factor Supply
Factor Utilization
Factor Productivity
38
Explaining GDP Growth

• In the short run, changes in GDP are better
  explained by changes in factor utilization (e.g.
  the employment rate).
• In the long run, changes in GDP are better
  explained by changes in factor supply (e.g. the
  labour force) and changes in productivity (e.g.
  labour productivity).