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MAC for midterm

Macroeconomics (Đại học Hà Nội)

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MAC

LEC 1: MEASURING A NATION’S INCOME

1. The economy income and expenditure

- Gross domestic product (GDP) measures the total income of everyone in the economy and
the total expenditure on the economy’s output of goods and services
- For economy as a whole: income = expenditure
- Circular-flow diagram –
assumptions:
● All goods and services are
bought by households
● Households spend all of
their income
● Households buy goods
and services from firms
and firms use their
revenue from sales to pay
wages to workers, rent to
landowners, and profit to
firm owners. GDP = the
total amount spent by
households in the market
for goods and services.
And = total wages, rent,
and profit paid by firms in
the markets for the factors
of production

2. Measurement of GDP
- GDP: market value of all final goods and services produced within a country in a given
period of time.
- Y = C + I + G + NX
● Y = GDP
● C = consumption: spending by households on goods and services
● I = investment: spending on capital equipment, inventories, and structures
● G = gov purchases: gov consumption expenditure and gross investment spending on goods
and services by local, state, and federal gov (-transfer payment)
● NX = net exports = exports - imports
○ Exports: spending on domestically produced goods by foreigners
○ Imports: spending on foreign goods by domestic residents

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3. Real vs nominal GDP

- Total spending rises from 1 year to the next: economy produces a larger output of goods and
services and/or goods and services are being sold at higher prices
- Nominal GDP: production of goods and services valued at current prices
- Real GDP: production of goods and services valued at constant prices, designate 1 year as
base year, not affected by changes in price
- For the base year: Nominal GDP = Real GDP
- The GDP deflator: measure of the price level
● Measures the current level of prices relatives to the
level of prices in the base year
- Inflation: economy’s overall price level is rising
● Inflation rate: % change in some measure of the price level from one period to the next.
GDP deflator ∈ year 2−GDP deflator∈ year 1
● Inflation in year 2 = x 100
GDP deflator∈ year 1

4. GDP - Good measure of economic well-being?

- Larger GDP: good life, better healthcare, better educational systems
- Measure: ability to obtain many of the inputs into a worthwhile life
- GDP: not a perfect measure of well-being bcz not including leisure, value of almost all
activity that takes place outside markets, quality of the environment and no distribution of
income

LEC 2: PRODUCTION AND GROWTH

I. Productivity: its role and determinants

- Productivity = Y/L (the average quantity of goods and services produced per unit of labor
input)
● Y = real GDP = quantity of output produces
● L = quantity of labor
- Productivity’s determinants:
1. Physical capital per worker
- The stock of equipment and structures used to produce goods and services is called physical
capital, denoted K
- Capital per worker = K/L
- Productivity is higher when the average worker has more capital (machines, equipment,...)
- An increase in K/L causes an increase in Y/L

2. Human capital per worker

- Human capital (H); the knowledge and skills workers acquire through education, training,
and experience.
- The average worker’s human capital = H/L
- Productivity is higher when the average worker has more human capital (education, skills,…)

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- An increase in H/L causes an increase in Y/L

3. Natural resources per worker

- Natural resources (N): the inputs into production that nature provides, e.g., land, mineral
deposits
- Other things equal, more N allows a country to produce more Y
- In per-worker terms, an increase in N/L causes an increase in Y/L

4. Technological knowledge
- Technological knowledge: society’s understanding of the best ways to produce goods and
services
- Technological progress means any advance in knowledge that boosts productivity (allows
society to get more output from its resources)
- Technological knowledge refers to society’s understanding of how to produce goods and
services
- Human capital results from the effort ppl expend to acquire this knowledge.
- Both are important for productivity.

II. The production function

- The production function is a graph or equation showing the relation between output and
inputs: Y = A x F(L, K, H, N)
● F( ) - a function that shows how inputs are combined to produce outputs
● “A” - the level of technology
● “A” x the function F( ), so improvements in technology (increase in “A”) allow more output
(Y) to be produced from any given combination of inputs
- The production function has the property constant returns to scale: changing all inputs by the
same percentage causes output to change by that percentage.
● E.g.: 2Y = A x F(2L, 2K, 2H, 2N)
- Y/L = A x F(1, K/L, H/L, N/L)

III. Economic growth and public policy

1. Saving and investment: A tradeoff between current and future consumption.
- The catch-up effect: With the same amount of capital (capital per labor), a poor country can
receive/create more output (output per labor) than a rich country due to the diminishing
return to capital of the aggregate production function.

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2. Investment from abroad:

- Foreign direct investment: a capital investment that is owned and operated by a foreign
entity
- Foreign indirect investment: a capital investment financed with foreign money but operated
by domestic residents
3. Education, health & nutrition: Education Policy & Health care expenditure
4. Property rights and political stability: Justice system
5. Research and development: Technology progress
6. International trade:
- Inward-oriented policies: aim to raise living standards by avoiding interaction with other
countries (e.g. tariffs, limits on investment from abroad)
- Outward-oriented policies: promote integration with the world economy (e.g., the
elimination of restriction on trade or foreign investment)
7. Population growth
- Stretching natural resources
- Diluting the capital stock

LEC 3: UNEMPLOYMENT

- Unemployment: a situation where some ppl are willing and able to work, but are unable to
find paid employment.
- Unemployment results in lost incomes and production, lost human capital
1. Types of unemployment:
- Natural rate of employment: the normal rate of unemployment around which the actual
unemployment rate fluctuates

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● Frictional unemployment: occurs when workers spend time searching for the jobs that best
suit their skills and tastes, short term for most workers
● Structural unemployment: occurs when there are fewer jobs than workers in some labor
market, usually long term (quantity of labor supplied > quantity of labor demanded)
- Cyclical unemployment rate: the deviation of unemployment from its natural rate
associated with business cycles

2. How is unemployment measured?

- Employed:
- Unemployed:
- Not in the labor force:
- The unemployment rate: U/E rate = Unemployed/Labor force
- The labor force participation rate (LFPR) = Labor force/Adult population
- Natural U/E = Frictional U/E = Structural U/E
● Cause of frictional U/E: job search
● Cause of Structural U/E: above equilibrium wage

3. Job search
- Job search unemployment different from other types of unemployment:
● Not caused by a wage rate higher than equilibrium
● Caused by the time spent searching for the right job
- Sectoral shift: changes in the composition of demand among industries and regions
- Gov programs to reduce searching time;
● Gov-run employment agencies: provide information about job vacancies in order to match
workers and jobs more quickly
● Public training programs: ease the transition of workers from declining to growing
industries and to help disadvantaged group escape poverty
● Unemployment insurance: partially protect workers’ incomes when they become
unemployed:
○ Offer workers partial protection against job losses
○ Offer partial payment of former wages for a limited time to those who are laid off
- Effect of unemployment insurance:
● Increase the amount of search unemployment
● Reduce the search efforts of the unemployed
● Improve the chances of workers being match with the right jobs

4. Why is there unemployment

- Above equilibrium wage due to:
● Minimum wage laws: when the minimum wage is set above the level that balances supply
and demand, it creates unemployment

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● Unions: a worker association that bargains with employers over wages and working
conditions
○ Collective bargaining: process by which unions and firms agree on the terms of
employment -> above equilibrium wages for their members
■ Unionized workers: reap the benefits
■ Non-unionized workers: bear costs - unemployed at higher wages
○ A strike: withdrawal of labor from the firm, organized if the union and the firm
cannot reach an agreement
○ Are unions good or bad for the economy?
■ Causing inefficient and inequitable allocation of labor
■ A necessary antidote/remedy to the market power of firms that hire workers
● Efficiency wages:
○ Reason for using efficiency wages:
■ Worker health
■ Worker turnover
■ Worker effort
■ Worker quality

LEC 4: SAVING, INVESTMENT, AND THE FINANCIAL SYSTEM

I. Financial institutions in the US economy

- The financial system: the group of
institutions that helps match the
saving of one person with the
investment of another
- Financial markets: institutions
through which savers can directly
provide funds to borrowers (e.g.,
bond market, stock market)
- Financial intermediaries:
institutions through which savers
can indirectly provide funds to
borrowers (e.g., take deposits,
loans)
- Mutual funds: institutions that sell
shares to the public and use the
proceeds to buy portfolios of
stocks and bonds

II. Saving and investment in the national income account

1. Kinds of saving
- Private saving: the portion of households’ income that is not used for consumption or paying

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taxes = Y - T -C
- Public saving: Tax rev - gov spending = T - G
- National saving = private saving + public saving = Y - C - G

2. Saving and investment

- Saving = investment in a closed economy
3. Budget deficits and surpluses
- Budget surplus: an excess of tax rev over gov spending (public saving = T - G >0)
- Budget deficit: a shortfall of tax rev from gov spending (public saving = T - G <0)

III. The market for loanable funds

1. The market for loanable funds
- A supply-demand model of the financial system
- Help us understand:
● How the financial system coordinates saving and investment
● How gov policies and other factors affect saving, investment, the interest rate
- The supply of loanable funds comes from saving:
● Households with extra income can loan it out and earn interest
● Public saving, if possible, adds to national saving and the supply of loanable funds. If
negative, it reduces national saving and the supply of loanable funds
- The demand for loanable funds comes from investment:
● Firms borrow the funds they need to pay for new equipment, factories,...
● Households borrow the funds they need to purchase new houses

2. Policy 1: Saving incentives: S shift right (increase)

3. Policy 2: Investment incentives: D shift right

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4. Policy 3: Gov budget deficit: S shift left (decrease)

- Crowding out:

LEC 5: THE MONETARY SYSTEM

1. The meaning of money

- Money: set of assets in an economy that ppl regularly use to buy goods and services from
other ppl
- The functions of money:
● Medium of exchange: item that buyers give to sellers when they want to purchase goods and
services
● Unit of account: Yardstick ppl use to post prices and record debts
● Store of value: item that ppl can use to transfer purchasing power from the present to the
future
- Liquidity: Ease with which an asset can be converted into the economy’s medium of
exchange
- Kinds of money:
● Commodity money: money that takes the form of a commodity with intrinsic value
○ Intrinsic value: item would have value even if it were not used as money
● Fiat money: money without intrinsic value, used as money because of gov decree
- Money in the economy:
● Money stock: quantity of money circulating in the economy
● Currency: paper bills and coins in the hands of the public
● Demand deposits: balance in bank accounts
- Measures of money stock: M1,M2

2. Central bank and its functions

- Functions:

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● Issues currency
● Act as banker to the gov
● Regulate banks to promote safe and sound banking practices
● Act as a banker’s bank, making loans to banks and as a lender of last resort
● Conduct monetary policy by controlling the money supply
- The primary tool - open-market operation: purchase & sale of gov bonds
● Increase the money supply: open-market purchase
● Decrease the money supply: open market sale

3. Banks and the money supply

- Reserves: deposits that banks have receives but have not loaned out
- If all deposits are held as reserves, banks do not influence the supply of money
- Money creation: fractional reserve banking
● Banking system
● Banks hold only fraction of deposits as reserves: banks create money, increase in MS
● Reserves ratio: fraction of deposits that banks hold as reserves
● Bank must hold - reserves requirement: minimum set by the Fed
● Bank may hold additional excess reserves

- The money multiplier: amount of money the banking system generates with each dollar of
reserves, reciprocal of the reserve ratio =1/RR
- The tools of monetary control
● Open-market operations
● Reserve requirements: regulations on minimum amount of reserves that bank must hold
against deposits
● The discount rate:
○ Higher discount rate reduces the MS

- Problems in controlling the money supply

● The central bank: does not control the amount of money that households choose to hold as
deposits in banks
● The central bank does not control the amount that bankers choose to lend

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