Chapter 11

1. Price index
- The consumer price index (CPI): A measure of the overall cost of the goods
and services bought by a typical consumer.
- How to calculate the Consumer price index:
+ Fix the basket
+ Find the prices
+ Compute the basket’s cost
+ Choose a base year and compute the index
Price of basket of goods∧services ∈current year
Consumer price index = ∗100
Price of baskets∈base year

+ Compute the inflation rate (the percentage change in the price index from
the preceding period)
CPI year n−CPI year (n−1)
Inflation rate in year n = ∗100
CPI year n

- The producer price index (PPI) is a measure of the cost of a basket of goods
and services bought by firms
- Because firms eventually pass on their costs to consumers in the form of
higher consumer prices, changes in the producer price index are often
thought to be useful in predicting changes in the consumer price index.
2. Problems in measuring the cost of living
- The goal of the consumer price index: to measure changes in the cost of
living.
- 3 problems:
+ Substitution bias:
 When prices change from one year to the next, they do not all change
proportionately.
 Consumers substitute towards goods that have become relatively less
expensive.
+ The introduction of new goods:
 When a new good is introduced, consumers have more variety from
which to choose, and this in turn reduces the cost of maintain the same
level of economic well-being.
+ Unmeasured quality change:
 The quality of a good deteriorates from one year to the next while its
price remain the same => the value of a dollar falls (because you are
getting a lesser good for the same amount of money)
CHAPTER 13: SAVING, INVESTMENT AND THE FINANCIAL SYSTEM
- The financial system is the group of institutions in the economy that help to
match one person’s saving with another person’s investment
>>>> Moves the economy’s scarce resources from savers to borrowers
- Financial systems:
+ Financial markets include: bond market and stock market
+ Financial intermediaries include: commercial banks and mutual funds
- Financial markets are the institutions through which a person who wants to save
can directly supply funds to a person who wants to borrow.
(Bond is a certificate of indebtedness that specifies the obligations of the borrower
to the holder of the bond)
1. Financial markets:
- Savers can directly provide funds to borrowers
a. Bond market:
- IOU: a certificate of indebtedness
- seller of the bond is the borrower
- Principal: amount borrowed
- Date of maturity: the time at which the loan will be repaid (the rate of interest
that will be paid periodically until the loan matures)
- Characteristics of bond:
+ Bond’s term: the length of time until the bond matures.
Perpetuity: this bond pays interest forever but the principal is never repaid.
The interest rate on a bond depends on its term and long-term bonds are usually
riskier than short-term bonds b/c holders of long-term bonds have to wait longer
for repayment of principal.
Interest ($ )
Interest rate = Principal ( $)∗100

Interest rate:
+ Saving int. rate
+ Landing int. rate -> Borrower have to repay to the lander
+ Bond’s credit risk: the probability that the borrower will fail to pay some of the
interest or principal.
Default: a failure to pay
Borrowers can default on their loans by declaring bankruptcy.
Govt bonds pay low interest rates -> a safe credit risk
Financially shaky corporations raise money by issuing junk bonds, which pay very
high interest rates
+ Bond’s tax treatment: the way the tax laws treat the interest earned on the bond.
The interest on most bonds is taxable income – the bond owner has to pay a
portion of the interest in income taxes.
>>> bonds issued by state and local govt pays a lower interest than bonds issued
by corporations or the federal govt.
+ Inflation protection
2. Stock market:
- cổ phiếu là tờ giấy xác nhận bạn có partial ownership -> if the company earns
profit, you will receive dividends from the company. >>> It means you will take
risk or earn money from the company.
- To raise money for new investments, corporations can issue stocks (equity
finance) and bonds (debt finance)
+ The owner of shares is a part owner of the corporation
+ The owner of bonds is a creditor of the corporation
- share: one unit of stock of company
- stock: represents shares of ownership of a company
- stockholder (also referred to as shareholder)
3. Financial intermediaries:
- Savers can indirectly provide funds to borrowers
a. Commercial banks:
- Institution that connect savers and borrowers
- Banks pay interest  take in deposits from savers
- Make loans to borrowers  Banks charge interest to borrowers.
b. Mutual funds:
- Institution that sells shares to the public
- Uses the proceeds to buy a portfolio of stocks and bonds
- Advantages of mutual funds:
+ Diversification
+ Access to professional money managers
3. National income accounts
- Accounting refers to the way in which various numbers are defined and added up
+ A personal accountant might help an individual add up his income and expenses
+ A national income accountant does the same thing for the company as a whole
- Identity:
+ An equation that must be true because of the way the variables in the equation
are defined
+ Identifies are useful to keep in mind => they clarify how different variables are
related to one another.
- First identity: GDP
+ Closed economy:
NX=0
+ Open economy: NX is different from 0 (NX = 0 if N=X)
- Y=C + I (private) + G
- National saving (S national)
+ Total income in the economy that remains after paying for consumption and govt
purchases
+ Y-C-G = I private
+ S national = Y-C-G
+ S national = I private
- Saving = (Disposable) Income – Consumption
- Net taxes = Taxes – Transfer payments: the remaining taxes after subtracting the
transfer payments
- S private = (Y – Taxes + Transfer payments) – C = Y – (Tx – Tr) – C = Y - T – C
- S public = Tx – (G+Tr) = (Tx – Tr) – G = T – G
- National saving = S private + S public = Y – C – G
- National saving = Private investment
=> It’s true for the economy as a whole
=> It doesn’t mean that saving and investment are equal for every individual
household or firm.
- The term saving and investment can sometimes be confusing
- Buying some stock or a bond from a corporation might be thought as investing,
but a macroeconomist would call this act saving rather than investment
- In the language of macroeconomics, investment refers to the purchase of new
capital, such as equipment or buildings
- Budget surplus: T-G>0
- Budget deficit: T-G<0
- Balanced budget: T-G=0
4. The market for loanable funds:
- Supply side & Demand side
- To examine the main variable: interest rate
- Market for loanable funds:
+ Market in which
Those who want to save supply funds
Those who want to borrow demand funds
(supply funds -> saver, demand funds -> borrower)
+ One interest rate:
>> Return for saving (applied for lenders)
>> Cost of borrowing, also called price of a loan (applied for borrowers)
- Source of the supply of loanable funds is national saving
- Source of the demand of loanable funds id private investment
4 ways:
1. Budget deficit affects the supply of loanable funds because public saving is one
of the components of the national saving
2. The supply curve shifts to the left
3. determine the new equilibrium compared to the initial ones to show the changes
4. Judge this event’s effect is negative or positive and what is its impact on the
economy?
Focus only on the demand curve: higher interest rates, lower quantity demanded of
loanable funds -> it means that the investment decreases and leads to the decrease
in GDP -> this event has negative impact on the economy
- Government policies can affect the economy’s saving and investment:
+ Saving incentives
+ Investment incentives
+ Government budget deficits and surpluses
- Policy 3:
Budget  Tax unchanged, Government payments increases -> Deficit >> Int. rates
rise >> Investment falls => Crowding-out effect
CHAPTER 16
1. Liquidity
- The most liquid asset is money because money is the economy’s medium of
exchange
- The relatively liquid assets are mostly stocks and bonds (bonds and stocks can be
sold easily with low cost
- Selling a house or a famous painting (which need more time and effort) are less
liquid
2. 4 kinds of money
a. Commodity money
- Money that takes the form of a commodity with intrinsic value
- When an economy uses gold as money, it is said to be operating under a gold
standard
b. Fiat money
- Money without intrinsic value, it is used as money because of government decree
>> Bills and Coins
c. Bank money
- Money is held in commercial banks
- Including checks, drafts, debit cards, credit cards
- To use bank money:
+ For using checks or debit cards, each buyer must have a demand deposit account,
so that she can use to pay to sellers anytime she wants
+ Sellers must have bank accounts to receive money from buyers
*Checks:
- Check is a written order, usually on a standard printed form, directing a bank to
pay money
*Draft:
- Draft is a written order for money to be paid by a bank, especially to another
bank
*Credit card: (= draft)
- Credit card is a small plastic card that can be used as a method of payment
- The money being taken from the holder’s bank account at a later time
*Debit card:
- Debit card is a small plastic that resembles a credit card but functions like a check
- It can be used as a method of payment, the money being taken from the holder’s
bank account immediately without the payment of interest.
d. Mobile money
- Mobile money is a solution that allows users to transfer money and make
payments without a bank account or an internet connection
2. Money in an economy
- Money stock: the quantity of money circulating in the economy
- Currency: paper bills and coins in the hands of public and in reserve in
commercial banks
(Currency is clearly the most widely accepted medium of exchange in an
economy)
- Demand deposits: balances in bank accounts that depositors can access on
demand by writing a check or swiping a debit card at a store
- Measures of money stock:
+ M1: currency, demand deposits, traveler’s checks, other checkable deposits
+ M2: Everything in M1, savings deposits, small time deposits, Money market
mutual funds, A few minor categories
3. Banking system
a. The Central Bank:
- an institution that oversee and ensure the health of the banking system, as well as
control the money supply.
Mr A goes to the bank and deposits $100. => Money supply is higher than $100.
Mr A goes to the bank and withdraws $100 => Decrease in money supply
Money creation process: a process where small deposits -> larger money supply
Money destruction process: a process where a small withdraw of money -> larger
decrease in money supply in the economy
Change in M = Kn * change in initial demand deposit
1
Ex: $1,000= R=10 % (-/+100)

Total money supply = Money supplier * Initial deposit

Total money supply 1
=> Money supplier = =
Initial deposit Reserve ratio

Total money created = Total money supply – Initial deposit

Credit creation process: a process where a small deposit -> larger money supply
Money multiplier and reserve ratio: inverse relationship
Commercial banks have to hold more reserves
-> commercial banks lend less money and this leads to a smaller money multiplier.
Unit of total reserve generates the amount of money supply => the same =>
deposits generate the amount of money supply
 Initial deposit=Total reserve
Eg: 1 unit of initial deposit creates 10 units of money supply (R=10%)
Total reserve = Required reserve + Excess reserve
Monetary base: Bank reserves + currency in the hand of the public (M=C+R)
Money supply: Currency in circulation + Checkable bank deposits (Total deposits)
(M=C+D)
Total deposit is from D = Kn * Initial Deposits
=> Money supply is larger than monetary base
The discount rate: The interest rate on loans the Central bank makes to loans.
Discount rate higher -> banks borrow money from central bank
Reserve requirements: Regulations that set the minimum amount of reserves
CHAP 17
Inflation: Increase in price level
Deflation: Decrease in price level
Disinflation: Reduction in the rate of inflation
Hyperinflation: Extraordinarily high rate of inflation
The classical theory of inflation is studied by 2 approaches:
+ A supply-demand diagram -> depend on the price level (CPI, GDP def)
+ An equation
1/P is the value of unit of money
Inflation drives up prices and drives down the value of money (real value = Nom.
Value/Price level)
Money supply (MS):
The money supply curve is vertical at a fixed amount at any price level
At any price of level, there is no change in the quantity of money
Money Demand (MD): depends on price level
Reflects how much wealth people want to hold in liquid form
Objects for holding money in the hand:
+ Transaction
+ Precaution
+ Speculation
Price level increases -> Reduces the value of money -> more goods and services
are purchased
Focus on the price level, the demand curve is upward sloping. While the opposite
is for the value of money 1/P, the demand curve is downward sloping. (because
these 2 elements are inverse.
If the company injects more money into the economy, the money supply shifts
rights and price level increase and interest rate increase too.
Nominal variable is measured in monetary units
Real variable is measured in physical units (eg. Kilogram,…)
Nominal variables:
+ Nominal GDP
+ Nominal int. rate (measured in percentage but from the nominal int. rate, you can
determine the nominal interest)
+ Nominal wage
Real variables:
+ Real GDP (using constant price in the base year -> real GDP reflects the change
in quantity of goods and services)
+ Real interest rate
+ Real wage
Price: normally measured in terms of money
Relative price: Price of one good relative to another good
Real wage = W/P
Classical dichotomy:
Changes in money supply affect nominal variables but real variables in the long
run
Money neutrality: the proposition that changes in the money supply but do not
affect real variables (affect the nominal variables)
=> Changes in money supple do not affect real variables in the long run
+ Not completely realistic in short run
Velocity of money
V= P*Y/M= Nominal GDP / Money supply
Quantity equation: M*V=P*Y
The quantity theory in 5 steps:

CHAPTER 19
Nominal GDP = C+I+G+NX (at current prices)
Not Real GDP (at constant prices)
1. 3 key facts about economic fluctuations:
+ Economic fluctuations are irregular and unpredictable
+ Most macroeconomic quantities (real GDP and Investment) fluctuate together
+ Output falls -> unemployment rises
2. Economic fluctuations
3. Aggregate demand
- Classical dichotomy and monetary neutrality: correct in the long run but not
realistic
- YAD = f(P)
- Reasons why AD slope downward:
AD = Y = C+I+G+NX (assume G is fixed by policy)
Y: output produced
AD: output demanded
Y -> GDP (or AS)
C+I+G+NX -> AD
- 3 reasons
+ Wealth effect: Price level and consumption
Price level rises -> Real value of money increases -> poorer -> Consumer spending
falls -> YAD falls
Recall: Fisher effect
Nom. Int. rate (rise)= Inf. Rate (rise) + Real int. rate (unchanged)
+ Interest effect: price level vs investment YAD
Price level rises -> Inflation rises -> Nom. Int. rate rises ->Investment falls -> Y AD
falls
+ Exchange rate effect:
P (domestic) increases -> E (real exchange rate) rises -> Domestic currency
depreciates -> Imports increases -> NX decreases -> YAD falls
4. Shift of the AD curve
- 4 things can shift AD curve if price level is unchanged:
+ Changes in consumption
+ Changes in investment
+ Changes in govt purchases
+ Changes in net exports
Movement along the AD curve: price level changes -> affect: C, I, NX
Shift of the AD curve: price level unchanged -> affect: C, I, G, NX
5. Short run aggregate supply
- AS curve slopes upward in short run and vertical in the long run
- Theories explain why the AS curve slopes upward in short run:
+ Sticky wage theory:
 Nominal wages are slow to adjust to changing economic conditions
 Nominal wages are based on expected prices
 Price = Cost of production + Tax + Profit
 If price rises, cost of production unchanged, tax unchanged -> profit
increases -> stimulate firms to produce more
+ Sticky price theory:
 Prices of some goods and services are slow to adjust to changing economic
conditions
 This sticky prices occurs due to costs to adjusting prices, called menu costs
 Firms set sticky prices in advance based on expected price level
 Price level increases -> firms with menu costs wait to raise prices: their
prices of goods are relatively low, which increase demand for their products
and increase output and employment.
+ Misperceptions theory:
 If actual price rises above price level expected, a firm sees its price rise
before realizing all prices are rising and may increase output and
employment
6. Shift of the SRAS curve:
- Price level is unchanged
- Change in labor, capital, natural resources or technological knowledge
- Change in expected price level
Actual price unchanged, expected price level increases -> Nominal wage increases
-> Cost increases -> Profits falls -> SRAS curve shifts left
7. Long run aggregate supply curve
- In the long run, the aggregate supply curve is vertical
- Natural rate of output is determined by the economy’s stocks of labor, capital,
natural resources, and the level of technology
- But price level doesn’t affect the natural rate of output (in the long run,
everything always changes)
a) Shift of the LRAS curve
- Change in labor
Natural rate of unemployment increases -> the number of labor falls, the quantity
of goods and services supplied falls -> LRAS shifts left
- Change in capital (stock)
The more investment, the more capital
Investment: flow in a limited period of time
- Change in natural resources knowledge
- Change in technology
8. The aggregate equation
Y = YN + a (P – PE)
Y: output
YN: natural rate of output
P: Actual price level (CPI/GDP def)
PE: Expected price level
a: a positive coefficient that measures how much Y responds to unexpected
changes in P
output in the short run is smaller output in the long run -> recessionary gap
output in the short run is higher than output in the long run -> Inflationary gap
In the short run, economic fluctuations are caused by events that shift the AD
and/or AS curves
Case 1: with government’s intervention Fiscal policy and monetary policy
B-> A (get back in the output of the long run and there is no changes in price level
and output)
Case 2: Real estate market crash
B -> C
Price level falls -> inflation rate falls -> nominal interest rate falls
Y falls and U-rate increases
Price of a good (unchanged) = cost of production (falls) + Tax(unchanged) + Profit
(rise)
Nominal interest rate is lower -> Interest rate is lower -> invest more -> cost of
production falls
Profit rises > (SRAS) shifts to the right until LR equilibrium
Price rises -> Inflation rate increases (1)
Y falls -> stagnation (2)
(1) & (2) => stagflation
If the demand pull and the cost happen at the same time, determine the final short
run equilibrium using AD-AS model
- Demand pull: AD curve shift right -> Price rise, Inflation rate rise, Y increases ->
U rate falls
- Cost push inflation: Ad curve shifts left -> Price rise, Inflation rate rise, Y
decreases, U rate increases
When these happen in the same time, Price level rise, Inflation rate increases and Y
ambiguous and U rate ambiguous.
CHAPTER 21