Download (IS) Y

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
MACROECONOMICS
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HUỲNH VĂN THỊNH
Home phone:(84.8) 39911812; (84.8) 66786400
Cell phone: 0989 0110 19
Email: thinh.huynhvan@gmail.com
thinhhv@ueh.edu.vn
Web:
http://sites.google.com/site/huynhvanthinhsite
http://sites.google.com/site/economicsfamily
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MACROECONOMICS
Macroeconomics is the study of the
economy as a whole. Its goal is to explain
the economic changes that affect many
households, firms, and markets at once.
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Macroeconomics answers questions like the
following:
 Why is average income high in some countries and
low in others?
 Why do prices rise rapidly in some time periods
while they are more stable in others?
 Why do production and employment expand in
some years and contract in others?
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CONTENTS
Chapter 1
AGGREGATE DEMAND AGGREGATE SUPPLY
AND EQUILIBRIUM
Chapter 2
MEASURING AGGREGATE OUTPUT
Chapter 3
THE MULTIPLIER MODEL
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CONTENTS
Chapter 4
THE IS – LM FRAMEWORK
Chapter 5
OPEN-ECONOMY MACROECONOMICS:
BASIC CONCEPTS
Chapter 6
INFLATION AND UNEMPLOYMENT
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Chapter 1
Aggregate Demand,
Aggregate Supply
and Equilibrium
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I. Aggregate Demand, AD
AD= C + I + G + X – M
1. Consumption, C:
The spending by households on goods and services,
with the exception of purchases of new housing.
• Durable goods (exception of purchases of new
housing)
• Non-durable goods
• Services
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• Mathematical Function:
C = Co + Cm*Yd
Co= Autonomous consumption
Cm=MPC= Marginal propensity to consume
Marginal consumption
Cm = dC/dYd
The marginal propensity to consume measures households’ willingness to
change consumption spending as result of a change in disposable income Yd
0 < Cm < 1
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Example:
C= 100 + 0.8*Yd
Co= 100= Autonomous consumption, constant
Cm=0.8= Marginal propensity to consume
Yd change 1$ => C change 0.8$
Yd=Disposable income
Yd = Y- T + Tr = Y – Tn = C + S
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•
•
•
•
•
•
Y=GDP=Output=Gross domestic Product
T=Tax
Tr=Transfer payment
Tn= Net tax = T – Tr
C=Consumption
S=Saving
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•
•
•
•
•
•
Y = 100
T = 10
Tr = 6
Tn = T – Tr = 10 – 6 = 4
Yd = Y – T + Tr = Y – Tn =100-10+6=100-4=96
Yd = 96 = C+S
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2. Saving, S:
S = Yd – C
S = -Co + (1-Cm)*Yd
1-Cm=MPS= Marginal propensity to save
Cm + MPS = 1
Example:
C=100+0.8*Yd
S= -100 +(1-0.8)*Yd
S= -100 +0.2*Yd
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3. Net tax, Tn:
Tn = T – Tr
3.1. Tax, T:
T = To +Tm*Y
To= Autonomous tax, constant
Tm=Marginal tax
Tm=dT/dY
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Example:
T=100+0.1*Y
To=100= Autonomous tax, constant
Tm=0.1= Marginal tax
Y change 1$ => T change 0.1$
Marginal tax # Tax rate
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Marginal tax, Tm:
Tm=dT/dY
Tax rate, t (%):
t (%)= T/Y
Example:
T=100+0.1*Y
Tm=0.1
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T=100+0.1*Y
t (%)=????
Y
T
0
100
100
110
200
120
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t=T/Y
infinity
110%
60%
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But
????
dT/dY=T/Y
????
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dT/dY = T/Y  To=0
Or
Tm = t  To=0
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3.2. Transfer payments, Tr:
Transfer consist of government payments
which involve no direct service by the recipient,
such as unemployment insurance payment…
Tr = Tro
Autonomous transfer, constant
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3.3 Net tax, Tn:
Tn = T - Tr
Tn = To + Tm*Y - Tr
Tn = To - Tro + Tm*Y
Tn = Tno + Tm*Y
Tno = Autonomous net tax, constant
Tno = To - Tro
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Example:
T=100+0.1*Y
Tr=60
Tn=T-Tr=100+0.1*Y-60
Tn=(100-60)+0.1*Y
Tn=40+0.1*Y
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To = 100 = Autonomous tax
Tr = 60 = Transfer
Tno = 100 – 60 = 40 = Autonomous net tax
Tm = 0.1 = Marginal tax
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4. INVESTMENT, I:
The spending on capital equipment, inventories, and
structures, including new housing.
*
*
*
Capital equipment
Structures (including new housing)
Inventories
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Mathematical function:
I = Io + Imy*Y - Imi*i
Io = Autonomous investment, constant
Imy =Marginal Propensity to invest for Y
Imi =Marginal propensity to invest for i
Y = GDP = Output
i = Interest rates
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Imy > 0 ; Imi > 0
Y and i is inverse relationship
Y and I is the same direction
Example:
I=350+0.4*Y-200*i
Io = 350 = Autonomous investment
Imy = 0.4 = Marginal propensity to invest for Y
Y change 1$ => I change 0.4 $
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Imi = 200 = Marginal propensity to invest for i
i increase 1% => I decrease 200 $
i decrease 1% => I increase 200 $
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5. Government Spending, G:
The spending on goods and services by local, state, and
federal governments.
Does not include transfer payments because they are
not made in exchange for currently produced goods or
services.
G=Go
Autonomous Government Spending, constant
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6. Net Exports, Xn, Nx:
Xn = X – M
Xn = Exports minus imports
6.1 Exports, X:
A country exports domestic goods and services
X = Xo
Autonomous exports, constant
Gross exports are exogenous, largely
determined by the level of income in foreign
countries.
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6.2. Import, M:
A country imports foreign-made goods and
services
M = Mo + Mm*Y
Mo= Autonomous import, constant
Mm=Marginal propensity to import
Mm > 0
Y and M is the same direction
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6.3. Net Exports, Xn:
Xn = X – M
Xn = Xo – (Mo +Mm*Y)
Xn = (Xo – Mo) – Mm*Y
Xn = Xno - Mm*Y
Xno = Xo – Mo
Xno = Autonomous net exports
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Example:
X = 250
M = 100 + 0.2*Y
Xn = X – M = (250-100)-0.2*Y
Xn = 150 - 0.2*Y
Xo = 250 = Autonomous exports
Mo = 100 = Autonomous imports
Mm = 0.2 = Marginal propensity to imports
Xno = 150 = Autonomous net exports
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SUMMARY
AD = C + I + G + X - M
AD = C + I+ G + Xn
C = Co + Cm*Yd
S = -Co + (1-Cm)*Yd
Yd = Y – T + Tr = Y – Tn = C + S
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T = To + Tm*Y
Tr = Tro
Tn = T – Tr = Tno + Tm*Y
I = Io + Imy*Y - Imi*I
X = Xo
M = Mo + Mm*Y
Xn = X – M = Xno - Mm*Y
G = Go
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Aggregate Demand Curve:
P, Price Level
AD
Y, Output
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P, Price Level
AD2
AD1
Y, Output
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AD1 => AD2 => AD increase
AD2 => AD1 => AD decrease
AD increase  (C+I+G+Xn) increase
AD decrease  (C+I+G+Xn) decrease
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II. Aggregate Supply, AS:
Aggregate Supply depends on the state of
technology and the supply cost of available
human resources, capital resources and natural
resources.
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Aggregate Supply Curve:
P, Price Level
AS
Y, Output
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P, Price Level
AS1
AS2
Y, Output
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AS1 => AS2 => AS increase
AS2 => AS1 => AS decrease
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AS increase  * Decrease :
+Cost of human Resources
+Cost of Capital Resources
+Cost of Natural Resources
* Increase:
+Technology
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AS decrease  * Increase :
+Cost of human Resources
+Cost of Capital Resources
+Cost of Natural Resources
* Decrease:
+Technology
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III. Aggregate Demand
and Aggregate Supply
The economy’s actual output and price level
are determined by the interaction of aggregate
demand and aggregate supply
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P, Price Level
ADo
ASo
Po
Yo
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Y, Output
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AD2
P, Price Level
AD1
AS1
P2
P1
Y1
Y2
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Y, Output
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P, Price Level
AD1
AS1
AS2
P1
P2
Y1
Y2
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Y, Output
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SUMMARY
No change in the AS
AD increase => P increase ; Y increase
AD decrease => P decrease; Y decrease
No change in the AD
AS increase => P decrease ; Y increase
AS decrease => P increase; Y decrease
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Consumption
Aggregate
Demand
Aggregate
Supply
Cost of Capital
Resources
Investment
Government
Spending
Cost of Human
Resources
Aggregate
Output
General Price
Level
Cost of Natural
Resources
Technology
Net Exports
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CHAPTER 2
MEASURING
AGGREGATE OUTPUT
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I. Gross Domestic Product, GDP
1. Gross domestic product (GDP) is a measure of
the income and expenditures of an economy.
GDP is the total market value of all final goods
and services produced within a country in a
given period of time.
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• “GDP is the Market Value . . .”
– Output is valued at market prices.
• “. . . Of All. . .”
– Includes all items produced in the economy and legally
sold in markets
• “. . . Final . . .”
– It records only the value of final goods, not intermediate
goods (the value is counted only once).
• “. . . Goods and Services . . .”
– It includes both tangible goods (food, clothing, cars) and
intangible services (haircuts, housecleaning, doctor visits).
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• “. . . Produced . . .”
– It includes goods and services currently produced, not
transactions involving goods produced in the past.
• “ . . . Within a Country . . .”
– It measures the value of production within the geographic
confines of a country.
• “. . . In a Given Period of Time.”
– It measures the value of production that takes place within
a specific interval of time, usually a year or a quarter
(three months).
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THE COMPONENTS OF GDP
• GDP includes all items produced in the
economy and sold legally in markets.
• What Is Not Counted in GDP?
– GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
– It excludes items produced and sold illicitly, such
as illegal drugs.
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2. CALCULATING GDP
2.1 Nominal GDP, GDPn:
GDPn year t ($)=Σ(Pt*Qt)
GDPn is the value of all final goods and services
produced in the economy during a given year,
calculated using the prices current in the year in
which the output is produced.
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2.2 Real GDP, GDPr:
GDPr year t ($)=Σ(Po*Qt)
GDPr is the total value of all final goods and
services produced in the economy during a
given year, calculated using the prices of a
selected base year.
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2.3 Expenditure Approach:
GDP = C + I + G + X – M
2.4 Income Approach:
GDP = w + i + r + П + De + Ti
w = wage; i = interest ; r= rent
П = Profits; De = Depreciation;
Ti = Indirect tax
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II. GDP deflator, GDPd:
GDPd year t (100) = GDPn year t/GDPr year t
GDPd year t (100) = Σ(Pt*Qt)/Σ(Po*Qt)
The GDP deflator is a measure of the price level
calculated as the ratio of nominal GDP to real
GDP times 100.
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III. Consumer Price Index, CPI:
CPI year t (100)=Σ(Pt*Qo)/Σ(Po*Qo)
Calculated by surveying market price for a
market basket intended to represent the
consumption.
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IV. Producer Price Index, PPI:
PPI year t (100)=Σ(Pt*Qo)/Σ(Po*Qo)
A measure of the cost of a typical basket of
goods and services purchased by producers
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V. Inflation, Inf:
Inf year t (%)=
=[Price Index year t/Price Index year (t-1)]-1
“Price Index” maybe GDP deflator or CPI or PPI
Inf > 0 => Inflation
Inf < 0 => Deflation
Inf year t(%)=
[(1+gGDPn year t)/(1+gGDPr year t)]-1
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VI. GDP growth, g, gGDP:
1. Annual growth:
gGDPn year t(%)=[GDPn year t/GDPn year (t-1)]-1
gGDPr year t(%)=[GDPr year t/GDPr year (t-1)]-1
[Excel =rate(….)]
gGDPn year t(%)=[(1+gGDPr year t)*(1+Inf year t)]-1
gGDPr year t(%)=[(1+gGDPn year t)/(1+Inf year t)]-1
Inf year t(%)= [(1+gGDPn year t)/(1+gGDPr year t)]-1
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Example:
GDPn year 2000 = 100 $
GDPn year 2001 = 120 $
gGDPn year 2001 = (120/100)-1 =20%
GDPr year 2000 = 100 $
GDPr year 2001 = 110 $
gGDPr year 2001 = (110/100)-1 =10%
Inf year 2001=(1+20%)/(1+10%)-1=9.09%
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2. The average growth over the period:
gGDP/Period=(GDP t/GDPo)^(1/X)-1
GDPt = GDP period t
GDPo = GDP period o
X=Nper= The number of Periods = (t - o)
gGDPn/Period=(GDPn t/GDPn o)^(1/X)-1
gGDPr/Period=(GDPr t/GDPr o)^(1/X)-1
[Excel =rate(….)]
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Example:
GDPn 2000 = 100 $
GDPn 2005 = 200 $
gGDPn/year (2000 ->2005) =
=(200/100)^(1/(2005-2000))-1=14.87%
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gGDPn/month (2000 -> 2005) =
=(200/100)^(1/((2005-2000)*12))-1=1.16%
gGDPn/6 months (2000 -> 2005) =
=(200/100)^(1/((2005-2000)*2))-1=7.18%
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GDPr 2000 = 100 $
GDPr 2005 = 180 $
gGDPr/year (2000 ->2005) =
=(180/100)^(1/(2005-2000))-1=12.47%
gGDPr/month (2000 -> 2005) =
=(180/100)^(1/((2005-2000)*12))-1=0.98%
gGDPn/6 months (2000 -> 2005) =
=(200/100)^(1/((2005-2000)*2))-1=6.05%
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VII. GDP per capita
(Per capita Income, PCI)
PCI year t = GDPr year t/POP year t
POP = Population
GDP year 2000 = 1000 $
POP year 2000 = 100 (People)
PCI year 2000 = 1000/100 =10 $
gPCI year t (%)=
[(1+gGDPr year t)/(1+gPOP year t)]-1
gPCI year t(%)=[PCI year t/PCI year(t-1)]-1
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VIII. Forecast the related years
GDP a =
GDP b*(1+gGDP/Period)^(Period a – Period b)
Example:
GDP 2000 = 100 $
gGDP/year =10%
GDP 2005 =100*(1+10%)^(2005-2000)=161.05
GDP 1995 =100*(1+10%)^(1995-2000)=62.09
[Excel FV(…) or PV(…)]
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CHAPTER 3
THE MULTIPLIER MODEL
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I. EQUILIBRIUM OF AD AND AS
We have:
AD=C+I+G+X-M
AS=Y
For AS=AD or Y=C+I+G+X-M
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And
C=C+Cm*Yd
Yd=Y-T+Tr=Y-Tn=C+S
T=To+Tm*Y
Tr=Tro
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G=Go
X=Xo
M=Mo+Mm*Y
I=Io+Imy*Y
(Keyness: Assuming that Imi=0)
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….Finally, we have:
Y=m*Ado
Y: Equilibrium Income
m: Ado Multiplier, Expenditure Multiplier
Ado: Autonomous Aggregate Demand
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m = 1/[1-Cm*(1-Tm)-Imy+Mm]
Ado =[Co + Io + Go + Xo – Mo
-Cm*(To-Tro)]
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Example:
C=100+0.8*Yd
T=20+0.1*Y
Tr=32
I=50+0.4*Y
G=55
X=40
M=15+0.2*Y
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Equilibrium Income is:
Y=m*Ado
m=1/[1-0.8*(1-0.1)-0.4+0.2]=12.50
Ado=100+50+55+40-15-0.8*(20-32)=269.60
Y=12.50*=3370
When Equilibrium Income, we have:
T=20+0.1*Y=20+0.1*3370=357
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Tn=T-Tr=357-32=325
Yd=Y-Tn=3370-325=3045
C=100+0.8*Yd=100+0.8*3045=2536
S=Yd – C=3045-2536=509
I=50+0.4*Y=50+0.4*3370=1398
Xn=X-M=40-(15+0.2*Y)=25-0.2*Y=25-0.2*3370=
Xn= -649 (Deficit)
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Budget=B=T-Tr-G=Tn-G
B=(To-Tro)+Tm*Y-Go=Tno+Tm*Y-G
If:
B > 0 => Surplus
B < 0 => Deficit
B = 0 => Equilibrium
B=Tn-G=325-55=270 (Surplus)
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II. EXPENDITURE MULTIPLIER:
The expenditure multiplier measures the
multiplied effect changes in autonomous
spending have upon equilibrium income
Y=m*Ado
=>ΔY=m*ΔAdo
ΔAdo= ΔCo+ ΔIo+ ΔGo+ ΔXo - ΔMo
-Cm*(ΔTo- ΔTro)
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ΔC=ΔCo+Cm*ΔYd
ΔS=-ΔCo+(1-Cm)*ΔYd
ΔYd=ΔY-ΔT+ΔTr=ΔY-ΔTn
ΔT=ΔTo+Tm*ΔY
ΔTr=ΔTro
ΔTn=ΔTno+Tm*ΔY
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ΔG=ΔGo
ΔX= ΔXo
ΔM=ΔMo+Mm*ΔY
ΔXn= ΔXno-Mm*ΔY
ΔI=ΔIo+Imy*ΔY
ΔB=ΔT- ΔTr - ΔG= ΔTn- ΔG= ΔTno+Tm*ΔY- ΔGo
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If:
m=1, when Ado increase 1$ => Y increase 1 $
m=10, when Ado increase 1$ => Y increase 10$
m=100, when Ado increase 1$=>Y increase 100$
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From:
1
m
[1  Cm *(1  Tm)  Im y  Mm]
If we want to increase the value of m:
Cm lead to 1
Imy lead to 1
Tm lead to 0
Mm lead to 0
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Example:
C=30+0.8*Yd
T=50+0.1*Y
Tr=40
G=200
X=60
M=20+0.2*Y
I=35+0.4*Y
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m=
12.50
Ado=
Y=
Tn=
Yd
C=
S=
Xn=
B=
3,712.50
381.25
3,331.25
2,695.00
636.25
-702.50
181.25
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If ΔGo change =
ΔTno=
ΔAdo=
ΔY=
ΔTn=
ΔYd=
ΔC=
ΔS=
ΔXn=
ΔB=
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100.00
1,250.00
125.00
1,125.00
900.00
225.00
-250.00
25.00
87
CHAPTER 4
THE IS-LM FRAMEWORK
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This chapter develops schedules for equilibrium
in the goods (IS) and money (LM) market.
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I. Product Market Equilibrium:
The IS Curve
Equilibrium Income AD=AS
AD=C+I+G+Xn
AS=Y
C=Co+Cm*Yd
I=Io+Imy*Y-Imi*i
G=Go
Xn=Xno-Mm*Y
Yd=Y-Tn
Tn=Tno+Tm*Y
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…..Finally we have IS equation:
(IS) Y=(m*Ado)-(m*Imi)*i
m=1/[1-Cm*(1-Tm)-Imy+Mm]
Ado=Co+Io+Go+Xno-Cm*(To-Tro)
Xno=Xo-Mo
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The slope of IS:
-m*Imi (negative)
Imi=0 => Vertical IS curve
the interest elasticity of investment demand is
zero
Imi=Small=> Steep IS curve
the interest elasticity of investment demand is
low
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Imi=high => Flat IS curve
the interest elasticity of investment demand is
high
Imi=Infinity => Horizontal IS curve
the interest elasticity of investment demand is
infinity
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Steep
IS Curve
i
Vertical
IS Curve
Horizontal
IS
Curve
Flat
IS Curve
Y
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IS increase IS shift to the right
IS decrease  IS shift to the left
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Factors that shift the IS schedule:
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Example:
C=10+0.8*Yd
T=20+0.1*Y
Tr=15
G=250
X=50
M=30+0.2*Y
I=120+0.4*Y-10*i
Find IS equation for equilibrium income in the
goods market?
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(IS) Y=(mt*Tm+m*Ado)-(m*Imi)*i
m=1/[1-0.8*(1-0.1)-0.4+0.2]=12.50
mt= -0.8*12.50=-10
Tno=20-15=5
Ado=10+120+250+50-30-0.8*5=396
Imi=10
(IS) Y=(12.50*396)-(12.50*10)*i
(IS) Y = 4950 - 125*i
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Government Spending increases 10$, ceteris
paribus,
Find IS2 equation for equilibrium income in the
goods market?
IS2=IS+ΔIS or Y2=Y+ ΔY
ΔY=m*ΔAdo
ΔTno=ΔTo- ΔTro
ΔAdo=ΔCo+ ΔIo+ ΔGo+ ΔXno-Cm* ΔTno
ΔXno= ΔXo- ΔMo
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ΔAdo = ΔGo=10; ΔTno=0
Δ Y=m* Δ Ado
ΔY= 12.50*10=125
(IS2) Y2=Y+ Δ Y=(4950+125) -125*i
(IS2) Y2 = 5075 – 125*i
[(IS) Y = 4950 - 125*i]
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II. Money Market Equilibrium:
The LM Curve
1. The Money System:
1.1. Money Supply:
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The meaning of money:
Money is the set of assets in an economy that
people regularly use to buy goods and services
from other people.
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The Functions of Money:
Money has three functions in the economy:
– Medium of exchange
– Unit of account
– Store of value
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• Medium of Exchange
– A medium of exchange is an item that buyers give
to sellers when they want to purchase goods and
services.
– A medium of exchange is anything that is readily
acceptable as payment.
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• Unit of Account
– A unit of account is the yardstick people use to
post prices and record debts.
• Store of Value
– A store of value is an item that people can use to
transfer purchasing power from the present to the
future.
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• Liquidity is the ease with which an asset can be
converted into the economy’s medium of
exchange.
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• Commodity money takes the form of a
commodity with intrinsic value.
– Examples: Gold, silver, cigarettes.
• Fiat money is used as money because of
government decree.
– It does not have intrinsic value.
– Examples: Coins, currency, check deposits.
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• Currency (Cu) is the paper bills and coins in
the hands of the public.
• Demand deposits (D) are balances in bank
accounts that depositors can access on demand
by writing a check.
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– The money supply (Sm, M) refers to the quantity
of money available in the economy.
– Monetary policy is the setting of the money supply
by policymakers in the central bank.
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• Open-Market Operations
– The money supply is the quantity of money
available in the economy.
– The primary way in which the CB (Central Bank)
changes the money supply is through open-market
operations.
• The CB purchases and sells Government bonds
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• Open-Market Operations
– To increase the money supply, the CB buys
government bonds from the public.
– To decrease the money supply, the CB sells
government bonds to the public.
• Banks can influence the quantity of demand
deposits in the economy and the money supply.
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• Reserves (R) are deposits that banks have
received but have not loaned out.
• In a fractional-reserve banking system, banks
hold a fraction of the money deposited as
reserves and lend out the rest.
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• The reserve ratio (R/D) is the fraction of
deposits that banks hold as reserves.
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• When a bank makes a loan from its reserves,
the money supply increases.
• The money supply is affected by the amount
deposited in banks and the amount that banks
loan.
– Deposits into a bank are recorded as both assets
and liabilities.
– The fraction of total deposits that a bank has to
keep as reserves is called the reserve ratio.
– Loans become an asset to the bank.
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Banking Money Creation with FractionalReserve
• This T-Account shows a bank that…
– accepts deposits,
– keeps a portion
as reserves,
– and lends out
the rest.
• It assumes a
reserve ratio
(R/D) of 10%.
First National Bank
Assets
Reserves
$10.00
Liabilities
Deposits
$100.00
Loans
$90.00
Total Assets
$100.00
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Total Liabilities
$100.00
115
Money Creation with FractionalReserve Banking
• When one bank loans money, that money is
generally deposited into another bank.
• This creates more deposits and more reserves
to be lent out.
• When a bank makes a loan from its reserves,
the money supply increases.
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The Money Multiplier
• How much money is eventually created by the
new deposit in this economy?
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The Money Multiplier
• The money multiplier (K) is the amount of
money the banking system generates with each
dollar of reserves.
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The Money Multiplier
Increase in the Money Supply = $190.00!
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The Money Multiplier
Original deposit = $100.00
• 1st Natl. Lending = 90.00 (=.9 x $100.00)
• 2nd Natl. Lending = 81.00 (=.9 x $ 90.00)
• 3rd Natl. Lending = 72.90 (=.9 x $ 81.00)
• … and on until there are just pennies left to
lend!
• Total money created by this $100.00 deposit is
$1000.00. (= 1/.1 x $100.00)
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• The money multiplier is the reciprocal of the
reserve ratio (R/D):
Sm=M = 1/(R/D)
• Example:
– With a reserve requirement, R/D = 20% or .2:
– The money multiplier is 1/.2 = 5.
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The CB’s Tools of Monetary Control
• The Central Bank (CB) has three tools in its
monetary toolbox:
– Open-market operations
– Changing the reserve requirement
– Changing the discount rate
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The CB’s Tools of Monetary Control
• Open-Market Operations
– The CB conducts open-market operations when it
buys government bonds from or sells government
bonds to the public:
• When the CB sells government bonds, the money
supply decreases.
• When the CB buys government bonds, the money
supply increases.
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The CB’s Tools of Monetary Control
• Reserve Requirements
– The CB also influences the money supply with
reserve requirements.
– Reserve requirements are regulations on the
minimum amount of reserves that banks must hold
against deposits.
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The CB’s Tools of Monetary Control
• Changing the Reserve Requirement
– The reserve requirement is the amount (%) of a
bank’s total reserves that may not be loaned out.
– Increasing the reserve requirement decreases the
money supply.
– Decreasing the reserve requirement increases the
money supply.
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The CB’ Tools of Monetary Control
• Changing the Discount Rate
– The discount rate is the interest rate the CB
charges banks for loans.
• Increasing the discount rate decreases the money supply.
• Decreasing the discount rate increases the money supply
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SUMMARY
• The term money refers to assets that people
regularly use to buy goods and services.
• Money serves three functions in an economy:
as a medium of exchange, a unit of account,
and a store of value.
• Commodity money is money that has intrinsic
value.
• Fiat money is money without intrinsic value.
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SUMMARY
• The central bank, regulates the Nation
monetary system.
• It controls the money supply through openmarket operations or by changing reserve
requirements or the discount rate.
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SUMMARY
• When banks loan out their deposits, they
increase the quantity of money in the economy.
• Because the CB cannot control the amount
bankers choose to lend or the amount
households choose to deposit in banks, the
CB’s control of the money supply is imperfect.
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SUMMARY
H=Cu+R
Sm=Cu+D=K*H
H=B=High Power Money
Cu=Currency
R=Reserver
Sm=M=Money Supply, Supply of Money
K=Money Multiplier
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SUMMARY
K=Sm/H=(Cu+D)/(Cu+R)=
=(Cu/D+D/D)/(Cu/D+R/D)=
Cu
1
D
K 
R
Cu

D
D
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SUMMARY
Cu/D= Currency ratio
R/D= Reserve ratio
Sm=K*H
ΔSm=K*ΔH
If:
K=1, when H increase 1$=> Sm increase 1$
K=10, when H increase 1$=> Sm increase 10$
K=100, when H increase 1$=> Sm increase 100$
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SUMMARY
From K, if we want to increase the value of K:
R/D=> Decrease
=>R=> Decrease
=>D=>Increase
Cu/D=>Decrease
=>Cu=> Decrease
=>D=> Increase
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SUMMARY
Example:
H=100; Cu/D=10% ; R/D=5%
K=(1+Cu/D)/(R/D+Cu/D)=
=(1+10%)/(5%+10%)=7.33
Sm=K*H=7.33*100=7.33
Cu=10%D
R=5%D
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SUMMARY
H=Cu+D=10%D+5%D=100
D=100/15%=666.67
Cu=10%D=66.67
R=5%D=33.33
If ΔH =20 => Δ Sm=K* ΔH=7.33*20=146.60
….
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1.2 Money Demand, Dm, Md, L, Lp:
Money is demanded because of its transactions
use and its quality as a store of value. Money is
also a component of investors’ portfolios.
Dm=Dmo+Dmy*Y-Dmi*i
Dm = Demand for money
Dmo = Autonomous Money Demand
Dmy = Marginal Money Demand for Y
Dmi = Marginal Money Demand for i
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Y=Income, output; i= Interest rate
Dmy > 0 ; Dmi > 0
Dm and i is inverse relationship
Dm and Y is the same direction
Example:
Dm=100+0.4*Y-200*I
Dmo=100; Dmy=0.4 ; Dmi=200
When Y increase 1$=> Dm increase 0.4$
When i increase 1%=> Dm decrease 200$
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2. The LM curve:
Equilibrium exits in the money market when the
demand for money equals the supply of money.
We assume that the money supply is controled
by the central bank (Sm=K*H), we also continue
to assume that the price level is constant.
Demand for money Dm=Dmo+Dmy*Y-Dmi*i
Sm=Dm=>….
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=>The LM Equation:
(LM)i=(Dmo-Sm)/Dmi + (Dmy/Dmi)*Y
Dmo=Autonomous Money Demand
Sm=Money Supply
Dmi=Marginal Money Demand for i
DmY=Marginal Money Demand for Y
Y=Income, Output
i=Interest rate
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The Slope of LM: Dmy/Dmi (Positive)
Dmi=0 => Vertical LM curve
the interest elasticity of Money demand is zero
Dmi=Small=> Steep LM curve
the interest elasticity of Money demand is low
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Dmi=high => Flat LM curve
the interest elasticity of Money demand is high
Imi=Infinity => Horizontal LM curve
the interest elasticity of Money demand is infinity
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i
Vertical
LM Curve
Steep
LM Curve
Flat
LM Curve
Horizontal
LM
Curve
Y
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LM increase LM shift to the right
LM decrease  LM shift to the left
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Factors that shift the LM schedule:
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Example:
H=100; Cu/D=20%; R/D=5%; Dm=200+0.4*Y-10*i
Find LM equation for the Money Market Equilibrium ?
(LM)i=(Dmo-Sm)/Dmi + (Dmy/Dmi)*Y
Dmo=200
Sm=K*H=[(1+20%)/(5%+20%)]*100=4.80*100=480
Dmy=0.4
Dmi=10
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(LM) i=(200-480)/10 + (0.4/10)*Y
(LM) i= -28 + 0.04*Y
Central Bank increases H=10, ceteris paribus
Find LM2 equation for the Money Market
Equilibrium ?
From (LM)i=(Dmo-Sm)/Dmi + (Dmy/Dmi)*Y
=>(ΔLM)Δi=(ΔDmo - ΔSm)/Dmi + (Dmy/Dmi)*ΔY
ΔSm=K*ΔH
(LM2)=LM+ ΔLM or i2 = i +Δi
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ΔSm=K*ΔH=4.80*10=48
Dmi=10
(ΔLM)Δi=(ΔDmo - ΔSm)/Dmi+ (Dmy/Dmi)*ΔY
(ΔLM)Δi=(0 - 48)/10 + (0.4/10)*0=
Δi=- 48/10= - 4.80
(LM) i= -28 + 0.04*Y
(LM2) i2=(-28-4.8) + 0.04*Y
(LM2) i2= -32.8 + 0.04*Y
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III. The IS and LM combined
The point of intersection of the IS and LM curves
gives the combination of the interest rate and
income (io, Yo) which produces equilibrium for
both the money and product markets.
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i
IS
LM
io
Y
Yo
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IS2
i
IS1
LM1
i2
i1
Y1
Y2
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Y
150
i
IS1
LM1
LM2
i1
i2
Y1
Y2
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Y
151
No change in the IS
LM increase => i decrease ; Y increase
LM decrease => i increase; Y decrease
No change in the LM
IS increase => i increase ; Y increase
IS decrease => i decrease; Y decrease
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Example:
(IS) Y = 4950 - 125*i
(LM) i= -28 + 0.04*Y
Find the income level and rate of interest at
which there is simultaneous equilibrium in the
money and goods markets
i=28.33 (%/year)
Y=1408.33 ($)
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© 2007 Thomson South-Western
• Open and Closed Economies
– A closed economy is one that does not interact
with other economies in the world.
• There are no exports, no imports, and no capital flows.
– An open economy is one that interacts freely with
other economies around the world.
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• An open economy interacts with other
countries in two ways.
– It buys and sells goods and services in world
product markets.
– It buys and sells capital assets in world financial
markets.
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THE INTERNATIONAL FLOW OF GOODS
AND CAPITAL
• The Flow of Goods: Exports, Imports, and Net
Exports
– The United States is a very large and open
economy—it imports and exports huge quantities
of goods and services.
– Over the past four decades, international trade
and finance have become increasingly important.
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• Exports are goods and services that are
produced domestically and sold abroad.
• Imports are goods and services that are
produced abroad and sold domestically.
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• Net exports (NX) are the value of a nation’s
exports minus the value of its imports.
• Net exports are also called the trade balance.
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• A trade deficit is a situation in which net
exports (NX) are negative.
– Imports > Exports
• A trade surplus is a situation in which net
exports (NX) are positive.
– Exports > Imports
• Balanced trade refers to when net exports are
zero—exports and imports are exactly equal.
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• Factors That Affect Net Exports
– The tastes of consumers for domestic and foreign
goods.
– The prices of goods at home and abroad.
– The exchange rates at which people can use
domestic currency to buy foreign currencies.
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– The incomes of consumers at home and abroad.
– The costs of transporting goods from country to
country.
– The policies of the government toward
international trade.
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The Flow of Financial Resources: Net
Capital Outflow
• Net capital outflow refers to the purchase of
foreign assets by domestic residents minus
the purchase of domestic assets by foreigners.
• A U.S. resident buys stock in the Toyota
corporation and a Mexican buys stock in the
Ford Motor corporation.
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• When a U.S. resident buys stock in Telmex, the
Mexican phone company, the purchase raises
U.S. net capital outflow.
• When a Japanese residents buys a bond
issued by the U.S. government, the purchase
reduces the U.S. net capital outflow.
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• Variables that Influence Net Capital Outflow
– The real interest rates being paid on foreign
assets.
– The real interest rates being paid on domestic
assets.
– The perceived economic and political risks of
holding assets abroad.
– The government policies that affect foreign
ownership of domestic assets.
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The Equality of Net Exports and Net
Capital Outflow
• For an economy as a whole, Xn and NCO must
balance each other so that:
NCO = Xn
• This holds true because every transaction that
affects one side must also affect the other side
by the same amount.
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Saving, Investment, and Their
Relationship to the International Flows
• Net exports is a component of GDP:
Y = C + I + G + Xn
• National saving is the income of the nation
that is left after paying for current
consumption and government purchases:
Y – C – G = I + Xn
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• National saving (S) equals Y – C – G so:
S = I + Xn
• Or
Domestic + Net Capital
Saving =
Investment
Outflow
S
=
I
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NCO
168
International Flows of Goods and Capital: Summary
© 2007 Thomson South-Western
THE PRICES FOR INTERNATIONAL TRANSACTIONS: REAL
AND NOMINAL EXCHANGE RATES
• International transactions are influenced by
international prices.
• The two most important international prices
are the nominal exchange rate and the real
exchange rate.
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• The nominal exchange rate is the rate at which
a person can trade the currency of one
country for the currency of another.
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• The nominal exchange rate is expressed in two
ways:
– In units of foreign currency per one U.S. dollar.
– And in units of U.S. dollars per one unit of the
foreign currency.
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• Assume the exchange rate between the
Japanese yen and U.S. dollar is 80 yen to one
dollar.
– One U.S. dollar trades for 80 yen.
– One yen trades for 1/80 (= 0.0125) of a dollar.
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• Appreciation refers to an increase in the value
of a currency as measured by the amount of
foreign currency it can buy.
• Depreciation refers to a decrease in the value
of a currency as measured by the amount of
foreign currency it can buy.
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• If a dollar buys more foreign currency, there is
an appreciation of the dollar (Exchange rate
increase)
• If it buys less there is a depreciation of the
dollar (Exchange rate decrease)
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Real Exchange Rates
• The real exchange rate is the rate at which a
person can trade the goods and services of
one country for the goods and services of
another.
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• The real exchange rate compares the prices of
domestic goods and foreign goods in the
domestic economy.
– If a case of German beer is twice as expensive as
American beer, the real exchange rate is 1/2 case
of German beer per case of American beer.
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• The real exchange rate depends on the
nominal exchange rate and the prices of goods
in the two countries measured in local
currencies.
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• The real exchange rate is a key determinant of
how much a country exports and imports.
Nominal ex change rate× Domestic price
Real exchange rate=
Foreign price
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• A depreciation (fall) in the U.S. real exchange
rate means that U.S. goods have become
cheaper relative to foreign goods.
• This encourages consumers both at home and
abroad to buy more U.S. goods and fewer
goods from other countries.
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• As a result, U.S. exports rise, and U.S. imports
fall, and both of these changes raise U.S. net
exports.
• Conversely, an appreciation in the U.S. real
exchange rate means that U.S. goods have
become more expensive compared to foreign
goods, so U.S. net exports fall.
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SUMMARY
• Net exports are the value of domestic goods
and services sold abroad minus the value of
foreign goods and services sold domestically.
• Net capital outflow is the acquisition of
foreign assets by domestic residents minus
the acquisition of domestic assets by
foreigners.
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SUMMARY
• An economy’s net capital outflow always
equals its net exports.
• An economy’s saving can be used to either
finance investment at home or to buy assets
abroad.
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SUMMARY
• The nominal exchange rate is the relative price
of the currency of two countries.
• The real exchange rate is the relative price of
the goods and services of two countries.
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SUMMARY
• When the nominal exchange rate changes so
that each dollar buys more foreign currency,
the dollar is said to appreciate or strengthen.
• When the nominal exchange rate changes so
that each dollar buys less foreign currency, the
dollar is said to depreciate or weaken.
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CHAPTER 6
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• Unemployment and Inflation
– The natural rate of unemployment depends on
various features of the labor market.
• Examples include minimum-wage laws, the market
power of unions, the role of efficiency wages, and the
effectiveness of job search.
• The inflation rate depends primarily on growth in the
quantity of money, controlled by the Central Bank.
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• Unemployment and Inflation
– Society faces a short-run tradeoff between
unemployment and inflation.
– If policymakers expand aggregate demand, they
can lower unemployment, but only at the cost of
higher inflation.
– If they contract aggregate demand, they can lower
inflation, but at the cost of temporarily higher
unemployment.
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• The Phillips curve shows the short-run tradeoff between inflation and unemployment.
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Figure 1 The Phillips Curve
Inflation
Rate
(percent
per year)
B
6
A
2
Phillips curve
0
4
7
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Unemployment
Rate (percent)
190
The Phillips curve shows the short-run
combinations of unemployment and inflation that
arise as shifts in the aggregate demand curve
move the economy along the short-run aggregate
supply curve.
The greater the aggregate demand for goods and
services, the greater is the economy’s output, and
the higher is the overall price level.
A higher level of output results in a lower level of
unemployment.
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How the Phillips Curve is Related to
Aggregate Demand and Aggregate
Supply
(a) The Model of Aggregate Demand and Aggregate Supply
Price
Level
102
Inflation
Rate
(percent
per year)
Short-run
aggregate
supply
6
B
106
B
A
High
aggregate demand
Low aggregate
demand
0
(b) The Phillips Curve
7,500 8,000
(unemployment (unemployment
is 7%)
is 4%)
Quantity
of Output
A
2
Phillips curve
0
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(output is
8,000)
Unemployment
7
(output is Rate (percent)
7,500)
192
An Adverse Shock to Aggregate Supply
(a) The Model of Aggregate Demand and Aggregate Supply
Price
Level
AS2
P2
3. . . . and
raises
the price
level . . .
B
A
P
Aggregate
supply, AS
(b) The Phillips Curve
Inflation
Rate
1. An adverse
shift in aggregate
supply . . .
4. . . . giving policymakers
a less favorable tradeoff
between unemployment
and inflation.
B
A
PC2
Aggregate
demand
0
Y2
Y
2. . . . lowers output . . .
Quantity
of Output
Phillips curve, P C
0
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Unemployment
Rate
193