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EB222 Macroeconomics Fall 2012 Review Slides Instructor: Shan A. Garib

EB222 Macroeconomics Fall 2012 Review Slides Instructor: Shan A. Garib. Please review the following slides in ADDITION to quizzes 1-5. The Short-Run Aggregate Supply Curve. Positive Slope SRAS because of Prices ALL Prices increase > suppliers costs in wages are sticky so real wages fall

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EB222 Macroeconomics Fall 2012 Review Slides Instructor: Shan A. Garib

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  1. EB222 Macroeconomics Fall 2012 Review Slides Instructor: Shan A. Garib

  2. Please review the following slides in ADDITION to quizzes 1-5

  3. The Short-Run Aggregate Supply Curve • Positive Slope SRAS because of Prices • ALL Prices increase > suppliers costs in wages are sticky so real wages fall • So suppliers hire more workers and produce more c) Real GDP increases c) Real GDP a) Labour Market b) PF1 LRAS1 S1 SRAS1 W2 Y2 P2 Price Level Real Wage W1 Y1 P1 D1 Y1 Y2 L1 L2 Number Employed Real GDP/ Year

  4. 8.3 Equilibrium • SR equilibrium occurs at intersection of AD and SRAS • At P2 there is an excess of goods in the market so prices fall • Demand/Supply shock: any economic event that causes a shift in demand/supply • A) Inflationary Gap – output > natural GDP • B) Recessionary Gap – output < natural GDP LRAS1 SRAS1 a P2 Price Level P1 b AD1 Y1 Y2

  5. 8.4 The Long-Run Adjustment Process • Demand/Supply shock: any economic event that causes a shift in demand/supply causing a inflationary or recessionary gap • At “a” the economy is at full employment/production (6 salads) • At “b” firms are operating at beyond natural production rates • There is excess demand for inputs (that go into producing goods eg lettuce) and prices for inputs rise • Higher input prices shift the SRAS to left from “b” to “a” again LRAS1 SRAS1 SRAS2 a Price Level P1 b P2 AD1 Y2 Y1

  6. The Long-Run Adjustment Process • Demand/Supply shock: any economic event that causes a shift in demand/supply causing a inflationary or recessionary gap • At “a” the economy is at full employment/production (6 salads) • At “b” firms are operating at below natural production rates • There is surplus inputs in the market (that go into producing goods eg lettuce) and prices for inputs fall • Lower input prices shift the SRAS to right from “b” back to “a” again LRAS1 SRAS2 SRAS1 b Price Level P2 a P1 AD1 Y2 Y1

  7. 8.5 AD and AS in an Open Economy • How does a stronger CAD affect aggregate supply? CAD buy 3 USD, or 1:3 • -if CAD stronger compared to other currencies: CAD now buy 4 USD • a) The US lettuce is cheaper for producers to import (input prices lower) • b) AS shift outward, Agg. P lowers, UN down • c) Cheaper imports (higher M) mean lower NX = (X-M) and AD lowers and shifts to left • AD = C + I + G + (X-M) • 5 = 1 + 2 + 2 • 4 = 1 + 2 + 1 CAD Increases LRAS1 SRAS1 a SRAS2 b P1 Price Level P2 AD1 P3 c AD2 Y1 Y3 Y2

  8. AD and AS in an Open Economy • How does a weaker CAD affect aggregate supply? CAD buy 4 USD or 4:1 • -if CAD weaker compared to other currencies: CAD now buy 1 USD, or 1:3 • a) The US lettuce is expensive for producers to import (input prices higher) • b) AS shift inwards , Agg. P increases, UN up • c) More expensive imports (M goes down) mean higher NX = (X-M) and AD increases and shifts to right • AD = C + I + G + (X-M) • 5 = 1 + 2 + 2 • 6 = 1 + 2 + 3 CAD Weakens LRAS1 SRAS2 c SRAS1 P1 Price Level b P2 AD2 P3 a AD1 Y2 Y3 Y1

  9. 8.6 Inflation in the Short-Run • Demand-pull inflation: increases in AD not matched by increases in AS • WWI, government spending on making weapons, labour • Cost-Push inflation: decreases in AS not matched by decreases in AD Cost-Push Inflation Demand-Pull Inflation LRAS1 LRAS1 SRAS1 SRAS1 P2 Price Level Price Level b P2 P1 AD1 P1 a AD2 AD1 SRAS2 Y2 Y1 Y2 Y1

  10. If the nation’s consumption function is C = $500 + 0.25Y. There are no taxes. The value of saving is: IF Y = 0, CONSUMPTION = 500 WHICH IMPLIES SAVING = - 500 The Marginal Propensity to Consume (MPC): THE MPC = 0.25, SO THE Marginal Propensity to Save (MPS) is: 1 - MPC 1 - 0.25 = 0.75 The value of the multiplier is: THE MULTIPLIER IS 1 / (1 – MPS ) = 1 / 0.25 = 4

  11. The consumption function is given as: C = 75 + 0.75(Y – T) where T – taxes, set at $150bn and I + G + (X - M) = $225bn the equilibrium GDP is: SINCE, Y = C + I + G + ( X – M ) Y = 75 + 0.75 ( Y – T ) + 225 Y = 75 + 0.75Y – 0.75T + 225 Y + 0.75Y = 75 - 0.75T + 225 Y(1 – 0.75) = 75 – 0.75 (150) + 225 Y = ( 75 – 112.5 + 225) / ( 0.25 ) Y = 187.5 / 0.25 Y = 750

  12. The Interest Rate Effect • Interest rate effect works as follows: • a decrease in the price level  • increase of real cash  • banks have more money to lend  • interest rates fall  • investment expenditures (I) increase • AD = C + I + G + (X-M) • IfI increases then AD increases • Output decreases and prices rise

  13. Calculating Percentage Changes Change % change = ------------------------------------ Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5

  14. Calculating Percentage Changes Change % change = ------------------------------------ Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7

  15. Calculating Percentage Changes Change % change = ------------------------------------ Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 226.7 % change = -------------------- 2557.5

  16. Calculating Percentage Changes Change % change = ------------------------------------ Original Number 1980 GDP = 2784.2 1979 GDP = 2557.5 Change -----> 226.7 226.7 % change = -------------------- 2557.5 % change = .0886413 = 8.8%

  17. How Is the Unemployment Rate Computed? Number of Unemployed UR = ------------------------------------------ Number unemployed = 5,650,000 + Number employed = 134,749,000 Labor Force = 140,399,000 Labor Force 5,650,000 UR = --------------------------------------- 140,399,000

  18. Natural Unemployment Rate Most economists estimate the natural unemployment rate to be 5 or 6 percent. If we take a 5 percent unemployment rate as our working definition of full employment, anything above 5 percent would be cyclical unemployment Frictional 2.5% (Natural) Structural 2.5%(Natural) 5.0% (Full unemployment) Cyclical 1.7%(Not natural) Unemployment Rate 6.7% + +

  19. Modeling Economic Growth • Productivity = GDP / # workers or labour hours • Relationship between economic growth and increases in productivity

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