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Week 1

Ch. 2: A tour of the book

Aggregate Output
● There are 3 central macroeconomic variables:
○ Output (Y)
○ Inflation (π)
○ Unemployment (U)
● GDP is a measure for total output (total production = total demand)
● Real GDP (Y) is the value of produced goods in terms of constant prices
● Nominal GDP ($Y) is the value of produced goods in current prices
● Expansions are years of GDP growth
● Recessions are years of GDP shrinkage


The inflation rate
● Inflation is sustained rise of general prices
● Deflation is sustained decrease of general prices
● Inflation is measured with two instruments:
○ GDP deflator ($Y/Y)
○ Consumer Price Index (CPI)
● Okun’s law: if output growth is high, unemployment decreases
● Phillips Curve: At low unemployment, Inflation accelerates


The short, medium and long run
● Output is made of Consumption, Investment and Government spending
● Output is determined by:
○ short run: Demand
○ Medium run: technology and capital stock
○ Long-run: research and development, education, and savings



Ch. 3: The Goods Market

The demand for goods
● Inventory investment: producing more than what is sold in a given year
● The goods market considers investment as exogenous (Z = C + 𝐼 + G)
○ Z: demand
○ C: consumption

, ○ 𝐼 (i bar): investment as exogenous)
■ A bar above means that is determined exogenously
● Consumption (C = 𝐶0 + 𝐶1(Y - T)) is made of:
○ 𝐶0: Autonomous consumption
○ 𝐶1(Y - T): Marginal propensity to consume/save
𝑑 𝑑
● Disposable income (𝑌 ) is made of the remaining of Income after tax (𝑌 = Y - T)
● Investments are purchases by firms of capital goods.
● Government spending: purchases by local governments
○ Fiscal policy: combination of G (gov’t expenditures) and T (taxes)


Determination of equilibrium output
● Equilibrium in Goods market is when Z = Y (supply = demand)
𝑑
● As consumption depends on disposable income (𝑌 ), the equilibrium in goods market is
given by the multiplier effect times remaining elements:
○ Z = Y = (1/1- 𝐶1) (Co + 𝐼 + 𝐺 - 𝐶1t)
■ Where (1/1-𝐶1) is the multiplier effect
● Multiplier effect tells what would happen if autonomous consumption, investment or fiscal
policy is changed.
● In this model, fiscal policy can influence output via multiplier effect
● Equilibrium level of output (Y*) is when production equals demand (Y*: Y=Z)


Investment equals savings
● Equilibrium in the goods market happens when either:
○ Y=Z : production/income equals demand
○ I=S : Income equals savings.
𝑑
● Savings (S) are the sum of private savings (𝑌 - C) and government savings (T-G)
𝑑
○ S = (𝑌 -T) + (T-G)
● Propensity to consume (1-𝐶1) is also called propensity to save: what is not consumed is
saved

, Week 2

Ch. 4: Financial Markets

Demand for money
● Money is an instrument of transactions, and a vehicle to accumulate wealth across time
and space
● Income is a flow (expressed in units of time): Passive + Active yields
𝑑
● Money demand (𝑀 ) is a formula of nominal income times a decreasing function of the
interest rate
𝑑
○ 𝑀 = $Y L(i)
○ (-)
𝑑
● Equilibrium in financial markets is where Money demand (𝑀 ) meets Money supply (M)
𝑑
○ M = $Y L(i) = 𝑀
● An increase in the supply of central bank money (H) leads to an decrease in the interest
rate
● An increase in nominal income leads to an increase in the interest rate
● Central bank can change supply of CB Money (H) with open market operations:
○ Expansionary OMO: more money (H, M) in market
■ CB buys bonds: interest decreases
○ Contractionary OMO: less money (H, M) in market
■ CB sells bonds: interest increases


Determining the interest rate
● Interest paid by bonds is given by today’s market value of payable amount.
○ When price of bond ($Pb) is high: interest is low
○ When price of bond ($Pb) is low: interest is high
● Financial markets are graphed with i (interest rate) on Y-axis and M (Money supply) on
X-axis
● Banks need to hold more reserves when amount of checkable deposits is larger
𝑑 𝑑
● Demand for reserves by banks (𝐻 ) is equal to ratio of 𝑀 Mandatory for reserves
𝑑 𝑑
○ 𝐻 = Θ𝑀 = Θ$YL(i)
■ Θ: reserves ratio or mandatory proportion of funds that the bank needs to
keep as reserves.
● Central bank can change the CB (central bank) money supply (H) with open market
operations
○ Open market operations: CB creates money, buys ST government bonds,
excess reserves can be used for loans
● Equilibrium in Demand-Supply of CB money (H*) is when demand and supply are equal