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Macroeconomics 1 summary
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(note: summary is written in English) The summary contains: * summary week 1 up until week 7 * complete formula list * representations of models and how they change
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MacroeconomicsSummary of macroeconomics
Inhoud
Table of Contents
H1. Introduction to Macroeconomics.....................................................................................................3
H1.1. Gross Domestic Product............................................................................................................3
H1.1.1. Production approach of GDP..............................................................................................3
H1.1.2. Income approach of GDP....................................................................................................3
H1.1.3. Expenditure approach of GDP............................................................................................3
H1.1.4. Nominal and Real GDP.......................................................................................................4
H1.1.5 Growth Rate GDP................................................................................................................4
H1.2. Inflation.....................................................................................................................................5
H1.3. (Un)employment.......................................................................................................................5
H2. Classical Theory................................................................................................................................6
H2.1. Circular flow models (open economy).......................................................................................7
H2.1.1. Exchange rate.....................................................................................................................7
H2.1.2. model for small open economies.......................................................................................7
H2.2. Circular flow model (closed economy)......................................................................................9
H2.2.1. the interest rate..................................................................................................................9
H2.2.2. model for closed economies...............................................................................................9
H2.3. Monetary system.....................................................................................................................10
H2.4.1. The central bank...............................................................................................................10
H2.4.2. calculations of Money......................................................................................................11
H2.4.3. inflation, interest and exchange rate................................................................................12
2.4. (Un)Employment.......................................................................................................................14
H3. Neoclassical theory........................................................................................................................15
H3.1. Keynesian building blocks........................................................................................................15
H3.1.1. The Keynesian cross model..............................................................................................15
H3.1.2. The liquidity preference model........................................................................................16
H3.2. IS-LM model............................................................................................................................17
H3.2.1. The investing-saving curve................................................................................................17
H3.2.2. The liquidity preference-money supply curve..................................................................17
H3.3. The Mundell Fleming model....................................................................................................18
Formula’s..............................................................................................................................................19
,Models and changes in models............................................................................................................21
The IS-LM model...............................................................................................................................21
The Mundell-Fleming (IS*-LM*) model............................................................................................22
Numerical information for exam...........................................................................................................24
,H1. Introduction to Macroeconomics
Macroeconomics is the study of the whole (aggregated) economy.
Three core variables of macroeconomics:
1. Gross Domestic Product (GDP): The monetary value of final goods and services.
2. Inflation (π): A general increase in prices and fall in the purchasing value of money.
3. Unemployment rate (u): The percentage of people in the labour force who are unemployed.
Exogenous variable: a variable that is given (you don’t have to explain the variable)
Endogenous variable: a variable that is dependent on other variables in the model (a variable that needs to be
found)
H1.1. Gross Domestic Product
The gross domestic product represents the monetary value of final goods and services. This means that the GDP
measures the economic activity in a country.
There are three approaches when it comes to GDP:
(1) Production approach: total value of all final goods and services produced in an economy during a given
period
(2) Income approach: total value of the income earned with the production of all final goods and services
in an economy during a given period
(3) Expenditure approach: total expenditures for the final goods and services produced in an economy
during a given period
Note: when calculating GDP, all the above approaches should give the same GDP.
The three GDP approaches can differentiate in actuality. But theoretically, the GDP should give the same GDP. A
case wherein two GDP approaches differentiated in actuality: production approach (excluding import and
export) and the expenditure approach (including import and export).
H1.1.1. Production approach of GDP
The production approach calculates the total value of all final goods and services produced in an economy
during a given period.
Calculation production approach: GDP =
Σ
P
i
x
Q
i
the GDP of production approach is often referred to as ‘’ GDP at market prices”.
Included in GDP: final goods and services, government services, etc.
Not included in GDP: intermediate goods and services, home goods, etc.
Calculation production approach (with taxes): GDP = GDP at market prices (VA) + taxes – subsidies
VA: value added by sector
H1.1.2. Income approach of GDP
Income is seen as two components: labour income and capital income. Both are hard to measure accurately.
The income approach of GDP is build-up:
Compensation of employees (labour income)
Operating surplus (capital income)
Mixed income (partly labour income, partly capital income)
+ taxes / - subsidies
H1.1.3. Expenditure approach of GDP
The expenditure approach of GDP is the total expenditures for the final goods and services produced in an
economy during a given period.
Calculation: Y (real GDP) = C + I + G + NX
,Consumption (C): private consumption
Investments (I): gross capital formation and inventory investment
Government spending (G): general government consumption
Net exports (NX): export – import
(note: purchases of financial assets are not gross capital formation)
H1.1.4. Nominal and Real GDP
Nominal GDP: Value of a goods or services measured at the current price (sometimes called nominal spending)
Calculating nominal GDP: PtYt = Σ Pi,t x Qi,t
When nominal GDP works best:
Performing short-term analysis
Forecasting or calculating revenue
Analysing budgets
Real GDP: Value of goods or services measured at the base year (sometimes called real spending)
Calculating real GDP: Yt = Σ Pi,0 x Qi,t
When real GDP works best:
Comparing economic growth overtime
Evaluating long-term trends
Comparing international relationships
Formulating government policies
Analysing investments
GDP deflator: A price index that shows how, on average, prices for all goods and services produced in an
economy change over time.
Calculating GDP deflator: nominal GDP / real GDP
High GDP: nominal GDP is high or real GDP is low
Low GDP: nominal GDP is low or real GDP is high
Consumer Price Index (CPI): An index that measures the monthly change in prices paid by consumers for a
certain good/service.
Calculating CPI over time: Pt = ( )/ (¿Σ¿P¿i¿,¿0¿¿x¿¿Q¿i¿,¿0¿)
Σ
P
i
,
t
x
Q
i
,
0
The price index compares price of the base year and current year.
The GDP deflator and CPI strongly correlate.
Some differences between GDP deflator and CPI
GDP Deflator Consumer Price Index
Measures the price of all goods Measures the price of all goods
and services produced and services consumed
Does not include import Does include import
Changing weights Fixed weights
H1.1.5 Growth Rate GDP
Chain-weighted GDP: manner to calculate real GDP ; calculate the value of goods and services produced this
year using the prices these things cost last year.
it uses prices from a period to help compute real growth for that period.
Calculating chain-weighted GDP:
Geometric chain-weighted GDP: gCH = √(1+g1)(1+g2)
Arithmetic chain-weighted GDP: gCH= (g1+g2)/2
Calculating growth rate GDP: gn= (Y2 – Y1)/Y1
Y= GDP
Ynn= GDP year..
,Y21= GDP, base year 1, current year 2
H1.2. Inflation
Inflation is the general increase in prices and fall in the purchasing value of money. It also is a representative of
economic growth. A small but positive inflation rate is economically useful, while high inflation tends to feed on
itself and impair the economy's long-term performance.
Cycle of inflation: less jobs available -> higher wages -> higher consumption -> increasing inflation / increasing
prices -> decrease in purchasing power (PP) - > higher wages.
Most common causes of inflation:
Imbalances in supply or demand
Supply shock
Expectations of inflation (e.g. expecting higher prices, so demanding higher wages)
Monetary or fiscal policy
Characteristics inflation:
(1) Reduction in purchasing power
(2) Inflation feeds on itself (when it is to high)
(3) Raises interest rates
(4) Decline in value of something (e.g. mortgage gets ‘less’ expensive)
Calculating inflation: π = (Pt – Pt-1)/Pt-1
The equation shows the difference in price levels.
H1.3. (Un)employment
Macroeconomics divides the adult population in three groups: employed, unemployed and not in the labour
force.
Labour Force (L): Employed (E) + Unemployed (U)
Employed (E): people who have a job
Calculating employment rate: e = E / adult population
Unemployed (U): people who don’t have a job, but are looking for one
Calculating unemployment rate: u = U/L
Participation rate: labour force w.r.t. the adult population
Calculating participation rate: p = L/adult population
, H2. Classical Theory
Classical economics refers to the school of thought of economics that originated in the late 18th and early 19th
centuries. The classical theory focusses on economic growth the long-run.
Characteristics:
Long-run equilibrium /steady state
Price flexibility
Self-regulating markets
K and L are exogenous
Real GDP (Y) is exogenous
Classical dichotomy: refers to the idea that real variables, like output and employment, are independent of
monetary variables.
The assumption is that in the long run, nominal variables (such as M, P and π) do not influence real variables
(such as Y ), but only other nominal variables.
The classical dichotomy implies a strong relationship between the money supply and price level, and the growth
rate of money supply and inflation.
Circular flow model: National income flow model ; The circular flow model demonstrates how money moves
through society.
Components: households, firms, government, financial markets.
All variables are real term (adjusted for the level of prices)
circular flow of economy
circular flow model for closed economy:
Flow of money, domestic
Equilibrating force: (real) interest rate (r)
NX=0
circular flow model for small open economy:
Flow of money, foreign as well as domestic
Equilibrating force: (real) exchange rate ( ε
¿
NX=0, NX>0 or NX<0
Y = constant in long-run
Circular flow model for a large open economy:
Has both closed economy and small open economy characteristics
Pragmatic short-cut:
Effect on r and I? -> look at closed economy
Effect on ε and NX? -> look at small open economy
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