Transcript 26-2

Two Approaches to GDP
Consumption by
Households
Wages
Investment by
Businesses
Rents
+
+
Government
Purchases
+
Expenditures
By Foreigners
24-1
G
= D=
P
+
+
+
+
Interest
Profits
Statistical
Adjustments
Unemployment
• Types of unemployment
–Frictional (search and wait)
–Structural (occupational and
geographical)
–Cyclical
• Full employment redefined
–No cyclical unemployment
• Natural rate of unemployment
• Full employment rate
26-2
Inflation
• Rise in general level of prices
• Consumer price index (CPI)
–Market basket
–300 goods and services
–Typical urban consumer
–2 year updates
CPI =
Price of the Most Recent Market
Basket in the Particular Year
Price estimate of the Market
Basket in 1982-1984
x
100
26-3
Rate of Inflation
• Rate of inflation
This year index – last year index
last year index
26-4
Changes in Equilibrium
Inflationary GDP
gap
Increase in Aggregate Demand
Price Level
AS
Demand-Pull
Inflation
P2
P1
AD1
**increase in
price level
diminishes the
multiplier effect
AD
Qf
Q1 Q2
Real Domestic Output, GDP
29-5
Changes in Equilibrium
Negative GDP
gap
Decrease in Aggregate Demand
Price Level
AS
b
P1
c
P2
**No change in
price level
protects full
multiplier effect
a
Creates a
Recession
AD1
AD2
Q1 Q 2 Qf
Real Domestic Output, GDP
29-6
Changes in Equilibrium
Decrease in Aggregate Supply
Price Level
AS2
Cost-Push
Inflation
P2
P1
AS1
b
a
AD
Q1 Qf
Real Domestic Output, GDP
29-7
Changes in Equilibrium
Increases in Aggregate Supply –
Full-Employment With Price-Level Stability
Price Level
AS1
P3
P2
P1
AS2
b
c
a
AD2
AD1
Q1
Q2Q3
Real Domestic Output, GDP
29-8
The Phillips Curve
 The graphical representation of the relationship
between the rates of Unemployment and
Inflation.
The Long-Run Phillips Curve
At natural rate of
unemployment
PCLR
Annual Rate of Inflation (Percent)
15
PC3
12
b3
PC2
9
a3
b2
PC1
6
c3
a1
c2
b1
3
0
a2
3
4
5
6
Unemployment Rate (Percent)
35-10
Taxes and Aggregate Supply
Supply-side economics
Tax incentives to work
Tax incentives to save and invest
The Laffer curve
100
Tax Rate (Percent)
•
•
•
•
n
m
Laffer Curve
m
l
Maximum
Tax Revenue
0
Tax Revenue (Dollars)
35-11
The Monetary Multiplier
Monetary
multiplier
=
Graphic
Example
1
required reserve ratio
=
1
R
New Reserves
$100
$80
Excess
Reserves
$400
Bank System Lending
Money Created
$20
Required
Reserves
$100
Initial
Deposit
32-12
Rate of interest, i percent
Demand for Money
(a)
Transactions
demand for
money, Dt
(c)
Total
demand for
money, Dm
and supply
(b)
Asset
demand for
money, Da
10
Sm
7.5
=5
+
5
2.5
Dt
Da
Dm
0
50
100
150
200
Amount of money
demanded
(billions of dollars)
50
100
150
200
Amount of money
demanded
(billions of dollars)
50
100
150
200
250
300
Amount of money
demanded and supplied
(billions of dollars)
33-13
Loanable Funds
Expansionary Fiscal Policy
Recessions
Decrease
Aggregate
Demand
Price Level
$5 Billion
Additional
Spending
AS
Full $20 Billion
Increase in
Aggregate Demand
P1
AD1
AD2
$490
$510
Real Domestic Output, GDP
30-15
Contractionary Fiscal Policy
Reduce
Demand Pull
Inflation
$3 Billion
Initial Decrease
In Spending
Price Level
AS
Full $12 Billion
Decrease in
Aggregate Demand
P1
AD4
AD3
$510
$522
Real Domestic Output, GDP
30-16
Crowding Out
A Large Public Debt to Finance Public Investment Will Cause…
16
If Public Spending
Spurs More Private
Investment Will
Increase to ID2
Real Interest Rate (Percent)
14
12
b
10
c
8
a
6
Interest Rate
Rise Will
4
Decrease
2 Investment
a to b
0
5
10
CrowdingOut Effect
ID2
ID1
15
20
25
30
35
40
Investment (Billions of Dollars)
30-17
Self-Correction
• New classical view
–Rational expectations theory
–Monetarists
• Automatic correction will occur
• Speed of adjustment
• Unanticipated price-level
changes
• Fully anticipated price-level
changes
36-18
Flexible Exchange Rates
The Market for Foreign Currency (Pounds)
P
Dollar Price of 1 Pound
S1
$3
$2
Dollar
Depreciates
(Pound
Appreciates)
Exchange
Rate: $2 = £1
Dollar
Appreciates
(Pound
Depreciates)
$1
D1
0
Q1
Q
Quantity of Pounds
38-19