econ 203 part1 lecture notes promo fall 2011

8/13/2019 ECON 203 Part1 Lecture Notes Promo Fall 2011

1/22

ECON 203

Introduction to Macroeconomics

Lecture Notes

Second Edition

HANY FAHMY

E. [email protected]

w. www.hftutoring.com

T. 514 979 4232

This material is copyrighted and the author retains all rights. No part of this material may be reproduced or transmitted in any

forms or by any means, or sorted in a data base or retrieval system without the prior written permission of HF Consulting.
mailto:[email protected]:[email protected]


2/22

CO U R S E PA C K A G E IN F O R M A T I O N

This is a free copy of the first part of ECON 203 course package. If you ainterested to know more about this course package or any other course

you are currently taking, please take a minute and check our website

w w w. h f t u t o r i n g . c o m

or call us on

514 963 3707 or 514 979 4232

You can also benefit from our WALK INpromotions on all our

services:

Weekly Tutorials

Crash Courses

Private Tutoring

Free Advising with our instructors

Just visit our office located on 2015 Drummond (with Maisonneuve),

8thfloor, Suite 822to learn more about these promotions.

Looking forward to hearing from you and wishing you a great semester!

The Administration

HFTutoring
http://www.hftutoring.com/http://www.hftutoring.com/http://www.hftutoring.com/


3/22

Part 1

Lecture Notes on the Circular

Flow and the Basic Keynesian Mode

Second Edition

w w w . h f t u t o r i n g . c o m

[email protected]

This material is copyrighted and the author retains all rights. No part of this material may be reproduced or transmitted in any fo

or by any means, or sorted in a data base or retrieval system without the prior written permission of HF Consulting
http://www.hftutoring.com/http://www.hftutoring.com/


4/22

ECON 203, Winter 2010 Hany Fahmy1

Lecture Notes onThe Circular Flow of Income and the National Accounts

In this note I introduce briey the main indicators of macroeconomic performance. Inparticular I focus on output, general price level and employment. The handout starts withan introduction and a review of the basic macroeconomic concepts. After that, the circularow of income and the national accounts are discussed in detail.

1 E-mail address: [email protected]

1

Page 4


5/22

Introduction and Basic

Macroeconomic Concepts

A. Nominal and Real Gross Domestic Product (GDP)

Nominal GDP, GDPN; isthe valueof all nal goods and services produced in an economyin a specic period of time, usually one year.

GDPN=P Y; (1)

wherePis the general price level andY is the quantity of nal goods and services produced.Real GDP,GDPR, isthe quantityof nal goods and services produced in an economy in

a specic period of time measured in the market price of the base year.

GDPR= GDPN

GDP deflator (2)

and

GDP deflator=GDPN

GDPR 100: (3)

Consider an economy producing two goods, xand y, such that in 2006,the base year,

20 units ofx are sold at $5 each, and 8 units ofy are sold at $50 each. In 2007, 25 units ofx were produced at a price of $20 per unit, and 10 units ofy were produced at a price of$100 per unit. Given the previous information, we can calculate the real and nominal GDPin both years as:

GDPN(2006) = (20 5) + (8 50) = $500;

andGDPR(2006) = (20 5) + (8 50) = $500:

Observe that both the real and nominal GDP values are exactly the same in the base year.It follows then, the GDP deator in the base year is always 100. This can be seen fromequation (3) above, where

GDP Deflator(2006) = GDPN

GDPR 100 =

500

500 100 = 100:

As for 2007, we have:

GDPN(2007) = (25 20) + (10 100) = $1500;

2

Page 5


6/22


7/22

Example 1 Assume for simplicity that our basket consists of only two goods: wheat andcloth, were 2003 and 2004 prices are reported in the following table

P (2003) P (2004)Wheat 4 5 Cloth 12 16

Assume further that the representative consumer in the Canada buys 5 units of each consumer

good. Compute the 2004 CPI using 2003 as the base year. Based on the previous information,we can compute the following.

The value of the bundle (basket) at the base year is

(5 wheat 4) + (5 cloth 12) = 80:

The value of the bundle in 2004 is

(5 wheat 5) + (5 cloth 16) = 105:

The CPI in 2003 isIndex2003 =

80

80 100 = 100:

and the CPI in 2004 is

Index2004 =105

80 100 = 131:25:

E. Employment and the Labor Force

The employed, E;are those who worked part-time or full-time during the past week; theunemployed, U N;are those who were not employed during the past week but actively

searched for work at some time during the last four weeks. The labor force, L;is

L= E+ U N:

The total population consists of those who are in the labor force and those who are not inthe labor force. People in the labor force are either employed or unemployed. Those whoare outside the labor force are the children, retirees, and those who decided not to be in thelabor force. Therefore, the unemployment rateis calculated as

Unemployment rate=Labor Force Employed

Labor Force 100%;

and the participation rateis the labor force divided by the working age population.

Problem 2 In an economy, 100,000 people are in the labor force and the unemploymentrate is 25%. As this economy moves out of a recession and jobs increase, 10,000 discouragedworkers become encouraged to search for jobs. What is the new unemployment rate?

Solution 3 See solution in class.

4

Page 7


8/22

F. The Business Cycle and the Trade o Between Ina-

tion and Unemployment

The business cycle shows how the economic activity, i.e., the GDP, changes over time. Acycle starts from a trough (minimum point) and ends at a trough. The economy is said tobe in an expansion phase if it is moving from a trough to a peak along the business cycle.The economy is said to be in a recession if it is moving from a peak towards a trough. A

depression is a severe recession.According to the Keynesian school, there is always a trade-o between ination and

unemployment; if the economy is featuring a recession, for instance, ination will decreasebut unemployment will increase and vice-versa in expansion.

Although, the trade-o between ination and unemployment can be observed along thebusiness cycle, yet this is not always the case; an economy might feature high ination andhigh unemployment at the same time. This phenomenon is known as stagation.

G. The Full Employment Level of Output, Yp, and the

Natural Rate of Unemployment UNwhen all resources in the economy are fully utilized, the economy is said to be at the potential(full employment) level of output, denoted Yp: This is the optimal level of output that welike to have. If this level is achieve, unemployment should be zero, however, this is notcompletely true. The idea is that there exist a level of unemployment even if all resourcesare fully utilized. This unemployment rate that exists at the potential level of output iscalledthe natural rate of unemploymentand denotedUN: UNexists because offrictional,structural, andseasonal unemployments.

Frictional, Structural, and Seasonal Unemployment

Frictional Unemployment is a type of unemployment that exists when individuals leave jobsfor other jobs (between jobs). Structural Unemployment is another type of unemploymentthat exists due to a change in the structure of the economy. For instance, A computerspecialist located in a small town, where people hardly use computers, is unemployed becausethe structure of the economy does not provide a suitable job in his eld. A third type ofunemployment occurs when the individual is specialized in a seasonal job.

Natural unemployment can be justied on the basis of any of the three previously men-tioned types of unemployment.

Cyclical UnemploymentA fourth type of unemployment is resulting from uctuations on the business cycle; it iscalled cyclical unemployment. For instance, laying o worker in a recession is classiedunder cyclical unemployment.

Remark 4 The equilibrium level of unemployment (the level of unemployment that exists

5

Page 8


9/22

atYf) is never zero. This is mainly because of the frictional, seasonal, and structural unem-ployment.

Remark 5 The equilibrium level of unemployment in Canada is about 6%.

Example 6 Say, for instance, that the current unemployment rate is 11%. Assume furtherthat you learned that 2% is due to frictional unemployment, 4% is due to structural unem-ployment, and 5% is due to cyclical unemployment. Then, you can deduce that the naturalrate of unemployment, UN, is 6%.

6

Page 9


10/22

The Circular Flow and National

Accounts

The circular ow of income is a diagram that shows how real resources and money paymentsare channeled between households and the business sector. The diagram is omitted here.

A. Three Approaches to Measuring GDP

A.1. The Output Approach to GDP

GDP is measured as the value of all nal goods and services in an economy in a specicperiod of time, usually one year. Therefore, according to this approach

GDP =P Y:

A.2. The Expenditure Approach to GDP

1. The GDP is measured as the aggregate expenditures in an economy as

GDP =C+ I+ G + X M;

where:

C Consumption expenditures is spending by households on currently produced goodsand services.

I Investment expenditures is expenditure by business on currently produced nalgoods and services, e.g., Iincludes the value of machines, buildings, equipment, andinventories used by business. Note that Ihere is gross investment, i.e., it does notconsider depreciation.

Net Investment= Gross Investment depreciation:

G Government expenditures is the purchase of currently produced nal goods andservices by the government.

XExports are expenditures by foreigners on our domestic goods and services.

M Imports are expenditures by domestic residents on foreign products.

7

Page 10


11/22

A.3. The Income Approach to GDP

We know that at equilibriumY =GDP;

where Y is the income earned by all factors of production. Therefore, we can measure theGDP from the income side. To this end, we dene the following

Net domestic income = employment income + prots and business income

+ interest and investment income

orN DI=W+ BI ;

where:

1. W Employment Income is the sum of all wages, salaries, and benets paid to labor.

BIBusiness Income is the sum of prot, interest, investment and business income.

Once we know theNDI;the GDP at basic price and at market price can be obtained

as GDP at basic price= N DI+ CCA;

andGDP at market price(GDPN) =N DI+ CCA + Net TIN;

whereCCA denotes the capital consumption allowance which measures the deprecia-tion in capital stock and Net TIN denotes net indirect taxes which are the sales andexcise taxes minus subsidies as

Net TIN=Sales and Excise Taxes Subsidies:

B. GDP versus GNPGDP is the income or output produced inside the country boarders regardless of citizenshipor borders. Gross National Product (GNP) and Gross National Income (GNI) are equal andrepresent the GDP plus the net foreign property income as

GNP =GDP+ (Inflow outflow) of foreign properties:

Remark 7 Caution when calculating the GDP. The following points should be taken intoaccount when calculating the GDP using any of the previously mentioned approaches:

1. Final goods and services only should be included in the calculations of GDP. Inter-mediate goods should not be included in the calculations of GDP. The value addedapproach is used to avoid double counting problems. The value added, V A; is thesum of the dierences between the market value of output, O; and the cost of inputspurchased from other businesses, I; at each stage of production.

V A=X

(O I):

8

Page 11


12/22

2. Goods that are resold do not enter the GDP calculations because they have alreadybeen recorded

3. Many goods and services are excluded from the GDP calculations since they are notmarketed and thus hard to measure. These include home cleaning, unreported jobs,maintenance, and other households activities.

4. Transfers of ownership are not included in GDP calculations. Purchase of shares is an

example

Remark 8 Nominal GDP can be expressed, using the previously mentioned three approaches,as

GDPN=N DI+ CCA + Net TIN;

orGDPN=P Y;

orGDPN=P [C+ I+ G + N X]:

Hence GDPR = Y =C+ I+ G + N X:

9

Page 12


13/22

ECON 203, Winter 2010 Hany Fahmy1

Lecture Notes onThe Analysis of AD and the AD-AS Model

In this note I give three versions of Aggregate Expenditure (AE) model. In each version,I consider (1) the AE function, (2) the equilibrium level of output, and (3) the Multiplier.The analysis is then followed by a detailed discussion of the AD-AS model. The aggregatedemand (AD) and the aggregate supply (AS) model is a framework used to explain thebehavior of real output and prices in an economy. The interaction between AD and ASyields the actual equilibrium level of output and prices.

1 E-mail address: [email protected]

1

Page 14


14/22

The Keynesian AD Analysis

Version 1: No Government and No Foreign Sector

The Model

AD GDP AE=C+ I ;

C=c0+cY;

I=I0;

where:c0 is the autonomous consumption, which is the level of consumption that does not

depend on income;c= 4C

4Y MP Cis the marginal propensity to consumer (MPC). It explains the change

in consumption caused by a change in income. In other words, it shows how much out ofeach additional increase in income by one dollar is devoted to consumption. MPC is alwaysa fraction, i.e.,

0< MPC


15/22

(2) The Equilibrium Level of Output in Two Dierent Ways

We are after the aggregate equilibrium level of output, i.e., the output level at which theaggregate demand, AD; is equal to the aggregate supply, AS:

In general, the AD andASequations are expressed as follows:

AD AE GDP = C|{z}

Cons: Expenditure

+I+ G

andAS Y = C

|{z}

Planned Cons:

+S+T :

So, at equilibrium we have

G+I+ C=AE=Y =C+ S+T :

Now, back to our model, the equilibrium condition is then

AE= Y

Using the AE= A0+cY, we can solve for the equilibrium level of output, Y:An alternative way to express the equilibrium level of output can be obtained by noting

that also at equilibriumI=S:

Investment is constant (autonomous), but saving is not; it depends on income. Consequently,we need to derive the saving function. Since saving appears only in the AS equation, ASY = C+S, then we can use the denition of the consumption function and express thesaving function as

S=Y C=Y [c0+cY]:

Rearranging yields S= c0+ (1 c)Y;

where

(1 c) =4S

4Y MPS:

Figure 1 illustrates the realization of general equilibrium using the two previously mentionedways.

Problem 4 Suppose that consumption is $20,000 when income is $31,000, and consumptionincreases to $20,800 when income increases to $32,000, what is the marginal propensity to

save?


Problem 6 Suppose that T = 0 and Z = 0. If MP C = 0:6, then we can say that asaggregate income increases by one unit, aggregate consumption will increase by60%:


3

Page 16


16/22


17/22

(3) The Multiplier

The multiplier,( 4Y4A0

);is the ratio of the change in equilibrium income Ydue to the changein any of the components of the autonomous expenditure A0:

Claim 9 The multiplier in version is 11MP C

:

Proof. 3 To see this, impose the general equilibrium condition and solve for the equilibriumlevel of income as follows.

At equilibriumY =AE=C+ I ; (1)

whereC=c0+cY (2)

andI=I0: (3)

(2) and (3) in (1) yieldsY = (c0+I0) +cY:

solving for Y yields

Y = 11 c (c0+I0)

or

Y = ( 1

1 c)A0;

and thus4Y

4A0=

1

1 c:

In general the multiplier can be obtained from the following general form.

Multiplier= 1

1 slope of AE

Version 2: Introducing the government

The Model

AD GDP AE=C+ I+ G;

C=c0+cY d;

Yd = Y T;

T =tY ;

I=I0;

G= G0;

where:Yd is the disposable income (income after tax);t is the tax rate.

3 The proof is not required.

5

Page 18


18/22

(1) The AE Function of Version 2

We can derive the AE function by simply substituting the consumption function, the invest-ment, and the government expenditure into the AE identity. This yields

AE= A0+c(1 t)Y;

where

A0= c0+I0+G0

is the autonomous expenditure.

(2) The Equilibrium Level of Output

At equilibrium we haveAE= Y :

Using theAEfunction derived in (1) above, we can solve for the equilibrium level of output,Y:

(3) The Multiplier

Using our general formula, the multiplier in version 2 is obtained as

Multiplier= 1

1 slope of AE =

1

1 [M P C(1 t)]:

Remark 10 Notice that the multiplier in version 1 is higher than the multiplier in version2.

Version 3: An Open EconomyThe Model

AD GDP AE= C+I+G+X Z;

C=c0+cY d;

Yd = Y T;

T =tY ;

I=I0;

G= G0;X=X0;

Z=z Y;

wherez= 4Z4Y M P Zis the marginal propensity to import (MPZ). It explains the change

in expenditure on imports caused by a change in national income.

6

Page 19


19/22

Page 20


20/22

Tax Multiplier

We have seen the expenditure multipliers associated with the above three models. The taxmultiplier is dierent than the expenditure multipliers that we have seen. The tax multipliersimply shows the eect of changing taxes on real GDP. Since taxes aect output negatively,the tax multiplier has a negative sign and is obtained as

Tax Multiplier= M P C

1 M P C

Remark 14 It is easy to see that if the government changed both the government spendingand taxes by the same amount and in the same direction, then output will change by the

same value, that is,4Y = 4T = 4G

8

Page 21


21/22


22/22

econ 203 part1 lecture notes promo fall 2011

Documents