Econ 203 chap4:

• The output gap measures the difference between potential output and actual output.
Output Gap = Y – Y* (Y*=potential output)
• When Y < Y*, the output gap is a recessionary gap.
• When Y > Y*, the output gap is an inflationary gap.

• Recessions are associated with unemployment and lost output

•Booms can bring inflation.

• When real GDP is less than potential GDP, there is cyclical unemployment

• Productivity is a measure of the amount of output that the economy produces per unit of
input.

• Labour productivity is the level of real GDP divided by the level of employment (or total hours
worked)

CPI: consumer price index

• The purchasing power of money is the amount of goods and services that can be purchased
with a unit of money.
• Inflation reduces the purchasing power of money. It also reduces the real value of any sum
fixed in nominal (dollar) terms.

• Net exports are the difference between exports and imports and are often called the trade
balance.

Nominal and real interest rate:

Chapter 5:

Value added = Sales rev. − Cost of intermediate goods

Value added = Payments owed to the firm’s factors of production

• Three different ways of measuring national income.

1. The concept of value added.
2. Sum the total flow of expenditure on final domestic output.
3. Sum the total flow of income generated by the flow of domestic production.
• All three measures yield the same total, gross domestic product (GDP), which is the total
value of goods and services produced in the economy during a given period.

GDP from the Expenditure Side:

• GDP for a given year is calculated from the expenditure side by adding up the expenditures
needed to purchase the final output produced in that year.

1. Consumption Expenditure
 Household expenditure on all goods and services.
2. Investment Expenditure
 Expenditure on the production of goods not for present consumption.

• Investment expenditure also includes inventories.

• Investment expenditure also includes capital goods and residential housing.
• The economy’s total quantity of capital goods is called the capital stock.
• Creating new capital goods is called fixed investment.

• Net investment = Gross investment – Depreciation

• The total amount of investment in any given year is the sum of the changes in inventories, the
additions to the stock of plant and equipment, and the new construction of residential housing
units.

3. Government Purchases: – Expenditure on currently produced goods and services,

exclusive of government transfer payments

4. Net Exports
Net exports = Exports – Imports

GDP from the Income Side

• Involves adding up factor incomes and other claims on the value of output until all of that
value is accounted for

1. Factor Incomes : Three main components of factor incomes: wages and salaries, interest,
and business profits.
2. Non-factor Payments
Indirect taxes are taxes on the production and sale of goods and services.
Subsidies act like negative taxes. They are payments from the government to firms.

• When we calculate GDP from the income side, we include a “fudge factor”, called statistical
discrepancy.

Statistical discrepancy makes sure that the independent measures of income and expenditure
come to the same total.

• Real and Nominal GDP

– Total GDP valued at current prices is called nominal GDP.
– GDP valued at base-period prices is called real GDP.

• The GDP Deflator

– If nominal and real GDP change by different amounts over a given time period, then prices
must have changed over that period.

• Movements in the CPI measure the change in the average price of consumer goods.
• Movements in the GDP deflator reflect the change in the average price of goods produced in
Canada.

GDP
Expenditure side: intermediate goods are excludes to avoid double counting

Personal consumption
Government purchases
Exports
Imports
Net private investment.
Depreciation

Income approach:
GDP=Wages and salaries +Interest income +Indirect taxes +Business profits +Depreciation -Subsidies

Net domestic income:

wages and salaries+ interest income+ business profits
Chap 6:

Desired aggregate expenditure= AE = C + I + G + (X − IM)

Elements of aggregate expenditure that do not change systematically with national income are
called autonomous expenditures.

Components of aggregate expenditure that do change systematically in response to changes in

national income are called induced expenditures.

Desired AE is in closed economy

Disposable income = household income ‒ taxes

Consumption function:

Average propensity to consume (APC) : APC = C / YD(disposable income)

Marginal propensity to consume (MPC) MPC = C / YD
The MPC is the slope of the consumption function.
– The constant slope of the consumption function shows that the MPC is the same at any level
of disposable income

Saving function:

Average propensity to save (APS): APS = S / YD , S: desired savings YD: disposable income
Marginal propensity to save (MPS): MPS = S / YD

Disposable income is spent or saved, APC+APS=1 and MPC+MPS=1

The consumption function shifts upward with an increase in wealth, a decrease in interest
rates, or an increase in optimism about the future.

The saving function shifts downward with an increase in wealth, a decrease in interest rates, or
an increase in optimism about the future.

Three categories of investment are:

1-Inventory accumulation
2-residential construction
3-New plant and equipment
Investment expenditure is
(1) the most volatile component of GDP
(2) strongly associated with aggregate economic fluctuations.

Determinants of desired investment expenditure are:

(1) the real interest rate
(2) changes in the level of sales
(3) business confidence

The current level of real GDP is not an important determinant of current desired investment.

Aggregate Expenditure:
AE= C+I (desired consumption + desired investment)
-The slope of the AE function is the marginal propensity to spend, which in this simple model, is
just the marginal propensity to consume.
-The aggregate expenditure function relates desired aggregate expenditure to actual national
income

Equilibrium national income:

•If desired aggregate expenditure exceeds actual income, inventories are falling (firm increase
output) and there is pressure for actual national income to rise.
• If desired aggregate expenditure is less than actual income, inventories are rising(firm reduces
output) and there is pressure for actual national income to fall.
• The equilibrium level of national income occurs when desired aggregate expenditure equals
actual national income.

At equilibrium, AE=Y
• If actual Y < Y0 , desired AE will exceed national income, and output will rise.
•If actual Y > Y0 , desired AE will be less than national income, and production will fall.
• Only when Y = Y0 will the economy be in equilibrium, (E0 ).

• What determines the size of the change in national income?

– The simple multiplier is the ratio of the change in equilibrium national income to the change
in autonomous expenditure that brought it about, calculated for a constant price level.
– In the simple macro model, the multiplier is greater than 1.

ΔY 1
Simple multiplier = =
ΔA 1−z
• z is the marginal propensity to spend (MPS=MPC(slope of the consumption function and AE
function) out of national income
•A is the change in autonomous expenditure
• The larger the marginal propensity to spend, the steeper the AE function and the larger is the
simple multiplier.

Chap 7:
Introducing government:
• Fiscal policy is the use of the government’s tax and spending policies to achieve government
objectives.

National income(Y) , Disposable income(YD), T (taxes), t(net tax rate)

YD=Y-T =Y-tY =(1-t)Y

Budget balance=T-G
• When net revenues exceed purchases, the government has a budget surplus.
• When purchases exceed net revenues, the government has a budget deficit

The marginal propensity to import (m) is the increase in import expenditures induced by a $1
increase in national income.
IM = mY
• Net exports is given by NX = X – mY

z = MPC(1 – t) – m in open economy

z=MPC in closed economy

Chapter 8: