1. The total income of everyone in the economy

2. Total spending on the output of goods and services in the economy

Includes everything produced in the economy and legally sold on the market.

It does not include things that are illegally produced and sold, nor does it include things that are produced and consumed within the family but do not enter the market.

Includes goods and services currently produced.

Transactions involving things produced in the past, such as used cars, are not included.

Some things that contribute to a good life are not included in GDP, such as leisure and environmental quality.

The value of virtually all activities conducted outside the market is not included.

There is no income distribution involved.

1. Fix the basket and determine which prices are most important to ordinary consumers.

2. Find the price. Find the price of each item and service in the basket at each point in time.

3. Use price data to calculate the cost of a basket of goods and services in different periods.

4. Select the base year and calculate the index. One year is designated as the base year, which is the basis to which other years are compared (the choice of the base year is arbitrary when using an index to measure changes in the cost of living).

Consumer Price Index = (price of a basket of goods and services in the current year ÷ price of a basket in the base year) × 100

5. Use the consumer price index to calculate the inflation rate.

Inflation rate in the second year = [(CPI in the second year - CPI in the first year) ÷ CPI in the first year] × 100%

1. Substitution bias

2. Introduction of new items

3. Unmeasurable quality changes

1. Physical capital per capita Physical capital: The stock of equipment and buildings used to produce goods and services.

2. Human capital per capita Human capital: The knowledge and skills that workers acquire through education, training, and experience.

3. Natural resources per capita Natural resources: Inputs provided by nature that are used to produce goods and services, such as land, rivers, and mineral deposits.

4. Technical knowledge Technical knowledge: Society's understanding of the best ways to produce goods and services.

One way to increase future productivity is to invest more of current resources in the production of capital

Encouraging savings and investment is one way governments can promote growth and, in the long term, improve living standards in an economy.

Diminishing returns: As the amount of input increases, the return from each additional unit of input decreases.

Catch-up effect: The characteristic that countries that start out poor tend to grow faster than countries that start out rich.

Foreign direct investment: Capital investment owned and operated by a foreign entity.

Foreign Portfolio Investment: Investments financed in foreign currency but operated by domestic residents.

Human capital brings positive externalities. Externality: The impact of one's actions on the welfare of bystanders.

All else being equal, healthier workers are more productive.

Market price is a tool for the market to achieve a balance between supply and demand. An important prerequisite for the price system to work is widespread respect for property rights in the economy.

Property rights refer to people's ability to exercise power over the resources they own.

One threat to property rights is political instability. Economic prosperity depends in part on political prosperity.

International trade in goods and services improves the economic welfare of a country's citizens.

The amount of trade a country has with other countries depends not only on government decisions but also on geography.

To a large extent, knowledge is a public good.

Governments can encourage research and knowledge advancement through funding, tax breaks, and the patent system.

leading to stress on natural resources. But growth in human creativity offset the impact of population growth.

diluted the capital stock.

Promoted technological progress.

Bond: A document that obliges a borrower to the bondholder for a debt, specifying a maturity date and interest rate.

Stock: A claim on partial ownership of a business. The price of stock transactions is determined by supply and demand. The demand (and price) of stocks reflect people's expectations for the company's future profitability. Key stock market data: prices, dividends, price-earnings ratios.

Bank: An institution that absorbs funds from fund owners and lends them to those in need of funds.

Mutual Fund: An institution that sells shares to the public and uses the proceeds to purchase a portfolio of stocks and bonds.

National Savings (Savings S): Total income remaining in an economy after spending on consumption and government purchases.

GDP (Y) = consumption (C) investment (I) government purchases (G) net exports (NX)

Closed economy: An economy that does not interact with other economies. In a closed economy, imports and exports are zero. Open economy: An economy that interacts with other economies in the world.

In a closed economy, GDP (Y) = consumption (C) investment (I) government purchase (G) ⇒ GDP (Y) - Consumption (C) - Government Purchase (G) = Investment (I) = Savings (S) T represents the amount the government receives from households in the form of taxes minus the amount returned to households in the form of transfer payments Then: Savings (S) = GDP (Y) - Consumption (C) - Government Purchase (G) ⇒S= (Y-T-C) (T-G), private savings: (Y-T-C), public savings: (T-G)

Private Savings: The income left over by households after paying taxes and consumption. Public Savings: Tax revenue remaining after the government has paid its expenditures. Budget surplus: The balance in which tax revenues exceed government expenditures. Budget deficit: A shortfall in tax revenue caused by government spending. Balanced budget: Government spending exactly equals tax revenue.

In the language of macroeconomics, investment refers to the purchase of new capital, such as equipment or buildings; households purchase bonds, stocks, mutual fund shares, or deposit in banks as savings.

The identity S=I means that saving and investment are equal for the entire economy, but this is not necessarily true for each individual household and business.

Crowding out (effect): Reduction in investment caused by government borrowing.

When the government reduces national saving through budget deficits, interest rates rise and investment falls. Because investment is important to long-term economic growth, government budget deficits reduce the economy's growth rate.

Budget surpluses increase the supply of loanable funds, lower interest rates, and stimulate investment. Higher investment, in turn, means more capital accumulation and faster economic growth.

The debt-to-GDP ratio is an indicator of a government's fiscal health.

1. The prices of some assets fell sharply

2. Bankruptcy of financial institutions

3. Decreased confidence in financial institutions

4. Insufficient credit

5. Economic downturn

6. Vicious cycle

1. Insurance. From an overall economic perspective, the role of insurance is not to eliminate the inherent risks in life, but to share risks more effectively. The insurance market is plagued by two types of problems: First, adverse selection, where high-risk people are more likely to apply for insurance than low-risk people; second, moral hazard, where people have less incentive to act cautiously to avoid risks after purchasing insurance.

2. Diversification of enterprise-specific risks. Diversification: Reducing risk by replacing one risk with a large number of smaller, unrelated risks. Risk is measured by the standard deviation in statistics. Diversification can eliminate company-specific risks, but it cannot eliminate market risks. Business-specific risks: Risks that affect only one company. Market risk: Risk that affects all companies on the stock market.

3. The trade-off between risks and benefits. When deciding how to allocate savings, people must decide how much risk they are willing to take in order to earn high returns. Understanding the risk-return trade-offs does not in itself tell us what we should do; the choice of a certain combination of risk and return depends on one's risk aversion, which reflects one's preferences.

The (U.S.) Bureau of Labor Statistics places each adult (16 years and older) in a surveyed household into three categories: 1. Employed persons: including people who work as paid employees, people who work in their own businesses and are paid, and people who work in family businesses but do not receive pay. 2. The unemployed: includes people who are able to work and have tried hard to find a job in the previous four weeks but failed to find a job. It also includes people who have been laid off and are waiting to be recruited back to work. 3. Non-labor force: includes people who do not fall into the first two categories, such as full-time students, houseworkers and retirees.

Labor force: The total number of workers, including both employed and unemployed people. Labor force = Number of employed persons Number of unemployed persons

Unemployment rate: The percentage of the labor force that is unemployed. Unemployment rate = (Number of unemployed/labor force) × 100%

Labor force participation rate: The labor force as a percentage of the adult population. Labor force participation rate = (labor force/adult population) × 100%

Natural rate of unemployment: The normal rate of unemployment around which the unemployment rate fluctuates. Cyclical unemployment rate: The deviation of the unemployment rate from the natural rate of unemployment.

It is easy to distinguish between those who work full-time and those who do not work at all, but it is much harder to distinguish between those who are unemployed and those who are not in the labor force.

Discouraged worker: A person who wants to work but has given up looking for one. Although they are actually workers without a job, they are not represented in unemployment statistics.

It's best to think of the official unemployment rate as a useful but imperfect measure of unemployment.

Most unemployment is short-term, while most unemployment observed in any given period is long-term.

Much of the unemployment in the economy is caused by a small number of workers who have been out of work for a long period of time.

Frictional unemployment: Unemployment caused by the time it takes for workers to find jobs that best suit their tastes and skills. This type of unemployment is often thought to explain the shorter duration of unemployment. Structural unemployment: Unemployment caused by insufficient jobs available in certain labor markets to provide a job for everyone who wants to work. This type of unemployment is often thought to explain the longer duration of unemployment.

Structural unemployment occurs when wages for some reason are higher than the level that equalizes supply and demand. There are three possible reasons for above-equilibrium wages: minimum wages, unions, and efficiency wages.

Frictional unemployment is usually the result of changes in labor demand among different firms.

Changes in the composition of demand between industries or regions are called sectoral shifts. Sector shifts temporarily cause unemployment because workers take time to find jobs in the new sector.

Frictional unemployment is inevitable simply because the economy is always in flux.

The process of sectoral shifts resulted in higher productivity and living standards, but workers in declining industries found themselves losing their jobs and looking for new ones.

1. Workers’ health. Concerns about worker health do not apply to businesses in rich countries.

2. Worker turnover rate. There is a cost for companies to hire and train new workers, and companies with high worker turnover rates tend to have high production costs.

3. Quality of workers. High wages attract better workers to apply for the job.

4. Worker effort level. High wages give workers an incentive to put in their best effort.

1. Medium of exchange: What the buyer gives to the seller when purchasing goods and services.

2. Unit of Account: The standard used by people to express prices and record debts.

3. Store of value: something that people can use to convert current purchasing power into future purchasing power.

Economists use liquidity to describe the ease with which an asset can be converted into a medium of exchange in the economy. Liquidity: The ease with which an asset can be converted into a medium of exchange in the economy.

1. Commodity currency: currency in the form of commodities with intrinsic value, such as gold.

2. Legal currency: Currency that has no intrinsic value and is used as currency determined by government decree.

The amount of money circulating in the economy is called the money stock.

Currency: Paper money banknotes and coinage held by the public.

Demand deposit: A bank account balance that a depositor can withdraw at any time by writing a check.

The money stock of the U.S. economy includes not only currency, but also deposits in banks and other financial institutions.

The Federal Reserve is governed by its Board of Governors, which consists of seven governors appointed by the president and confirmed by the Senate. The governors serve 14-year terms.

The most important of the seven members of the Board of Governors is the Chairman, who appoints Fed officials, presides over Board of Governors meetings, and regularly testifies on Fed policy before various congressional committees. The President has the power to appoint the Chairman for a four-year term.

The Federal Reserve System consists of the Federal Reserve Board of Governors in Washington, D.C., and 12 regional Federal Reserve banks located in major cities in the United States.

The Federal Reserve has two interrelated jobs: the first is to regulate banks and ensure the normal functioning of the banking system, and is the bank's bank and lender of last resort; the second is to control the amount of money available in the economy, which is called Money supply, decision makers’ decisions about money supply constitute monetary policy.

The Federal Open Market Committee is composed of the seven governors of the Federal Reserve and five of the 12 regional bank presidents.

Through decisions of the Federal Open Market Committee, the Federal Reserve has the power to increase or decrease the amount of dollars in the economy.

The Fed's main tool is open market operations -- the buying and selling of U.S. government bonds.

The Fed's policy decisions have an important impact on the economy's inflation rate in the long term and on economic employment and production in the short term.

The Fed changes the amount of reserves in the economy either by buying and selling bonds in open market operations or by making loans to banks.

Open market operations: The Fed buys and sells U.S. government bonds. Open market operations are the Fed's most commonly used monetary policy tool.

Discount rate: The interest rate at which the Federal Reserve makes loans to banks. The Fed can change the money supply by changing the discount rate.

The short-term auction tool is a borrowing amount determined by the Federal Reserve and a competitive auction among banks participating in bidding competition.

The Fed affects the reserve ratio both by controlling the amount of reserves banks must hold and by the interest rate the Fed pays banks to hold reserves.

Mandated Reserves: Regulations regarding the minimum amount of reserves that banks must hold against their deposits. An increase in statutory deposit reserves increases the reserve ratio, reduces the money multiplier, and reduces the money supply.

In October 2008, the Fed began paying interest on reserves. The higher the reserve rate, the more reserves banks choose to hold, so an increase in the reserve rate increases the reserve ratio, lowers the money multiplier, and reduces the money supply.

The Fed's control of the money supply is imprecise, and the Fed must overcome two problems, each of which arises from the massive money supply created by our sectoral reserve banking system.

The first problem is that the Fed cannot control the amount of money households choose to hold in bank deposits. The second problem is that the Fed cannot control how much banks choose to lend.

In a fractional reserve banking system, the amount of money in the economy depends in part on the behavior of depositors and bankers. The Fed can respond to changes by bringing the money supply closer to a level of its choosing.

Federal Funds Rate: The interest rate a bank pays for an overnight loan from another bank. The discount rate is always closely related to changes in the federal funds rate.

When the federal funds rate rises or falls, other interest rates tend to move in the same direction.

Although the actual federal funds rate is determined by supply and demand in the interbank loan market, the Fed can influence this market using open market operations.

All other things being equal, a decrease in the federal funds rate target implies an expansion of the money supply.

The first view of inflation is that it is about the value of money, not the value of things, and this view helps to derive the theory of inflation. Inflation is a broad economic phenomenon that involves first and foremost the value of the medium of exchange in the economy.

We can look at the general price level in the economy from two aspects: on the one hand, so far we have been looking at the price level as the price of a basket of goods and services; on the other hand, we can also look at the price level as the value of money a measure of. When the general price level rises, the value of money falls.

Factors that determine the value of money: supply and demand. Money supply: The Federal Reserve and the banking system jointly determine the supply of money. Money Demand: Money demand reflects the amount of wealth that people want to hold in liquid form. Although many variables affect the demand for money, one variable is most important - the average price level in the economy. An increase in the price level (a decrease in the value of money) increases the quantity of money demanded.

What factors ensure that the amount of money supplied by the Fed is balanced with the amount of money people demand? The answer depends on the length of time considered. In the short term, interest rates play a key role; in the long term, the overall price level will adjust to a level that makes money demand equal to money supply.

When the money supply increases making more dollars available, the price level rises, which makes each dollar less valuable.

Quantity Theory of Money: A theory that holds that the amount of money available determines the price level, and that the growth rate of the amount of money available determines the inflation rate. According to the quantity theory of money, the amount of money available in the economy determines the value of money, and growth in the quantity of money is the primary cause of inflation.

The direct effect of currency injection is the creation of excess money supply.

The injection of money increases people's demand for goods and services, but the economy's ability to produce goods and services does not change. This increase in demand for goods and services causes prices to rise, and rising price levels increase the quantity of money demanded. Finally, the economy reaches a new equilibrium when money demand equals money supply again.

Nominal variable: A variable measured in monetary units. Real variable: A variable measured in physical units.

Classical dichotomy: The theoretical distinction between nominal and real variables. Dichotomy refers to the division into two categories, classical refers to early economic thinkers.

According to classical analysis, changes in money supply affect nominal variables but not real variables. This irrelevance of changes in money supply to real variables is called monetary neutrality.

Monetary neutrality is not entirely true. Most economists now believe that in the short run, currency changes have an impact on real variables, whereas classical analysis is true for the economy in the long run.

In economics, money velocity refers to the speed at which an average dollar moves through the hands of different people in the economy.

To calculate money velocity, we divide the nominal value of output (nominal GDP) by the quantity of money. If P represents the price level (GDP deflator), Y represents output (real GDP), and M represents the amount of money, then the money circulation velocity is: V = (P×Y)/M. The equation can be slightly organized and rewritten as: M×V=P×Y. This equation shows that the quantity of money (M) times the velocity of money circulation (V) is equal to the price of the product (P) times the output (Y).

Quantity Equation: The equation M×V=P×Y, which links the quantity of money, the velocity of money circulation, and the dollar value of the economy’s output of goods and services. The quantity equation states that an increase in the amount of money in the economy must be reflected in one of three other variables: the price level must rise, output must rise, or the velocity of money must fall.

In many cases, the velocity of money is relatively stable.

Explain all the factors needed to explain the equilibrium price level and inflation rate: (1) The velocity of currency circulation has always been relatively stable. (2) Since the velocity of money circulation is stable, when the central bank changes the quantity of money M, it causes the nominal output value P×Y to change in the same proportion. (3) An economy’s output of goods and services Y is mainly determined by factor supply (labor, physical capital, human capital and natural resources) and available production technology. In particular, since money is neutral, it is not Does not affect output. (4) When output Y is determined by factor supply and technology, when the central bank changes the money supply M and causes the nominal output value P × Y to change in the same proportion, these changes are reflected in changes in the price level P. (5) When the central bank rapidly increases the money supply, the result is high inflation. These five steps are the essence of the quantity theory of money.

Hyperinflation is generally defined as monthly inflation exceeding 50%, meaning that price levels will rise more than 100 times within a year.

Inflation Tax: Revenue raised by the government through the creation of money.

An inflation tax is more subtle, like a tax levied on everyone who holds currency.

Interest rates are an important variable for macroeconomists to understand because they link the present economy to the future economy through their effects on savings and investment.

The nominal interest rate is the interest rate known at the bank, and the real interest rate is the nominal interest rate corrected for the effects of inflation.

The supply and demand of loanable funds determines the real interest rate, and according to the quantity theory of money, the growth of the money supply determines the inflation rate.

Money is neutral in the long run, and changes in money growth do not affect real interest rates. Since real interest rates are unaffected, nominal interest rates must adjust one-for-one to changes in inflation. So when the Fed increases money growth, the long-term result is higher inflation and higher nominal interest rates.

Fisher effect: The one-to-one adjustment of nominal interest rates to inflation. The analysis of the Fisher effect is correct in the long run, but not in the short run because inflation is unpredictable. Specifically, the Fisher effect states that nominal interest rates adjust to expected inflation.

The classical dichotomy divides variables into real variables (variables that measure quantities or relative prices) and nominal variables (variables that are measured in monetary terms).

According to classical macroeconomic theory, changes in the money supply affect nominal variables but not real variables, that is, monetary neutrality.

Most economists believe that classical theory describes the world in the long run but not in the short run.

When looking at year-to-year economic changes, the assumption of monetary neutrality no longer applies. In the short run, real variables and nominal variables are highly correlated, and changes in the money supply can temporarily cause real GDP to deviate from its long-term trend.

Models of short-run economic fluctuations focus on the behavior of two variables: the first is the economy's output of goods and services, measured by real GDP; the second is measured by the CPI or GDP deflator. overall price level.

Aggregate Demand and Aggregate Supply Model: A model used by most economists to explain short-term fluctuations in economic activity around its long-term trend.

Aggregate demand curve: A curve showing the quantity of goods and services that households, businesses, governments, and foreign customers want to buy at each price level.

Aggregate supply curve: A curve that shows the quantity of goods and services that firms choose to produce and sell at each price level.

The aggregate demand and aggregate supply models are completely different from the market demand and market supply models in microeconomics. Microeconomic substitution from one market to another is not possible for the economy as a whole.

1. Price level and consumption: wealth effect. Lower price levels increase the real value of money and make consumers wealthier, which in turn encourages them to spend more. Increased consumer spending means greater demand for goods and services. Conversely, rising price levels reduce the real value of money and make consumers poorer, which in turn reduces consumer spending and the quantity of goods and services demanded.

2. Price level and investment: interest rate effect. The price level is a determinant of the quantity of money demanded. A lower price level lowers interest rates, encouraging more spending on investment goods, thereby increasing the demand for goods and services. Conversely, rising price levels raise interest rates, dampen investment spending, and reduce the quantity of goods and services demanded.

3. Price level and net exports: exchange rate effect. When the U.S. price level falls, causing U.S. interest rates to fall, the real value of the dollar in the foreign exchange market falls. This depreciation stimulates U.S. net exports, thereby increasing demand for goods and services. Conversely, when the U.S. price level rises and causes U.S. interest rates to rise, the real value of the dollar rises, and this appreciation reduces U.S. net exports and the quantity of goods and services demanded.

Importantly, the aggregate demand curve is drawn assuming "other things being equal", and in particular, all three explanations of the downward-sloping aggregate demand curve assume that the money supply is fixed. A change in the quantity of money shifts the aggregate demand curve.

1. Shifts caused by changes in consumption: When the price level is given, events that increase consumer spending (tax cuts, stock market surges) shift the aggregate demand curve to the right; when the price level is given, events that decrease consumer spending ( Tax increases, stock market downturns) shift the aggregate demand curve to the left.

2. Movement caused by changes in investment: When the price level is given, events that increase corporate investment (optimism about the future, a decrease in interest rates due to an increase in money supply) shift the aggregate demand curve to the right; Events that reduce business investment (pessimism about the future, rising interest rates due to a reduction in the money supply) shift the aggregate demand curve to the left.

3. Shifts caused by changes in government purchases: increases in government purchases of goods and services (increased spending on national defense or highway construction) shift the aggregate demand curve to the right; decreases in government purchases of goods and services (cuts in spending on national defense or highway construction) spending on highway construction) shifts the aggregate demand curve to the left.

4. Movement caused by changes in net exports: When the price level is given, events that increase net export spending (foreign economic prosperity, speculation that causes exchange rate declines) shift the aggregate demand curve to the right; when the price level is given, net export spending is reduced Events (foreign recession, speculation causing exchange rate increases) shift the aggregate demand curve to the left.

In the long run, an economy's production of goods and services (its real GDP) depends on its supply of labor, capital, and natural resources, and on the technology available to convert these factors of production into goods and services.

The price level does not affect these long-run determinants of real GDP, so the long-run aggregate supply curve is vertical.

The aggregate supply curve is vertical only in the long run.

Natural level of output: The level of production of goods and services that an economy achieves in the long run when unemployment is at its normal rate.

Any change in the economy that changes the natural level of output shifts the long-run aggregate supply curve.

1. Movement caused by labor changes. Any change in the number of workers and the natural unemployment rate will shift the long-term aggregate supply curve.

2. Movement caused by changes in capital. An increase in the capital stock in the economy increases productivity, thereby increasing the supply of goods and services, with the result that the long-run aggregate supply curve will shift to the right. Otherwise, move to the left.

3. Changes in natural resources cause movement.

4. Movement caused by changes in technical knowledge.

Although many factors determine the economy in the long run, and in theory these factors can cause such a move, the two most important factors in the real world are technology and monetary policy.

Long-term trends are the result of the superposition of short-term fluctuations. Short-term fluctuations in output and price levels should be viewed as departures from sustained long-term trends in output growth and inflation.

The long-run aggregate supply curve is vertical because in the long run the aggregate price level does not affect the economy's ability to produce goods and services. In contrast, in the short run the price level does affect the economy's output. The short-run aggregate supply curve slopes upward to the right.

When the actual price level in the economy deviates from people's expected price levels, supply deviates from its long-term or natural level.

1. Sticky wage theory. According to the sticky wage theory, the short-run aggregate supply curve slopes upward because nominal wages are determined based on expected prices, and when the actual price level turns out to be different from the expected level, nominal wages do not respond immediately.

2. Sticky price theory. Sticky price theory emphasizes that the prices of some goods and services are also slow to adjust to changes in economic conditions.

3. Illusion theory. According to the illusion theory, changes in the general price level temporarily mislead suppliers about what is happening in the individual markets in which they sell their products. Because of these short-run illusions, suppliers respond to changes in the price level, and this response causes the aggregate supply curve to slope upward to the right.

Supply of output = natural output level α (actual price level – expected price level) where α is the number that determines how much output responds to unexpected changes in the price level.

Whether the short-run aggregate supply curve slopes upward to the right is due to sticky wages, sticky prices, or an illusion, these conditions are not permanent.

When considering what causes the short-run aggregate supply curve to shift, we must consider all the variables that shift the long-run aggregate supply curve plus a new variable—the expected price level, which affects sticky wages, sticky prices, and the illusion of relative prices .

Shifts in the long-run aggregate supply curve are typically caused by changes in labor, capital, natural resources, and technological knowledge, and these same variables also shift the short-run aggregate supply curve.

When people change their expectations about the price level, the short-run aggregate supply curve will also shift.

General conclusion: An increase in the expected price level reduces the supply of goods and services and shifts the short-term aggregate supply curve to the left; a decrease in the expected price level increases the supply of goods and services and shifts the short-term aggregate supply curve to the right.

1. Determine whether an event shifts the aggregate demand curve or the aggregate supply curve (or both curves).

2. Determine the direction of the curve movement.

3. Use graphs of aggregate demand and aggregate supply to illustrate how this shift affects output and the price level in the short run.

4. Use aggregate demand and aggregate supply diagrams to analyze how the economy changes from its new short-term equilibrium to its long-term equilibrium.

1. In the short run, movements in aggregate demand cause fluctuations in the output of goods and services in the economy.

2. In the long run, movements in aggregate demand affect the overall price level, but do not affect output.

3. Policymakers who influence aggregate demand can potentially mitigate the severity of economic fluctuations.

1. Movements in aggregate supply will cause a combination of stagflation-recession (reduced output) and inflation (increased prices).

2. Policymakers who can influence aggregate demand can potentially mitigate the adverse effects on output, but only at the expense of exacerbating the inflation problem.

Liquidity preference theory: Keynes's theory, which believes that the adjustment of interest rates balances money supply and money demand. This theory of interest rate determination will help explain why the aggregate demand curve slopes downward to the right, and how monetary and fiscal policy can shift this curve.

This theory is essentially just an application of supply and demand. According to Keynes, adjustments in interest rates balance money supply and money demand.

Money supply: The first part of the liquidity preference theory is the money supply. The money supply in the U.S. economy is controlled by the Federal Reserve, which changes the money supply mainly by changing the amount of reserves in the banking system by buying and selling government bonds in open market operations. Because the money supply is fixed by the Fed's policy, it does not depend on other economic variables, in particular it does not depend on interest rates.

Demand for Money: The second part of the liquidity preference theory is the demand for money. Liquidity refers to the ease with which the asset can be converted into a medium of exchange in the economy. While many factors determine the quantity of money demanded, one factor highlighted by liquidity preference theory is interest rates. An increase in interest rates increases the cost of holding money, so the demand for money decreases; a decrease in interest rates reduces the cost of holding money, and increases the demand for money.

Equilibrium in the money market: According to the liquidity preference theory, the adjustment of interest rates balances the supply and demand of money.

Loanable funds theory and liquidity preference theory are used for different purposes. When considering the long-term determinants of interest rates, it is best to remember the loanable funds theory, which emphasizes the importance of the propensity to save and investment opportunities in the economy. When considering the short-term determinants of interest rates, it is best to remember the liquidity preference theory, which emphasizes the importance of monetary policy.

The price level is a determinant of the quantity of money demanded. A higher price level increases the quantity of money demanded given the interest rate.

The analysis of the interest rate effect can be summarized into three steps: (1) higher price levels increase money demand; (2) higher money demand causes higher interest rates; (3) higher interest rates reduce The quantity demanded of goods and services. The same logic works in the opposite direction.

As illustrated by a downward-sloping aggregate demand curve, there is a negative relationship between the price level and the quantity of goods and services demanded.

Whenever the quantity demanded of goods and services changes at a given price level, the aggregate demand curve shifts.

When the Fed increases the money supply, it lowers interest rates, increases the quantity of goods and services demanded at a given price level, and shifts the aggregate demand curve to the right. When the Fed tightens the money supply, it raises interest rates, reducing the quantity of goods and services demanded at a given price level, shifting the aggregate demand curve to the left.

In recent years, the Federal Reserve has used policy by setting a target for the federal funds rate - the interest rate banks charge each other on short-term loans.

Liquidity preference theory illustrates an important principle: monetary policy can be described in terms of both money supply and interest rates.

Conclusion: Monetary policy changes aimed at expanding aggregate demand can be described as both an increase in the money supply and a reduction in interest rates; monetary policy changes aimed at tightening aggregate demand can be described as both a decrease in the money supply and a decrease in interest rates. for interest rate increases.

Liquidity trap: According to the liquidity preference theory, expansionary monetary policy works by lowering interest rates and stimulating investment spending. However, if interest rates have fallen to close to zero, then monetary policy may no longer be effective. Nominal interest rates will not fall below zero. In this case, expansionary monetary policy increases the money supply and makes the public's portfolio more liquid, but since interest rates cannot fall any further, the additional liquidity will no longer have any effect. Aggregate demand, production and employment would be "stuck" at low levels.

When policymakers change the money supply or the level of taxes, it indirectly shifts the aggregate demand curve by affecting the spending decisions of firms or households. In contrast, when the government changes its purchases of goods and services, it directly shifts the aggregate demand curve.

There are two macroeconomic effects that make the magnitude of changes in aggregate demand different from changes in government purchases: the first is the multiplier effect; the second is the crowding out effect.

Multiplier effect: The additional change in aggregate demand caused when expansionary fiscal policy increases income and thus consumer spending.

The multiplier effect occurs because an increase in total income stimulates additional spending by consumers.

Positive feedback from investment demand is sometimes called an investment acceleration number.

Marginal Propensity to Consumption (MPC): The proportion of a household's extra income that is spent on consumption rather than on savings.

Multiplier = 1/(1-MPC) This multiplier formula illustrates an important conclusion: the size of the multiplier depends on the marginal propensity to consume. The larger the MPC, the larger the multiplier.

The logic of the multiplier effect is not limited to changes in government purchases; it applies to any event that changes spending in any component of GDP—consumption, investment, government purchases, or net exports.

In macroeconomics, the multiplier is an important concept because it illustrates how much the economy can multiply the effects of changes in spending.

Crowding out effect: The reduction in aggregate demand caused when expansionary fiscal policy causes interest rates to rise, thereby reducing investment spending.

The crowding-out effect partially offsets the impact of government purchases on aggregate demand.

When the government increases purchases by a certain amount, the increase in total demand for goods and services can be greater or less than that amount, depending on the size of the multiplier effect and the crowding-out effect.

Another important tool of fiscal policy is the level of taxes. The magnitude of changes in aggregate demand caused by tax changes is also affected by the multiplier effect and the crowding-out effect.

In addition to the multiplier and crowding-out effects, there is another important factor that determines the magnitude of the change in aggregate demand caused by a tax change: households' perception of whether the tax change is permanent or temporary.

If monetary policy responds appropriately, joint changes in monetary and fiscal policy can keep aggregate demand for goods and services unaffected.

The main argument is that these policies have a considerable time lag in their economic impact. Critics of stabilization policy claim that the Fed often reacts too late to changing economic conditions, causing economic fluctuations rather than containing them. These critics favor negative monetary policies such as low and stable money supply growth.

There is also a time lag when fiscal policy takes effect, but the time lag in fiscal policy is mainly due to the political process.

Automatic Stabilizer: Fiscal policy changes that stimulate aggregate demand when the economy enters a recession without policymakers taking any intentional action.

All economists agree that time lags in policy implementation make policy less effective as a short-term stabilization tool.

The most important automatic stabilizer is the tax system. Government spending also acts as an automatic stabilizer.

In 1958, Phillips published "The Relationship between Unemployment and the Rate of Change of Money Wages in Britain, 1861-1957" in the "Economics" magazine. In this article, Phillips explained the relationship between the unemployment rate and the inflation rate. negative correlation. In 1960, Samuelson and Solow published "An Analysis of Anti-Inflation Policies" in the "American Economic Review", using U.S. data to show the negative relationship between inflation and unemployment. Their reasoning is that this correlation occurs because low unemployment is associated with high aggregate demand, and high aggregate demand puts upward pressure on wages and prices throughout the economy. Samuelson and Solow called the negative relationship between unemployment and inflation the Phillips curve.

Policymakers can choose any point on this curve by changing monetary and fiscal policies to affect aggregate demand.

The Phillips Curve illustrates that the combination of inflation and unemployment that occurs in the short term is due to a shift in the aggregate demand curve that causes the economy to move along the short-term aggregate supply curve.

Changes in aggregate demand cause inflation and unemployment to move in opposite directions in the short run, which is exactly the relationship illustrated by the Phillips curve.

Because monetary policy and fiscal policy can shift the aggregate demand curve, they can move the economy along the Phillips curve. The Phillips Curve provides policymakers with a menu of combinations of inflation and unemployment.

Friedman and Phelps concluded (based on the principles of classical macroeconomics) that there is no reason to think that inflation and unemployment are related in the long run.

The growth of the money supply determines the inflation rate. Regardless of the inflation rate, the unemployment rate tends to the natural rate of unemployment. Therefore, the long-run Phillips curve is vertical.

The vertical long-run Phillips curve shows that in the long run, unemployment does not depend on money growth and inflation.

The vertical long-run Phillips curve and the vertical long-run aggregate supply curve are two sides of the same coin. Both mean that monetary policy only affects nominal variables (price level and inflation rate) but does not affect real variables (output and unemployment). ). Regardless of the monetary policy adopted, in the long run output and unemployment are at their natural levels.

The natural unemployment rate is not necessarily the socially desirable unemployment rate, nor is it static.

Faster money growth does not weaken the market power of unions or reduce unemployment levels; it simply causes higher inflation.

While monetary policy cannot affect the natural rate of unemployment, other policies can. Policy changes that lower the natural rate of unemployment will shift the long-run Phillips curve to the left and the long-run aggregate supply curve to the right, so that the economy can enjoy lower unemployment at any given rate of money growth and inflation. and higher yields.

Friedman and Phelps introduced a new variable into the analysis of the trade-off between inflation and unemployment: expected inflation. Expected inflation measures how much people expect the general level of prices to change. Because the expected price level affects nominal wages, expected inflation is a factor in determining the position of the short-run aggregate supply curve.

In the short run, changes in the quantity of money cause unexpected fluctuations in output, prices, unemployment, and inflation.

The Fed's ability to cause unanticipated inflation by increasing the money supply exists only in the short term.

Friedman and Phelps' analysis can be summarized as follows: Unemployment rate = natural unemployment rate - α (actual inflation - expected inflation) The variable α is a measure of how responsive unemployment is to unexpected inflation.

This equation means that there is no stable short-run Phillips curve. Each short-run Phillips curve reflects a specific expected inflation rate.

Friedman and Phelps concluded that policymakers face only a short-term trade-off between inflation and unemployment. In the long run, a faster expansion of aggregate demand will cause higher inflation without any reduction in unemployment.

Natural rate hypothesis: The view that regardless of the rate of inflation, unemployment will eventually return to its normal or natural rate.

Sacrifice ratio: The percentage of annual output lost during a one percentage point reduction in inflation. The sacrifice rate is generally estimated to be 5, that is, for every percentage point reduction in the inflation rate, 5% of output must be sacrificed each year in this transformation.

If a country wants to reduce inflation, it must endure a period of high unemployment and low output. The size of this cost depends on the slope of the Phillips curve and how quickly inflation expectations adjust to the new monetary policy.

Rational expectations: The theory that when people predict the future, they can make full use of all the information they have, including information about government policy.

Proponents of rational expectations, based on the Friedman-Phelps analysis, point out that when economic policy changes, people adjust their inflation expectations accordingly, something that studies of inflation and unemployment that attempt to estimate sacrifice rates fail to take into account The direct impact of policy institutions on expectations. Therefore, according to rational expectations theorists, estimates of sacrifice rates are an unreliable guide to policy.

According to Sargent, the sacrifice rate may be much smaller than previously estimated. Indeed, in the most extreme case, the sacrifice rate can be zero: if the government makes a credible commitment to a low-inflation policy, people are rational enough to immediately lower their inflation expectations. The short-run Phillips curve will shift downward, and the economy will soon reach low inflation without paying the price of temporarily high unemployment and low output.

The annual data plot of unemployment rate and inflation rate (measured by GDP deflator) from 1979 to 1987 shows that Volcker's anti-inflation did come at the expense of high unemployment.

Exports: Goods and services produced domestically and sold abroad.

Imports: Goods and services produced abroad and sold domestically.

Net exports: A country’s export value minus its import value, also known as the trade balance. Net exports (NX) = a country’s export value – a country’s import value

Trade surplus: The excess of exports over imports.

Trade deficit: The excess of imports over exports.

Balance of trade: A situation in which exports equal imports.

Factors that affect a country’s exports, imports and net exports include: 1. Consumers’ perceptions of domestic and foreign Hobbies for items; 2. Prices of domestic and foreign items; 3. People can use domestic currency The exchange rate for purchasing foreign currency; 4. The income of domestic and foreign consumers; 5. Transfer from one country to another The cost of transporting goods to a country; 6. Government policy on international trade. With these variables As the volume of international trade changes, so does the volume of international trade.

Net capital outflow (NCO): foreign assets purchased by domestic residents minus capital purchased by foreigners national assets. Capital flows come in two forms: foreign direct investment and foreign portfolio investment.

Net capital outflows can be either positive or negative.

Important factors affecting net capital outflow: 1. The real interest rate obtained by foreign assets; 2. Domestic The real interest rate earned by assets; 3. The economic and political risks that can be perceived by holding foreign assets insurance; 4. Government policies that affect foreign ownership of domestic assets.

An open economy trades with the rest of the world's economies in two ways: goods and services in the world market and world financial markets.

Net exports and net capital outflows measure the type of imbalance in these two markets, respectively. net export balance measures the imbalance between a country's exports and its imports; net capital outflows measure the foreign purchases by its residents The imbalance between the volume of assets and the volume of domestic assets purchased by foreigners.

For the economy as a whole, net capital outflows must always equal net exports. NCO=NX

The following conclusions are summarized for the entire economy: 1. When a country has a trade surplus (NX>0), it sells to Foreigners have more goods and services than foreigners buy. its net sales of goods and services from abroad The foreign currency obtained must be used to purchase foreign assets. Therefore, capital flows out of a country (NCO >0). 2. When a country has a trade deficit (NX < 0), the goods it purchases from foreigners are equal to services more than are sold to foreigners, how is it a net purchase of these goods and services on the world market? What about fundraising? It must sell assets abroad, so capital flows into the country (NCO < 0).

International flows of goods and services and international capital flows are two sides of the same coin.

A country's savings and investment are key to its long-term economic growth. Savings in a closed economy is equivalent to investment, but in an open economy, things are not that simple.

Since Y=C I G NX, national savings is what is left after paying for fixed-term consumption and government purchases The national income, that is, national savings S=Y-C-G, can be obtained: Y-C-G=I NX, that is, S=I NX. Because net exports NX = net capital outflow NCO, we can get, S = I NCO, that is, savings = domestic investment Net capital outflow.

In a closed economy, NCO=0, so S=I. In an open economy, savings serve two purposes: Path: domestic investment and net capital outflow.

The nominal exchange rate is the rate at which one can exchange one country's currency for another country's currency. One exchange rate can always Expressed in two ways.

Appreciation: The increase in the value of a country's currency, measured by the amount of foreign currency it can purchase.

Depreciation: The decrease in the value of a country's currency as measured by the amount of foreign currency it can purchase.

Exchange rate index: A unit that converts many exchange rates into a single measure of the value of an international currency.

The real exchange rate is the rate at which a person can exchange goods and services from one country for goods and services from another country.

Real exchange rate (E) = nominal exchange rate (e) × domestic price (P)/foreign price (P※)

The real exchange rate depends on the nominal exchange rate and the prices of goods in both countries measured in their respective currencies.

The real exchange rate is a key factor in how much a country exports and imports.

A country's real exchange rate is a key determinant of its net exports of goods and services.

Law of One Price: An item should be sold for the same price everywhere, otherwise there will be untapped Opportunities to make profits.

Arbitrage: The process of taking advantage of price differences for the same thing in different markets.

According to the purchasing power parity theory, a currency must have the same purchasing power in all countries.

The implication of purchasing power parity theory on exchange rates is that the nominal exchange rate between the currencies of two countries depends on the price levels of the two countries.

Suppose P is the price of a basket of goods in the United States (measured in dollars), P※ is the price of a basket of goods in Japan (measured in yen), and e is the nominal exchange rate (the number of yen that can be purchased with 1 dollar), then 1/ P=e/P※, after sorting, we can get: 1=eP/P※. The left side of the equation is a constant and the right side is the real exchange rate, so if the purchasing power of a dollar is always the same domestically and abroad, then the real exchange rate - the relative price of domestic goods and foreign goods - will not change.

By sorting out the above equation, we can solve for the nominal exchange rate: e=P※/P. That is, the nominal exchange rate is equal to the ratio of the foreign price level (measured in foreign currency units) to the domestic price level (measured in domestic currency units). According to the purchasing power parity theory, the nominal exchange rate between the currencies of two countries must reflect the price levels of the two countries.

When a central bank prints large amounts of money, the value of that money decreases, both in terms of the goods and services it can buy and in terms of the other currencies it can buy.

Purchasing power parity theory is not entirely correct, and changes in exchange rates do not always guarantee that the dollar will Nations have always had the same real value.

The purchasing power parity theory does not always hold true in practice for the following two reasons: 1. Many items are not Easily traded; 2. Even tradable items are not traded when they are produced in different countries. Complete replacement is not always possible. For these reasons, real exchange rates are in fact constantly fluctuating.

But the basic logic of the purchasing power parity theory is credible: when the real exchange rate deviates from the purchasing power parity theory At the desired level, people will have incentives to buy and sell goods between countries. substantial and lasting Changes in the nominal exchange rate reflect changes in domestic and foreign price levels.

Savings (S) = domestic investment (I) net capital outflow (NCO). Both sides of this equation represent both sides of the loanable funds market. The supply of loanable funds comes from national savings (S), and the demand for loanable funds comes from domestic investment ( I) and net capital outflow (NCO).

Loanable funds should be interpreted as domestically generated flows of resources that can be used for capital accumulation. Whether purchasing domestic capital assets (I) or foreign capital assets (NCO), such purchases increase the demand for loanable funds. Since net capital outflow can be either positive or negative, it can either increase or decrease the demand for loanable funds caused by domestic investment. When NCO>0, there is a net outflow of state-owned capital. At this time, the net purchase of overseas capital increases the demand for domestically generated loanable funds; when NCO<0, there is a net inflow of state-owned capital. At this time, capital from abroad Resources reduce the demand for domestically generated loanable funds.

The supply and demand of loanable funds depend on the real interest rate. In addition to affecting national savings and domestic investment, a country's real interest rate also affects the country's net capital outflow.

Interest rates adjust to balance the supply and demand for loanable funds. At the equilibrium interest rate, the amount people want to save is exactly balanced by the desired amount of domestic investment and net capital outflow.

Net capital outflow (NCO) = net exports (NX). This identity states that the imbalance between purchases and sales of foreign capital assets (NCO) is equal to the imbalance between exports and imports of goods and services (NX). Both sides of the equation represent the two parties in the foreign exchange market, with net capital outflows representing the amount of dollars supplied to purchase foreign assets, and net exports representing the amount of dollars required to purchase net exports of U.S. goods and services.

The real exchange rate is the price that balances supply and demand in the foreign exchange market. The real exchange rate is the relative price of domestic goods relative to foreign goods and is thus a key determinant of net exports. An increase in the real exchange rate reduces the quantity of dollars demanded in the foreign exchange market.

Exchange rate changes affect both the cost of purchasing foreign assets and the benefits of owning those assets, with the two effects offsetting each other.

At an equilibrium real exchange rate, the demand for dollars from foreigners caused by net exports of U.S. goods and services exactly balances the supply of dollars from Americans caused by net outflows of U.S. capital.

Two identities: S=I NCO, NCO=NX.

In the loanable funds market, supply comes from national saving (S), demand comes from domestic investment (I) and net capital outflow (NCO), and the real interest rate balances supply and demand. In the foreign exchange market, supply comes from net capital outflows (NCO), demand comes from net exports (NX), and the real exchange rate balances supply and demand.

Net capital outflow is the variable linking these two markets. The key determinant of net capital outflow is the real interest rate, and the net capital outflow curve links the loanable funds market and the foreign exchange market.

The supply and demand of loanable funds determine the real interest rate, the real interest rate determines the net capital outflow, and the net capital outflow provides the supply of U.S. dollars in the foreign exchange market. The supply and demand for dollars in the foreign exchange market determine the real exchange rate.

Two markets determine two relative prices: the real interest rate and the real exchange rate. The simultaneous adjustment of these two relative prices brings supply and demand in the two markets into balance.

A deficit occurs when government spending is greater than government revenue. Because the government budget deficit represents negative public saving, it reduces national saving (the sum of public and private saving). Therefore, the government budget deficit reduces the supply of loanable funds, causing interest rates to rise and crowding out investment.

In an open economy, government budget deficits raise real interest rates, crowd out domestic investment, cause the dollar to appreciate, and shift the trade balance toward the deficit.

Trade policy is a government policy that directly affects the amount of goods and services a country imports or exports. Usually its purpose is to support a specific domestic industry. Common trade policies are tariffs (i.e., taxes on imported goods) and import quotas (i.e., taxes on imported goods). Limitations on the quantity of items produced abroad and sold domestically).

Import quotas reduce both imports and exports, but net exports (exports minus imports) do not change. Therefore, trade policy does not affect the trade balance. That is, policies that directly affect exports or imports do not change net exports.

Since NX=NCO=S-I, net exports are equal to net capital outflows, and net capital outflows are equal to national savings minus domestic investment. Trade policies do not change the trade balance because they do not change national saving and domestic investment. Given a given level of national savings and domestic investment, adjustments in the real exchange rate keep the trade balance unchanged no matter what trade policy the government pursues.

While trade policies do not affect a country's overall trade balance, they do affect certain businesses, industries, and countries.

The microeconomic impact of trade policy is greater than the macroeconomic impact.

Capital flight: A large and sudden decrease in demand for a country's assets.

Capital flight from a country increases the country's real interest rate and reduces the value of the country's currency in foreign exchange markets. A depreciating currency makes exports cheaper and imports more expensive, which shifts the trade balance toward a surplus, while rising interest rates reduce domestic investment, which slows capital accumulation and economic growth.