Understanding Macroeconomic Variables and Concepts
Exogenous and Endogenous Variables
Exogenous Variables: Variables taken in/given out by models.
Sticky vs. Flexible Prices
Sticky Prices: Resistance of prices to change despite changes in the broader economy.
Flexible Prices: Adjust in the long run to market shortages/surpluses.
Gross Domestic Product (GDP)
GDP: Measures the total income of everyone in the economy (total expenditure).
- Only for current goods.
- Only counts final goods, not intermediate goods.
- Households sell labor to firms. Firms sell Goods & Services to households, and pay wages back to households.
Real vs. Nominal GDP
Real GDP: Adjusted for inflation. For example, real GDP for 2015 based on 2014 prices is calculated as (2014 price * 2015 quantity).
Nominal GDP: 2015 price * 2015 quantity.
GDP Deflator: Nominal GDP / Real GDP
Components of Expenditure
Consumption (C), Investment (I), Government Expenditure (G), Net Exports (NX).
- C: Consumption
- I: Business fixed investment (PP&E), Residential fixed (new homes), inventory investment (firms increase their inventory).
- G: Government purchases
- NX: Net exports (trade with other countries: exports – imports)
Gross National Product (GNP)
GNP: GDP + factor payments from abroad – factor payments to abroad.
Net National Product (NNP)
NNP: GNP – depreciation | NNP ≈ National Income
Categories of National Income (NI)
- Compensation of employees
- Proprietors’ income
- Rental income
- Corporate profits
- Net interest
- Taxes on production/imports
Personal Income
National Income – indirect business taxes – corporate profits – social insurance contributions – net interest + dividends + government transfers to individuals + interest income.
Disposable Personal Income
Personal income – personal taxes.
Labor Force Statistics
Labor Force: # of employed + # unemployed
Labor Force Participation Rate (LFPR): (Labor Force / adult population) * 100
Factors of Production
Factors of Production: Inputs used to produce Goods & Services (capital and labor).
Production Function: Y = F(K, L) = output is a function of capital (K) and labor (L).
Competitive Firm: Small in the market it competes in, with little influence on prices.
Marginal Product of Labor and Capital
MPL: Extra amount of output a firm gets for one extra unit of labor.
MPL = F(K, L+1) – F(K, L)
MPK: Extra amount of output a firm gets for one extra unit of capital.
MPK = F(K+1, L) – F(K, L)
As the amount of L/K increases, holding K/L constant, marginal output decreases.
To maximize profit, firms rent more K until MPK = real rental price.
Constant Returns to Scale
A production function has constant returns to scale if an increase of an = % in all factors of production causes an increase in Y of the same %.
∆Profit = ∆Revenue – ∆Cost = (P * MPK) – R | MPK = R/P (real rental price measured in units of goods, not $.) Economic Profit = Y – (MPL * L) – (MPK*K)
Marginal Propensity to Consume/Save
MPC/MPS: Amount by which consumption/saving changes when disposable income increases by $1.
Interest Rates
Nominal Interest Rate: The reported rate; investors pay it to borrow money.
Real Interest Rate: Nominal interest rate adjusted for inflation | Nominal = real + inflation rate.
National Saving
Y – C – G = I = National Saving = S | Y – T – C = private saving | T – G = public saving.
Y – C(Y-T) – G = I(r) | Shows national saving depends on income Y, and G&T.
Interest rate increases, investment decreases. Government purchases cause interest rates to increase, crowding out investment.
S is the supply of loanable funds, and its price is the interest rate. Households lend money to investors or deposit savings that banks loan out. Investment is the demand for loanable funds. The quantity of loanable funds depends on i(r).
Fiscal and Monetary Policy
Fiscal Policy: Decisions about taxing & spending.
Monetary Policy: Management of interest rates and money supply.
Money: A store of value, medium of exchange, unit of account.
Fiat Money: Money with no intrinsic value.
Commodity Money: Money that derives value from a commodity (gold).
Open Market Operations: Buying/selling government bonds.
Demand Deposits: The money people hold in their checking accounts.
Deposits that banks receive but do not lend out are bank reserves (assets).
Deposits for a bank are liabilities (offset with reserves).
Banking Systems
100% Reserve Banking: Keep the full amount of each depositor’s funds in cash.
Fractional Reserve Banking: Keep a fraction of deposits in reserves, loan out the rest.
Banks create money by earning interest on loans.
Capital requirements ensure banks can pay off depositors and creditors.
Monetary Base and Ratios
Monetary Base: # of dollars held by the public (C) and banks in reserves (R).
Reserve Deposit Ratio (rr): Fraction of deposits banks hold.
Currency Deposit Ratio (cr): Amount of currency held (C) as a fraction of demand deposits – this reflects the preferences of households.