Lesson Plan



Measuring the Economy - Introduction to AD & AS



I. Definitions

- what is Aggregate Demand?
- what is Aggregate Supply?
II. Aggregate Demand (AD)

- why is AD downward sloping?

- wealth effect

- foreign sector substitution effect
- interest rate effect
- what causes AD to shift?

- consumption (C)

- Investment (I)
- Government (G)
- Net Exports (Exports - Imports)
III. Aggregate Supply (AS)

- why is AS upward sloping?

- lagging input prices

- money illusion
- what causes AS to shift?

- resource costs

- technology
- government influences on labor/leisure choices
IV. AD & AS Equilibrium

- equilibrium defined (note: we will discuss the details of how one gets to equilibrium later in the course.
- Demand pull inflation
- Cost push inflation
- economic growth
- recession

Lesson Plan



Measuring the Economy - Employment and Unemployment



I. Definitions

- unemployment

- definition

- graphically in a labor market

- what is the price of labor?

- the quantity of labor?
- voluntary unemployment
- involuntary unemployment
- measuring employment and unemployment

- who are the employed?

- who are the unemployed?
- what is the labor force?
- what is the labor force participation rate?

- for the country

- for groups
- what is the unemployment rate?

- for the country

- for groups
- problems with the measurements

- discouraged workers

- dishonest non-workers
- Types of unemployment

- frictional unemployment

- structural unemployment
- seasonal unemployment
- cyclical unemployment

- what is a business cycle?

- induced unemployment

Lesson Plan



Measuring the Economy - Inflation



I. Definitions

- what is inflation?
- what is an index?
II. How are price indexes constructed?

- determine the market basket
- assign weights
- calculate aggregate numbers for each year
- choose a base year and divide each aggregate number by base year aggregate number
- multiply each resultant number by 100
- real versus nominal variables

- definition of each

- using price indexes to get a real variable
- example
- example of calculating a price index
- types of price indexes

- consumer price index (cpi)

- producer price index (ppi)
- GDP deflator
III. Costs & Benefits of Inflation

- Repricing costs
- Distortion costs
- who wins from inflation?
- who loses from inflation?
IV. Types of Inflation

- Demand Pull Inflation
- Cost Push Inflation
- Expectational Inflation

Lesson Plan



Measuring the Economy - Gross Domestic Product (GDP)



I. Gross Domestic Product (GDP)

- definition
- what is Gross National Product (GNP)?

- how do GDP and GNP differ?

- uses of GDP

- economic indicator

- measure of economic well-being
- inter-country comparisons
II. Measuring GDP

- the expenditure approach

- Consumption (C)

- definition

- what is included?
- Investment (I)

- definition

- what is included?
- Government purchases (G)

- what is included?

- Net Exports (NX)

- Exports (X)

- Imports (M)
- NX = X - M
- GDP = C + I + G + NX
- the income approach

- the relationship of income to output

- national income (NI) = sum of all resource payments
- definition of wages, interest, rent and profits
- reconciling the expenditure and income approaches

- GDP = C + I + G + NX

- Net Domestic Product (NDP) = GDP - depreciation
- NI = NDP - indirect business taxes + net income earned abroad
- value added

- definition

- the mechanics of computing NI or GDP through sales of goods and services
- additional definitions

- National Income

- less corporate profits, social security taxes, and net interest

- plus transfer payments, personal interest, and dividends
- equals Personal Income (PI)
- Disposable Personal Income (DPI) = PI - personal taxes
- Problems with GDP

- Inaccuracy

- Non-market transactions

Lesson Plan - Classical Macroeconomics



I. Foundations of Classical macroeconomics

- business cycles

- definition of a business cycle

- classical macroeconomics on business cycles

- automatic market adjustments

- Say's law
- flexible wages, prices, and interest rates ensure no unemployment
II. How does it work?

- classical focus on capital markets

- Investment as the demand for capital

- why is the demand for capital downward sloping?

- Savings as the supply of capital

- why is the supply of capital upward sloping?

- the interest rate as the price of capital

- what is the equilibrium in the market? and how is it maintained?

- results = as long as interest rates are flexible, no leakages due to savings and full employment is achieved
- the impact of flexible wages and prices when Savings exceed Investment

- if S > I then AS > AD (why?), therefore

- surplus of goods produced which causes falling prices/layoffs

- therefore, demand for labor falls, causing surplus of labor and
- falling wages
- but falling wages and prices increase AD (why?) until we move back to fully employment
- end result

- can only be temporarily absent from full employment

- AS is vertical
- changes in AD only have an impact on prices not output
- problems

- how do we explain the great depression?

Lesson Plan - Keynesian Macroeconomics



I. Keynesian versus classical macroeconomics

- classical focuses on AS

- asserts that AS is vertical

- thus, AS determines employment while AD determines prices

- Keynesian focuses on AD

- assumes that AS is horizontal, at least in the short-run

- thus, AD determines employment while AS determines prices

II. Aggregate Expenditures

- what is aggregate expenditures (AE)?

- total value of domestic spending on goods and services

- what does an Aggregate expenditures curve show?
- what are the components of AE?

- consumption

- investment
- government spending
- net exports
- Consumption and Saving

- what is autonomous consumption?

- what is induced consumption?
- what is autonomous savings?
- what is induced savings?
- what is the relationship between disposable income (Yd), Consumption (C), and Savings (S)?

- Yd = C + S

- graphics

- the consumption function

- what is the relationship between C and Yd?

- how is S found on the graph?

- the savings function

- what is the relationship between S and Yd?

- what is the relationship between the two graphs?
- what is the marginal propensity to consume (mpc)?

- what is the marginal propensity to save (mps)?

- mpc + mps = 1 (why?)
- what is the average propensity to consume (apc)?

- what is the average propensity to save (aps)?

- apc + aps = 1 (why?)
- other determinants of consumption (besides Yd)

- wealth

- household type
- stocks
- Investment (I)

- why do we invest?

- relationship between investment and expected rate of return

- other impacts on investment

- cost of new capital

- taxes
- interest rates
- effect of investment on Aggregate Expenditures
- Government Spending (G)

- what is autonomous government spending?

- Net Exports

- autonomous exports (X)

- autonomous imports (M)
- AE = C + I + G + (X - M)

- but recall that C = Ca + mpc*Yd

- so AE = Ca + mpc*Yd + I + G + (X - M)
- what does the AE function look like graphically?
- what is the relationship between C and National Income (Y)?

- assume no taxes, no transfers, no retained earnings => Y = Yd = GDP

III. Keynesian Equilibrium

- What is Demand in the Keynesian model?

- Aggregate Expenditures

- additional assumptions

- no government or foreign sectors

- what is equilibrium?

- equilibrium exists where Y (income or output) = AE (demand)

- graphically
- what is the equilibrating mechanism?

- planned vs. unplanned investment

- what happens to unplanned investment (inventories) when Y > AE?
- what happens to unplanned investment (inventories) when Y < AE?
- the relationship of Savings to Investment at equilibrium
- mathematical example
- the multiplier - if autonomous expenditures (either C or I) increase, by how much does equilibrium output increase?

- the multiplier effect - output increases by a multiple of the original increase in spending

- why?

- calculating the multiplier (Keynesian autonomous spending multiplier = 1/mps)

- what is the mps? the leakage from the system

- other potential leakages?

- taxes and imports

- what is full employment output?

- recessionary gaps

- inflationary gaps
- GDP gaps
- what is the relationship between Keynesian AE and AD?

- what impact does falling prices have on Keynesian equilibrium?

- graphically
- recessionary, inflationary, and GDP gaps for AD

Lesson Plan - Government Fiscal Policy



I. Addition of Government Spending to the Keynesian Model

- What happens to Aggregate Expenditures?
- What happens to equilibrium income/output?
- the autonomous spending multiplier revisted
- discretionary fiscal policy

- recessionary policy

- inflationary policy
II. Addition of Taxes to the Keynesian Model

- which component of AE does taxes affect, C, I, or G?

- how is consumption affected?

- assume that taxes are autonomous

- the impact of taxes on disposable income (Yd)
- AE after the addition of taxes

- mathematically

- graphically
- impact on consumption?
- impact on savings?
- what is equilibrium now?

- Y = AE

- I + G (injections) = S + T (leakages)
- unplanned I = 0
- the tax multiplier

- tax multiplier = Y/T

- end up with tax multiplier = - mpc/mps

- interpretation of the tax multiplier?
- balanced budget multiplier

- suppose G = T, by how much does equilibrium Y change?

- always equals 1. why?
- what does this mean?
III. Keynesian Fiscal Policy

- what is fiscal policy?

- policy changes in government spending or taxation

- expansionary fiscal policy

- enacted in order to increase AE and equilibrium Y. What works?

- increase in G

- decrease in T
- both an increase in G and a decrease in T
- balanced budget increase in G (what does this mean?)
- recessionary fiscal policy

- enacted in order to decrease AE and equilibrium Y. What works?

- decrease in G

- increase in T
- both a decrease in G and an increase in T
- balanced budget decrease in G
IV. Non-Discretionary Fiscal Policy

- definition?

- changes in government spending or taxes that are automatic.

- examples

- automatic tax adjustments

- automatic spending adjustments
V. Full Employment Budget

- what is the full employment budget? (Suppose the *actual* budget is in surplus (or deficit) but we are not at full employment Y. Does the surplus (or deficit) reflect government fiscal policy?)

- not necessarily

- examples

Lesson Plan - Money



I. Why do we have money?

- in a self-sufficient world is money useful?
- in a world of specialization and exchange is money useful?

- why not simply barter?

- uses of money

- medium of exchange

- store of value
- measure of value (unit of account)
- standard of deferred payment
- what is money?

- commodity monies

- definition = money which has some intrinsic value (i.e., value in use)

- goods used as money include precious metal, wheat, tobacco, etc.
- what characteristics must a good have for it to serve well as money in the long-run?

- durability

- divisibility
- homogeneity
- portability
- stability of supply
- scarcity
- fiat money

- definition = money which has no intrinsic value (i.e., no value in use)

- why use fiat money?

- cheaper

- controllable supply
- does fiat money possess the characteristics which make a money long-lasting?
II. The supply of money in a fractional reserve banking

system
- the supply of money

- what is currency?

- measures of the supply of money

- M1 = currency + Demand Deposits (what are those?)

- M2 = M1 + small time deposits (what are those?)
- M3 = M2 + large time deposits + institutional money market funds
- L = M3 + other liquid assets
- what is the difference between these different measures?
III. The creation of money in a fractional reserve banking

system
- the reserve ratio (rr) = the percent of deposits which are not loaned out.
- use the following assumptions to see how money is created

- all banks have the same reserve ratio (rr)

- no banks hold excess reserves (reserves in excess of that implied by rr)
- there are no cash drains from the system
- What happens when $1,000 in extra money is deposited into a demand deposit account?

- what is a t-account? (Make sure you can follow the accounting t-accounts)

- assuming the rr=20 percent, the bank will

- keep $200 on hand to meet cash requirements

- loan out $800 to another customer
- what does that customer do with the $800? Deposit it in a bank => demand deposits increase by a further $800
- Hence, the bank will loan out a further $640, which will be deposited in a bank
- Hence, the bank will loan out a further $512, which will be deposited in a bank
- Hence, the bank will loan out a further $410, which will be deposited in a bank
- Hence, the bank will loan out a further $328, which will be deposited in a bank
- etc.
- Every time demand deposits increase => the money supply increases
- how much in total has the money supply increased?

- $1,000 increase in the money supply from the initial $1,000 deposit

- plus $4,000 additional increase in the money supply through fractional reserve banking
- the potential money multiplier = mp = for every dollar in additional deposits, how much could the money supply increase?

- mp = 1/rr (why? remember that rr = reserve ratio)

- if RR = total (planned) reserves, then rr*Demand Deposits (DD) = RR
- the actual money multiplier = ma = for every dollar in additional deposits, how much does the money supply increase?

- why do banks hold Excess Reserves?

- xr = the excess reserve ratio = the proportion of demand deposits that banks do not loan out in excess of the reserve ratio

- ma = 1/(rr + xr) (why?)

- assumes that no one, either firms nor individuals, hold money as cash

- what is the monetary base (MB)?

- currency plus reserves

- Hence, ma = MS/MB

- MS = money supply = M1

- or MS = ma*MB
- Multibank expansion of the money supply
- How is money destroyed?
- What happens if people do hold cash?

Lesson Plan - The Federal Reserve System



I. Organization/definitions

- what is a central bank?

- historical examples

- The Federal Reserve System (the FED)

- created in 1913

- semi-private corporation owned by member banks
- 7 member board of governors

- nominated by pres. and confirmed by congress (14 year term)

- supervise the Fed and general policy control
- 12 reserve banks with 12 districts in the U.S.

- purpose is to supply regions in the U.S. with central banking

- about 14,000 member banks either charted by the FED (national banks) or by states (state banks)
- profit margin is set by law, excess profits go back to the U.S. treasury
- The Feds open market committee

- consists of 7 board of governors and 5 additional members (from the presidents of the 12 regional reserve banks.

- purpose = to make decisions about the buying and selling of U.S. treasury notes (what are those?)
- Purpose of the Fed

- banker for commercial banks - lender of last resort

- banker for the federal government
- controls the U.S. money supply
- regulates money markets
II. Tools of the Fed in Controlling the U.S. Money supply

- legal reserve requirements (rr) are set by the FED.

- what are legal reserves?

- recall that ma = 1/(rr + xr). Hence, as rr increases, ma decreases.
- recall that MS = ma*MB. Hence, as rr increases, MS decreases
- most powerful tool of the FED but rarely used.
- open market operations

- most used tool to control the money supply

- definition? (the buying and selling of U.S. treasury bills/bonds)
- decisions regarding made by open market committee
- how does buying/selling U.S. treasury bills change the money supply?

- impact on the monetary base?

- example
- where does the Fed get the money to buy the treasury bills?
- the discount rate

- the Fed, as lender of last resort for commercial banks, will lend commercial banks money but charges them an interest rate which is called the discount rate.

- where does the Fed get the money to loan to member banks?
- how does the discount rate (dr) affect the money supply?

- if dr < the market rate of interest (i) => tendency to borrow money and hold less in excess reserves (why?) but when xr decreases, ma increases which increases the money supply.

- if dr > i => the reverse happens
- jawboning (moral suasion)

- what's that?

- impact on money supply?
- margin requirements and other regulatory controls

- definitions

- who affects the money supply in the U.S. besides the Fed?

- private individuals (how?)

- the U.S. government (how?)
- banks (how?)

Lesson Plan - Monetary Theory and Policy



I. Definitions/Basics

- what kind of assets make up wealth?

- money

- either no interest is paid or it is relatively low.

- bonds, certificate of deposits, etc.

- earn a fixed interest rate (how else are bonds/CDs different than money?)

- real capital (plants, equipment, real estate, etc.)
- for simplicity, assume only two assets

- money = M1

- bonds = all other assets
- what is the relationship between bond prices and the market rate of interest?

- assert a negative relationship between the two

- why?

- example
II. The market for money

- the supply of money

- recall that the Fed controls the supply of money

- the demand for money - why do people wish to hold money?

- transaction demand for money

- precautionary demand for money
- speculative demand for money
- real vs. nominal demand for money
- graphs of money demand
- the market for money - putting supply and demand together

- what is the price of money?

- what is equilibrium in the market?
- suppose not at the equilibrium. What moves the market back to the equilibrium?
- what impact does changing money demand or supply have on the market?

- () in money demand will () the market rate of interest (i)

- () in money supply will () the market rate of interest (i)
- how do changes in the money supply affect the macro economy?

- the Keynesian transmission mechanism

- recall that as the market rate of interest that Investment spending (why?)

- if the Fed the money supply, i , which causes I to
- but when I , aggregate expenditures also
- the in aggregate expenditures causes equilibrium output and income (Y) to also
- impact on AD?
- and the reverse?
- how do changes in MD affect the macro economy?
- the classical transmission mechanism

- the equation of exchange

- what is the velocity of money?

- M*V = P*Q
- both velocity (V) and output (Q) are assumed fixed (why?) hence changes in the money supply only affect prices.
- the classical view of investment
- classical monetary transmission
- monetarism

- demand for money

- transmission mechanism
- differences between the three theories

- transmission mechanisms

- velocity of money
- demand for money
- impact of money on investment
- final impact on economy
III. Monetary Policy

- what is monetary policy?
- how effective is it compared to fiscal policy?
- the keynesian viewpoint
- the monetarist viewpoint

Lesson Plan: The Public Debt



I. The public debt

- what is the budget deficit

- surplus?

- deficit?
- what is the national (public) debt?
- private budget constraints
- public budget constraints

- local/state governments

- federal government
- are deficits/debts bad?

Lesson Plan: Aggregate Demand and Aggregate Supply



I. Aggregate Demand

- why is the AD downward sloping (revisited)?
- shifts in AD

- monetary policy

- fiscal policy
- autonomous changes in C, I or net exports
- expectations
II. Aggregate Supply

- why is the AS upward sloping (revisted)?

- money illusion

- price lags
- different ranges of the AS curve.
- shifts in AS

- what affects regular supply curves?

- labor (or other resource) market shocks
- expectations of inflation
- government regulation/policy
- monopoly power
- external shocks
- long-run AS versus short-run AS

- what is the impact of an adverse supply shock in the short and long-run?

- demand pull inflation
- cost push inflation

Lesson Plan: Monetary and Fiscal Policy



I. Fiscal Policy

- Should the government's budget always be balanced?

- how about for individuals?

- the lesson of the depression.
- conclusions
- what constitutes fiscal policy?

- changes in G

- changes in T
- changes in G and T
- balanced budget changes in G
- Crowding out = the tendency of increases in government spending to reduce some private spending.

- full employment crowding out

- does crowding out also occur at less than full employment?
II. Monetary Policy

- Policy (target) variables

- national income/output (i.e., unemployment)

- the price level (i.e., inflation)
- etc.
- Policy instruments

- monetary base

- interest rates
- etc.
- Policies

- stable growth in the money supply

- constant interest rates
- etc.
III. The application of monetary or fiscal policy

- examples
- the relative effectiveness of fiscal vs. monetary policy

- the monetarist view

- the keynesian view
- conclusions

- expansionary vs. recessionary policies

- fiscal vs. monetary policy
- applications
IV. Topics

- the phillips curve
- rational expectations

LESSON PLAN - INTERNATIONAL TRADE



I. Advantages of Trade

- availability of different goods
- gains from the scale of production
- growth in the economy

- increases in technology

- increases in capital stock
- gains from specialization - production possibility model

- example of the gains

- definitions

- absolute advantage

- terms of trade
- consumption possibility frontier
- comparative advantage
- when is specialization and exchange advantagous?

- whenever both countries have a comparative advantage

- impact of transaction costs

- definition

- impact of transaction costs on trade
- why are portions of the U.S. against trade?