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Macroeconomics by Mind Map: Macroeconomics

1. Closed Economy

1.1. Long run

1.1.1. Given a fixed level of resources, i.e. labour and capital, the country faces a fixed national income. AS = Y = F(K,L) = F(Kbar,Lbar) = Ybar Hence we have, Y = C + G + I(r) Y-C-G = I(r) This is the real side of the economy: We have a real and nominal dichotomy in the long run. The interest rate is determined by the real side of the economy, through the equilibrium in the loanable funds market.

1.1.2. Aggregate Demand in the long run is given by the quantity theory of money MV = PY Comes from V = T/M Assumptions about V We also assume that nominal GDP approximates the number of transactions in the economy. P = GDP deflator, Y = real output. Since income, Y, is fixed by the supply side of the economy in the long run, any increase in money supply will translate to a 1:1 increase in the price level - is this necessary the case? Mundell-Tobin effect

1.1.3. IS: Y = (A' - ir)/(1-c(1-t))

1.1.4. LM: M/P = l0 + l1Y - l2r Simplifying and combining the two, we have M = P*F(Y) which is essentially approximately MV = PY. Money Demand is L(Y,i) We also know there is the Fisher effect, where i = r + expected inflation

1.2. Short run

1.2.1. AD IS Combinations of r and Y at which the goods and services markets are in equilibrium Y = (A' - ir)/ (1- c1(1-t)) LM Ms/P = l0 + l1Y - l2r Combinations of r and Y at which the money market is in equilibrium IS-LM equilibrum Effects of Fiscal Policy Effects of Monetary Policy Others AD: Combination of P and Y at which the goods and money market are at equilibrium (i.e. combination of IS-LM equilibrium points) Downward sloping due to the Pigou and Keynes effect

1.2.2. AS Assume there exists a natural rate of unemployment AS Models Misperception Model Sticky Wage Model - Philips 1960 Why is the AS upward sloping? Increase in Price

1.2.3. Dynamic AD-AS Philips Curve Rewrite the aggregate supply curve DAD DAS

2. Growth Theory

2.1. Assume a closed economy with a production function F(K,L) = Y

2.1.1. Output per worker will be Y/L = y = f(k) Grows at a rate of g

2.1.2. Assume savings rate = s

2.1.3. savings per worker = sy = sf(k) We know that in the long run, S = I, sy = i = sf(k) At the steady state, sf(k) = (n+g+d)k, breakeven investment. Y grows at a rate of n+g We then assume that there is a depreciation rate for capital i.e. -dk = depreciation of capital per worker.

2.1.4. How to achieve growth in the long run? Use golden rule to determine if savings rate is too high MPK > n+g+d Reduce capital gains tax, corporate income tax and estate tax as they discourage savings. Replace income tax with a consumption tax Improve incentives for a retirement savings account Equalise tax treatment to different types of investment i.e. Private capital stock, public infrastructure, human capital Encourage investments that have certain positive externalities. Encourage technological progress Patent laws Tax incentives for R&D Grants for research at universities Industrial policies Reduce capital gains ta

2.1.5. Convergence Theory If the world behaves like Solow Growth model, then we should except convergence in the long run except when we begin with different s,n,g. However, no such absolute convergence.

3. Open Economy

3.1. Small and Open

3.1.1. Fixed Exchange Rate Short Run Dynamic Model Long Run

3.1.2. Flexible Exchange Rate Short Run Dynamic Model Long Run Spending need not equal output & Saving need not equal investment. Y = C + G + I + NX(e) S - I = NX(e) r = r* e adjusts to equilibrate the markets Assumptions: 1. Domestic and foreign bonds are perfect substitutes. 2. Perfect Capital Mobility 3. Takes r* as given. For a fixed level of real exchange rates, we have the following relationship:

3.2. Small and no/limited capital mobility

3.2.1. Fixed Exchange Rates Long Run Short Run Dynamic Model

3.2.2. Flexible Exchange Rates Long Run Short Run Dynamic Model

3.3. Large and Open

3.3.1. Fixed exchange rates Short Run Long Run Dynamic Model

3.3.2. Flexible Exchange Rates Short Run Long Run Large and Open economy Dynamic Model

4. AD-AS analysis

4.1. Labour Market Diagram

4.2. IS-LM Diagram

4.3. AD-AS Diagram

4.4. AD-AS Diagram

4.4.1. Starting point: LR equilibrium

4.4.2. Given a shock Short run impact of shock Given a real demand shock What if there was a change in income tax? How is the LR equilibrium achieved

5. Measurement

5.1. Inflation

5.1.1. GDP Deflator Paasche index Tends to suggest an overestimation Includes capital goods Excludes imports Changing basket of goods A fall in the quantity of a good, together with a rise in price can be under represented in such a index as the weights assigned to that good falls as its quantity falls Since goods are seldom perfect substitutes of each other, there is a loss in welfare that is not being captured by the GDP deflator here.

5.1.2. CPI Laspeyres index Tends to suggest an overestimate since substiution effects of price changes are ignored. Uses a fixed basket of consumer goods Includes imports, exclude capital goods

5.2. Unemployment

5.2.1. Measured based on number of unemployed/ labour force.

5.2.2. Excludes discouraged workers Participation rate = labour force / population

5.2.3. Steady state of unemployment = s/s+f, when s(L-U)=fU Frictional unemployment Search unemployment Sectoral shifts Public Policy Structural Unemployment According to Mankiw: real wage unemployment Limitations Assumes job finding is not instantaneous but does not explain why. Does not explain how unemployment is there in the first place.

5.2.4. Okun's Law 3% - 2 x %change in unemployment

5.3. Classical Dichtomy

5.3.1. The theoretical separation of real and nominal variables in the classical model, which implies that nominal variables do not affect real variables.

5.3.2. Money neutrality Changes in money supply do not affect real variables. In the real world, money is APPROXIMATELY neutral in the long run.