Principles of Macroeconomics

S=I+NX or

S=I+NCO

=> NX = NCO

\(Exch_{real}=\frac {(\frac{\text{foreign currency}}{\text{local currency}})\cdot \text{domestic price}}{\text{foreign price}}\)

Involved markets:

1. Market for loanable funds (real interest rate / Quanitity of loanable funds)
2. Market for foreign-currency exchange (Real exchange rate / Quanitity of CHF)

Link: Net capital outflow with respect to the real interest rate

• reduce the supply of loanable funds,
• drive up the interest rate,
• crowd out domestic investment,
• cause net foreign investment (net capital outflow) to fall.

Because foreigners need Swiss Francs to buy Swiss net exports, there is an
increased demand for Swiss Francs in the market for foreign-currency.
This leads to an appreciation of the real exchange rate.
There is no change in the interest rate because nothing happens in the loanable
funds market.
There will be no change in net exports.
There is no change in net foreign investment even though an import quota
reduces imports.
An appreciation of the Swiss Franc in the foreign exchange market encourages
imports and discourages exports.
This offsets the initial increase in net exports due to the import quota.

• If investors become concerned about the safety of their investments, capital can quickly leave an economy.
• Interest rates increase and the domestic currency depreciates.

Okun’s law states that in order to keep the unemployment rate steady, real GDP needs to grow at or close to its potential.

1. Household spending decisions.

2. Firms’ decision making.

3. External sources.

4. Government policy

5. Confidence and expectations

In the Keynesian cross diagram, the 45o line connects all points where total spending would be equal to national income.

Short-run equilibrium occurs where the expenditure function E = C + I + G + NX crosses the 45° line and refers to a point where actual spending is equal to planned spending.

There are Autonomous expenditure, which are not dependent on income/output

The marginal propensity to consume (MPC) is the fraction of extra income that a household consumes rather than saves.
Multiplier = 1/(1 - MPC) = 1/MPS (where MPS is the marginal propensity to save)

If the MPC is 3/4, then the multiplier will be:
xMultiplier = 1/(1 - 3/4) = 4

The multiplier is important because it shows how the economy can amplify the impact of changes in spending.

• When the nominal interest rate is equal to zero, and once people have enough money for transaction purposes, they become indifferent between holding money and holding bonds.
• The demand for money becomes horizontal. This implies that, when the nominal interest rate is equal to zero, further increases in the money supply have no effect on the nominal interest rate.

The inflationary gap is the difference between full employment output and actual expenditure

when actual expenditure is greater than full employment output.

When there is a deflationary gap the economy is not operating at full employment (there is spare capacity in the economy: underused resources, unemployment). This is equivalent to an economy operating inside its production possibility frontier.

Inflation rate againts unemployment

It is vertical (inflation rate againts unemployment). => 

unemployment remains at its natural rate in the long run.

\(CPI_t=\frac {\text{Price of basket in year t}}{\text{Price of basket in base year}}\cdot \text{100%}\)

\(\text{Inflation rate in year 2}=\frac {CPI_{t2}-CPI_{t1}}{CPI_{t1}}\cdot \text{100%}\)

• Substitution bias
• Introduction of new goods
• Unmeasured quality changes

1. The GDP deflator reflects the prices of all goods and services produced domestically, whereas the consumer price index reflects the prices of all goods and services bought by consumers.

2. The consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year (only occasionally does the ONS change the basket) whereas the GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year.

Real interest rate = Nominal interest rate – Inflation

Y=C+I+G+NX

Encourage saving and investment.
Encourage investment from abroad.
Encourage education and training.
Establish secure property rights and maintain political stability.
Promote free trade.
Promote research and development.

Unemployed: A person is considered as unemployed, if that person does not have a job and(!) is able and available (willing) to work at current wage rates

1. Frictional unemployment due to job search, and
2. Structural unemployment due to
   1. minimum wage laws
   2. unions
   3. efficiency wages (above-equilibrium wages paid by firms in order to increase worker productivity.

Credit default swaps (CDS) is a means by which a bondholder can insure against the risk of default.

Y=C+I+G+NX => closed economy, NX=0

Y-C-G=S=I

S=(Y-T-C)+(T-G) private and public saving

It is attractive to save so the supply of loanable funds increases

increases the incentive to borrow => increases the demand for loanable funds.