Principles of Macroeconomics

is the study of how the allocation of resources affects economic well-being.

• Buyers and sellers receive benefits from taking part in the market.

• Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product.

• Consumer surplus measures economic welfare from the buyer’s side.

• Producer surplus measures economic welfare from the seller’s side.

Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it.

Producer surplus is the amount a seller is paid for a good minus the seller’s cost.

It measures the benefit to sellers participating in a market.

Consumer surplus + Producer surplus or

 Value to sellers - Cost to Producers

An allocation is Pareto efficient if no individual can be made better off without another being made worse off

The comparison among producers of a good according to their productivity

 Describes the productivity of one person, firm, or nation compared to that of another.

 The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.

Compares producers of a good according to their opportunity cost.  Whatever must be given up to obtain some item

The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

If a country has a comparative advantage, then the domestic price will be below the world price, and the country will be an exporter of the good.

If the country does not have a comparative advantage, then the domestic price will be higher than the world price, and the country will be an importer of the good.

• A tariff is a tax on goods produced abroad and sold domestically. (Tariffs raise the price of imported goods above the world price by the amount of the tariff.)

An import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.

A trade deficit is a situation in which net exports (NX) are negative. Imports > Exports
A trade surplus is a situation in which net exports (NX) are positive. Exports > Imports
Balanced trade refers to when net exports are zero. Exports = Imports

Net capital outflow refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.

 (A Swiss resident buys stock in the Cadbury’s corporation and an American buys stock in Nestlé.)

The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another.

 The nominal exchange rate is expressed in two ways:
 In units of foreign currency per one Swiss Franc.
 And in units of Swiss Francs per one unit of the foreign currency.

Appreciation refers to an increase in the value of a currency as measured by the amount of foreign currency it can buy.

Depreciation refers to a decrease in the value of a currency as measured by the amount of foreign currency it can buy.

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

The real exchange rate compares the prices of domestic goods and foreign goods in the domestic economy.

The real exchange rate is a key determinant of how much a country exports and imports.

A depreciation (fall) in the Swiss real exchange rate means that Swiss goods have become cheaper relative to foreign goods. This encourages consumers both at home and abroad to buy more Swiss goods and fewer goods from other countries. As a result, Swiss exports rise, and Swiss imports fall, and both of these changes raise Swiss net exports. Conversely, an appreciation in the Swiss real exchange rate means that Swiss goods have become more expensive compared to foreign goods, so Swiss net exports fall.

The purchasing-power parity theory is the simplest and most widely accepted theory explaining the variation of currency exchange rates.

If the purchasing power of the dollar is always the same at home and abroad, then the exchange rate cannot change.

The nominal exchange rate between the currencies of two countries must reflect the different price levels in those countries.

Purchasing-power parity is a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries.

But:

Many goods are not easily traded or shipped from one country to another.

Tradable goods are not always perfect substitutes when they are produced in different countries.

courages people to save

discourages people to invest and to buy assets.

NCO also represents the quantity of country A's currency available on the foreign exchange market, and as such can be viewed as the supply-half that determines the real exchange rate, the demand-half being demand for A's currency in the foreign exchange market. As can be seen in the graph, NCO serves as the perfectly inelastic supply curve for this market. Thus, changes in the demand for A's currency (e.g. change from an increase in foreign demand for products made in country A) only cause changes in the exchange rate and not in the net amount of A's currency available for exchange.

• drive up interest rate
• recude the supply of loanable funds
• crowd out domestic investements
• cause net capital outflow to fall.

A trade policy is a government policy that directly influences the quantity of goods and services that a country imports or exports.

Because they do not change national saving or domestic investment, trade

policies do not affect the trade balance.

Capital flight descripes the process of foreign investors selling there domestic assets of a country, for example because of a political crisis within the country. 

This increases the net capital outflow --> which increases the demand of loanable funds (loanable funds = domestic investement + net capital outflow)

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

 There is a time-lag between any downturn in economic activity and a rise in unemployment and vice versa.

 Unemployment is a therefore a lagged indicator.

Recession is a period of declining real incomes and rising unemployment.
 The technical definition gives recession occurring after two successive quarters of negative economic growth.

 Depression is a severe recession.

 Business cycle is the study of the fluctuations in economic growth around the trend growth.

Comovement refers to the movement of pairs of variables.
 Economists compare another economic variable such as inflation or employment

with GDP over time and see if any relationship can be determined.
 Procyclical is a variable that is above trend when GDP is above trend.

 Real wages is an example – it tends to increase faster during booms
 Countercyclical is a variable is that is below trend when GDP is above trend.

 Unemployment is an example since unemployment tends to fall as GDP grows.

In keynesian model: employement, inflation and real wages are procyclical but unemployement countercyclical

new classical model: employement, inflation procyclical but real wages and unemployement countercyclical

real business cycles models: employement, labour productivity and real wages are procyclical

• A leading indicator can be used to foretell future changes in economic activity.

•  A lagging indicator occurs after changes in economic activity have occurred.

•  A coincident indicator occurs at the same time as changes in economic activity.

he deflationary or output gap is the difference between full employment output and expenditure when expenditure is less than full employment output.

The inflationary gap is the difference between full employment output and actual expenditure when actual expenditure is greater than full employment output.