Full Employment

Full employment equilibrium exists where AD intersects SRAS & LRAS at the same point.

Recessionary gap exists when equilibrium occurs below full employment output.

                                       

Inflationary gap exists when equilibrium occurs beyond full employment output.

                                              

Aggregate Supply

The aggregate supply curve depicts the quantity of real GDP that is supplied by the economy at different price levels.

Long Run vs Short Run

• Long run: Period of time where input prices are completely flexible and adjust to changes in the price level. In the long run the level of real GDP supplied is independent of the price level.
• Short run: Period of time where input prices are sticky and do not adjust to changes in the price level. In the short run the level of real GDP supplied is directly related to the price level.

Long Run Aggregate Supply (LRAS): Marks the level of full employment in the economy (analogous to PPC) because input prices are completely flexible in the long run, changes in price level do not change firm's real profits and therefore do not change firms level of output. Meaning that LRAS is vertical at the economy's level of full employment.

Short Run Aggregate Supply (SRAS) Because input prices are sticky in the short-run, the SRAS is upward sloping.

                                           

An increase in SRAS is seen as a shift to the right. A decrease in SRAS is seen as a shift to the left
The key to understanding shift in SRAS is per unit cost if production
Per unit production cost= total input cost/total output

Determinant of SRAS

• Input prices 
• Domestic resource prices 
• Wages (75% of all business cost)
• Cost of capital
• Raw materials (commodity prices)

Foreign resource prices

• Strong $ = lower foreign resource prices
• Weak $ = higher foreign resource prices

Market power-monopolies and cartels that control rss control the price if those rss

• Increase In resource prices (AS Shift <)
• Decreases In resource prices (AS Shift >)

Productivity

• productivity = total output/ total inputs
• More productivity= lower unit production cost (AS Shift >)
• Lower productivity = higher unit production cost (AS Shift <)

Legal institutions environment (Taxes and subsides)

• taxes ($ to government) on business increase per unit production cost (AS Shift <)
• subsidies ($ from government) to business reduce pet unit production cost (AS Shift >)

Government regulation

• Government regulation created a cost of compliance (AS Shift <)
• Government deregulation reduces compliance costs (AS Shift >)

Aggregate Demand

The aggregate demand shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level. The relationship between the price level and the level of real GDP is inverse.

Three reasons AD is downward sloping

• Real-Balance effect: When the price level is high households and businesses cannot afford to purchase as much output. When the price level is low households and businesses can afford to purchase more output
• Interest-Rate effect: A higher price level increase the interest rate which tends to discourage investment. A lower price level decreases the interest rate which tends to encourage investment.
• Foreign purchases effect: The higher the price level, an increase in demand for relatively cheaper imports.

Shifts in AD

• Two parts to a shift in AD
• A ∆ in C, Ig, G, and/or Xn
• A multiplier effect that produces a greater change than the original ∆ in the 4 components.
• Increase in AD = AD >
• Decrease in AD = AD <

Consumption

• Households spending
• Consumer Wealth: More spending (AD Shifts >)
• Less wealth: Less spending (AD Shifts <)
• Consumer expectations
• Positive Expectations: More spending (AD Shift >)
• Negative Expectations: Less spending (AD Shift <)
• Household indebtedness
• Less debt: More spending (AD Shift >)
• More debt: Less spending (AD Shift <)
• Taxes
• Less taxes: More spending (AD Shift >)
• More taxes: Less spending (AD Shift <)

Gross private investment

• Te real interest rate
• Lower real interest rate: More investment (AD Shift >)
• Higher real interest rate: Less investment (AD Shift <)
• Expected returns
• Higher expected returns: More investment (AD Shift >)
• Lower expected returns: Less investment (AD Shift <)

Government spending

• More government spending (AD Shift >)
• Less government spending (AS Shift <)

Net exports

• Exchange rates (International value of $)
• Strong $ : More Imports and fewer exports (AD Shift <)
• Weak $ : Fewer imports and more exports ( AD Shift >
• Relative income
• Strong Foreign Economies: More exports (AD Shift >)
• Weak Foreign Economies: Less exports (AD Shift <)

Unemployment

Unemployment: Is the percentage of people who do not have a job but are part of the labor force.

Labor force: The number of people in a country that are classified as employed or unemployed.
Unemployment rate =                                       Number of unemployed

                                                   Number of unemployed + Number of Employed         X 100

Not in the labor force: 

• Kids 
• Retired people
• Military personal
• Mentally insane 
• Incarcerated
• Full time students
• Stay at home parents
• Discourage workers

Forms of Unemployment:

• Voluntary- Between jobs, new opportunities, new choices, new lifestyle, educational level.
• Seasonal- People wait for the right moment to conduct their trade. Ex: School Bus Driver, construction workers.
• Cyclical - Down turn in the business cycle, recession, down price.
• Structural- Associated with lack of skills, decline in industry, change in technology.

Full Employment when there is not cyclical unemployment present in the economy. Natural Rate of Unemployment (NRU) achieved when labor markets are in balanced 4-5%
NRU = Structural UNP + Frictional UNP

Unemployment is good, because its less pressure to raise wages, more workers available in future expansions.

Unemployment is bad because, there is not enough consumption (GDP). There is too much poverty, too much government is needed

Okun's law - For every 1% unemployed above NRU causes a 2% decline in real GDP

Inflation

Inflation: A rise in general level of prices. The Inflation Standard: 2% - 3%

Inflation Rate: Measures percent increase. Key indicator of Economies Strength.

Deflation: Decline in general price level

Disinflation: Occurs when inflation rate declines

CPI: "Consumer Price Index" measures inflation by tracking the yearly price of consumer goods and services. Indicates changes in price levels and price of living.

Formulas:

• Finding Inflation Rate Using market base data.                                                                            Current  Year Market Basket value - Base Year Market value X 100                                                 Base Year Market value
• Finding Inflation Rate using price index                                                                                         Current year price index - Base year price index    X 100                                                           Base year price index
• Estimating Inflation Using Rule of 70. Used to calculate the number of years it would take for the price level to double at any given rate of inflation.                                      Years Needed to double inflation =                     70

                                                                     Annual inflation rate

• Determining real wages                                                                                                                        Real Wages = Nominal wages / Price level  X 100
• Finding real Interest rate                                                                                                                 Real interest rate = Nominal interest rate - Inflation Premium 
• Cost of borrowing/lending money that's adjusted for expected inflation; expressed as percentage.

Cause of inflation: 

• Demand-pull inflation- Cost by excess of demand over output that pulls prices upward.
• Cost-push inflation- Cause by a rise in per unit production rise due to increase resource cost

Effect of inflation: Hurt people with fixed income, savers, lenders/creditors. Helps borrowers and fixed contracts.

• Anticipated: People are told that they will get laid off (Get a new job or spend less money)
• Unanticipated: People told its their last day in the job.

Inflation Helps:

• Borrowers 
• Debt will be repaid with cheaper dollars than those that were loaned out 
• Fixed Contract 

Inflation Hurts:

• Fixed income 
• Social security 
• Savors 
• People that save money  
• Lenders / Creditors  
•  Not going to be repaid back 

Nominal and Real GDP

Nominal GDP - Value of output produced in current prices  

• P x Q 
• Can increase from year to year if either output or price increase 

Real GDP - Value of output produced in constant or based year prices  

• Adjusted for inflation  
• Based Price x Quantity 
• Can increase from year to year only if output increases  

Price index - measure inflation by tracking changes in the price of a market basket of goods compared to the base year 

• Price of market basket of goods in current year / price of market basket of goods in base year 

GDP Deflator 

• Also a price index that is used to adjust from nominal to real GDP 
• In the base year the GDP deflator is
•  =100 Years after base years
• >100 For years before the base year  
• <100 (Nominal GDP/ Real GDP)  ×100 

Inflation 

• (New GDP deflator - Old GDP deflator / Old GDP deflator) ×100 

Expenditure and Income Approach

Expenditure Approach:  C + Ig + G + Xn = GDP 

• Add up the market value of all the domestic expenditures made on final goods and services in a single year.

Income Approach: W + R + I + P + Statistical Adjustments

• Add up all the income earn by households and firms in  a single year.
• W: Wages
• R: Rents
• I: Interest
• P: Profits (Proprietor's income)

Budget: Government Purchases of goods and services + Government Transfer Payments - Government tax and Fee collection.

• If the number is positive its Budget Deficit.
• If the number its negative its a Budget Surplus.

Trade: Exports - Imports

GNP: GDP + Net Foreign Factor Payment 

NNP (Net National Product): GNP - Depreciation

NDP (Net Domestic Product):GDP - Depreciation

National Income:

• GDP - Indirect Business Taxes - Depreciation - Net Foreign Factor Payment
• Compensation Of Employees + Proprietors Income + Rental Income + Interest Income + Corpus Profits

Disposable Personal Income: National Income - Personal Household Taxes + Government transfer payments