Principles of Macroeconomics

Units

1. 1

   Measuring national income

   4 lessons

   1. The circular flow of incomeDraw the circular flow of households and firms through the goods market and the factor markets, and show with numbers why the value of output, total income and total expenditure are the same amount.
   2. GDP and its componentsDefine GDP as the market value of all final goods and services produced within a country in a period, decide what counts, and compute GDP from the expenditure identity Y = C + I + G + NX.
   3. Real versus nominal GDPCalculate nominal GDP, real GDP at base-year prices, and the GDP deflator from a two-good table; distinguish changes in production from changes in prices.
   4. GDP and well-beingExplain what GDP leaves out (leisure, home production, the underground economy, environmental quality and distribution) and why GDP per person still goes with life expectancy and literacy across countries.
2. 2

   Measuring the cost of living

   3 lessons

   1. The consumer price indexBuild the CPI from a fixed basket and a base year, compute the inflation rate from two CPI values, and say how the CPI differs from the GDP deflator.
   2. Problems in measuring inflationExplain substitution bias, the introduction of new goods and unmeasured quality change as the reasons the CPI overstates the rise in the cost of living, and compute the size of each in a worked example.
   3. Correcting for inflationConvert dollar amounts across years with a price index, explain indexation, and use the Fisher relation r = i − π to find a real interest rate from a nominal rate and inflation.
3. 3

   Unemployment

   3 lessons

   1. Measuring unemploymentClassify the adult population from a household survey into employed, unemployed and not in the labor force, compute the labor force, the unemployment rate and the labor force participation rate, and explain why discouraged workers make the rate understate joblessness.
   2. Frictional, structural and cyclical unemploymentDistinguish frictional, structural and cyclical unemployment, define the natural rate of unemployment, and compute cyclical unemployment as the actual rate minus the natural rate.
   3. Why some unemployment persistsExplain how job search and unemployment insurance lengthen frictional unemployment, and how wages held above equilibrium by minimum wage laws, unions and efficiency wages create structural unemployment, with the size of the surplus of labor computed from the labor market graph.
4. 4

   Production and long-run growth

   3 lessons

   1. Economic growth around the worldCompare real GDP per person across countries, compute growth rates and their compounding over decades, and use the rule of 70 to find how long an income takes to double.
   2. Productivity and its determinantsExplain why living standards rest on productivity, name its four determinants (physical capital, human capital, natural resources and technological knowledge), and use diminishing returns to capital to explain the catch-up effect.
   3. Public policy and growthExplain how saving and investment, foreign investment, education, health, property rights and political stability, free trade, research and development, and population growth each raise or lower productivity, and why only better technology keeps growth going.
5. 5

   Saving, investment and the financial system

   4 lessons

   1. Financial markets and intermediariesDescribe how bond markets, stock markets, banks and mutual funds move saving to borrowers who invest, and use the terms maturity, credit risk, dividend and diversification correctly.
   2. Saving and investment in national accountsDerive S = I for a closed economy from Y = C + I + G, split national saving into private saving Y − T − C and public saving T − G, and compute budget deficits, surpluses and their effect on government debt.
   3. The market for loanable fundsUse supply of loanable funds (from saving) and demand (from investment) to find the real interest rate, and show what saving incentives, an investment tax credit and a government budget deficit do to the interest rate, saving and investment, including crowding out.
   4. Present value and riskCompute future value with compounding and present value by discounting, use the rule of 70 for doubling, decide on an investment by comparing present value with cost, and explain risk aversion, diversification of firm-specific risk and the efficient markets hypothesis.
6. 6

   Money and banking

   4 lessons

   1. What money isDefine money by its three functions (medium of exchange, unit of account, store of value), contrast commodity money with fiat money, and compute the M1 and M2 money supply measures from their parts.
   2. Banks and money creationUse bank T-accounts to show how fractional reserve banking creates money, compute the simple money multiplier 1/R, explain how current practice (no reserve requirement since March 2020, ample reserves) differs from the textbook model, and compute a bank's leverage ratio and the effect of a fall in asset values on its capital.
   3. The central bank and its toolsDescribe the Federal Reserve's structure and its tools (open market operations, interest on reserves, discount lending and reserve requirements) as the textbook models them and as the Fed uses them today, and explain bank runs and how deposit insurance and the lender of last resort prevent them.
   4. Money growth and inflationUse the quantity equation MV = PY to compute velocity and the price level, explain the classical dichotomy and monetary neutrality, show that money growth minus output growth gives inflation, and explain the inflation tax, hyperinflation and the costs of inflation, including shoeleather and menu costs.
7. 7

   Aggregate demand and aggregate supply

   4 lessons

   1. Facts about economic fluctuationsDescribe the three key facts about short-run fluctuations: they are irregular and unpredictable, most macroeconomic quantities move together, and when output falls unemployment rises; read recessions and expansions off a business cycle chart and use Okun's rule of thumb.
   2. The aggregate demand curveExplains the downward slope of AD through the wealth effect, interest rate effect and exchange rate effect, and what shifts AD from consumption, investment, government and net exports.
   3. Long-run and short-run aggregate supplyContrasts the vertical long-run aggregate supply curve at potential output with the upward-sloping short-run curve explained by sticky wages, sticky prices and misperceptions.
   4. Demand and supply shocksUses the AD-AS model to trace a demand shock and an adverse supply shock causing stagflation, from short-run effects to the return to long-run equilibrium.
8. 8

   Monetary and fiscal policy

   3 lessons

   1. Monetary policy and liquidity preferenceUses Keynes's liquidity preference theory, money supply and money demand, to show how the central bank sets the interest rate and shifts aggregate demand.
   2. Fiscal policy and the multiplierDerives the spending multiplier 1/(1 - MPC), the tax multiplier, and how the crowding-out effect partially offsets fiscal expansion.
   3. Automatic stabilizers and active policyWeighs active stabilization against policy lags, compares discretionary policy with automatic stabilizers like income taxes and unemployment insurance, and debates over deficits.
9. 9

   Inflation and unemployment tradeoff

   3 lessons

   1. The Phillips curvePresents Phillips's original curve and Samuelson and Solow's tradeoff between inflation and unemployment, linked to movements along short-run aggregate supply.
   2. Expectations and the natural rate hypothesisExplains Friedman and Phelps's argument that the long-run Phillips curve is vertical at the natural rate, with expected inflation shifting the short-run curve.
   3. Supply shocks and disinflationAnalyzes the 1970s oil shocks, the sacrifice ratio, rational expectations, and the Volcker disinflation as a test of costless disinflation.
10. 10

    The open economy

    4 lessons

    1. Net exports and capital flowsDefines net exports and net capital outflow and shows the identity NX = NCO, and S = I + NCO linking saving, domestic investment and foreign investment.
    2. Nominal and real exchange ratesDefines nominal and real exchange rates, computes the real exchange rate from prices, and states purchasing power parity with the Big Mac index as an example.
    3. A model of the open economyLinks the loanable funds market and foreign currency exchange market to show how budget deficits, trade policy and capital flight affect the real exchange rate and net exports.
    4. Fixed and floating exchange ratesCompares fixed and floating exchange rate systems, currency crises, and the trilemma between fixed rates, free capital flows and independent monetary policy.