Summary and general review for ECON1102 Summer 2023
This document is a general review of the important topics covered over
the term. It also speci…es in bracket the part for each Chapter that we have
covered, and by default, examinable in the …nal exam. Below are just main
point covered in each Chapter to give you some direction on …nalizing your
study. If you know the material very well, as you read the bullet points below
you should be able to elaborate the details without looking them up!
Chapter 1 (all sections)
In Unit 1 we focused on de…ning and measuring GDP and look at the
di¤erence between nominal and real GDP.
De…ned recession.
How to measure CPI and in‡ation.
How to calculate real GDP.
Chapter 2 (all sections)
Labour market de…nitions including labour force, unemployment rate,
employment rate and participation rate.
Distinction between frictional unemployment (with job …nding rate and
job destruction rate), structural unemployment and cyclical unemploy-
ment. The …rst two form the natural rate of unemployment u.
Okun’s Law relating the output gap YY
Y to cyclical unemployment
u u.
Demand and Supply of labour in competitive markets, learned that
MPL = W
P
Introduce minimum wage law and how it generates unemployment in
the competitive labour market.
Showed how taxes can also generate unemployment.
Chapter 3(all sections)
1
Interest rates, nominal and real. How to calculate real interest rate
using CPI and the approximation from the Fisher equation i = r + .
Ex-post and expected real interest rate.
Introduced the zero lower bound.
Some evidence of negative nominal interest rate.
Investment, private, public and inventory.
Investment and capital accumulation kt+1 = It + (1 )kt.
Marginal productivity of capital, and user cost of capital de…nition.
Formulation of Investment Demand curve I(r). Along with what can
explain the shifts of the investment curve!
National Saving de…nition, household saving, saving and wealth, and
economic factors a¤ecting saving (shifting the saving curve S(r)).
Business saving, Retained Earnings (RE)
Government saving and the budget balance (BB = T G)
NS(r) = S(r) +RE +BB.
Factors shifting the NS(r) and Crowding out e¤ect of government in-
crease in spending (via rise in G).
Chapter 4 (all sections)
Introduces Income-Expenditure model of GDP using the assumption
of sticky prices.
Firms adjust production in short term instead of prices (the Keynesian
assumption).
Introduced Planned Aggregate Expenditure (PAE). PAE may di¤er
then measured Y because planned investment IP may di¤er from I
measured, the di¤erence being the change in inventories.
2
From PAE to equilibrium GDP (Y ). Set PAE = Y , IP = I and solve
for Y .
In equilibrium, no change in inventories, but in disequilibrium, either
inventories are growing or depleting. Leading …rms to adjust produc-
tion as a response.
Introduced two sector model of PAE, households and …rms only.
Introduced a consumption function for households, with marginal propen-
sity to consume.
In equilibrium PAE = Y gave us a multiplier.
Changes in autonomous variables in equilibrium Y (shifting PAE), and
the impact of the multiplier.
Equilibrium using national saving, and the paradox of drift.
Three sector model, the open economy with net export and marginal
propensity to import.
E¤ect on the equilibrium and the multiplier (added m). And shocks to
export can be explored on equilibrium Y .
Chapter 5 (all sections)
Introduced government via G0 and the tax function T = T0+ tY in the
two sector model (closed economy).
Find equilibrium Y again, but now the multiplier has t.
Impact of G0 and T0 on equilibrium /Y via the multiplier, and the
balanced budget multiplier.
Fiscal policy can a¤ect Y and bring Y to Y .
Concept of automatic stabiliser (e.g. t as tax collection grows in boom
and fall in recession).
Discretionary …scal policy (e.g. change G0 or T0).
Budget de…cit and public debt, and how they are related (equations).
3
Sustainability of public debt.
Four sector model, reintroduce net export.
Find equilibrium Y , and new multiplier has c; t;m in it.
Chapter 6 (all sections)
Asset returns and prices.
Bonds and bonds pricing (Present value!) with link to market interest
rate.
Money, de…nition, monetary aggregate in the data, demand for money
(as function of nominal interest rate i), what shifts the money demand
(P; Y ).
Banks balance sheets, assets and liabilities, and how banks can create
money using leverage.
Important ratios in the banking sector.
Bank runs and liquidity.
Long-run Quantity Theory of Money links change in P to change inM
(assume V and Y constant!).
Chapter 7 (all sections)
The role of Central Banks, targets and instruments.
In‡ation targeting, headline and core in‡ation.
Monetary policy framework.
Cash rate target, Exchange settlement accounts (ESA), and determi-
nation of the cash rate.
Implementation of monetary policy to maintain cash rate within the
corridor around the cash rate target.
Open market operations, what are they?
4
Term structure of interest rates (short vs long term rates) and the yield
curve.
Monetary policy rule (Taylor rule) and simpli…ed version linking r to
, gives a policy reaction function (assumed behaviour of the central
banks in response to in‡ation changes).
Chapter 8 (all sections)
Aggregate Demand and Aggregate Supply (AD-AS).
Introduce real interest rate r into the consumption and investment
function, a¤ecting both negatively.
Substituting the simpli…ed Policy Reaction Function we get PAE as
function of with PAE negatively a¤ected by increases in .
Derived the AD from PAE considering di¤erent , and map the equi-
librium PAE = Y with associated . (see handwritten notes in Unit
8) Shows why AD is negatively sloped.
Factors shifting the AD curve.
Adaptive expectations and horizontal AS curve.
In‡ation shocks, temporary shock via " > 0 or " < 0. Because the shock
is temporary it means "+1 = 0. But in‡ation next period +1 =
= 1 + ", the next period in‡ation is changed because of Adaptive
expectations.
Re-introduced the potential output Y into AD-AS curves to show long
run equilibrium.
Considered permanent shocks to AD starting from Y = Y . If positive
output gap, goes up and AS shifts upward. If negative output gap,
goes down and AS shifts downward. Final result Y = Y but at higher
or lower . Without anything else changing in the process.
Temporary AD shocks, AD shifts left or right, but quickly returns to it
initial position before in‡ation pressures quick in! Result is temporary
output gap and return to Y = Y and stays constant.
5
Temporary AS shock, similarly, either goes up (unfavorable shock
" > 0) or down (favorable shock " < 0). Create output gap and
starts adjusting gradually back to initial AS, with eventually Y = Y
again, back to its initial level.
With both temporary shocks to AD or AS, everything else the same,
the economy is self adjusting back to its long run equilibrium Y ; .
(back on the trend in a dynamic setting!)
Thus, real business cycles are equilibrium phenomena with Y moving
around Y .
Government and central banks can use discretionary …scal and mon-
etary policies to reduce the cycles created by temporary. This is at
their discretion dictated by their forecast on how fast are the tempo-
rary shock would take to return to initial levels, or if the shocks are
viewed as permanent.
We learned that policy responses come with lags in their e¤ect.
If the shocks to AD are viewed as permanent, a negative permanent
shock to AD can be accommodated by expansionary …scal or mone-
tary policy to return Y = Y , and initial . The reverse if positive
permanent shock. But again in reality this may take time.
If the shocks to AS are viewed as permanent, a shift upward in AS can
be accommodated by expansionary …scal or monetary policy, returning
Y = Y but at the cost of higher ! The government and central
bank face a trade o¤, bring Y quickly back to Y with higher if they
accommodate the AS shock, or do not accommodate and let adjust
gradually back to Y = Y and initial . The reverse for permanent
downward shift in AS.
In‡ation target (RBA is 2-3%)
Learned how to use AD-AS to represent events like GFC or Covid.
Shock to potential output (e.g. wars lower Y ).
Chapter 9 (only section 9, 9.1, 9.2)
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Learned about the Balance of Payments, details on the current account
and the capital/…nancial account.
How to represent international transactions in the BoP accounts.
How the lack of NS to …nance investment can come from international
borrowing: I - NS = NX. If negative the country is a net lender on the
international markets.
Chapter 10 (only section 10.1.1, 10.2 complete, 10.3 complete, 10.4 com-
plete)
Learn how to represent growth from inputs, mainly Labour, Capital and
Technological progress (also known as TFP or multifactor productivity
(A)).
Linked MPL to Average productivity of labour, same for capital, using
a production function speci…cation known as Cobb-Douglas. The func-
tion exhibit constant returns to scale and diminishing marginal product
of labour and capital.
Transforming the production function into growth rate, we can do
growth accounting. We can estimate/calculate the residual of the ob-
served growth rates of GDP that is not coming from labour and capital
growth.
This is called Growth Accounting, it allows us to estimate the change
in TFP, the change in parameter A as the residual from the data we
can measure and estimates of the labour and capital shares of output
via the parameter . (Also known as Solow Residual).
Best of luck for the …nal exam, and thank you for all the interactions
during the summer term! We have enjoyed teaching introductory macro to
all of you and we hope that you have enjoyed your learning experience.
Best wishes Benoit
and Simon