ECO 221

jÉ
§

¥
 Macroeconomics : Deals with
aggregate economy as a
whole
Microeconomics individual
: Deals with economic
agents .

GDP :
Gross Domestic Product
Total mavrket value of all final
goods and services

produced in in
a
country a
given yeah
.

commodities
Two
Orange , Orange Juice
- -

-
Two firms -

Firm A :
orange Juice
Firm B
Orange
:

Firm A transacts :

Wages 15000
:
◦

◦
Taxes
paid 5000 =

◦
Revenue
from sale : -

Oranges to
public : 10000
to Firm B : 25000

Firm B transact "s :

Wages 10000
◦ :

Taxes :
◦
2000
◦

Oranges purchased : 25000

Rev
from juice 40000
◦ . :

GDP ?
Product Method : Rev for A t Rev for B ✗
sold
Oranges to B from A are not
final .

Value added by
A- 100001-25000
:

B : no 000 -
25000
=
50000
-
Income Approach :
Total wages : 25000
Firm A
profit before taxes : 20000
'

Firm B
profit before taxes : 5000
=
50000

Expenditure Approach :
Firm A final :
10000

Firm B
final : 40000

Total : 50000

FUNDAMENTAL NIA IDENTITY :

Total Production =
Total Expenditure =
Total Income

Product Approach :

→
GDP =

¥2 ,
VAJ VA : Value added

I Added in
concept year )
→ Flow a

→
Inventory ,
stocks
also
,
capital goods produced's
included in that
in a

year are
year GDP .

→ GDP ≠ Money in Circulation

Factors of Production :

Land →
Rent
-
Labour →
Wages ( Usually fixed )
-

Capital → Produced means

of production (generally
last
long >( →
Interest
-

Entrepreneurship
t .
→
Profits Highly volatile)

bears the risk

of business

Product Approach A

Market :
[ Piqi
E- I

goods leg Home economic

'

→ Non market
-

.
production)
Draw
→ GDP is a measure
of activity .

home production really economic

-

Is an
backs
activity
-

→
Quality of life improvements
Underground 1
parallel economy )
→
economy
( )
{ Legal for
tax evasion

Illegal Drug trading

( etc )
,

→ Non -
traded items .
( Like national defense )
funder counted)
Included in GDP :
-

Newly produced goods

Final
goods
-

Addition to capital goods ( investment in capital)

-

Inventories ( Unsold products)

( Even if the products are intermediate)

GDP vs GNP
→ Final
goods produced
within the territorial
→ Final
goods and services
produced by residents of
boundary of the
country the
country .

GNP=GDPtNFIAJ
↳ Net factor income from
-

abroad
NNP= GNP Depreciation Indian abroad
earnings
-
-

Foreigners
'

earnings in
NDP : GDP Depreciation
-
India

Expenditure Approach
Y → GDP

Y = C + I t G + (x -

M)
↑ ↓.
↑ ↑
Consumption Investments Govt
.
Exports Imports
Expenditures
✗ Private consumption of households Durables
→ →

↳ Non durables
Include prices after adding taxes ↳ services

(I fixed
→ Private investment expenditure s Business invest .

-Residential investment

# s
Inventory
↓
accumulation

Construction of newhouses
convention)
Intended or
(Accounting unintended
Includes
goods &
→
G → Government Expenditure → Govt purchase of
services
↳ Transfers
( Giving
Excludes
citizens
money
/
goods
free)
to

for
↳ www.t on
Ñeⁿ"ʳᵈ
debt
leg likegovtNational
.
bonds

Savings Certificate)
Imports ( M ) are subtracted because
they had been
added while
counting C I and G ,
but should not have
been included

Exports ( X ) are added because

they were
produced in
the country but have not been counted in C. I or G

Ex ante : Planned .

Ex post : Realized

All the calculations are considered in an ex

post sense .
 ~
GDI

>
I 1 Time
Development
Cycles General trend in GDP

Income Approach
compensation of employees ( without deducting taxes)
◦
.

Proprietor's
Proprietor 's of incorporated
◦
income :
non

G businesses .
*
D
Rental incomes
Registered as

eg Royalties for company

: artists a

◦
Net interest
Corporate profits Profits of incorporated businesses
◦ : .

Taxes on
production &
imports
◦

◦ Business current transfers :

corporate charity contributions
°
Add depreciation
◦
Add NFIA
adding this makes it GNP
 → Govt
-

Transfers
Private Disposable Income =
GDP t NFIA + TR 1-
Interest on national Debt -
T
↓
taxes

Private Income =
Private Disposable Income + T

Net Govt Income = T -

TR -
Interest

savings and Wealth :

Wealth = Assets -
Liabilities

saving
time .
is the net addition to wealth over a
period of
Private
savings =
Spit =
Pvt
Disposable Income -

C
ti

consumption
=

@ + NFIA -
Tt TR t
Interest -
C

Govt Savings = S
govt
=
Net Govt Income -

Govt Purchase
=
E -
TR -
Interest) -

G
↳ Government
expenditure
s 5
Spvtt
=

govt
Y t NFTA C G
= -
-

Ct It NX t
Gt NFIA C G
= - -

Inlet X M
Exports
-
=
 5 =
It ( N ✗ + NFIA ) >
The net of
current Alc Balance
/ what a
sold to the
country
world 4s what
Spvttsgovt It CA it
brought from
=

the world .

Spvt C-
It
Sgovt ) + CA uses
of saving
= →

identity
Govt's
budget
deficit
Wealth is the measure
of Assets Liabilities at any point
-
-

time
of
National wealth
s
Physical domestic land & capital ( K )
> Net
foreign assets

-
Direct tax : Income tax
&
Indirect tax : taxes sales
of goods services
on
,

like GST .

Can coke
of ⑧µpp→ Included for GDP
at mktval
^
Actual
value
⑧ 2 Taxes

↳ Included for GDP at factor

costs .
 GN
GDPn.pt NFTA
Pmp
=

GNPmp Depreciation AN
Pmp
-

NNPmp
-

(Indirect tax -

Subsidy
NN
Businesses ) Pfc
=
to

TÉÉ-ax
NN National Income
Pfc =

Role of the Government :

1. To
provide public goods .

( Independent
Public
goods of who
-

>
produces the
goods)
Non -

rivalry in consumption non - exdndability

→
If one can use then →
cannot exclude someone
anyone
can use who hasn't
paid for this .

Roads Law and order

Eg Eg Defense
: :

2 Externalities :
Marginal social cost is not equal to
marginal private cost .

such
Msc Govt tries to
externalities
keep
in check
MPC
by
taxes / subsidies
Pollution
MB _
i. ;
I. 9¥ !.at a
Graph of negativeexteanalitf
 MPC
Msc

i
.
µ,
Marginal
benefits
Vaccines

" "

Hip ! 9%
q
Graph of pFÉexternality-
3. To
provide merit
goods regardless
Everybody should have
:

of purchasing power or

willingness to do so .

Example food primary :

.
education

4.
Enforce contracts and property rights
:

without
property rights people are reluctant to
,
invest .

Without contracts
financial agents cannot fn
,
.

5- To run businesses :
controversial .
Aim was to use the
profits
for public good but incur losses .

Real v15 Nominal GDP

N
Nominal GDP
¥ Piri
→ :

,
↳ in
monetary
units

→ Real GDP
Fix base
°
2003 04 as
year
-

→
calculate Nominal GDP in 2003-04
each
For subsequent year
→
,

Real GDP =
Ép°"q
E- I
,
 called GDP at constant
-

prices .

find quantum of
-

Used to out the increase in

and
goods services .

&
-
To keep up with
changingis basket of goodstime
services
,
the base
year shifted from to
time .

Nominal GDP
GDP Deflator =

Real GDP
✗ 100

Consumer Price Index ( CPI ) :

weighted
and
average
services .
of prices of different goods
N

CPI =
tiwi

Weights for item ancan be calculated

by the average budget share for that item

Inflationist ,
=

P-BHp-p.PT ✗ 100
 Interest Rates
The reward
gets for sacrificing current consumpn
-

one

is interest .

Nominal IR = The interest that is

current
provided for
postponing consumption
Real IR =
Normal IR -

Inflation

The Production Function

=
f- ( L K
, )
single homogenous Latour capital
good
ASSUMPTIONS ①
Fc=§¥ Fk=?g¥ > 0
:
> 0 ,

↓ ↳ "

Marginal prodn Marginal Prod

of capital
of labour
②
% < 0 ,
32k¥ < 0 Diminishing
Marginal Prod "

③
§µ > 0 Fix =
FKL > O ,
K and L
are
comflem .
 y ⑥ F(tL,tk)=tFCL,k )
* t>0

Constant returns to
scale CCRS )

Example :

L
Y=AK %
' -

Cobb -

A> 0 ✗ C- 10,1 )
,

Douglas ↳
Total factor
foodh fu productivity parameter
( captures tech )
.

In the short run

,
K is
fixed .

) LAI
' ✗

Ctxk
-

-
F =
,

TIL E) ,
= PFCL , E) -
WL -
irk
↳
↳
Profit given
objective ( Lik )
May
-

: *

PF
8g¥
FOC : =
0 =
w
,

↑
Value of
Marginal product
( VMA )
 →
PF, =
w → Nominal
≠

\
wage
Figg
Real
wage

FL

Demand L

Labor supply :

utility ofensumptioleisure
n >

Max u / get
c. l
sit .
Pc ≤ 11 e) -
w

solving 1*1
above :
get c*l ) ,
Wp )
I> Real d-
is
To wage

↳
¥:#
supply "

LA L
 Important questions in economics
-

What to produce ? → Due to scarcity

◦
resource
How to produce ?
◦

◦
For whom to
produce ?
-
Model :

Assumptions
¥Ñʰ¥ Refutable proposition

Market for loanable

funds :

-
Demand
for loanable funds is for investment .

§ } /
Worth return
investing rate
real
decrease
rate
of fr ✗

interest [ real) rate

of
I return on
a
safe asset
InvestmentE)
Supply of Loanable funds :

8
Savings increase with
S increase in interest
rate .

S
 ✗
At equilibrium :
S
S =
I -
①
sit ↓
Planned Planned investment
I savings
Planned
STI
't
g, [
investment

From identity if
Uses
of savings we remove
govt
-

influence due to closed economy ,

we
get
5- I
← ↳ Actual Investment
-
②
Actual
savings
Actual Investment Unintended
:
Planned It
change in
-

inventory
③
.

Also
by definition planned savings Actual savings -
-
= .
,

-
From ① , ② and ③ at eqm ,

Actual Investment = Planned Investment

WIP
Ls
No
involuntary
-

*
unemployment
(F) _
All those
work at
willing
the market
to

↳ rate are able to work

wage
.

0 Lf L 4 :
full employment
 y
YIL , E)

÷
I

full employment 4- L

level
of Full employment
output
Demand
A- D=
Aggregate CTI
-
=

Y
AS
Aggregate supply Cts
= =
=

since F- s hurried ¥ saved

CTI Cts:

Thus A-D= AS

-
y = ( AEK ) Lt
'" -1
(AE ) ✗ La
¥ Fi
=

7
Increases when tech is improved ,

thus Fut ,
thus ↳ ↑
Since
Marginal product of
labour is the labour demand
curve .
 Functions of Money :

Four functions of money :

Medium
of exchange
◦
.

Measure
of value
◦
.

store
of value
somethingstoreperishable like
mangoes
◦ :

cannot
for long Money
value .

store value
can
for long .

◦ standard
of deferred payments terms
Debts paid in : are

of money .

Quantity Theory of Money :

MV =
☒Y ( unit /
year)
← ↓ ↳ app ( output
Stock of ↓ price
Canarium) form)
Transaction of the
money single good for consume
"

( Rs ) velocity-1
( year ) ( Rs / unit)
.

PY : Nominal
GDP

transaction velocity :

of times money changes

No hands
average
-
-
on an .

Depends length of pay period

on
-

.
 MY = PY

take both
-

log on sides .

la Mt lnv =
lap + ln Y

* dm-de.to f. t 0
=
+

◦ Increase in stock
of money leads to inflation .

Cambridge Equation
Ms FA=

↳
money supply is fixed (
by policymakers) .

Md
}
KPY k>0
'm:{
= "
,

consider
↳
Depends on institutional
features an asset
as

In eqm ,
Ms : Md
TM =
KPH
→
In the classical model , Y is
fixed at
full employment
level .

in
change money supply only prices change
→ so a .
, ,

Dichotomy supply will have

→
classical :
Change in
moneyGDP
no

impact on .
 @ Ip) ↳
* Ñ= KPH
(F)
- -
- - - - -
.

¥ ↳
P
, ,* ,
Aggregate
i supply
yf
¥
Aggti
- - - -
.
. _ . . -

i.
I !
Demand

L*
Yt Y
GDP GNP
: L

↳ (since there is Ñ=
no
KPY PY -
_
constant
external market) I I ↓ PAD
fixed fixed palsy is
a rect .

hyperbola
Market
for loanable funds ( with Govt)
5- It (G -

T)
↳ take G and T as policy variables
°
Dlr )= ICH t [ G- -

F) 5
*
Demand
for loanable
funds
↓
Govt in

surplus
%fdYf.it
Ifr)t(G-T)
""

sit
 S -
No deficit initially
-

Thereafter ( G -
)
T >0
vi. - - -
- -

¥ l
i i
It (G T )
- - - - - - - -

I
-

1 i.
i : i.

I i. ! I

I. s* sit

} -

budget deficit } - decline in private Investment

} -

increase in private savings

AD @ fit It +
G ↑

[
=

Govt
increasing expenditure does not affect GDP ( Aggt
Demand)
> -

Full
crowding out ( Increasing G increases r
,

which crowds out C and I )

Takes
lwmpsum F- F (
I. Tax
relatively invariant to
→

income economic decisions

, )
→ DG =
0T
No
change in rate ofin interest
◦
.

changing ) expenditure way ( lump sum

-

Govt loans tax

any .

or
money printing does not affect GDP .
 Indirect taxes
◦
Different from Lumpsum or income taxes .

taxes products buys

◦
on one .

◦ sales tax .

2. Income Tax →
Govt takes
away
t for every hour you
work .

reduced
Lets
say now taxes
from t →
t o
-

w /P
'
S
E E.
e
' supplyatattaxtax t
supply
:

t D
-

- - - - - - - - - - - - - - -

;
i i
i. i
1 I ↳
i. !
Ei ,
it * L
'
I

Y
'
l

÷
iii.
-

{i
- -

i iii. i
-

(
1 1

11 ! I
'

increase i

in
prod
"
i
,
!
: i
L* i* L

classical model labour / productivity

supply
→ In ,

is a
determining factor in increasing
production .

→ Classical Dichotomy :
Nominal variable cannot affect
real variables .
 (
Great Depression : 1929-33 :

challenged classical Model)

I Demand
Not all
output is demanded deficiency )
-

)
Less than full employment ( under
employment
-

↳
Lead to John
Keynes proposing Keynesian
Model
Economic
.

Economics
Keynesian :

{
Unutilized productive capacity
Assumptions :
.

Recession
Assumption 2 :

Underemployment Period .

Output demand determined

Assumption 3 : is

complete contrast to classical model )

model
simple Keynesian :

AD = Ct I 1- G

Consumption fn :

closed C= It CY I Ola < I

>0
Economy , ,

"
wlogovt .

↳ to consume
Marginal propensity
 C CLY)
If income increases by t
-

unit consumption
, increases .

but
by
< C ( 1) units .

g-
→
slope = C -

Even if income
goes to 0
,

consumption is still
non zero (E)
Y GDP (4) & income
Using
-

interchangeably .

I I "
animal instinct
"

depends
→ = : Investment on the

of not
the investors
to understand
.

Highly volatile and

easy
.

→ At eqm :

↓
✗ = AS
ti
= AD →
ti
◦ + It
!F govt
◦
.

output Aggt Aggt

.

Supply Demand
Y =
It oil + I
4- c) Y = It I

y=Yo
 A- D= Ct I
C che)
;
i. Keynesian
ns.o# Cross .

c- :

:
't
Y
y
Multipliers

¥t d-
} Investment Multiplier
=

1- c.

I
DIC
DE DE
↑
by ,
AD ↑ by ,
Y↑
by
by by
↑ COE COE CDI
by ,
AD ↑ , Y ↑ ,

C ↑
by EOE , AD ↑ EOE Y c2oÉ
by by
↑
, ,

ad
goes on
infinitum
- - -
.

of DEC ltct it )
4
=
= - . . .

→ S= Y -

c = Y E -
il -

S= -
Et Cl c) Y -

→ At eqm
A- D= Y
CTI = Cts
Its
Planned Investment ←
 A- D= CTI
C :
CU)
"
:
c- !
u5° !
,

yay
" At 4=5
i s -= Actual I > Planned I
1 S -

Which means there is

t ,

unintended inventory
i i.
" accumulation .

E
; I ¥
.
I Producers try to reduce Y .

'

i. i. :
At 4=4
I 1 y* g-
Actual
-

5- I < Planned I
-
Which indicates unintended
inventory documentation
Producers try to increase Y .

Introducing govt
.

to the model
A- D= Ott 1- G
Assume T=F Clump sum tax)

C =
It
clY-T→ disposable income
 Closed with
econ
govt
.

Y= It CCY F) + E
-

+ G-

y =
( I -
at + I + 5)
I -
C

÷ "
=

tax Multiplier :

Y =
It ocy F) -

+ I + G-
f- ↑ → Private Disposable Income * → constraints
→
ADI → Y *

E-ct-i.to?-tG-2Y-*---Ic
Y =

< 0
IF

→ F OF cot Yt cot
↑
by ,
Cti
by ,
by
44 cot , Cti CZOT clot
by by ,
Y ti
by '

OY =
-

loot + GOT t -
- ^
.

)
= -
COFC Itc + d- . _
)
= -
cot
Fc
 ( OF)
Balanced
Budget Multiplier G- =
:

DY = CCDY -

DF ) + dG-

But dG- =
di

dy = CCDY -
dÉ ) + DE

¥l:
Paradox of thrift tendency to save rather than consume

C-it oil
%
Eztczy s
,

I i. :

ii.
: i

to y* ← y*
marginal propensity
consume
a ,

c- _
It it
It
ftp.?Y
5- Y C ↳
everyone starts
saving
- -
= -

more
per unit income
marginal propensity
to save but overall (nation 's)
the same
savings stays
.

Savings as a
fraction of income :

G- 11 c)
-

+
-

=
 IS -

LM Model
Intestinentavings'quidity Money >

Closed Economy with Govt .

Goods mkt : Y It cY 1- Icr) + G- (

Ateqm)
-
=

Assume
'

I ( r) < 0 I
example Ilr ) ir i. < 0
- =
+
, ,

✓
Two Girl
endogenous variables .
,

one
equation

* cr)

IS -

Curve
The locus all such combinations fr, Y )
of that keep the

goods mkt in equilibrium

V0
As 8
from
goes thus ro r,
,
↑
-

Icv )↑ AD ↑
, ,
81 l
y
-
-
- - - -
- - - -
-

:
i
'

i. !
AS has to increase
for eqm .

Is so Y ↑ .

i. !
%
 In eqm :

Y= Itch 1- Icr) t G-
DY =
CDY + I' Cmdr
( 1- c) DY = I' Crldr

¥/ ;¥
= I
< 0
IS

Y / Yr)
"
-

Eqm eq can be written as : =D

%
¥
= -

Fy
-

C- c) Y =
It irt G-
Y= Itir G- TI
(¥48
+ = C- +It G- +
I -

C I -
C

¥/
= < 0

V0
As 8
from
goes thus ro r,
,
&
-

Icv )↑ AD ↑
, ,
8
y y
-
-
- - -
- - - -

i. ! Is
'
AS has to increase
for eqm .

So Y↑
¥ ¥ Is
.

: i ↳ If G- E or E is increase
,

%
r
→ when G- ↑ ,

AD > AS
,
so
for eqm ,

AD needs to be
brought)
r
%
- - - - - - -
- - -

! down ( If ✗ f-As) is same

ro
.
- - - - - -

:|
- - - -

That is done
i
→
by
interest rate
'

:
increasing
which reduces investment
Yo Y demand thus ADH

In presence of T ,

7- It CCY -
F) + Itirt G-

CF
Egm Y It It G-
¥c)r
= _

, +
1- C

→
If i is
higher ,
IS curve is flatter
(than before ) change
An increase
in
in
investment .
r
,
leads to
higher
r

If AS 1=414 ,
ADH for eqm
8, -
so Icr ) t so r↑ .

\ but
←
if i is
higher the

;↑
" "
"

'
increase in r
required to
1s reduce AD to eqm level is
, is
lower .

Y←% Y
→
If c↑ ,
IS is
flatter
If 84 (from rotor , )
AD ↑ so Y G- As )
8. --
•
- -

,
- - -

needs to increase
'

,
.

is
higher
r, - - - - - -

r
- - - -
i - - - - . . _ . .
.
When c increase in
' ,
'

, I i. IS
AD is more (
than
before) .

I 1 I is
Hence Y f- As) needs to be
,
increased for eqm ( than
i. i.
,
more

Yo Yi Yi before)

Money Market
Transactions demand
pqd
Precautionary demand
Money
demand speculative demand ( Money as an asset )

→
Money is an asset
→
Money is
very liquid
.
[ Liquidity : ease
of conversion

↳ most
into other assets )

1 I 1 I >

Money Gold Real Pension account (for someone young )

Estate

decreasing liquidity →
.

interest llr ) l Cr ) < 0

'
→
Money earns no .
→
,

Portfolio Choice Problem ( Simplified ) :

Money Higher interest rate

the
higher is
→
Two Assets < Bonds the
,

opportunity
and
cost
of holding
is held
money less
.
money as

asset .
 For
Keynesian Money Demand

Mᵈ= kPYt llr ) K 0 >

,
'
l Crs < 0

↳ transactional demand ,

Ms =

speculative demand

r
At eqm
Mˢ=M-
:

-_nµd
T -
MT =
KPY 1- Llr )

r* - -

T : More lenders than

borrowers 84
I -
,

I : More borrowers than

lenders
Ñ
pqd.ms r↑ ,

LM Curve
( ri Y )
locus of all such that keep the money market
in equilibrium .

LM eqn :

llr )
¥ =
KY +
- -

( actually LIT ) / p )
Total differential :

0= KAY
'
+ l Cr) dr

%/ *
=
¥ > 0
 r

[
↑ dmd ↑
LM( MT ) Money .

,
so

ri - - -
- - -

inzlmz )
- - - -
- -
-

more borrowers than lenders

;
✗g - - - - n - n - n

'

:
r↑ .

¥ ,
{
.
AT ↑ Mˢ↑ so
% Y, more lenders than borrowers
Y
rate of interest rly .

the K, steeper
Higher the LM
-

r
1^92
k> 0
,
Md > O
,

M LM ,
q•
- - - ^ -
- - - - - - - -

•↑
.

"
to
bring the
speculative
demand
1

v. - - - - - - -
-

-9 I money eqm down

for
,;
.
,

;
Yo ¥ , y

More sensitive the llr ) f

"
lie ;
to r the
higher
-

Il Cr) 1)
'
is flatter the ,
LM curve .

LM ,
Y↑ Md ↑
T LMz but since for the same

i
V. change in r ,
now

F- speculative
- - - - - - -
"

dmd
- - - -

changes more ,
.

I r needs to
change less to
i establish
eqrh .

Yo Y, y
 IS :
y= Italy F) - 1- Icr ) 1- G- I' < 0

LM
1¥ kytllr ) K> 0, l 's o
: =

r
LM

r* - - - - - - - - - - - -
-9
:

I. IS

i.
't
Y Y
Fiscal Govt
policy strategy
:
revenue
-

r
LM
n n - n - r - -
- - - - -
*
§ ↑ Y↑ , 8T
,

r* - - - - - - - - - - - -
-9 1 '

! 1
IS

i. ! Is

't
Y Y
r
LM ☒ ↑
'
Y↑ , rly
LM
r* - - - - - - - - - - - -
-9
: &
'
I
.

IS
¥ ¥ .

't
Y Y
 7¥ / is .im
<
3¥ / skin
w

Simple Keynesian
Model .

G- ↑ through 41^7
multiplier
←y
-

mechanism
, ,

↓ Mᵈt↑
Y↓ r↑ I
-
Two opposing
this
, , ,

- forces but
out mechanism
crowding wins .

Monetary Policy
-
-
-
-
r -
LM ↑ Y↑ , riv !
.

' '
LM -
-
-
- -

r*
-
- - -

- - - - - - - - - - - -
-9
: &
'
I
.

Is
! !
i. :
't
Y Y

☒↑ I ↑,
,
v4
, Y↑,M↑,r↑ , 44

Initial rise in 4 wins .

 IS -1M
Multiplier :

Y =
Italy F) _ + I -
ir + G-
Is c- c) Ytir =
G- t E- et

lr
tf
LM KY -
=

- assuming linear .

C- c)
¥, ¥- i¥; 3¥
☒ + = =
'

¥, k¥§ %÷
im -
=
°

I
;÷÷,=_ei÷i
=

Govt Exp
2¥ / @-c¥§
.

→
= > 0
[ say Multiplier

1¥ / say =
¥

Y-oihs.im <
2¥ / skin
Higher the k , steeper the LM curve
-

fiscal policy is
less effective
Higher k ,
lower multiplier .

V LM 1 higher to
LM

iii.'

\
i

it
'
is
'

I l
Is
I 1 !

Higher l , higher the multiplier , LM -

curve is flatter .

fiscal policy is more effective .

Higher C,
higher the multiplier , fiscal policy more effective .

Balanced
Budget Multiplier
dÉ=dF
→
C- c) DY + idr = d G- _
cdt =
C- c) dci
KDY -
ldr =
0

T¥ / +(÷
> °
=

is un , BBM
-
 }
CRR : Cash Reserve Ratio
Central banks like RBI
SLR : liquidity Ratio
'
LM
LM

H '
I IS

H
y*y*
¥
During lockdown (Covid Crisis)

Is
c- c) Y tir =
G- + I + I -
at

LM KY er Ñ/

P-gnormaliudtot.CI
-
=

-
c) dyt idr = 0

RDY -
ldr = DAY
1 : Iet
¥-9 r+¥1 > °
= =
1-

I 'ñ :L i
r

1M As I → ✗ 27 → 0
Jm
'
LM

ro → Even a small
fall in rate of interest
i
- - - - -
- - -

r
,
- - - - - - -

i i
-
causes people to increase the
amount
of money they hold by
i i
a
1 1
IS
I 1 lot .

I 1

I i. Renders monetary policy ineffective

% 71 Y

Labor Market (Blanchard ,

-
0
ch >
.

)
Non institutional civilian
population of working ( 16-60 yrs)
age
- -

available to work at
any point of time
↳
.

-
labour force : sum
of people who are either currently working
or
actively looking for jobs
rate Labour Force
Participation
-

LF =

Non institutional
-

population
↳ US women , 43rd to 43rd from 1960s to now
↳
US men stable at about ,
85 -

95%
↳ India men , about 90% t .

↳ India women , declined in the last 30 years .

↳
Female LF participation rate follows a trend like :

FLFPR

\
GO -

Urban

/ Rural

I to 11 Years of Edncat
"
 Unemployment Rate =
Looking for work
Labor Force

Quits
/
Separations
° Flows into & out of employment Layoffs
Hives

◦ Duration
of unemployment
◦
Sometimes, decline due unemployed
unemployment rate
might to

people getting discouraged and not wanting to work

anymore
.

Employment Rate No of employed

• = -

Non institutional
population
Determination :
age
→

Perfectly Competitive Model : -

Free entry ,
exit
Everybody has knowledge of
-

wages
All workers
employers are
-

homogeneous .

→ Due to homogeneity , there is no room for bargaining

for employers workers
or .

→ However ,
in organised sectors , trade unions can

negotiate the rates ( collective Bargaining )

wage
.

Gains to
TV

- - - - • - - - - - - r .

!
Employer
 Wage Determination
The classical model method works situations
poorly in
-

very
with a large employing firm I like MCD ,
Taco Bell ,
etc
-

) .

Collective
Bargaining
ITE
Efficient frontier ( otherwise
&
-
the
employer
#
worker
in , ,
, ,
,
go separate)
and
what the
employer
% →
worker can achieve together
ITÉ %
optimality ( made
- -
- ^ . .
- -

Pareto
- - - -

be
.

Morone can

↓ i better

outside Tuf Tw Off without

other one
option
getting worse
◦
A)
Share of the surplus gets is increasing in her outside
-

one

option

Efficiency Wages :

Some firms make

overpay the workers so as to quitting
difficult .
In this time ,
workers undergo training & become
useful for the firm .
?⃝
 W =
PeF( up)
1
↳
↓ ↓ everything else
(min wages NREGA etc)
nominal
wage expected unemployment ,

Price level rate

JI < 0
JU

-
Price expectation imp :

Price exp - ↑ w ↑ → Product " cost ↑ Prices actually

rise

Inflation

Simple Production Fn
output →
labour
←
✗ = [
[ 1=4 ]
'

cost ← C =
WY :

↳ wage

Mo
2¥
= =
w

↓
Marginal
cost
In perfect eqm ( perfect competition)
, ,
MC = price
→ As market Power ↑ , price ↑
There is market power (monopoly power )
→
some
usually in
Price
macroeconomics .
So p > MC .

Price -

Setting :

P= ( Itm) W
↳ markup , m > 0
 Real wage if ¥m
( Price setting )
: =
→ ps

Higher them ,
lower is the real wage .

Wage setting :

P :P )
PFIU 2) / Assuming
W= ,
,

3¥ < 0

Higher the
unemployment rate lower are ,
the outside option .

lower
leverage for collective bargaining .

Flu ,z) WS ( wage setting)

if
= -
-

¥ there
→ Now , is involuntary
11µm't unemployment because
E pslm
'
,
m
'
< m ) of the deviation from
perfectly competitive
i
I pslm )
i i. (introduction
Hm
1 ! Ws
market
monopoly power)
of
i. !
u
'
wit u
natural rate of
}
↳
anything not equal to this can
unemployment be due business cycle fluctuations

losses ,
→
Monopolies lead to dead weight worse
for economy .

( Relative to perfect competition : lower output , higher prices)

Some
degree of monopoly power inevitable because huge
→ is

industries cannot be owned by lot of people .

Two
huge firms collude to keep the market
→
three can prices
-

high . ( High monopoly power, bad for economy)

 ¥

i÷m .

' l
Pslm )
Higher unemployment benefits
'
I was →

I
,
I WS
(changes 2) real same
wages
.

,
, ,
↳ motivate
u* u*
'

w May people to
stay
unemployed .

Trends in Inflation and unemployment

Phillips found negative relationship b/winflation and
unemployment rate ( till 1969 ) .
Policymakers try to use
this to decrease
unemployment levels .

•
However from > 0s negative relationship had vanished
,
the .

◦
However the
relationship between change in inflation and
the
unemployment rate was still found to be negative .

Phillips curve
understand the facts
Conceptual Framework to
-

-
W= Pe Flu ,z) - (Ws )
P= ( Itm) W ( Ps)
-

Assume Flu ,z) = 1- ✗ Utz ✗ 70

From ( WS) , ( PS) and above assumption

,
:

F- ( Itm) pe Fluid

p =
pelltm) ( 1- ✗ utz) -
 ④ holds at
any point in time , say t .

So write
,
we
may

Pt =
Pte / Itm) ( 1- ✗ Utz)

Dividing both sides by Pti

Pt =
Pt ( Itm) / 1- ✗ Utz) -
(D)
Ft -1 E--1
But Ptt Pt Ptt
1¥ Pt_p
= -

i
-
= It

Pt Inflation
inyear
,
I
g
-

=
It It

Similarly Pee =
It 1T¥
E--1
So (D) implies

(11-117) =
( Ittf ) ( Itm) ( I -
✗ Uttz )

Ctl =
I -
✗
4++2
(1+11-+9) ( Itm)
approximal"( it -
it ; -
m = I -
✗ Ut +2
> ,

It =
1T£ t @ 1- Z) -
✗ Ut
↳ The equation of Phillips curve

Inflation is affected by what

people expect inflation to be

How do people form expectation ?

-

Scenario t :
People may think inflation fluctuates around a
long
term average .

Scenario 2 :
Inflation tomorrow depends lively) on inflation today
 1T£ =
(1-0) E 1- 0-14--1
✓ where 0 E [ 0,1]
long term
average

If -0=0 we are in scenario I ,

so 1T¥ = It
,

Then Phillips equation boils down to

-

It = I t lmtz ) -
✗ ut
↳
changing this change
can

→ Reasonable model for inflationary expectations inflation .

until the 1960s in the US .

IT As the tried to
policymakers
-

reduce
unemployment rate
by increasing inflation
through 1960s , people
started expecting a higher
inflation rate in the

future They.
also realised that

u today's inflation rate would

positively affect tomorrow 's

inflation rate .

fshift from -

scenario 1 to scenario 2)
0=0 → 0=1
The
expectations augmented Phillips curve

1T£ -

1T£ = ( mtz) -

✗ Ut ,
✗ so

1T£-1
=

Tt Tt - = fmtz) -
✗
ut
-
,

Natural rate of unemployment un denotes as the rate

of unemployment that does not
change the inflation
rate .

0 =
Cmtz) -
✗
Un

un = MI → NAIRU
✗
Non -
accelerating Inflation
so
Rate of Unemployment
,

Tt ite =
✗ ( ut )
m
- - -

Tt -

Tt -1
= -
✗ ( Ut -

Un )

IT
↑ inflation rate to reduce

¥
"

-
'
- . unemployment "
but then inflationary expect
,

;
→

l
of people changes which ,

I 1 shifts the curve thus ,

I
'
i
1
increasing the unemployment
rate
< ,
, along with the

Unreduced Un w
higher inflation rate .

→
So , if with time u →
Un ,
we have to change Miz or ✗
to reduce
unemployment rate .
Economic Decision
Making :

If r is real interest rate

T◦dayylYv2#
/
l°°l°°lHrᵗ
¥42 ¥+4,
100

Machine costs 1000

→
get 80
per yr for
15 yrs
.

value
get 80
[ It
#
+ +
¥r, ]
-

we
- - -

,,

"Y¥÷
=

Buy machine if lost

today < Profit predicted
Present discounted
value
PDV forever
of 8012s . each yr .

80
[It ,¥, t
]
= -
- - -

80/11-1-1
"
81
8¥
= =
=

"
Eri
 Higher the r
,
lower is PDV .

→
However , if there is uncertainty ( which there is , practically) ,

it cannot be taken as constant .

PDV in uncertain real world :

( Hr,¥iHrj)+ ]
801 It 1-
Hr
+ 1-
Ctrillltr;)
+ -
- "