1 / 130

ECO 120- Macroeconomics

ECO 120- Macroeconomics. Weekend School #1 21 st April 2007 Lecturer: Rod Duncan Previous version of notes: PK Basu. Topics for discussion. Module 1- macroeconomic variables Module 2 - basic macroeconomic models Module 3 - savings and investment What will not be discussed

Download Presentation

ECO 120- Macroeconomics

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. ECO 120- Macroeconomics Weekend School #1 21st April 2007 Lecturer: Rod Duncan Previous version of notes: PK Basu

  2. Topics for discussion • Module 1- macroeconomic variables • Module 2- basic macroeconomic models • Module 3- savings and investment • What will not be discussed • Answers to Assignment #1 (use the CSU forum for this)

  3. Microeconomics- the study of individual decision-making “Should I go to college or find a job?” “Should I rob this bank?” “Why are there so many brands of margarine?” Macroeconomics- the study of the behaviour of large-scale economic variables “What determines output in an economy?” “What happens when the interest rate rises?” Forms of economics

  4. Economics as story-telling • In a story, we have X happens, then Y happens, then Z happens. • In an economic story or model, we have X happens which causes Y to happen which causes Z to happen. • There is still a sequence and a flow of events, but the causation is stricter in the economic story-telling.

  5. Kobe, the naughty dog

  6. Modelling Kobe • Kobe likes to unmake the bed. • Kobe likes treats. • We assume that more treats will lead to fewer unmade beds. (Not a very good) Model: Treats↑ → Unmaking the bed↓ • We can use this model to explain the past or to predict the future.

  7. Elements of a good story • All stories have three parts • Beginning- description of how things are initially- the initial equilibrium. • Middle- we have a shock to the system, and we have some process to get us to a new equilibrium. • End- description of how things are at the new final equilibrium- the story stops. • “Equilibrium”- a system at rest.

  8. Timeframes in economics • In economics we also talk in terms of three timeframes: • “short run”- the period just after a shock has occurred where a temporary equilibrium holds. • “medium run”- the period during which some process is pushing the economy to a new long run equilibrium. • “long run”- the economy is now in a permanent equilibrium and stays there until a new shock occurs. • You have to have a solid understanding of the equilibrium and the dynamic process of a model.

  9. What are the big questions? • What drives people to study macroeconomics? They want solutions to problems such as: • Can we avoid fluctuations in the economy? • Why do we have inflation? • Can we lower the unemployment rate? • How can we manage interest rates? • Is the foreign trade deficit a problem? • [How can we make the economy grow faster?] Not taken up in this class. This class focuses on short-run problems.

  10. Economic output • Gross domestic product- The total market value of all final goods and services produced in a period (usually the year). • “Market value”- so we use the prices in markets to value things • “Final”- we only value goods in their final form (so we don’t count sales of milk to cheese-makers) • “Goods and services”- both count as output

  11. Measuring GDP • Are we 40 times (655/16) better off than our grandparents? • Australian GDP in 1960- $15.6 billion • Australian GDP in 2000- $655.6 billion • What are we forgetting to adjust for?

  12. Measuring GDP • Population- Australia’s population was 10 million in 1960 and 19 million in 2000. • GDP per person in 1960 = $15.6 bn / 10m = $1,560 • GDP per person in 2000 = $655.6 bn / 19m = $34,500 • Prices- $1,000 in 1960 bought a better life-style than $1,000 in 2000.

  13. Nominal versus real GDP • So how to correct for rising prices over time? • Measure average prices over time (GDP deflator, Consumer Price Index, Producer Price Index, etc) • Deflate nominal GDP by the average level of prices to find real GDP Real GDP = Nominal GDP / GDP Deflator

  14. Nominal versus real GDP • We use prices to value output in calculating GDP, but prices change all the time. And over time, the average level of prices generally has risen (inflation). • Nominal GDP: value of output at current prices • Real GDP: value of output at some fixed set of prices

  15. Some Australian economic history

  16. Business cycle • The economy goes through fluctuations over time. This movement over time is called the “business cycle”. • Recession: The time over which the economy is shrinking or growing slower than trend • Recovery: The time over which the economy is growing more quickly than trend • Peak: A temporary maximum in economic activity • Trough: A temporary minimum in economic activity.

  17. Australian business cycle

  18. Unemployment • To be officially counted as “unemployed”, you must: • Not currently have a job; and • Be actively looking for a job • “Labour force”- the number of people employed plus those unemployed • “Unemployment rate” • (Number of unemployed)/(Labour force)

  19. Unemployment • Working age population = Labour force + Not in labour force • Labour force = Employed + Unemployed

  20. Unemployment

  21. Inflation • Inflation is the rate of growth of the average price level over time. • But how do we arrive at an “average price level”? • The Consumer Price Index surveys consumers and derives an average level of prices based on the importance of goods for consumers, ie. a change in the price of housing matters a lot, but a change in the price of Tim Tams does not.

  22. Consumer Price Index • Then the CPI expresses average prices each year relative to a reference year, which is a CPI of 100. CPIt = (Average prices in year t)/(Average prices in reference year) x 100 • Inflation can then be measured as the growth in CPI from the year before: • Inflationt = (CPIt – CPIt-1) / CPIt-1

  23. Inflation

  24. Calculating GDP • Gross domestic product- The total market value of all final goods and services produced in a period (usually the year). • Alternates methods of calculating GDP • Income approach: add up the incomes of all members of the economy • Value-added approach: add up the value added to goods at each stage of production • Expenditure approach: add up the total spent by all members of the economy • The expenditure approach forms the basis of the AD-AS model.

  25. Expenditure approach • GDP is calculated as the sum of: • Consumption expenditure by households (C) • Investment expenditures by businesses (I) • Government purchases of goods and services (G) • Net spending on exports (Exports – Imports) (NX) Aggregate Expenditure: AE = C + I + G + NX

  26. Consumption and savings • We assume consumption (C) depends on household’s disposable income: • Disposable income YD = (Income – Taxes) • The consumption function shows how C changes as YD changes. • Household savings (S) is the remainder of disposable income after consumption. • The savings function shows how S changes as YD changes.

  27. Properties of a consumption function • What assumptions are we going to make about aggregate consumption of goods and services in an economy? • An aggregate consumption function is simply adding up all consumption functions of all individuals in society. • If personal income is 0, people consume a positive amount, through using up savings, borrowing from others, etc, so C(0) should be greater than 0. • As personal income rises, people spend more, so the slope of C(Y) should be positive.

  28. Consumption function • Consumption is a function of YD or C = C(YD). We assume that this relationship takes a linear (straight-line) form C = a + b YD where a is C when YD is zero and b is the proportion of each new dollar of YD that is consumed. • We assume that C is increasing in YD, so 0 < b < 1.

  29. A linear consumption function • C(Y) = a + b Y, a > 0 and b > 0 C(Y) C(0) = a, so even if Y=0, C > 0. Slope is b > 0, so C is increasing in Y. a Y

  30. Graphing a function in Excel • This subject use a lot of “quantitative data” (which means lists of numbers measuring things). • Students will need to develop their quantitative skills- • Graphing data • Using data to support an argument • Modelling in Excel • We will be using Excel during this subject. You must become familiar with Excel.

  31. Savings function • Household savings is a function of YD or S = S(YD). We assume S = c + d YD where c is S when YD is zero and d is the proportion of each new dollar of YD that is saved. • We assume that S is increasing in YD, so 0 < d < 1. • But also households must either consume or save their income, so C + S = YD. This can only be true if c = -a and b +d = 1.

  32. More terms • Average Propensity to Consume (APC) is consumption as a fraction of YD: APC = C / YD • Average Propensity to Save (APS) is savings as a fraction of YD: APS = S / YD • Since all disposable income is either consumed or saved, we have: APC + APS = 1

  33. More terms • Marginal Propensity to Consume (MPC) is the change in consumption as YD changes: MPC = (Change in C) / (Change in YD) • Marginal Propensity to Save (APS) is the change in savings as YD changes: MPS = (Change in S) / (Change in YD) • For our linear consumption and savings functions, MPC = b and MPS = d. If YD changes, then consumption and savings must change to use up all the change in YD , so MPC + MPS = 1.

  34. Graphing the functions • When YD = 0, C + S = 0, so at point A, the intercept terms are both just below 2 and of opposite sign. • The 45 degree line in the top graph shows the level of YD. At point D, C is equal to YD, so S = 0. • MPC = 0.75 is the slope of the C function. • MPS = 0.25 is the slope of the S function.

  35. What else determines C? • Household consumption will also depend on: • Household wealth • Average price level of goods and services • Expectations about the future • Changes in these factors will produce a shift of the whole C and S functions.

  36. Shifts of C and S functions • A rise in household wealth will increase C for every level of YD, so C shifts up. • A rise in average prices will lower the real wealth of households and so lower C for every level of YD, so C shifts down.

  37. Example: Alice and Sam • Question: Alice and Sam are a typical two-income couple who live for ballroom dancing. Their combined salaries come to $1,400 per week after tax. They spend: • $300 per week on rent, • $300 per week on car payments, • $200 per week on ballroom dancing functions and • $200 per week on everything else. • (a) Calculate their APC, APS, MPC and MPS.

  38. Example: Alice and Sam • Sam injures his back and is forced to take a lighter work-load, so their combined incomes drop to $1,000 per week. Due to the back injury, Alice and Sam are forced to stop their ballroom dancing, however their spending in the ‘everything else’ category rises to $300. • (b) Calculate their APC, APS, MPC and MPS. Create graphs to show this information.

  39. Consumption function • The consumption function relates the level of private household consumption of goods and services (C) to the level of aggregate income (Y). • We can represent the consumption function in three different and equivalent ways. • An mathematical equation • A graph • A table • For example the consumption function could be: • C = $100bn + 0.5Y

  40. Consumption function • We can represent this same function with a graph. C C(Y) = $100bn + 0.5Y $150bn Slope is 0.5 $100bn The MPC is 0.5 Y $100bn

  41. Consumption function • Or we can represent the same function with a table. • Three ways of represent-ing the same function.

  42. Exogenous variables • Exogenous variables are variables in a model that are determined “outside” the model itself, so they appear as constants. • For the aggregate expenditure model, we treat as exogenous: • Investment (I) • Government consumption (G) • Taxes (T) • Net Exports (NX)

  43. Aggregate expenditure • In a closed (no foreign trade) economy: AE = C(Y) + I + G • In an open economy: AE = C(Y) + I + G + NX • Changes in a or the exogenous variables (I, G, T or NX) will shift the AE curve. A change in b will tilt the AE curve. • Equilibrium occurs when goods supply, Y, is equal to goods demand, AE.

  44. Two sector model • Aggregate expenditure (AE) in the two sector model is composed of consumption (C) and investment (I). AE = C + I • In this model, we treat I as exogenous, so it is a constant. • Let’s use the same simple linear consumption function: C = 100 + 0.5Y I = 100 AE = C + I = 100 + 0.5Y + 100 = 200 + 0.5Y

  45. Aggregate expenditure function • This equation is a relationship between income (Y) and aggregate expenditure (AE). AE = 200 + 0.5Y $250bn Slope is 0.5 $200bn Y $100bn

  46. Aggregate expenditure function • But we could also use the table form.

  47. Equilibrium in two sector model • Equilibrium in a model is a situation of “balance”. In our AE model, equilibrium requires that demand for goods (AE) is equal to supply of goods (Y). Y = AE = C + I • For the equilibrium we are looking for the value of GDP, Y*, such that goods demand and goods supply are equal. • In our two sector AE model that means that we can look up our AE table and find where AE = Y. • The equilibrium value of Y will be our prediction of GDP for our AE model.

  48. Equilibrium • The equilibrium value of GDP is $400bn.

  49. Equilibrium • We could accomplish the same by using our graph of the AE function. • The AE line shows us the level of goods demand for each value of Y. • The 45 degree line represents the value of Y or supply of goods. • Equilibrium will occur when the 45 degree line and the AE line cross. At the crossing, goods demand is equal to goods supply for that level of Y.

  50. Equilibrium • The equilibrium value of Y is where the 45 degree line and the AE line cross. Y* is at $400bn. Y AE = 200 + 0.5Y 400 Y 400

More Related