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So far…
Topic
Textbook
chapters
I. INTRODUCTION TO ECONOMICS
A. What is Economics? Scarcity and choice
B. Supply, demand and market equilibrium
1, 1A, 2
3, 4
II. INTRODUCTION TO MACROECONOMICS
A. Overview
B. Measurement of key macroeconomic variables
5
6, 7
Big picture of the following units…
core of macroeconomic theory
Topic
III. MACROECOMIC EQUILIBRIUM IN A FIXED PRICE MODEL:
SORT-RUN ANALYSIS
A. The goods market
B. The money market
C. The goods and money markets together (The IS-LM model)
IV. MACROECOMIC EQUILIBRIUM IN A FLEXIBLE PRICE
MODEL: LONG-RUN ANALYSIS
A. Determination of the price level (The AS-AD model)
B. Labor Market
Textbook
chapters
8, 8A, 9, 9A
10, 11
12
13
14
We will start by understanding the goods market:
- Define concepts:
Income, disposable income, savings.
- Describe the components of the demand and their behavior:
Investment, government expenditure and consumption.
- Goods market equilibrium:
Understand how the equilibrium is determined and the
economic forces involved in a basic macroeconomic model.
- Change in equilibrium when an exogenous variable change its
value.
- Government finances and fiscal policies:
Government budget and debt.
Automatic stabilizers and counter/pro/a cyclical fiscal policies.
Aggregate output/Aggregate income/Real GDP
• Remember that Aggregate output/Aggregate income/Real
GDP are different approaches towards measuring the
same thing!
Y  C  I  G  EX  IM 
This course will
focus on a closed
economy set up.
Y  C  I G
components of the demand
Y  salaries  propietors ' income  ...
income categories
n
Y   pi qi
i 1
total value of goods and
services produced
There is no agent
behavior in these
equations;
they are just definitions!
Disposable income
• disposable income ≡ income – taxes
Y  Y T
d
There is no agent
behavior in this equation,
it is just a definition!
Savings
• Savings ≡ disposable income – consumption
S Yd C
There is no agent
behavior in this equation,
it is just a definition!
Components of the demand
• Investment: Purchases by firms of new buildings and
equipment and additions to inventories, all of which add
to firms’ capital stock.
- Investment (economic meaning ) ≠ Investment (financial meaning)
- For simplicity we will
assume (so far) that
I is exogenously given.
There is no agent behavior
in this component;
I is equal to some constant.
• Government expenditure:
Government expenditure (as % of GDP)
35
30
25
20
15
10
5
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
0
Denmark
Norway
Spain
Sweden
United Kingdom
- G is under the control of the government.
Moreover we will assume that such
expenditure is totally discretionary and
there is no particular behavior.
United States
There is no agent
behavior in this
component;
G is equal to
some constant.
• Consumption:
- In the General Theory, Keynes argued that the amount of
consumption undertaken by a household is directed related
to its consumption.
household
consumption
ii) curvature
i) autonomous consumption
household
income
- For simplicity we will assume that there is a linear relationship
between consumption and income (when is an assumption a
good assumption?) :
C  a  bY d  a  bY  T 
household
consumption
(C)
Marginal
propensity to =
consume
slope 
C
b
Y
∆C
∆Yd
a
household
disposable
income
(Yd)
This is a behavior
equation; it specifies
how consumption
depends on income!
Examples:
#1 (calculate mpc based on consumption equation)
C  100  0.75Y d
mpc=0.75
#2 (calculate mpc based on consumption/disposable income table)
Y
∆Yd=100
d
0
100
200
300
400
500
600
C
80
170
260
350
440
530
620
∆C=90
mpc 
C 90

 0.9
Y 100
- More on mpc…......the marginal propensity to save
Marginal propensity to consume (mpc):
fraction of a change in disposable income that is consumed.
Marginal propensity to save (mps):
fraction of a change in disposable income that is saved.
Property:
mpc + mps = 1
Proof:
Y d  C  S
Y d
C
S


Y d Y d Y d
1  mpc  mps
Goods market equilibrium
• Review:
How to obtain the equilibrium in the beef market?
pbeef
p s  a  bq
S
p d  c  dq
• Remember:
(p,q) are endogenous variables
• Equilibrium condition:
D
qbeef
p s  p d  p eq
q s  q d  q eq
• Equilibrium solution:
q eq 
ca
bd
p eq  a  b
ca
bd
• Goods market equilibrium
Y  C  I G
C  a  bY  T 
Endogenous and exogenous variables:
-Y and C are the endogenous variables (their values are
defined within the model)
- I, G and T are exogenous variables (their values are NOT
defined within the model. Their values are given)
- a and b are parameters (a refers to the autonomous
consumption and b to the marginal propensity to consume)
Equilibrium condition
Equilibrium solution
Example
Y  C  I G
C  a  bY  T 
a  100
b  0.8
I  50
G  40
T  40
Y eq  790
C eq  700
Change in equilibrium when an exogenous
variable value change
•
•
Y
 Government spending multiplier
G
Y
 Investment multiplier
I
Y
 Tax multiplier
G
Y Y

 balanced  budget multiplier
G T G  T
i) understand of transmission mechanism
ii) importance of mpc
iii) examples
Government finances and fiscal policy
• Government budget and debt:
- Government budget (surplus/ deficit)
US Federal Government Receipts and Expenditures, 2004 (Billions of Dollars)
AMOUNT
Receipts
Personal income taxes
Excise taxes and custom duties
Corporate income taxes
Taxes from the rest of the world
Contributions for social insurance
Interest receipts and rents and royalties
Current transfer receipts from business and persons
Current surplus of government enterprises
Total
Current Expenditures
Consumption expenditures
Transfer payments to persons
Transfer payments to the rest of the world
Grants-in-aid to state and local governments
Interest payments
Subsidies
Total
801.8
94.0
217.4
9.2
802.5
21.9
28.6
− 0.5
1,974.8
40.6
4.8
11.0
0.5
40.6
1.1
1.4
0.0
100.0
725.7
1,014.0
28.9
348.3
221.5
43.0
2,381.3
30.5
42.6
1.2
14.6
9.3
1.8
100.0
Net federal government saving—surplus (+) or deficit (−)
(total current receipts − total current expenditures)
PERCENTAGE
OF TOTAL
− 406.5
US Federal Government Surplus (+) or Deficit (−) as a Percentage of GDP,
1970 I–2005 II
- Government debt
The total amount owed by the federal government.
The Federal Government Debt as a Percentage of GDP,
1970 I–2005 II
• Automatic stabilizers and cyclicality of fiscal policies
- Counter/pro cyclical fiscal policies:
Acyclical fiscal policy occurs when fiscal policy is
independent of output fluctuations. E.g. constant pattern
of government expenditure.
Countercyclical fiscal policies tend to smooth output
fluctuations. E.g. decrease government expenditure during
booms and increase it during recessions. (Most developed
countries pursue this policy)
Procyclical fiscal policies tend to aggravate output
fluctuations. E.g. decrease government expenditure during
booms and increase it during recessions. (Most emerging and
developing countries pursue this policy)
- Automatic stabilizers:
Revenue and expenditure items in the government
budget that automatically change with the state of
the economy in such a way as to stabilize GDP.