Transcript Elements of Macroeconomics

Elements of Macroeconomics
Econ 10
Holmes
Micro: Trees
Pizza
Optimal prices, quantity
Eq. Price, quantity
Costs
etc.
Macro: Forest
How does our economy as a whole perform?
Some major issues
Unemployment: people who want to work but can’t
Inflation: increase in overall price level
Recession: decrease in value of produced goods
Gross Domestic Product: how much do we-as an economy-make?
Savings Rate: How well do we save our income
Interest rate: how to stabilize economy
Trade deficit: how much are we sending overseas?
Stocks, bonds, investment….
Micro focussed on individual agents (or markets).
Macro focuses on the performance of the economy in
aggregate.
A Caution
Throughout macro lessons, we will often use micro as
a motivation/analogy for macro issues. Recall,
however, that we are dealing with society-wide
analysis.
GDP
Gross Domestic Product: the total value of all final goods and
services produced in a given year
We get by adding up everything that was produced in the US
Some issues:
1. Market activity only (no home production)
2. No leisure
3. Bads and goods
4. No ecological costs
Suppose my neighbor and I mow our own lawns. In GDP?
Suppose we pay each other to mow our lawns. In GDP?
No double counting
Good Price Value added
Tree
$20
$20
Wood $35
$15
2 x 4's $50
$15
Deck $150
$100
$150
Note that we either
a. count the value of
final goods and
services or
b. add up the value
added at each stage
GDP for this good is $150, not $20+$35+$50+$150
Big Idea
GDP is both
a. the value of final goods and services produced in a year
b. the income of society (wages+salaries+profits+rents+dividends…)
Why? Think back to our deck example.
Good
Tree
Wood
2 x 4's
Deck
Price Value added
$20
$20
$35
$15
$50
$15
$150
$100
$150
owner of tree
to stockholders of weyerhauser
to guy who rented us the saw
labor for installation
Simple Model
What’s a government?
Closed economy (no foreign trade)
No banking system
Circular view of economy
(A variant of Figure 24-1, page 567)
C
S
D
Consumers
Y (income)
I
Firms
Y (production)
Definitions
S
Consumers
Y (income)
I
Note S includes
C
•savings
•stocks
D
•bonds
Firms
•gold*
Y (production) •real estate*
•anything to store value.
Y= GDP or income
C=Consumption (purchases by consumers on goods and services)
S=Savings (any income not consumed)
I=Investment (purchases by firms of capital)
D=Expenditures (demand for goods and services)
Examples
C
S
D
Consumers
Y (income)
I
Firms
Y
I buy a hamburger. (C)
I buy a painting to look
at (C).
I buy a Van Gogh b/c it
will be worth more (S).
I buy IBM stock (S).
Pizza Hut buys a pizza oven (I).
I buy a computer to surf the web (C).
I buy a computer for my consulting company (I).
Not as easy as you might think….
Check/PP
Define inflation, unemployment, recession.
Define Y, C, I, S, D.
What account (C,I,S) is it if I buy a CD and …
…I listen to the compact disc at home
…I use the data on the compact disc at work
…I earn 5% on my Certificate of Deposit.
Which of the following are in GDP?
I clean my house. I pay someone to clean my house.
I pay someone to clean my rugs after a hurricane. I clean my
house faster so I can watch TV.
Equilibrium
C
S
D
Consumers
Y (income)
I
Firms
Y
Suppose DY. Is the economy
in eq?
Answer: No. Compare value of
goods demanded and value of
goods produced.
How to equilibrate?
How to equilibrate?
Where does Y come in?
Where does D come out?
Best Buy
Y That’s a great idea!
D
D>Y
If more are bought in a day than
come in, where does BB get the
TV’s?
Best Buy
That’s a great idea!
Y=$100
D=$150
Answer: inventories. Inventories fall by $50.
D<Y
If less are bought in a day than
come in, where does BB put the
TV’s?
Best Buy
That’s a great idea!
Y=$200
D=$125
Inventories rise by $75.
Some equations
Y  D (in equilibriu m)
Y CS
DCI
C
C  C (Y , C A ) 0 
1
Y
I
I  I (Y , I A ) 0 
Y
What do these mean?
Y  D (in equilibriu m)
Y CS
DCI
C
1
Y
I
I  I (Y , I A ) 0 
Y
C  C (Y , C A ) 0 
Income= consumption + savings
(you do one or the other with your check)
Expenditure=consumption + investment
(that’s who buys stuff)
Consumption is determined by two things:
1. How much income society has
2. Stuff other than income
Furthermore, as income goes up by $1, C
increases between $0 and $1.
What do these mean?
Part II
Y  D (in equilibriu m)
Y CS
C/ Y is marginal propensity to consume.
S/ Y is marginal propensity to save.
I/ Y is marginal propensity to invest.
DCI
What kinds of things are in CA?
C
C  C (Y , C A ) 0 
 1 •Christmas
Y
•Summer vacations
I
•Overall confidence
I  I (Y , I A ) 0 
•Tastes, etc.
Y
Micro/Macro analogies
• As you get more wage
income, you spend
some of it and save
some of it
• As your business gets
more income, you
probably expand
• As society earns more,
it will consume some
and save some
• As firms produce
more, they must invest
more
Note that...
Y CS
Y  C  S
Y C S


Y Y Y
C S
1

Y Y
Sample
Suppose C/ Y=.6, I/ Y=.2
Y
100
200
300
C
60
120
180
S
40
80
120
D
120
200
280
I
60
80
100
Y=C+S, so 100=60+? S=40. D=C+I==>D=120.
Are we in equilibrium? No. D>Y. (inventories?)
As Y increases by 100, what happens to C?
C/ Y = .6, so C=100*.6 = 60. C increases by 60 to 120.
S must be 80, then. I/ Y = .2, so I=100*.2 = 20. D = 80+120.
Do again for Y=300.
Sample, cont.
Y
100
200
300
C
60
120
180
S
40
80
120
D
120
200
280
I
60
80
100
So the final equilibrium must be Y=D=200.
Note we could have figured S by using S/ Y=1- C/ Y=.4
What if we had an autonomous increase in S? say SA=20.
Old one
Autonomous effect
Y
100
200
300
C
60
120
180
S
40
80
120
D
120
200
280
I
60
80
100
Y
100
200
300
C
40
100
160
S
60
100
140
D
100
180
260
I
60
80
100
New equilibrium at Y=D=100
Note
DCI
D  C  I
DA  C A  I A
D C I


Y Y Y
Marginal Propensity to Spend
(MPS) D/ Y
Y
100
200
300
C
40
100
160
S
60
100
140
D
100
180
260
I
60
80
100
Here, DA= -20.
D/ Y = .6 + .2 = .8
(Can you do the table with D and Y only?)
Note that D fell 20 and Y fell 100. Here, then
Y/ DA= -100/ -20 = 5
The Multiplier
We call Y/ DA the multiplier.
Let’s analyze. Why does it multiply?
(A Micro Analogy)
Suppose you spend an additional $100. You buy a music
lesson. The teacher takes that $100 and spends .8*100 or
$80. She purchases a new guitar. The guitar owner spends
.8*80 or $64 on a manicure. The manicurist spends .8*$64
on a….
The initial DA gets multiplied throughout the economy.
Multiplier in Action
North Carolina gets hit with a hurricane. We spend $100
million on goods from South Carolina. They spend $80
million of that in Georgia, who spends $64 million in
Florida…
Does it really work geographically? No. But the multiple
waves are key.
Multiplier in Excel
Wave
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
…
dD
$100.00
$80.00
$64.00
$51.20
$40.96
$32.77
$26.21
$20.97
$16.78
$13.42
$10.74
$8.59
$6.87
$5.50
$4.40
$3.52
$2.81
$2.25
$1.80
$1.44
…
dY
$100.00
$80.00
$64.00
$51.20
$40.96
$32.77
$26.21
$20.97
$16.78
$13.42
$10.74
$8.59
$6.87
$5.50
$4.40
$3.52
$2.81
$2.25
$1.80
$1.44
…
total dY
$100.00
$180.00
$244.00
$295.20
$336.16
$368.93
$395.14
$416.11
$432.89
$446.31
$457.05
$465.64
$472.51
$478.01
$482.41
$485.93
$488.74
$490.99
$492.79
$494.24
…
$500.00
With a MPS of .8, the total
effect on Y is $500 for a
autonomous increase in D of
100.
Multiplier-Graph
$600.00
Increase in Y
$500.00
$400.00
$300.00
$200.00
$100.00
$0.00
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14 15 16 17 18 19
Wave
Multiplier-Algebra


1
MPS  DA 
DA

1  MPS
w 0 ,
w
Multiplier
Here, MPS=.8 ==>multiplier=1/(1-.8)=1/(.2)=5
So DA=100, multiplier=5 ==> Y=500
So you have two ways to find the
multiplier, given MPS
Y D1 D2
0 0
100 80 100
1. Pick two Y’s
2. Make one an eq.
3. Given MPS, compute D1 at high Y
4. Compute DA that solves (here 20)
5. Compute Y/ DA=100/20=5
Method 1
1. Compute 1-MPS
2. Compute 1/(1-MPS)
Method 2
Note on the Algorithm
It doesn’t matter which numbers you choose for the Y’s
Y
0
100
MPS
dY
dDa
Multiplier
D1 D2
Y
0
1.7
80 100
35.6
0.8
Y
D1 MPS
D2
100
1999
1999 dY
20
-40
367.8 dDa
-40
5
MPS
0.8Multiplier
dY
-2039
dDa
-407.8
Multiplier
5
D1 D2
1.7
29 36
0.8 Y
34 -1
6.8 0
5MPS
Y
3.14159
1.41421
D1MPS
D2
-1 dY
-0 dDa0
Multiplier
0.8
D1 D2
3.14
1.76 1.4
0.8
-1.73
-0.35
5
dY
1
dDa
0.2
Multiplier 5
…but 0,100 is easier than , 2
Which one do I choose?
The fraction is probably easier if you can remember the formula.
The algorithm is easier if you think you may forget it on the exam.
Algorithm movie is on the web.
IMPORTANT NOTICE: ON THE NEXT
TEST, NO CALCULATORS WILL BE
ALLOWED.
Multiplier Questions
MPC=.5, MPI=.3
MPC=.6, MPI=.3
MPSave=.5. MPI=.1
MPC=.7, MPI=.3
MPC=0, MPI=0
Discuss and interpret
these last two.
We’re ready!
You now have the tools to begin solving problems.
See MACRO PROBLEMS on the web for some practice.