Introduction to Macroeconomics PDF

lOMoARcPSD|41863074 Overview of Topics (Lecture 1b) Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour (darc...

lOMoARcPSD|41863074 Overview of Topics (Lecture 1b) Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Gross Domestic Product (Lecture 2) Lecture 2a - Introduction to GDP Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  GDP takes a while to calculate - data is done quarterly, and so the e2ects of COVID aren't seen in the above graph (that is from March)  Second quarter data will be available in November Lecture 2b - Methods of calculating GDP Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o Value added has to equal Fnal price of the Fnal good or service, which is equal to the expenditure of the Fnal good or service  This is why the produc6on method = expenditure method o Expenditure on output becomes income to producers of the good (either capital or labour)  Expenditure = income method o Methods will be equivalent due to treatment of unsold inventories  Some goods produced in one quarter which can't be sold Ill the next  E.g. if a company produces a car in Q1 of 2020 and sold in Q2, it's treated as produc6on AND expenditure (investment purchase) in Q1  However, in reality the expenditure doesn't happen unIl Q2 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o Two di2erent types of markets o Goods and services: Frm provides households with output, households provide Frms with money (in exchange) o That money is then paid back to the household through wage income/capital income o Income earned by household = expenditure done by households of the goods and services produced by Grms Lecture 2c - Nominal and Real GDP Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Base year prices (Ime 0) - so always using the year 2000, and keeping price constant and only focusing on quanIty over Ime o CONS:  ConsumpIon may be shiSed to cheaper goods e.g. energy  New goods such as the iPhone etc are introduced throughout the decade (iPhone introduced in 2007) Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 3a – In@ation Lecture 3a - In>ation  Data on prices e.g. goods in stores, as well as household expenditure (through surveying) Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Opposite to calculating real GDP - this time, quantities are held constant and in the base year  How much do we have to spend in order to purchase that basket of goods and services? Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 3b - Interest Rates Lecture 3b - Interest Rates  Nominal assets - shares in a bank etc (intangible)  Real assets - PPE, property (tangible) Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Real interest rates are important for purchasing decisions e.g. for assets such as houses Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  CPI is a measure of the quantity of goods and services households consume  Price level is typically referred to as GDP deflator - different to CPI because households don't purchase everything that's produced by manufacturers in the Australian economy Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 4a - Saving Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Wealth is a stock variable - how much you have at a particular point in time  Saving is a flow variable/concept - the amount you are saving per unit of time  GDP is a flow variable - value of production per unit of time o So are the other components of the income accounting identity Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 - Private saving: income less consumption less taxes  Public saving: taxes less transfer/interest payments less government expenditure 4b - Investment Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  K for capital, y for output Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Production function - as capital increases, output increases, but at a diminishing rate (law of diminishing returns) o Means first derivative of function is positive but second derivative is negative  If factors increase MB, you will increase capital stock and investment (and vice versa)  User cost of capital: real interest rate + depreciation cost  If user cost increases, capital stock and investment decrease  Optimal level of capital stock (K*) satisfies first order condition. Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  We assume firms seek to maximise profit - must choose a level of investment such that MB of capital = MC Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Equilibrium - real interest rate , investment and savings Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 5a - Measuring the Labour Market Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  REAL WAGE: Not just interested in monetary value of how much firm is paying the worker, but the REAL value of how many goods and services can be purchased by allocating one hour of your time to the labour market Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Unemployment defined us those who don't have a job and are ALSO actively searching for one  If you aren't searching, you are considered out of the labour force  Labour force participation rate: the rate of people who are actively searching to find jobs - Labour force divided by working age population (15-64 y/o)  Unemployment rate: unemployment divided by labour force Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Unemployment rate may be understated due to government subsidies and stimulus packages like Jobkeeper Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  As the economy recovers, the unemployment rate will fall (however relatively slowly)  Business cycles: usually unemployment will rise sharply and fall slowly after a recession 5b - Perfectly Competitive Model of Labour Market Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Firms seeking to produce output which is why they demand labour = derived demand Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  First order condition for profit maximisation  witIit is the cost of wage rate  rit is the real interest rate the firm has to pay for hiring capital Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  k represents capital - where the cost of depreciation in the above profit function is 0 for simplicity  Tells us how much labour should be hired in order to maximise profit  Economic interpretation of first order condition:  Value of MPL minus the wage = 0  Wage rate for firms to maximise profit must equal the price x marginal product of labour  Effect of hiring an additional worker depends upon the price of output (p) multiplied by additional output that this worker produces (marginal product) MINUS the cost of hiring this worker (wage)  Optimal condition for labour demand - if this condition is not satisfied, firms can alter employment to raise profits  If marginal product exceeds wage --> RAISE employment  If marginal product is lower than wage --> REDUCE labour  If marginal product exceeds real wage, firms should increase employment  If marginal product is lower than real wage, firms should reduce employment Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Marginal product = real wage HAS to hold in order to maximise profit  Where the two curves intersect is the profit-maximising point  On the left hand side: if a firm was hiring at L0, marginal product exceeds real wage - firms should increase labour as the output they get from the workers is more than what it is costing them, the red triangle would be the additional profit, and the green square is the cost of production  On the right hand side: if a firm was hiring at L1, real wage exceeds marginal product, by reducing labour the firm would be able to regain the green area as profit Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Labour supply curve affected by wage - where labour supply increases if labour increases Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Frictional unemployment: when people are moving or searching in between jobs  Structural: when the skills that workers possess are not those that are demanded by firms anymore  Cyclical: related to the state of the economy and its business cycles Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Natural rate of unemployment = frictional + structural 6a - Business Cycles - Facts of DeMnitions for Short Term Fluctuations Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Clear negative relationship  When output growth is high, unemployment is declining Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  When output growth is low, unemployment is increasing Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Cyclical rate of unemployment = unemployment - natural rate of unemployment o Where natural rate of unemployment = frictional + structural  Beta in the above equation is a parameter o If output gap is positive, cyclical unemployment will be negative  which implies that people are able to find jobs, including those who would usually be frictionally/structurally unemployed o If output gap is negative, cyclical unemployment is greater than 0 and the actual rate of unemployment is greater than the natural rate  Need an estimate for everything  You can't ask people whether they're structurally or frictionally unemployed  You also can't ask a firm what their natural level of output is, you can only ask how much they produce Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 6b - Business Cycles - Macroeconomic Models Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Keynesian Theory: That government should intervene to stabilise the business cycle  If output was too low - government should increase spending, reduce taxation, increase transfer payments Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Shocks that occurred during GFC are similar to that in the Great Depression - disruption in financial markets  Failure of some banks  But the magnitude of the shocks were different - and economic historians will argue it is because of change in macroeconomic policy  Better able to respond to the crisis in 2008 - learning from history, which is why knowledge of business cycles is important L7 - A Keynesian Model Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Assumptions of the Keynesian Model Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  MPC = the amount that consump6on rises when disposable income (Y - T) rises by a dollar Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Equilibrium in a Keynesian Model Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  If inventories get too large, Grms will reduce what they produce and vice versa  IF Y > PAE: output exceeds PAE, amount that Grms are producing exceeds amount households, Grms and government intend to purchase o BUILDUP of inventories: Frms will reduce their level of output they produce unIl equilibrium is restored (expansionary output gap)  IF Y < PAE: output less than planned expenditure, amount that people spend on the economy exceeds actual level of output produced o RUNDOWN of inventories: encourages Frms to produce more  45-degree line - represents all possible points where the economy's equilibrium condi6on is sa6sGed Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074  Increase in saving could occur through a decline in MPC, or a decline in Cbar (exogenous consump6on) o For the laXer case, the intercept will shiS down new equilibrium with less output o A decline in MPC shiSs down the slope of the PAE curve - new equilibrium with less output than original, but more than when Cbar fell Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Leakages and Injections Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o Expenditure on output becomes income to producers of the good (either capital or labour)  Expenditure = income method o Private saving = Y - C - T Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o Planned investment is exogenous - doesn't change o When saving increases, this means Cbar decreases, which means -Cbar INCREASES o As a result, there is a reducIon in output (Ya to Yb), but planned investment is unchanged. The savings schedule is shiSed up, but it does not change overall saving levels - they s6ll equal planned investment  There's actually been a nega6ve impact on the economy as output overall has decreased - PARADOX OF THRIFT PARADOX OF THRIFT o States that private saving is worse o2 for an economy as it leads to a fall in aggregate demand/output, and hence a decline in economic growth o Harmful as investments give lower returns - land, labour and capital are 'unemployed' o However, this theory was criIcised on the grounds that increases in savings decreases the real interest rate and leads to an increase in lending/investments/spending. Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 The Multiplier Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o Small change in expenditure leads to large change in equilibrium output = the mul6plier e\ect o The mul6plier is simply the deriva6ve of output with respect to any exogenous variable Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o When I increase output, demand for consumpIon = Cbar + c(Y - T) o MULTIPLIER EFFECT:  First round e2ect - direct e2ect associated with a change in Cbar, G, I, X - which leads to an increase in output/income  This income becomes the income that households take home aSer tax - (increases disposable income)  Part of this disposable income will be consumed, which increases Cd (consumpIon) again, which is going to further increase output  If output is increased further, income (a]er tax) is increased further, which will lead to a further increase in consump6on demand (however maybe successively smaller), and then an increase in output again o Works in the reverse direc6on as well - e.g. if planned investment is decreased, output / income / consumpIon will all decrease, which will lead to a further decline in output o This is because demand for goods and services in the economy is related to the level of output Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o ConsumpIon funcIon depends on output which is how the mulIplier e2ect keeps going o Round 1 is the DIRECT e2ect on planned investment, and then the e2ect on consumpIon is INDUCED o Successive rounds of increase in change in consumpIon are reduced Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o Suppose planned investment increases from IP0 to IP1 o Direct e2ect on output from the change in planned investment given by Y0 to Ya o However, at that new level of output there is an increase in consumpIon demand (Ya to Yb on the y-axis) o However, going from Ya to Yb on the y-axis there is an addiIonal impact on income (Ya to Yb on the x axis), which is caused by increase in consumpIon generated by the increase in income from Y0 to Ya o At Yb, that induces an addiIonal increase in consumpIon, which leads to an addiIonal increase in income going from Yb to Yc o Successive triangles (increases) get smaller and smaller, un6l we eventually converge to the new equilibrium at point Z o Direct e2ect from increase in planned investment o The rest of the e2ect is caused by the increase in consumpIon induced by the increase in income which is caused by previous increases in consumpIon/investment o Feedback between consump6on and output/income Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o This Ime, part of income is taxed away o The marginal rate of tax t dampens the impact of the mulIplier as it reduces the increase in aSer tax income Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o MulIplier is less than it would be if there was no taxaIon - which is condiIonal upon the MPC staying the same o When MPC increases, the mul6plier increases (e\ect decreased) o When the marginal rate of tax increases, mul6plier decreases  Multiplier will be smaller the higher the tax rate ---> if the tax rate is high, a change in domestic income won't flow through to expenditure as much o Propensity to import increased ---> multiplier will decrease, because a smaller proportion of disposable income will be spent on domestic goods/services o In the early 1990s, the RBA decided to raise nominal interest rates to 18% (very high) o This decreased planned investment by a lot, which as a result decreased aggregate output o Many people therefore became unemployed as the output gap increased, and were not able to Fnd jobs again even aSer the recession Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 o However, the beneFt from this recession was it reduced in`a6on over Ime Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])  lOMoARcPSD|41863074 Downloaded by Darcy Seymour ([email protected])