Macro Econ Bullock 1

8/7/2019 Macro Econ Bullock 1

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Long Run Growth

Small differences in long run growth makesignificant differences (compare 2% and 3% over50 years). (100 269 or 438)

Output growth; the rate of growth of output inthe entire economy

Per capita output growth is the rate of growth perperson in the entire economy ie the rate of

growth of Q/N. Productivity growth is the rate of growth of

output per worker ie the rate of growth of Q/L


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Productivity and Participation

If population grows faster than output, per capitaGDP falls

Q/N = Q/L x L/N => g Q/N = g Q/L + g L/N ie growth

rate of output per head is equal to the rate ofgrowth of output per worker (labourproductivity) plus the rate of growth of the labourforce as a fraction of the population.

Participation influenced by minimum workingage, retirement age, years of schooling,participation of women.


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Productivity

Output is dependent on labour (human capital) ,capital (physical) , and natural resources,entrepreneurship, management and technology.

The contribution of labour is dependent on

population growth, the percentage of thepopulation in the labour force, and averagelabour productivity: the education and training ofworkers, the quantity and quality of the capitalstock that workers use in production, the state of

technology, enterprise etc.. Health, education, R&D and the capacity to adapt

technology are important to long run growth.


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Short Term Fluctuations; Business

Cycle The long term growth rate is an average trend

and the economy, in the short run, may fluctuatearound that trend.

The business cycle moves from a peak (beginning

of recession), through a recession, a trough (endof recession), a boom and back to a peak. Informal definition of a a recession; negative

growth (economy contracts) for at least twoconsecutive quarters

Depression, a severe and protracted recession Boom; a particularly strong and protracted

expansion


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Potential Output or GDP

Potential output also known as full employmentoutput is the maximum sustainable level ofoutput that the economy can produce

Potential output is the maximum sustainableamount of output ( or real GDP).

Note maximum sustainable as output canexceed potential but not indefinitely.

Economic fluctuations may be due to changes inpotential output but will more likely be caused byfluctuations of actual output around potentialoutput.


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Output Gap

Defined as the difference between actual outputand potential output; Y-Y*, where Y* is potentialoutput.

YY* is a positive output or expansionary orinflationary gap where resources are utilized atabove normal rates resulting in inflation.


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Deflationary Output Gap


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Inflationary Output Gap


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The Nature of Macroeconomic Policy

To enhance the long run potential growththrough policy to enhance human capital,facilitate investment in physical capital, and

develop or adapt technology. Short run stabilization policy; to manage

aggregate demand to minimize deflationary andinflationary gaps.

Use of fiscal policy (government expenditure andtaxation), and monetary policy (money supplyand interest rates) for short run stabilization


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Aggregate Expenditure

Planned Aggregate Expenditure :

PAE = C + I+ G + X - M

C = C0 + bY , I = I0 , G = G0, X = X0, M= mY0 < b < 1 and 0 < m < 1

In (simple) closed economy without

Government, PAE=Y=C+I or I = (Y-C) =S and Y =C+S


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Determinants of Consumption

Income

Wealth

Interest Rates Price

Expectations about future income


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Consumption and Income


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Consumption Function


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Movements Along vs. Shifts of the

Consumption Function

A change in income a movement along the

consumption function

A change in any non-income determinant a

shift of the entire function, that is, a change in

autonomous consumption


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Non-Income Determinants of

Consumption

Wealth an increase will cause the

consumption function to shift upwards

Interest Rates a decrease will cause the

consumption function to shift upwards

Prices a decrease will cause the function to

shift upwards

Expectations positive expectations will shift

the function upwards


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Income, Consumption, Saving


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The Saving Function

Recall Y = C + I = C + S C = Co + bY

From first bullet, S = Y C = Y - (Co + bY)

= Y Co bY = -Co + (1 b)Y

Observe that the intercept is the negative of

the intercept of the consumption function and

the slope is (1 mpc)

E.g. C = 200 + 0.75Y S =Y C = Y- 200 -0.75Y

= -200 + 0.25Y


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Income, Consumption, Saving


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Determinants of Investment

Aggregate Income

Business Confidence

Technological Change The real interest rate

Tax Provisions


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Exogenous Investment


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Non-Income Determinants of

Planned Investment (IP)

Business Confidence an in business

confidence will planned Investment (IP)

Technological Change Improvements in

technology will Ip

Real Interest Rate a in the real interest

rate will Ip

Tax Credits an in tax credits for

investment will Ip


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Equilibrium Aggregate Output


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Circular Flow , Injections and

Withdrawals Circular flow of income is between households

(spending on goods and services) and firm

(paying incomes to households for factor

services. Injections are earnings of households that do not

result from spending of firms or earnings of firms

not from the spending of households (I, G, X) Withdrawals are incomes of households or firms

that are not passed on through respending in the

circular flow (S, T, M)


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Equilibrium in the Circular Flow

The circular flow of income is in equilibriumwhere there is no tendency for it to either

increase or decrease.

Injections increase the circular flow Withdrawals reduce the circular flow

The circular flow is in equilibrium where

withdrawals are equal to injections;(S+T+M)=(I+G+X)

In closed economy without Government

equilibrium is where S =I


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The Saving Investment Approach


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The Paradox of Thrift


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Algebra of Income

Y = C + I = C0 + bY + I0

Y bY = C0

+ I0

Y(1 b) = C0 + I0

Y = (C0 + I0 ) x 1/( 1 b)


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Algebra of the Multiplier I

Recall Y = (C0 +I0)/(1-b) = AE x 1/(1-b)

Therefore Y =AE x 1/(1-b)

= (C0

+ I0) x 1/(1-b)

If C0 = 0 Then Y = I0 x 1/(1-b)

= I0 x k

Where k = 1/(1-b) is the multiplier for a closedeconomy without government.

Note 0 < b < 1 k > 1


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Algebra of the Multiplier II

In closed economy without government,

equilibrium in aggregate expenditure may be

alternatively expressed as S = I

The maintenance of equilibrium requires that

a change in S is matched by a change in I

Therefore S = I and S/Y = I/Y

Therefore Y = I x 1/(S/Y) =I x 1/mps

Where k = 1/mps = 1/(1-mpc) = 1/(1-b)


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Intuition of the Multiplier

The multiplier is dependent on subsequent

rounds of respending based on the mpc.

The change in income from an initial $25

change in investment is:

$25+(.75x$25)+(.752x$25)+(.753x$25)+

+(.75n

x$25)$25(1+.75+.752+.753+.+.75n)=$25x1/1-.75

=$25x4.


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EXAMPLE

In a closed economy without Government,

consumption is given by C = 500 + 0.8Y and I=50.

Find a) the equilibrium level of income b) The

multiplier c) The equilibrium level of income if Iincreases by 25 d) The equilibrium level of

income if the mps increases to 0.4 e) The

equilibrium level of income if saving at zero

income increases to minus 400. (Assume all

changes from the original C and I)


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Answers a) and b)

a) Y = C + I = 500 + 0.8Y + 50

Y (1 -0.8) = 550

Y = 1/(1-0.8) x 550

= 5 x 550 = 2750

b) k = 1/(1- mpc) = 1 / (1 0.8) = 5

or If I increases by 25 then Y = 500+0.8Y+50+25 Y(1-0.8) = 575 and Y = 575x1/(1- 0.8) =2875

k = Y / AE = (2875-2750)/25 = 5


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Answers c) and d)

C) Y2 = C + I + I = 500 + 0.8Y + 50 + 25

Y2 ( 1 0.8) = 500 + 50 + 25

Y2

= 1(1-0.8)x575 = 5 x 575 = 2875

or Y = k x AE = 5 x 25 = 125

Y2 = Y1 + Y = 2750 + 125 = 2875

d) mps = 1mpc => mpc= 1mps = 1-0.4 = 0.6Y2 = (1/ 1-0.6) x 550 =2.5 x 550 = 1375


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Answer e)

e) Saving at zero income is equal to minus consumption

( -C) at zero income => consumption at zero income

is equal to minus consumption at zero income.

When consumption at zero income was 500, savingwas -500. If saving at zero income increases

(becomes less negative) to -400, then consumption

falls from 500 to 400.

Solve Y = 400 + 0.8 Y + 50 for Y

or Y2 = Y1 + Y where Y = k x AE and AE = -100


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Readings

Baumol & Blinder Chs 24-26

Frank & Bernanke Chs 19, 22, 23

Case fair Oster Chs 22 &23

Documents

Macro Econ Bullock 1