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Issues in Macroeconomics th Set of Notes

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					                                      MBA 500C, Economics

2011                                                                              Rogers

Notes                       Issues in Macroeconomics (MBN05)

 I.      Introduction

        A.   Keynes vs. Classicals

             1.    Aggregate Supply
             2.    Aggregate Demand

        B.   Fiscal Policy – changing G

        C.   Supply side Economics

        D.   The FED and Interest rates

        E.   International Economics and Aggregate Supply and Demand

        F.   Measurement Problems

 II.     Keynes vs. Classicals - Aggregate Supply

        A.    If Aggregate Demand drops –

             1.    Classicals mention PR
 Aggregate Demand: GDP =AD(PL, T, Wealth, r, Demographics, EXP, G, Yforeign, EXCH, Endowment, PR)

 Short Run Aggregate Supply: GDP = AS(PL, Costs, Resources, TECH, PR)

 Long Run Aggregate Supply: GDPFull = LRAS(PL, Resources, TECH, PR)

        B.   If Aggregate Demand drops, Supply adjusts
             1.    As Unemployment goes up and Capacity Utilization goes down
             2.    Wages and r and other costs go down
             3.    SRAS go to right to Full Employment. (SRAS1 to SRAS2)
             4.    The flexibility of AS bothered Keynes and others




                                                  1
C.    Keynes and Others

      1.   Aggregate Supply does not adjust fully

      2.   Downward rigidity of wages

      PL        LRAS
                                SRAS1
                                  SRAS2 Keynesian


                                         SRAS2 Classical




                                   AD1


                        AD2
                                 GDP




D.    Keynes and demand – the problem with supply – it will not solve the
      depression

      1.   Lowering wages and input price is futile

      2.   The problem lies on the aggregate demand side.

      3.   The graph shows it
     PL                  LRAS
                                  SRAS1

                                             SRAS2 Keynesian




                                           AD1




                                                 GDP


                       AD2



                                             2
III. Keynes vs. Classicals           -Aggregate Demand

   A.   Investment – as a market

        1.   Overview

             a.     Classical view
             b.     Keynesian view

        2.   Model of an investment market

             a.     Investment Demand from businesses I = I[r, EXP, O]

             b.     Investment Supply S=S(r, PL, T, Wealth, EXP, Demographics)
                    (1)        Savings = GDP – Consumption, S = Y –C

                    (2)        S=S(r, PL, T, Wealth, EXP, Demographics)

        3.   Both Classicals and Keynesian think r matters on both sides
             of the market I and S
             a.     Classicals think r is almost totally key to S and I

             b.      Keynesian think

                    (1)        EXP is the major component of I – changing expectation
                               drive investment leading bubbles and crashes

                    (2)         r is not important for S – other things matter much
                               more – other factors influence savings demographic
                               wealth etc

        4.   Graphs illustrate the difference -The Investment market

        5.   Housing Investment
                                                           r   Keynesian View of Investment Market
         r   Classical View of Investment Market


                                                                                      S2

                               S1                                                                  S1
                                    S2
                                         S3



                                                                                          D1

                          D2
                                                                          D3         D2
                     D1
                                              I or S                                           I or S




                                                  3
        B.   Translated into the Aggregate Demand and Supply Model (below)

Aggregate Demand: GDP =AD(PL, T, Wealth, r, Demographics, EXP, G, Yforeign, EXCH, Endowment, PR)

Short Run Aggregate Supply: GDP = AS(PL, Costs, Resources, TECH, PR)

Long Run Aggregate Supply: GDPFull = LRAS(PL, Resources, TECH, PR)

             1.     Thus Keynes views demand as very unstable – which leads to
                    instability in GDP and economy that only G intervention can
                    solve.

                    a.        Instability due to changes in expectations due to
                              uncertainty – Investment change

                    b.        Expectations are subject to waves - Booms and panics –
                              crowd psychology in dealing with unknowns

                    c.        Moves AD over wide cycles

             2.     In contrast Classicals say

                    a.        Investment is more it is tied to r

                    b.        S and C counteracted changes in I



                                                PL
   PL
                                                                     LRAS
                                                                                        SRAS


                                   SRAS


                                                                                  AD1



                                   AD2
                                 AD1
                                 AD3                                        AD2

                                       GDP                                               GDP


             Classical View                              Keynesian View




                                                     4
 IV.         Fiscal Policy – changing G            - Effect of G or Government Spending

Aggregate Demand: GDP =AD(PL, T, Wealth, r, Demographics, EXP, G, Yforeign, EXCH, Endowment, PR)
Short Run Aggregate Supply: GDP = AS(PL, Costs, Resources, TECH, PR)
Long Run Aggregate Supply: GDPFull = LRAS(PL, Resources, TECH, PR)

        A.     Income becomes

               Y = C + I + G or Y = C(Y) + I + G(.)

               If no NX, then, equilibrium

               Y =C + I + G.

        B.     Many factor affect level of G, but they:

               1.   Not been examined
               2.   Not look into it.

        C.     Keynesians - Use G to counteract instability in AD from I and C.

        D.     Classicals - view government spending as overcrowding.

               1.   Market supposedly usually at full employment.
               2.   So Upping G will lower C and I.

        E.     Both see Aggregate Demand increasing but Classicals see a long
               run vertical Supply curve so that on the average increasing
               government means lowering the amount of other spending - view
               government spending as overcrowding.

        F.     Ironically the success of Keynes made the classical on point.
                                                            PL        Problem since the 1960s
               Aggregate Demand Change due to
               Government Increase
                                                                                 LRAS
   PL                  LRAS

                                                                                             SRAS
                              SRAS



                                                                                           AD2(C+I+G2)




                                     AD1(C+I+G2)                                           AD1(C+I+G1)

                                                                                             Y
                                                                                             Y
                                AD1(C+I+G1)
                                              Y




                                                    5
 V.     Supply Side

      A.     If we are close to full employment but not there – Aggregate
             Demand may be futile – leading only to inflation
Aggregate Demand: GDP =AD(PL, T, Wealth, r, Demographics, EXP, G, Yforeign, EXCH, Endowment, PR)

Short Run Aggregate Supply: GDP = AS(PL, Costs, Resources, TECH, PR)

Long Run Aggregate Supply: GDPFull = LRAS(PL, Resources, TECH, PR)

      B.     A better strategy would be influence supply changing Resources,
             TECH, and/or PR

             1.     Taxes sometimes does

             2.     Also – programs to improve TECH – Clinton on technology
                    initiatives

             3.     PR – deregulation

             4.     predict ??????

                   PL
                                                LRAS2
                                        LRAS1

                                            SRAS1
                                                        SRAS2




                                                           AD1(C+I+G2)


                                                        AD2(C+I+G1)



                                                                         Y




                                                    6
 VI.      The FED and Interest rates

Aggregate Demand: GDP =AD(PL, T, Wealth, r, Demographics, EXP, G, Yforeign, EXCH, Endowment, PR)

Short Run Aggregate Supply: GDP = AS(PL, Costs, Resources, TECH, PR)

Long Run Aggregate Supply: GDPFull = LRAS(PL, Resources, TECH, PR)

       A.     Monetary Policy – influence Aggregate Demand through changing
              Money to influence r and then GDP

       B.     Lowering r raises I and C

       C.     But does this work

              1.    Essentially the FED changes Money by putting money in banks

                    a.     Buying bonds

                    b.     Lending money to banks- Discount Rate

                    c.     Changing the reserve requirements- allows banks to lend
                           more money

              2.    Putting money into the system lowers the interest rates

              3.    Federal Funds Rate – the federal funds rate is the interest
                    rate at which private depository institutions lend balances
                    (federal funds) at the Federal Reserve to other depository
                    institutions overnight. - overnight kit rate

            Aggregate Demand Change due to                  Aggregate Demand Change due to
            interest rate change                            drop in money supply
     PL                                                PL
                         LRAS
                                                                         LRAS
                                      SRAS
                                                                                  SRAS




                                     AD1(low r)                                          AD1


                                AD1(high r)                                        AD2
                                              Y                                                Y




                                                   7
 D.   But putting money into the system – can lead to high prices and
      raising interest rates.

 E.   The other side is that if you cut back on money it will lead to a
      fall in aggregate demand. By lowering the bank accounts it
      destroys wealth

      1.   There is a given M that will optimize GDP at any given level

      2.   1931 – evidence during the depression

      3.   Bailouts of savings and loans and hedge funds by FED

      4.   Delicate balancing act Paul Volker and Alan Greenspan

      5.   Actions we are doing now – money into system and fiscal
           policy

      6.   Problem is that it seems at the moment ineffective

 F.   At the moment –Policy seems at the moment ineffective

      1.   Last Fall – monetary policy did nothing

      2.   At this time, the fiscal policy – has really not taken
           effect.

                                                    Problem with putting too
                                                    much money in system
                                                    1960s
                                               PL
       Aggregate Demand Change due to
       interest rate change
                                                             LRAS
PL             LRAS

                                                                        SRAS
                      SRAS



                                                                      AD2(C+I+G2)




                             AD1(C+I+G2)                              AD1(C+I+G1)

                                                                        Y
                                                                        Y
                        AD1(C+I+G1)
                                      Y




                                           8
 VII.      Effect of Trade on GDP and National Income

Aggregate Demand: GDP =AD(PL, T, Wealth, r, Demographics, EXP, G, Yforeign, EXCH, Endowment, PR)

Short Run Aggregate Supply: GDP = AS(PL, Costs, Resources, TECH, PR)

Long Run Aggregate Supply: GDPFull = LRAS(PL, Resources, TECH, PR)

             Y =    C(..) +I(.) + G(..) + X or EX – IM

      A.     Foreign sector more important for most people today

             1.     USA 1950- Exports and Imports – 5% of GDP now Imports 15%
                    and Exports 10%

             2.     Other Countries it is much larger – Canada, Korea, European
                    Nations

             3.     Issue - EU but will nations stay together

      B.     How can one expect Exports (EX) and Imports (M) to behave, and
             what affects them?

      C.     Exports

                    EX = EX(PL, YFoeign, EXCH, Endowments, PR)

             1.     PL at home vs. Foreign – A higher PL Home makes our goods
                    more expensive abroad.

             2.     YForeign, the Income of the Foreign countries - If other
                    countries are prosperous, they will buy our goods.

             3.     Currency Fluctuations – If our currency rises compared to
                    the rest of the world, our goods are more expensive, and
                    vice versa.

                    a.     Depreciation of Currency is the fall in value of one
                           currency in relation to another.

                    b.     Appreciation of Currency is the rise in value of one
                           currency in relation to another.

             4.     PR




                                                   9
5.   Endowments of given Nations consists of the particular
     resources of given nations that lead to greater exports.

     a.   Natural Resources – Saudi Arabia- Oil, Canada – wood.

     b.   Special Human Resources – Example are:

          (1)   USA - Movies, Airplanes
          (2)   Japan - Steel, Cars
          (3)   Italy – clothing and other yuppie goods.

     c.   Path Dependence

          (1)   Path Dependence – Chance – USA – Planes and
                Hollywood - Italy – wines, tiles and fashion

          (2)   Human Capital

          (3)   Social Capital – system may make people and
                countries more productive.

6.   Government Trade Policies

     a.   Subsidies.

     b.   What our Government buys. A big defense industry often
          leads to the export of military goods. France, USA,
          Brazil, and Russia.

     c.   Japan and Asian countries try to manage product
          composition




                            10
      D.     Determinants of Imports

Aggregate Demand: GDP =AD(PL, T, Wealth, r, Demographics, EXP, G, Yforeign, EXCH, Endowment, PR)

Short Run Aggregate Supply: GDP = AS(PL, Costs, Resources, TECH, PR)

Long Run Aggregate Supply: GDPFull = LRAS(PL, Resources, TECH, PR)

             Y =    C(..) +I(.) + G(..) + X or EX – IM


             1.     The home PL is compared to foreign PLs and if it rises, then
                    IM rise because foreign goods are cheaper.

                    IM =(PL, Y, EXCH, Endowments, PR)

             2.     Y – higher income usually means more Imports

             3.     Currency Fluctuations – If our currency rises compared to
                    the rest of the world, imports are cheaper, and vice versa.

                    a.     Depreciation of Currency is the fall in value of one
                           currency in relation to another.

                    b.     Appreciation of Currency is the rise in value of one
                           currency in relation to another.

             4.     Endowments of given Nations consists of the particular
                    resources, if the nation lacks something, then it will
                    import it.

             5.     PR. - Government Policies are:

                    a.     Tariffs duties on foreign imports

                    b.     Steel Tariffs, 2002-2004

                    c.     Quotas on imports – 1981 - 2,300,000 Japanese cars.




                                                  11
     6.   Reasons

          a.    Infant industry argument – Protection will allow small
                industry to grow.

          b.    National Defense Certain industries are need, and they
                should be prosperous.

          c.    Pure Political Pressure without objective evaluation.

                (1)   Bush and Steel

                (2)   McNeil

E.   Summary of the International Sector

     1.   NX = EX – IM

          NX= EX(PL, YForeign, EXCH, Endowments, PR) - IM(PL, Y, EXCH,
          Endowments, PR)

          NX=   NX(PL, Y, YForeign, EXCH, Endowments, PR)

     2.   Effect on Aggregate Demand

          a.    A Rise in Import or Fall in Exports means a fall in Net
                Export means GDP i.e. Y fall.

          b.    Fall in Import or Rise in Exports leads to Rise in net
                export, means a GDP i.e. Y Rise.




                                 12
VIII. Measurement Problems

   A.    Given the science of economic statistics there are ways to
         measure these models, but they all have problems.

   B.    Thus, we often do not know where we are.

   C.    So we can get results that were unexpected.

   D.    The latest interest plays points to difficulties in
         measurments.

        PL       LRAS


                              SRAS




                             AD



                             GDP




             Z    Macro-Measurement Problem




                                       X




                                     13

				
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