Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Macroeconomic Theory Introduction

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Macroeconomic models help us in framing key questions that face macroeconomists:  How are the levels of output and employment are determined and why they fluctuate?  Why does inflation occur and when should we worry about it?  How does government policy affects inflation and unemployment?  Why unemployment is high for lengthy periods in some countries than others?  How do trade, international financial markets and exchange rates affect employment and inflation?  Why are some countries are rich and others are poor?

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Assumptions and terminology  A special feature of macroeconomics is that the behavior of different agents has to be taken into account simultaneously:  Actions of households (to enter the labor force, to spend, to save..etc)  Actions of firms (set wages, invest.. etc)  Actions will be sensitive to government actions (T, G, interest policy), current economic variables and expectations of these variables such as tax, wages…etc.

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  Aggregate supply side: refers to the supply of goods and services. The supply side consists of:  Factors of production  Technology  The way which incomes (workers and firms) are determined  Aggregate demand side Refers to aggregate demand for goods and services and consists of:  C, I, and G

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  C is the expenditure of individuals on goods and services (durable or non-durables)  I expenditures of capital goods mostly by firms. New housing and spending by the government on machinery are also I.  G on salaries, purchase of goods and services.  Short run (months)  A period during which aggregate demand, output and employment can change but before prices and wages respond to the change in output and employment (assuming they are given), i.e., they are fixed or sticky or rigid.  Assuming that wages and prices are given can also refer to the case when they change by a constant amount.

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  Therefore in the short run, wages and prices or their rate of change do not respond to changes in the level of output, it also means that it is the aggregate demand that determines the level of output and employment.  Medium run  The period during which wages and prices can respond to changes in output and employment. The supply side of the economy adjusts to establish a medium run equilibrium in which inflation is constant.  Capital stock (and technology) and the labor force (population and migration, i.e., the supply side of the labor market) are also constant.

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University  The attention is focused on the behavior of wages and price setters. No upward or downward pressure on wages or prices.  Long run: investigates the consequences of changes in technology such as productivity growth. The growth theory. Here we allow for population, physical capital and technology to change.

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Fluctuations in output and employment

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Fluctuations in output and employment

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Europe VS USA

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Fluctuations in output and employment

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Fluctuations in output and employment

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University

JUNE 2014

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University

Public debt

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Public debt

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Public debt

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Public debt

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Inflation and Monetary Policy  Monetary policy in some countries was directed at reducing unemp, in other countries to an inflation target.  Suppose that the CB policy is to set interest rates so as to steer the economy to a low target rate of inflation. In response to inflation it would put up interest rate, which ↓ AD as I(investment) ↓ due to higher interest rate, this in turn ↓ emp and inflationary pressures.  Fig 1.5 provides a schematic overview of the short and medium run macro model.

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Figure 1.5

Macroeconomic Theory Prof. M. El-Sakka CBA. Kuwait University Fluctuations in output and employment