McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10 Basic Macroeconomic Relationships McGraw-Hill/IrwinCopyright © 2015 by McGraw-Hill Education. All rights reserved.

I. Macro Model 1. Economists observe people and their behavior, then describe their behavior in a “model”, that is, through story-telling. Economists tell stories through words, math and graphs. 2. Given what economists have observed, we can divide the economy into three markets: (i) Goods market – Chapters 10, 11, 12 and 13 (ii) Money market – Chapters 14, 15 and 16 (iii) Foreign exchange market – Chapter Goals – We want low unemployment, low inflation and high potential GDP = Y growth. Model Background

4.We divide the economy into two time frames. (i) Short run: Price of goods and services is fixed (no inflation), and input price, such as wage, is also fixed. All variables are real variables. (ii) Medium/Long run: At least one of the prices is flexible. We can then examine inflation – in chapters to come.

AE = Consumption Only LO1 II. Consumption 1.We use the GDP (Y) = AE approach to examine the economy. 2.Recall that Y = AE (or supply = demand), and AE = C + I + G + NX. 3.This chapter, we focus on C and I only. 4. To describe Consumption (C): (i) C depends on consumer confidence, income (Y), taxes (T), and spending habit. (ii) In an equation, for example: C = (Y - T), for now T = 0. There is no government (yet) to collect taxes. Add T in Chapter 11.

AE = Consumption Only 5.Example: C = Y (i) Interpretations of the constant (100): (a) Subsistent consumption if Y = 0. (b) Consumer confidence if Y > 0.

AE = Consumption Only (ii) Consumer confidence in the news Thai consumer sentiment at 25-month low in June 7 Jul 2016, Thai consumer confidence dropped for a sixth straight month in June, a university survey showed on Thursday, due to worries about the impact of Britain's decision to leave the European Union on the domestic and global economy. Consumers were still concerned about low commodity prices, the University of the Thai Chamber of Commerce said. Overall Consumer Confidence Index reflects views on the economy, job opportunities and future income. The survey is usually done in the last week of the month. The index stood at 71.6 points in June, compared with 75.5 in January.

Marginal Propensities 6. Example: C = Y continued… (iii) The 0.8 is the spending habit, or we call it the marginal propensity to consume (MPC). MPC shows that for each additional Y that we earn, say, 1 baht, we always spend 80% of it. MPC = ΔC ΔY (iv)What remains, the 20%, or 0.2, is marginal propensity to save (MPS). MPS = ΔS ΔY (v)Together, MPC+MPS=1. LO1

LO2 Marginal Propensities 7. Graphing C = Y. (i) C = Y (ii) The 45-degree line, slope equals 1, means Y = AE. For now, AE = C only. (iii) Which area in the graph represents Savings > 0? Savings = 0? Savings < 0?

LO3 AE = Consumption + Investment Only III. Investment 1.Firms’ expenditure also depends on two things: Investment confidence and the interest rate (i). Why i? (i) Firms borrow money to pay for investment. (ii) Firms have the money to pay for investment. (iii) As long as the rate of return on investment (r) > i, the firms will invest. 2. An example of the I equation:____________________________.

3. Investment Confidence in the News: Investor Confidence Index likely to drop in March BANGKOK, 12 January 2016, Volatility in global markets and currencies is forecast to push down the local Investor Confidence Index by 17.85% to in March. The President of the Federation of Thai Capital Market Organization (FETCO), Worawan Tharapoom, made the three-month projection, citing previous figures. She said the foreign Investor Confidence Index would take the biggest hit, falling 57.15% to Ms. Worawan explained that the massive drop is the culmination of international concerns, and volatility in global markets and currencies, particularly China's weakening yuan. Other key factors include low fuel prices, unrest in the Middle East, and the U.S. Federal Reserve's decision to raise the benchmark interest rate. AE = Consumption + Investment Only

IV. Goods Market Equilibrium 1. Graphically, we can set Y = AE = C + I and find the equilibrium: (i) C = Y. (ii) I = 75 – 500 i, and suppose i = 0.05, so I = 50. (iii) AE = C + I = ________________________. Goods Market Equilibrium

2. Solving for Y = AE (supply = demand): Example: C = YI = 50 (i) Find the equilibrium production of Y such that the consumers and the firms can buy what they desire to buy (supply=demand).

Goods Market Equilibrium (ii) Show that Saving (S) = I (when there is no government and NX), and explain logically why. Saving is also called leakage from AE, while I is injection back into AE. (iii)What is the significance of S = I and implication on C and future Y?

Goods Market Multiplier V. Goods Market Multiplier 1.Question: If consumer confidence rises by 1, which leads the consumers to spend an additional 1 baht (or million), by how much would Y increase? Let MPC = 0.8. Round 1: Round 2: Round 3: 2.In total, the 1 baht increase has led to a _______ baht increase in the economy.

Goods Market Multiplier 3.If we add up all the increases in output, mathematicians tell us that the total result will look like below: (0.8) 2 + (0.8) 3 + (0.8) 4 … = 1= 1= 5 1 – Goods Market Multiplier = ΔY = 1 ΔConsumer confidence 1 - MPC 5.The same description applies if Investment confidence rises (replace  Consumer confidence with  Investment confidence). 6.The same description applies if C or I confidence drops (replace  with  ).

The Actual Multiplier Effect? VI. Actual Goods Market Multipliers 1.Thailand - Between to Source: %2007%20Impact%20of%20the%20Global%20Economic%20Crisis.pdf %2007%20Impact%20of%20the%20Global%20Economic%20Crisis.pdf 2.Canada - Around Source: Curtis, D. and Irvine, I., Macroeconomics, Lyryx, Chapter 7,