Intermediate Macroeconomics Ms. Majella Giblin nd September 2005

Course Overview One term Objectives of the course: –Undertanding of real world economic phenomena –Devise appropriate economic policy responses to moderate adverse effects to business fluctuations

Timetable Lectures: –Monday 9-10amRoom 941 –Thursday 2-3pmRoom 941 –Friday1-2pmRoom 903 Tutorials: –Monday1-2pmRoom 231A –Tuesday11am-12Room 208

Intermediate Macroeconomics: Overview The macroeconomy in the long run: –Income, Unemplyment, Inflation The macroeconomy in the short run: –Aggregate demand, aggregate supply Macroeconomic policy Open-economy macroeconomics

Assessment Continuous assessment30% –Individual written assignment Exam –End of semester written exam70%

Reading Essential reading: –Mankiw (2000) fourth edition –Blanchard (2000) second edition Supplementary reading: –Mankiw (2001) second edition

Source: Mankiw (2000) Introduction What do macroeconomists study? –Why some countries have experienced rapid growth in incomes? –Why other countries stay in poverty? –Why some countries have high rates of inflation? –Why other coountries maintain stable prices? –Why all countries have periods of recessions or depressions –How can government policy help?

Source: Mankiw (2000) Introduction: What is macroeconomics? Macroeconomics = the study of the economy as a whole. –It attempts to answer these questions –Studies: growth in incomes, changes in prices and the rate of unemployment Macroeconomic issues play a central role in the political debate because it deals with the state of the economy –It devises policies to improve economic performance

Source: Mankiw (2000) Macroeconomics and Microeconomics Microeconomics = the study of how households and firms make decisions and how these decisionmakers interact in the marketplace –Firms and households optimise – doing their best given scarce resources and constraints –Choose purchases to maximise their utility

Source: Mankiw (2000) Macroeconomics and Microeconomics Macroeconomics: –Studies economy-wide events which ultimatley arise from the interaction of many households and many firms –Therefore, macro- and micro- economics are inextricably linked –In macroeconomics we study aggregate variables = the sum of the variables describing many individual decisions

Source: Mankiw (2000) Macroeconomics and Microeconommics Example: –Total consumer spending = spending by many individuals within the economy –Total investment = investment decisions by many firms in the economy

Source: Mankiw (2000) Use of models To understand the economy, macroeconomists uses models –Theories that simplify reality –Applying assumptions –illustrates relationships among variables and dispenses of irrelevant details –Exogenous variables: determined outside the model, model does not attempt to explain them –Endogenous variables: model attempts to explain these variables

Soource: Mankiw (2000) Use of models Macroeconomists study many aspects of the economy, including, economic growth, unemployment, inflation –No single model covers all, so different models are used to explain different aspects of the economy

Source: Mankiw (2000) The Data of Macroeconomics Overview: 1.Gross Domestic Product (GDP) 2.Inflation 3.Unemployment rate –Three economic statistics that economists and policymakers use

Source: Mankiw (2000) 1. Gross Domestic Product (GDP) GDP: tells us the nation’s total income and expenditure on its output of goods and services Considered best measure of how well the economy is performing –Gauge of economic performance Viewed in two ways: a)Total income of everyone in the economy b)Total expenditure on the economy’s output

Source: Mankiw (2000) GDP Measure of both income and expenditure: –Two quantities are the same: for the economy as a whole income must equal expenditure GDP = the value of all goods and services produced domestically in the economy regardless of the nationality of the owners of the factors of production GDP = output = income = expenditure

Source: Mankiw (2000) GDP Computing GDP: –Example: –suppose an economy produces four apples and three oranges –Apples market price = 0.50 cents –Oranges market price = €1 –GDP = (price of apples x quantity of apples) + (price of oranges x quantity of oranges)

Source: Mankiw (2000) GDP GDP = (€O.50 X 4) + (€1 X 3) = €5.00 GDP includes the value of currently produced goods and services, used goods are not part of GDP GDP only includes the value of final goods not intermediate goods Underground economy is not included in GDP

Source: Mankiw (2000) GDP Real versus nominal GDP: –Real GDP values goods and services at constant prices –Nominal GDP values goods and services at current prices –Real GDP – a better measure of economic well-being –Real GDP rises only when the amount of goods and services produced in the economy rises –Nominal GDP can rise because output has increased or because prices have increased

Source: Mankiw (2000) GDP All ‘real’ variables are adjusted to take into account inflation Real GDP adjusts nominal GDP for inflation GDP deflator = Nominal GDP/Real GDP –Reflects what’s happening to the overall level of prices in he economy

Source: Mankiw (2000) GDP Example: –Consider an economy with one good: bread –P = price of bread –Q= quantity sold –Nominal GDP = total number of euros spent on bread for that year = P X Q –Real GDP = number of loaves of bread produced in that year times the price of bread in a base year = P base X Q

Source: Mankiw (2000) GDP Example: –Apples and oranges –We want to compare output in 1998 and 1999 –Choose a base year, such as prices that prevailed in 1998 Real GDP for 1998 = (1998 P apples x 1998 Q apples ) + (1998 P oranges x 1998 Q oranges )

Source: Mankiw (2000) GDP Real GDP in 1999 = (1998 P apples x 1999 Q apples ) + (1998 P oranges x 1999 Q oranges ) Real GDP in 2000 = (1998 P apples x 2000 Q apples ) + (1998 P oranges x 2000 Q oranges )

Source: Mankiw (2000) GDP Ireland %Δ%Δ Nominal GDP €139,097 m €148,556 m 6.8% Real GDP€139,097€145,3194.5% Source: CSO September 2005

Source: Mankiw (2000) GDP Components of expenditure: –Consumption (C) –Investment (I) –Government purchases (G) –Net exports (NX): Exports minus imports GDP (Y) = C + I + G + NX

Source: Mankiw (2000) GDP GDP versus GNP –GDP measures total income produced domestically –GNP measures total income earned by nationals (residents of a nation) GNP = GDP + Factor Payments From Abroad - Factor Payments to Abroad

Source: Mankiw (2000) GDP Ireland Real GDP€139,097m€145,319m Real GNP€116,374m€121,032m Source: CSO September 2005

Source: Mankiw (2000) 2. Inflation Inflation: increase in the overall level of prices Rate of inflation: the percentage change in the overall level of prices from one period to the next period Low inflation: desirable = certainty, stability and facilitates economic growth

Source: Mankiw (2000) Inflation Measure of the level of prices: –Consumer Price Index (CPI) = measures the price of a fixed basket of goods and services produced by a typical consumer –The CPI is the price of this basket of goods and services relative to the price of he same basket in some base year –The CSO computes the CPI

Source: Mankiw (2000) Inflation Laspeyres index = a price index with a fixed basket of goods and services Paasche index = a price index with a changing basket of goods and services Which is a better measure of the cost of living? Answer: neither is superior

Source: Mankiw (2000) Inflation When prices of different goods change by different amounts: –Laspeyres index (fixed basket) tends to overstate the increase in cost of living because it does not take into account that people can substitute more expensive goods for less expensive goods –Paasche index (changing basket) tends to understate the increase in the cost of living because it does not take into account the reduction in consumer welfare from having to substitute goods

Inflation Effects of inflation: –Erodes the value of money –Reduces international competitiveness –Menu costs

Inflation Consumer Price Index: Ireland % % % % % % % Source: CSO, September 2005

Source: Mankiw (2000) 3. Unemployment Rate Unemployment rate = percentage of people wanting to work who do not have jobs –Measures the fraction of the labour force out of work Labour force: the sum of employed and unemployed A person can be employed (in a paid job)

Source: Mankiw (2000) Unemployment Rate A person can be unemployed (waiting to start a new job and previously unemployed, on temporary layoff or is looking for a job) A person not in those two categories is not in the labour force (e.g. student, retiree) Labour force = number of employed + number of unemployed

Source: Mankiw (2000) Unemployment rate Unemployment rate = Number of unemployed x 100 Labour force Costs of unemployment: –High current govt expenditure and lower income tax revenue –Loss of output and income to economy –Low self-esteem and stress –Loss of income to individual

Source: OECD Economic Outlook, No. 75, June 2004