So far…

Big picture of the following units… core of macroeconomic theory

We will start by understanding the goods market: - Define concepts: Income, disposable income, savings. - Describe the components of the demand and their behavior: Investment, government expenditure and consumption. - Goods market equilibrium: Understand how the equilibrium is determined and the economic forces involved in a basic macroeconomic model. - Change in equilibrium when an exogenous variable change its value. - Government finances and fiscal policies: Government budget and debt. Automatic stabilizers and counter/pro/a cyclical fiscal policies.

Aggregate output/Aggregate income/Real GDP Remember that Aggregate output/Aggregate income/Real GDP are different approaches towards measuring the same thing! components of the demand income categories total value of goods and services produced There is no agent behavior in these equations; they are just definitions! This course will focus on a closed economy set up.

Disposable income disposable income ≡ income – taxes Savings Savings ≡ disposable income – consumption There is no agent behavior in this equation, it is just a definition!

Components of the demand Investment: Purchases by firms of new buildings and equipment and additions to inventories, all of which add to firms’ capital stock. - Investment (economic meaning ) ≠ Investment (financial meaning) - For simplicity we will assume (so far) that I is exogenously given. There is no agent behavior in this component; I is equal to some constant.

Government expenditure: - G is under the control of the government. Moreover we will assume that such expenditure is totally discretionary and there is no particular behavior. There is no agent behavior in this component; G is equal to some constant.

Consumption: - In the General Theory, Keynes argued that the amount of consumption undertaken by a household is directed related to its consumption. ii) curvature i) autonomous consumption household consumption household income

- For simplicity we will assume that there is a linear relationship between consumption and income (when is an assumption a good assumption?) : This is a behavior equation; it specifies how consumption depends on income! household consumption (C) household disposable income (Y d ) ∆C ∆Y d Marginal propensity to = consume

Examples: #1 (calculate mpc based on consumption equation) #2 (calculate mpc based on consumption/disposable income table) ∆C=90∆Y d =100 mpc=0.75

- More on mpc…......the marginal propensity to save Marginal propensity to consume (mpc): fraction of a change in disposable income that is consumed. Marginal propensity to save (mps): fraction of a change in disposable income that is saved. Property: mpc + mps = 1 Proof:

Goods market equilibrium Review: How to obtain the equilibrium in the beef market? p beef q beef S D Equilibrium condition: Equilibrium solution: Remember: (p,q) are endogenous variables

Goods market equilibrium Endogenous and exogenous variables: - Y and C are the endogenous variables (their values are defined within the model) - I, G and T are exogenous variables (their values are NOT defined within the model. Their values are given) - a and b are parameters (a refers to the autonomous consumption and b to the marginal propensity to consume) Equilibrium condition Equilibrium solution

Example

Change in equilibrium when an exogenous variable value change i) understand of transmission mechanism ii) importance of mpc iii) examples

Government finances and fiscal policy Government budget and debt: - Government budget (surplus/ deficit)

US Federal Government Surplus (+) or Deficit (−) as a Percentage of GDP, 1970 I–2005 II

- Government debt The total amount owed by the federal government. The Federal Government Debt as a Percentage of GDP, 1970 I–2005 II

Automatic stabilizers and cyclicality of fiscal policies - Counter/pro cyclical fiscal policies: Acyclical fiscal policy occurs when fiscal policy is independent of output fluctuations. E.g. constant pattern of government expenditure. Countercyclical fiscal policies tend to smooth output fluctuations. E.g. decrease government expenditure during booms and increase it during recessions. (Most developed countries pursue this policy) Procyclical fiscal policies tend to aggravate output fluctuations. E.g. decrease government expenditure during booms and increase it during recessions. (Most emerging and developing countries pursue this policy) - Automatic stabilizers: Revenue and expenditure items in the government budget that automatically change with the state of the economy in such a way as to stabilize GDP.