A Macroeconomic Model

Transcription

1 A Macoeconomic Model Mixed Spending News (New Yok Times) News Review: The ffect of the eal ate of inteest on investment. What is a Macoeconomic Model? The Aggegate Demand Schedule The Potential Output Schedule Using the Model to Pedict Unemployment and Inflation. Announcements Tun in you couse jounal at you ecitation this week. We will assess only the five jounal assignments listed on the web page. ach equies you to find an aticle and to wite a shot essay about it. The ecitation assignment fo this week is posted on the web page. Investment is invesely elated to the eal ate of inteest. Michele is building a new cinema called Cinema Paadiso and must decide how many sceens to install. ach sceen costs $1,000,000 but the Cinema will hold its value ove the coming yea. 1

2 Cinema Paadiso Afte paying the movie distibuto and meeting non-inteest expenses, Michele expects to net $2.00 pe ticket. Sceens cost $1,000,000 each. How many sceens should Michele build? Numbe of Numbe of Sceens Patons 1 40, , , , ,000 Use You Clicke To Answe The Following Gaded Question If he nets $2.00 pe paton, the pice of a sceen is $1,000,000 and the eal ate is 7.5% how many sceens should Michele build? A. 1 B. 2 C. 3 D Numbe of Numbe of Sceens Patons 1 40, , , , ,000 Cinema Paadiso Costs and Benefits Sceens Patons 40,000 75, , , ,000 Maginal Benefit $80,000 $70,000 $60,000 $50,000 $40, % Maginal Cost 7.5% 10.0% 2

3 What is a Macoeconomic Model? A model is a simplified desciption that captues the essential elements of a situation and allows us to analyze them in a logical way. A maco model is a simplified desciption of the foces that detemine equilibium levels of national output, inflation, unemployment and the eal ate of inteest. What is a Macoeconomic Model? A Macoeconomic model may be epesented by a system of equations. The equations ae solved simultaneously to pedict equilibium values fo output, inflation, and othe maco vaiables. The model is used to pedict the effects on the economy of diffeent shocks and changes in monetay and fiscal policy. What is a Macoeconomic Model? Thee ae lots of diffeent macoeconomic models because conomists disagee about the elative impotance of foces at wok on the economy. conomists disagee about the mechanisms though which those foces affect output, inflation, unemployment, and the eal inteest ate. What is a Macoeconomic Model? We will adopt a vey simple model that can be epesented by two schedules pesented in a single diagam. The model epesents mainsteam thinking. The model is designed to help us think about monetay policy in a logical way. If you undetake futhe study in economics, you will lean models that ae moe detailed. 3

4 Aggegate Demand Schedule Aggegate Demand is measued in constant dollas and equals C + I + G + NX, Whee C = Household Consumption I = Investment G = Govenment Spending NX = Net xpots Aggegate Demand is invesely elated to the eal ate of inteest ( ( ) because: Consumption falls when ises because a highe eal ate implies a highe cost of financing consume duable puchases and a highe ewad fo saving. Investment spending falls when ises because is a cost of investing. Net expots fall when ises because an incease in leads to an appeciation of the dolla making expots moe expensive and impots cheape. Aggegate Demand is Invesely Related to the Real Rate of Inteest. 0 Y = C+I+G+NX Potential Output Schedule Potential output is the output level associated with full employment of labo and capital. Potential output does not vay with the eal ate of inteest. Potential output inceases ove time as the economy gows. Y 0 4

5 Potential Output ( ( ) Does Not Vay with the Real Rate of Inteest. Aggegate Demand and Potential Output pefect Y = C+I+G+NX If the eal ate is 0, aggegate demand will not suppot potential output. 0 Y = C+I+G+NX Accounting fo Inflation in the Model Inflation tends to incease when the economy opeates above potential output. Inflation tends to emain unchanged when the economy is below but not too fa below potential output. Y 0 Inflation tends to fall when the economy is fa below potential output. 5

6 Accounting fo Inflation When the economy is opeating at o above potential, esouces ae vey scace. When esouces ae vey scace, thei equilibium pices ise. Rising esouce pices tanslate into ising output pices and into acceleated gowth in the geneal level of pices. Hence the inflation ate inceases. Accounting fo Inflation When the economy is opeating below potential, esouces ae not scace. When esouces ae not scace, thei pices do not ise. Thee is theefoe no tendency fo the geneal level of pices to gow moe apidly. Hence the inflation ate does not incease. Inflation Zones Accounting fo Unemployment Unemployment tends to incease when the economy opeates below potential output. Low Risk of Rising Inflation Y High Risk of Rising Inflation Unemployment falls when the economy opeates at o above potential output. Above potential output, wokes may be willing to povide ovetime labo. 6

7 Unemployment Zones Thee is a close elationship in the U.S. between high gowth in output and unemployment. Y High Unemployment Low Unemployment Monetay Policy Monetay Policy in the United States has a dual mandate. The Pimay Objective is to keep the inflation ate low and stable. A ecession lowes Aggegate Demand. As a emedy, the Fed lowes the inteest ate to 1, and the economy etuns to full employment without an incease in inflation. 0 AD expansion Povided the Pimay Objective is met, the Seconday Objective is to keep the economy opeating nea full employment. 1 Y 0 AD ecession 7

8 Choosing the Right Value fo the Real Rate Involves Complications Shocks ae constantly hitting aggegate demand. Some shocks push demand highe, some shocks push demand lowe. The Fedeal Reseve neve knows the position of the aggegate demand schedule fo sue. Setting the inteest ate at 1 isks inflation. If the Fed lowes the inteest ate to 1 and thee is a positive demand shock, the economy will end up in the inflation zone. 0 1 Y 0 AD actual AD expected Additional Complications Shocks ae constantly hitting the poduction secto as well. A good example is a change in the pice of petoleum. The Fedeal Reseve neve knows the potential output fo sue. Oveestimating potential output isks inflation. Modeling the Cuent Recession The fall in housing pices tiggeed the cuent ecession. The ecession was much deepe than nomal because financial fims failed. As the ecession deepened, consumes lost confidence in economic gowth and educed spending. 8

9 Modeling the Cuent Recession Nomal Fedeal Reseve Policy cannot povide a emedy fo the ecession. Banks and othe lendes have been afaid to lend even though the Fed has taken steps to povide them with cash. As we will see in next week s lectue, the cuent ecession has equied a combination of fiscal and monetay policy. Modeling the Cuent Recession. Monetay policy alone is unable to povide a emedy. 0 1 AD 2007 AD Y 0 AD nomal ecession What Have We Leaned? A Macoeconomic Model A maco model is a simplified desciption of the foces that detemine equilibium levels of national output, inflation, unemployment and the eal ate of inteest. The AD schedule is invesely elated to the eal ate of inteest. The Potential Output Schedule epesents the full- employment level of eal GDP. When the economy ends up to the left of the PO schedule, unemployment ises and inflation falls. To the ight of the PO schedule, unemployment falls and inflation ises. 9