Introduction to Macroeconomics

Short Run

Emanuele Ragusi, PhD

What’s about Macroeconomics?

The Macroeconomics focuses on the economic

performance of aggregate actors

(Government, families, enterprises and foreign

countries)

ECONOMIC

GROWTH

UNEMPLOY

MENT INFLATION

The Gross Domestic Product

The Gross Domestic Product (GDP) is the main indicator of

a State’s economic activity

GDP= is the sum of

incomes in the economy

during a given period

GDP= is the value of the

final goods and services

produced in the economy

during a given period

GDP= is the sum of added

value in the Economy during

a given period (added value

is the value of a production

minus the value of the

intermediate goods it uses in

a production)

PR

OD

UC

TIO

N S

IDE

INC

OM

E S

IDE

The composition of GDP

• It’s useful to decompose GDP to understand the goods’ demand determinants.

Line

2015

I II III IV

1 Gross domestic product 17649.3 17913.7 18060.2 18128.2

2 Personal consumption expenditures 12055.5 12228.4 12359 12429

3 Goods 3901.5 3978.1 4024.1 4010.9

4 Durable goods 1301.8 1326.4 1339.6 1347.6

5 Nondurable goods 2599.7 2651.8 2684.4 2663.3

6 Services 8153.9 8250.2 8334.9 8418.1

7 Gross private domestic investment 2995.9 3025.5 3030.6 3019.2

8 Fixed investment 2868.6 2897.9 2935.3 2943.4

9 Nonresidential 2280.7 2297.9 2319.4 2311.6

10 Structures 499.3 503.8 496 489.1

11 Equipment 1063.5 1064.6 1090.9 1083.9

12 Intellectual property products 717.8 729.6 732.4 738.6

13 Residential 588 600 615.9 631.8

14 Change in private inventories 127.3 127.5 95.3 75.8

15 Net exports of goods and services -551.6 -519.3 -530.4 -526.4

16 Exports 2257.3 2280 2259.8 2214.7

17 Goods 1517.5 1535.5 1508.9 1458.4

18 Services 739.8 744.5 750.9 756.3

19 Imports 2808.9 2799.3 2790.2 2741.1

20 Goods 2311.7 2299.9 2285.4 2234.1

21 Services 497.2 499.5 504.7 507

22

Government consumption expenditures and

gross investment 3149.5 3179.2 3201 3206.5

23 Federal 1218.2 1220.7 1224.3 1235.6

24 National defense 739 740.1 738.2 746.1

25 Nondefense 479.2 480.6 486.1 489.5

26 State and local 1931.3 1958.4 1976.6 1970.9

Nominal and Real GDP

Nominal GDP (€Y) = is the

sum of the quantities of

final goods produced at

current prices

Real GDP (Y)= is the sum

of quantities of final goods

produced times costant

prices

Production of most

goods increases

over time

Price of most goods

also increases over

time

The Unemployment

Unemployment (U): is the numebr of people who do not

have a job but arer looking for one.

Labour Force (L): it’s

the sum of employment

(N) and unemployment

(U)

𝐿 = 𝑈 + 𝑁

Unemployment rate:

it’s the ratio of the

number of people who

are unemployed to the

numebre of people in

the labor

𝑢 =𝑈

𝐿=𝐿 − 𝑁

𝐿= 1 −

𝑁

𝐿

The Inflation Inflation: is a sustained rise in the general level of prices

in the economy (price-level)

The Inflation rate(𝑷 o π): is the rate at which the price

level increases

π= 𝑷𝒕−𝑷𝒕−𝟏

𝑷𝒕−𝟏*100

How to

measure

the

inflation

level?

1° To Build up a price

index

𝑷𝒕 = 𝟏𝟎𝟎 ∗ 𝒈𝒊

𝒑𝒊𝒕

𝒑𝒕𝟎

𝒏

𝒊=𝟏

The

GDP

deflator

𝑷𝒕

=€𝒀𝒕𝒀𝒕

The

consum

er price

index

Why? Because if the

price of imported

goods increases

relative to the price of

domestic goods

(domestic prices are

cheaper than national

ones), the CPI runs

faster than GDP

deflator.

Why do economists care about inflation?

Pure inflation=

the prices and

wages level

increases

proportionately

Inflation affects income

distribution: retirement

pensions don’t keep up with

inflation (Russian case

1990s)

Inflation leads to more

uncertainty: it’s harder for

firms to make investement

decisions. Changing in

relative price level.

Deflation limits the ability of monetary policy to

affect output

Okun’s Law

• Economic growth and

unemployment

Phillips Curve

• Inflation rate and

unemployment

The approach to Macroeconomic model:

The model without Government

Markets

Goods Markets (Y)

the price is P

Labor market (N)

The price is W

(wage)

Families who buy

𝑌𝑑 and they sell

(offer) their labor

force 𝑁𝑠 to

enterprises and

perceive their profit

(π)

Enterprises produce

goods by technology

𝑌 = 𝐹(𝑁) and

demand labor force

𝑁𝑑 to families; they

sell the goods 𝑌𝑠

and redistribute

profits (π)

Two main

economic

actors

The Budget Constraint and

Aggregate Actors

𝑃𝑌𝑑= 𝑊𝑁𝑠 + 𝜋 𝑊𝑁𝑑 + 𝜋= 𝑃𝑌𝑠 A budget constraint represents all the combinations

of goods and services that a consumer may

purchase given current prices within his or her

given income. Consumer theory uses the concepts

of a budget constraint and a preference map to

analyze consumer choices. Both concepts have a

ready graphical representation in the two-good

case.

The market link

𝜋 =𝑃𝑌𝑑 −𝑊𝑁𝑠

𝑊𝑁𝑑 + 𝑃𝑌𝑑 −𝑊𝑁𝑠

= 𝑃𝑌𝑠

Replace 𝜋 into

the firms’ budget

constraint

𝑃𝑌𝑑 − 𝑃𝑌𝑠 + 𝑊𝑁𝑑 −𝑊𝑁𝑠 =0

𝑃 𝑌𝑑 − 𝑌𝑠 +𝑊 𝑁𝑑 − 𝑁𝑠 =0

The

Walras’

Lex

The excess demand supply

4 Aggregate variables

Output

(Y) Labor

(L)

Money

(M)

Bond

(B)

3 Main Economic Actors

Family

Aggregate consumers

and Firms’ owners

cash profits and

distribute labor; They

consume (C) a part of

Output and saving (S)

a part of it in bonds

(B)

Government

Outcome: Government

spending (G), and

transfers (Tr); Income

Taxes (T) and bond

issue (B)

Enterprises

produce Y, involving

labor input (L) and

capital one (K), Firms

sell Output to families

(C), to enterprises (I),

and to Government

(G). They ensure

themselves to the risk

through the bonds’

issue (B)

Price and Market

4 Goods 4 Market 4 Price

Output

Labor

Bond

Money

The Budget constraint: the Government

𝒀 − 𝑻 + 𝑻𝒓= 𝑪+ ∆𝑩𝑫

∆𝑩𝑆= 𝑰 I

𝑻 + ∆𝑩𝑺= 𝑮 + 𝑻𝒓

INCOM

E OUTCO

ME

G

Famil

y

Firm

s

Go

v.

INCOM

E

INCOM

E OUTCO

ME OUTCO

ME

The Goods Markets and IS Curve

(Close Economy)

The short run

Dott. Emanuele Ragusi

The Goods Markets

Fixed price

We assume that prices do

not react to excess

demand and therefore this

reaction, it has effect only

in the long run. Then

𝑃 = 𝑃 = 1

Fixed wages

In the short run we

assume that the wage

barganing impacts only in

the mid run

𝑊 = 𝑊 = 1

Two importat

assumption

The Goods Market’s short run

hypothesis

1. Fixed price

𝑷 = 𝑷 = 𝟏

2. The production is

equal to demand

𝒀 = 𝒁

Closed Economy:

The GDP components are:

• ConsumptionC;

• Investments I;

• Government SpendingG;

𝒁 ≡ 𝒀 = 𝑪 + 𝑰 + 𝑮

GDP components

• Goods and services purchased by private consumers C

• Nonresidential investment

• Residential investment

• Now we consider it as exogenous variable I=𝐼

I

• Goods and services purchased by Government

• The Government trasfers, as Medicare or Social Security payments, are excluded .

G C+I+G

National or

aggregate

spending

Consumption C

It depends on many factors: it’s a function of disposable

output (Yd),

We assume that the function is a linear relation

C= C(Yd) 0<C’<1

𝑪 = 𝒄𝟎 + 𝒄𝟏𝒀𝒅

𝒄𝟎

What people need

to consume if their

disposable income

is zero >0

𝒄𝟏 Propensity to

consume

0< 𝒄𝟏<1

Yd=Y-T+Tr

Disposa

ble

Output

Consumption

C

Y

d

𝑪 = 𝒄𝟎 + 𝒄𝟏𝒀𝒅

𝒄𝟏

𝒄𝟎

Investment and Government Spending

In this previous part we have assumed investment as

given, and so exogenous I=𝑰

The Fiscal policy components (G and T) are exogenous

because:

1. The Government behaviour isn’t linear as consumers

or firms;

2. The investment-saving model assumes G and T as

variables chosen by the government

The Equilibrium Output

𝑌 ≡Z

𝑌 = 𝐶 + 𝐼 + 𝐺

𝐶 = 𝑐0 + 𝑐1𝑌𝑑

𝐼 = 𝐼

𝐺 = 𝐺

𝑇 = 𝑇

𝑌𝑑 = 𝑌 − 𝑇

𝑌 = 𝑐0 + 𝑐1 𝑌 − 𝑇 + 𝐼 +𝐺 𝑌 = 𝑐0 + 𝑐1𝑌 − 𝑐1𝑇 + 𝐼 +𝐺 𝑌 − 𝑐1𝑌 = 𝑐0 + 𝐼 +𝐺 − 𝑐1𝑇

𝑌(1 − 𝑐1) = 𝑐0 + 𝐼 +𝐺 − 𝑐1𝑇

𝑌 =1

(1−𝑐1)(𝑐0 + 𝐼 +𝐺 − 𝑐1𝑇 )

Multiplier >1 Autonomuos

spending (𝑨 )

indipent of Output

Using a graph

Y 45°

Y ;

Z

𝒄𝟎 + 𝑰 +𝑮 − 𝒄𝟏𝑻

A

Z < Y

Z > Y

𝒄𝟏

Z

Z

Introduce Taxes and Tranfers

𝑌 ≡Z

𝑌 = 𝐶 + 𝐼 + 𝐺

𝐶 = 𝑐0 + 𝑐1𝑌𝑑

𝐼 = 𝐼

𝐺 = 𝐺

𝑇 = 𝑡0+tY

𝑌𝑑 = 𝑌 − 𝑇 + 𝑇𝑟

𝑌 = 𝑐0 + 𝑐1 𝑌 − 𝑡0 + 𝑡𝑌 + 𝑇𝑟 + 𝐼 +𝐺 𝑌 = 𝑐0 + 𝑐1𝑌 − 𝑐1𝑡0 − 𝑐1𝑡0𝑌 + 𝑐1𝑇𝑟 + 𝐼 +𝐺 𝑌 = 𝑐1(1 − 𝑡0)𝑌 + 𝑐0 + 𝐼 +𝐺 −𝑐1𝑡0+𝑐1𝑇𝑟

𝑌(1 − 𝑐1)(1 − 𝑡0) = 𝑐0 + 𝐼 +𝐺 − 𝑐1𝑡0+𝑐1𝑇𝑟

𝑌 =1

(1−𝑐1)(1−𝑡0)[(𝑐0 − 𝑐1𝑡0+𝑐1𝑇𝑟 + 𝐼 +𝐺 ]

Multiplier>1 Autonomous

spending(𝑨 )

Taxati

on 𝑇𝑟 = 𝑇𝑟

The Investment-Saving Model (IS curve)

Saving= 𝑺𝒑𝒗𝒕 + 𝑺𝒑𝒖𝒃

Private Saving 𝑺 ≡ 𝒀𝒅 − 𝑪

so

𝑺 ≡ 𝒀 − 𝑻 − 𝑪

Public Saving T−G

If T > G budget surplus

If T<G budget deficit

The Model I=S

𝒀 = 𝑪 + 𝑰 + 𝑮

𝑺≡𝒀−𝑻−𝑪

𝒀 − 𝑻 − 𝑪 = 𝑰 + 𝑮 − 𝑻

𝑺 = 𝑰 + 𝑮 − 𝑻

𝑰 = 𝑺 + (𝑻 − 𝑮)

𝑆 = 𝑌 − 𝑇 − 𝐶 = 𝑌 − 𝑇 − 𝑐0 − 𝑐1 𝑌 − 𝑇 = −𝑐0 + (1 − 𝑐1)(𝑌 − 𝑇)

The

propoensity

to save (s)

Using graph

S

Y

S= −𝒄𝟎 + (𝟏 −𝒄𝟏)(𝒀 − 𝑻)

𝟏 − 𝒄𝟏 −𝒔𝟎

Investments

Both families and firms buy goods to invest. In particular

the firms buy goods to invest in non-residential

investments, while families invest in «fixed investment» as

homes.

The investment demand is function of interest rate (r); in

fact the performance of bond should exceed the costs.

The interest rate is the price of investing project. If the

interest rate rises, the investing projects’ number will

decrease proportionally.

The Investment

Consider a firm deciding wheter or not to buy a new

machine. Suppose that to buy a new machine the firm must

borrow. The profit of the new machine is 10% per year. If

the interest rate is higher than additional profit, the firm

will not buy the new machine because the interest rate will

not cover the interest payment.

If the profits’ return rate is higher than interst rate, the

number of investment project will increase.

If the price (P) is major of r for each project (K), the

investment level (I) will be :

𝐼 = 𝐾𝑛

𝑛

𝑖=1

Investments

If r grows, then

𝐼 = 𝐾𝑛𝑛𝑖=1 falls and

vice versa

So:

𝐼 = 𝐼 𝑖 𝑐𝑜𝑛 𝐼′ < 0

𝐼 = 𝐼 − 𝑏𝑖

Using graph…

i

I 0 𝑰

I(

i)

-b

I(i

)’

I(i)

’’

i’

’ i’

The IS curve

Consider the Output equation and introduce the

Government and the Investment

𝑌 =1

1 − 𝑐(1 − 𝑡)[ 𝑐0 − 𝑐1𝑡0 + 𝑐1𝑇𝑟 + 𝐼 − 𝑏𝑖 + 𝐺 ]

Multiplier

m Autonomous: it’s

indipent by i

𝐴

𝑌 = 𝑚(𝐴 − 𝑏𝑖)

Graph derivation

Y

S

4

5

°

S

I

I

i i

Y

I

S