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Macroeconomics for Business
• Microeconomics
• Macroeconomics
–Living Standards (y/pop.)
–Inflation (P)
–Unemployment (U)
.
Living Standards
• Cross-Sectional Data– North America, Western Europe, Japan vs.
– South America, Eastern Europe, South Asia, Africa
• Time-Series Data– US over time; Sub-Saharan Africa
– China; Singapore
China’s Per Capita GDPand the Open Door Policy$
1500 1600 1700 1800 1900 2000
5000
3000
10000
Singapore 1959
Singapore 2000
Inflation
• Rule of 72
• Cross-Sectional Data--Venezuela vs. Japan
• Time-Series Data--Germany Then and Now; USA
Consumer Prices 1800 - 2000price level
1800 1860 1910 1940 1970 2000
Unemployment
• Cross-Sectional Data:– Switzerland vs.
Belgium
• Time-Series Data: – The U.S. today
vs. 1933
Y, y: Gross Domestic Product
• GDP vs. GNP
• Market Value
• Final Goods
• Produced
• Year
Value Added = Sales - Cost of Purchased Materials
Cotton $5 5-0 = 5
Shirt-Wholesale 15 15-5 = 10
Shirt-Retail 30 30-15 = 15 30
Sales Value Added
Nominal GDP, Real GDP & the GDP Deflator
Nominal (Y) = (P2005 x Q2005) - (P2005 x Q2005) [sales] [materials]
Real (y) = (P1997 x Q2005) - (P1997 x Q2005)
GDP Deflator = Nominal GDP/Real GDP
Base Year? Chain-Weighted Real GDP
Alternative Measures of Y,y
• NDP, NNP
• National Income
• Personal Income
• DPI
• Personal Consumption
• Personal Savings
• Size Distribution
• Functional Distribution
Alternative Measures of P
• GDP Deflator
• Consumer Price Index
• Producer Price Index
• Inflation vs. the Price Level
U = (unemployed/LF) x 100%
• LF
• Actively looking
• Discouraged workers
• “Unemployed but with a job”
• Age
• Paid work
•GDP Gap = Yp - Y
•Spending components of GDP C (70%)I (17%)G (19%)(X-M) (-6%)
The Federal Reserve System
• Board of Governors– Chairman
• District Banks
• FOMC (12) = 7 + 5
• Lender of Last Resort
• Targeting of Federal Funds Rate
Money Supply Definitions
• Monetary Base
• M1
• M2
The Money Supply:Central Bank Impacts
• Open Market Operations
• Discount Rate
• Reserve Requirements
The Money Supply:Private Impacts
• Currency/Deposit Ratio
• Excess Reserves
• Account Shifting
CLASSICAL MACROECONOMICS
VS. MERCANTILISM
• Real Assets vs. Money
• Openness vs. Balance of Trade
• Free Markets/Free Trade vs. Barriers, Subsidies
Adam Smith
COMPETITIVENESS
1. USA
2. Switzerland
3. Denmark
4. Sweden
5. Germany
Advantages of Backwardness
• Copy existing technology
• Small absolute gains constitute big percentages (1 2 = 100%)
Competitiveness:Main Factors
• Openness
• Role of Govt
– Tax Rates
– Regulation
• Labor
• Financial Sector
China’s PerCapita GNPand the OpenDoor Policy $
1500 1600 1700 1800 1900 2000
5000
3000
1000 0
Classical View of Production (y)
• Background
• y = F(K,N)
• N: ND & NS
• K = K
y
N
Slope = y/ N = MPN
MPN
N
Rule: Proceed as long as MR > MC
Here: MR = P x MPNMC = W
N
VMP = P x MPN
W0
ND
STOP
View ofEmployment(N)
What if W Changes?
W, VMP
N
W0
W0’
NDND’
VMP
At ND...
• W = P x MPN = VMP
• W/P = MPN
• Real Wages Around the World
NS: Labor Supply
• Upward Slope Not a Straightforward Matter
• Immigration
• LFP: The Changing Nature of Household Production
• Leisure Time in the USN
WNS
Labor Market Equilibrium
W
N
NS
ND(P x MPN)
WE
NE
Full Employment?
Overall Equilibrium for y, N
y
NW
N
y
NS
ND
yE
NE
What if P Rises?
• Labor Demand Shifts Right
• Labor Supply Shifts Left
• ‘N’ is Unaffected
• So ‘y’ Is Also Unaffected y
P ys
P0
P1
y
A
B
Key Classical Assumptions
• Wages Adjust Flexibly to Equilibrium– Contracts?
– Incomplete Information--Inertia?
• Workers Understand Their Real Wage and Base Their Labor Supply Decisions on It
View of Inflation
• Equation of Exchange
– MV = PT
– MV = Py
• Quantity Theory of Money
Consumer Prices 1800 - 2000price level
1800 1860 1910 1940 1970 2000
Classical View of yd
P
y
yd
Monetary vs. Nonmonetary Factors
The Classical Theory of Interest Rates
R
NPS, I
ERE
NPS
Key Factors:1) Net Private Saving2) Gross Investment
I
Suppliers and Demanders of Loanable Funds
• Households
• Businesses
• Government
• Foreigners
The Impact of the Government’s Budget
R
RB
RA A
B
S (NPS)
D (I + PSBR)
I
LF IA
IB
Budget Surplus
NPS S (NPS + SURPLUS)R
I
RA
RB
A
B
LFIA IB
3-Month Interbank Rates (S$ and SIBOR-US$)
0
2
4
6
8
10
1985 1990 1995 2000 2005
Year
Inte
rest
Rat
e (%
)
Series1
Series2
Role of R: Classical View
• Coordinate Present vs. Future
• Prevent Nonmonetary Events from Affecting V, Total Spending, yD
• yD = c + i + g; suppose deficit spending
– “Crowding Out”
J.M. Keynes (1883-1946)
• View of Capitalism
• WE? RE?
• S = I (ex ante)• Uncertainty, herd
mentality, animal spirits, instability
Keynesian View (cont’d.)
• Quantity Adjustment vs. Price Adjustment
• Y = E (Keynesian equilibrium)
• E = C + I + G• Y = C + I + G• Fiscal Policy vs.
Monetary Policy
Simple Keynesian Multipliers:No Crowding Out
kE = 1/1-b
kT = -b/1-b
kBB = 1
Closing the GDP Gap
Housing Bubble
1975 1995 2005
HOUSING
CONSUMER GOODS
Keynesian ys Curve
P
yyd
yd’
ys
A B
yA yB=yp
P
What if P Rises?
• Labor Demand Shifts Right
• Labor Supply Shifts Left
• ‘N’ is Unaffected
• So ‘y’ Is Also Unaffected y
P ys
P0
P1
y
A
B
Classical, but with W = W
P
y
ys
P0
P1
y0 y1
The Liquidity Preference Theory of Interest Rates
R
M
MS
MD = L(R,Y)
REE
Note Bond Market and LF
The Federal Reserve: June 2004
R
M
MD
MSMS’
E
E’
1.00%
1.25%
yD-yS Analysis
• yS slope*
• yD shifts (IS-LM events)*
• yS shifts
• yD slope
What if P Rises?
• Labor Demand Shifts Right
• Labor Supply Shifts Left
• ‘N’ is Unaffected
• So ‘y’ Is Also Unaffected y
P ys
P0
P1
y
A
B
Keynesian ys Curve
P
yyd
yd’
ys
A B
yA yB=yp
P
Classical, but with W = W
P
y
ys
P0
P1
y0 y1
yS Shifts: Note Production Costs
• Transition from SR to LR– Wage
adjustment
– Disappearance of money illusion (Pe)
• Supply shocks (energy, strikes, etc.)
• Supply-side economics? (tr, regulation)
• VLR: K, population, tech.
Restrictive Monetary Policy
yD
yD’
ySSR
yS’SR
ySLR
P
y
A
B
C
Stimulative Monetary Policy
P
yyD
yD’
ySSR
yS’SR
ySLR
A
B
C
Monetarism
• MS-->YSR and LR
• MS-->ySR
• MS-->PLR
• Fiscal Policy?
– yD? (Note slopes)
– LR yS (role of govt)Milton Friedman (1912- )
Name That Economist
• Classical
• Keynesian
• Neo-Keynesian
• Supply-Sider
• Monetarist
Robert MundellSupply-Sider
The Phillips Curve
Phillips Meets Friedman
PCSR
U
P
The Natural Rate of Unemployment
PCLR
Why Increased InflationCan Only TemporarilyReduce Unemployment
.
A
BC
Phillips Curve Movements
SR LR
Stimulative NW NE
Restrictive SE SW
Types of Unemployment
• Natural
– Frictional
– Structural• Skills
• Location
• Labor Market Restrictions
• Cyclical
P, U: Long Run Policies
• Target Low Inflation
• Caution on Labor Market Restrictions, Welfare
• Education & Training; Lifelong Learning
.
Austrian Business Cycle Theory
• Nonneutral Injections of Money, Misdirection
• i: Capital Goods vs. Consumption Goods
• Later Reversal in Relative Prices and Resource Allocation
• Frictions, UnemploymentFriedrich Hayek
Austrian Business Cycle Theory
R
NPS, I
NPSNPS + MS
I
I0 I1
Natural
Market PV & Duration;Misdirection
E
E’
A Metaphor: Pour in Honey
PK PC
Share Prices: Japan vs. US
CPI-Japan
Updating the Theory
• Responsiveness of C to R
– Durable Goods, Housing
– Proceeds from Refi’s
• Wealth Effects on C
• Duration of High-Tech Company Investments (dot.com cash flows)
• “R” vs. “Cost of Capital”
Housing Price Bubble?
1975 1995 2005
HOUSING
CONSUMER GOODS
Long Run Growth
• System
• Culture
• Saving (K)
• Education (Human K)
• Technology
$40000
5000
1500
$500
Competitiveness:Main Factors
• Openness
• Role of Govt
– Tax Rates
– Regulation
• Labor
• Financial Sector
Singapore $ per US $
0
0.5
1
1.5
2
2.5
1980 1985 1990 1995 2000 2005Year
Exch
ange
Rat
e
BALANCE OF PAYMENTS
• CREDITS (+) DEBITS (-)
• CURRENT ACCOUNT:– Exports Imports
– Investment Income Investment Income Received Paid
– Transfer Income Transfer Income Received Paid
• CAPITAL ACCOUNT:– Capital Inflow Capital Outflow
Flexible ER, Trade Deficit, BP = 0
foreign currency/$
$
Q
(Q + CO) (S)
EERE
X
(X + CI) (D)
(X-Q)<0
ER(X-Q=0)
Flexible ER, Trade Surplus, BP=0
X(X + CI) (D)
foreign currency/¥
EERE
Q(Q + CO) (S)
ER(X-Q)=0
¥
PURCHASING POWER PARITY?
• The Big Mac Test
• Short Run
• Long Run? Role of Inflation
• Barriers
• Sustained Capital Flows?
Major Reasons for Currency Movements
• Short-term: Expected IRRs, Central Bank intervention Long-term: – PPP?
– Reversal of Current Account Balance?
• Recent US
$