ECON 104 Lecture Notes PDF

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Lecture notes for ECON 104 Introduction to Macroeconomics taught by Patrick Dolenc....

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Austin Rossi Professor Patrick Dolenc Economics 104 Spring 2017 LECTURE NOTES - ECON 104

Wednesday, January 25, 2017 ● Starting Assumption: Humans are social creatures. ● Ants, wolves, etc. live in packs with leaders. ○ In each case, their social structures appear to be hard-wired. ○ Their social relationships seem to be part of their biological identity. ● We invent our social structures. ● Robert Heilbroner (1919-2005): ○ Organizing against Calamity ■ Custom & Tradition ■ Command ■ Self-Interest & Markets ● From “The Capitalist Revolution” ○ History’s hockey stick: living standards in five countries (1000-2010) ● Adam Smith (1723-1790): ○ Scottish philosopher & political economist ○ Author of 1776 work The Wealth of Nations ○ The Invisible Hand:

■ People operate out of self-interest ■ Competitive markets ■ Result: Socially optimal

Monday, January 30, 2017 ● The Invisible Hand: ○ “…he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention…” ○ Three parts: ■ Self interest ■ Competitive markets ■ Socially optimal ○ Markets are best equipped to provide for society’s interests ■ If this is true, what is the role for government? ● To get out of the way? ● Laissez Faire (hands-off) ● Positive vs. Normative dichotomy ○ Positive Economics ■ “What is” ■ Facts ■ Claims objectivity ■ Scientific work ○ Normative Economics

■ “What should be” ■ Opinions ■ Concedes subjectivity ■ Not science ● Typical economist view ○ Grounded in logical positivism ○ Scientific status only if verifiable ○ “Facts speak for themselves” ● Dolenc’s View ○ Rejects logical positivism ○ Positive-Normative is false dichotomy (facts are value-laden) ○ “Facts do not speak for themselves” ● Opportunity Cost: ○ When scarcity requires choices… opportunity cost is your next best option. ● The Fallacy of Composition: ○ The whole is more than the sum of the parts

Wednesday, February 1, 2017 ● Models: ○ Simplifications of reality ○ Include essential elements ○ Exclude non-essential elements ○ Process of simplifying is a strength, not a weakness. Why?

● Modeling Opportunity Cost: ○ Assume two producers ■ Gilligan and MaryAnn ○ Assume two productive activities ■ Gathering coconuts ■ Catching fish ○ Gilligan ■ He has 50 hours each week to spend on ■ It takes him 30 minutes to gather each coconut ■ It takes him 15 minutes to catch each fish ○ MaryAnn ■ Spends 80 hours each week on productive activities ■ It takes her 60 minutes to gather each coconut ■ It takes her 20 minutes to catch each fish Maximum Output Gilligan MaryAnn

Coconuts 100 80

Fish 200 240

○ Absolute advantage: Gilligan gathers both coconuts and fish at a faster rate ● Tasks to complete: ○ Production Possibilities Graphs ■ Each producer gets a graph ■ Constant slope = constant opportunity cost

○ Calculate Opportunity Costs ■ There are several methods

1. Tell a story 2. Use the slope of the graph ■ Slope of the graph is the opportunity cost of the horizontal axis 3. Use the inverse ■ For each producer, the opportunity costs will always be inverses ■ Opportunity Cost is your next best option Opportunity Cost Gilligan MaryAnn

■

Coconuts 2 Fish 3 Fish

Fish 0.5 Coconuts 0.33 Coconuts

What is the per unit opportunity cost?

Wednesday, February 15, 2017 ● Externalities: Remedies ○ Command-and-control regulation ○ Pigouvian taxes ■ If we tax an externality, it makes it more expensive and therefore less likely to happen ■ Generates revenue ○ Marketable permits ■ Set prices based on level of use ● Gross Domestic Product (GDP): The total dollar value of final output produced within a nation’s borders in a given time period.

○ Why do we need it? ■ Measure of macroeconomic output ■ Quantity scale for macro graphs ■ Comparisons across space ■ Comparisons across time ● Macro measures ○ Nominal GDP: prices and quantities ○ Real GDP: quantities only ○ The GDP Deflator: prices only ■ (Nominal GDP / Real GDP) * 100 = GDP Deflator

Wednesday, February 22, 2017

Income Factors of Production

Households

Businesses

Goods and Services Sold Consumptions Savings

Financial Institutions

Investment Government Spending

Taxes Government Imports

Rest of World

Exports

● Income = Output ○ If total income = total output, and if all products made are sold, then income must equal sales ○ People spend all of their income ● Leakages: Things that happen to household income besides being spent on goods and services ○ Savings ○ Taxes ○ Imports ● Injections

○ Planned Investment ■ Business spending that’s intended to increase future sales ○ Government Spending ○ Exports ● Savings → Financial Institution → Investment ● Taxes → Gov’t → Gov’t Spending ● Imports → Rest of World → Exports ● Notions of Equilibrium ○ Static Equilibrium ■ In equilibrium and not changing ○ Dynamic Equilibrium ■ In equilibrium, but on a path ○ If leakages > injections, recession ○ If injections > leakages, inflation ○ If leakages = injections, equilibrium

Monday, February 27, 2017 ● Exam 1 Details: ○ No multiple choice ○ 4 of the topics from the study guide ○ 2 analytical problems ■ One will be Gilligan and Mary Anne type problem ● Externalities:

○ Invisible Hand wants to guide the market to the Equilibrium ○ Increase in total cost of production would lead to a shift up in the supply curve

Monday, March 20, 2017 ● The Keynesian Cross (Aggregate Expenditure) Model ○ Focus on the demand/spending side of the economy ○ Keynesians… ■ Focus on aggregate spending ■ Emphasize multiple equilibria ■ Believe economy gets “stuck” ○ Aggregate Expenditures ■ Consumption (C) ■ Planned Investment (I) ■ Government Spending (G) ■ Wtres ratess, expectations ● Consumption Function ○

C=a+b Y d ■

C=¿ current consumption

■

a=¿ autonomous consumption

■

B=¿ marginal propensity to consume

■

Y d =¿ disposable income

● Marginal Propensity to Consume ○ The MPC is the fraction of each additional (marginal) dollar of disposable income

spent on consumption ○ MPC ¿ ΔC / ΔY d ○ The slope of the consumption function ● The 45-Degree Line ○ Spending ¿ Income ○ Equilibrium line for this model ○ Set of all possible equilibria ● One-Sector Model ○

C=100+0.75 Y D

○ Calculate equilibrium ○ Graph the model

Wednesday, March 22, 2017 ● Gross Private Domestic Investment (Actual Investment): ○ Expenditures by firms (e.g., plant and equipment) ○ New Residential Structures ○ Changes in Business Inventories ● Measuring GDP ○

GDP=C +I + G+ EX −ℑ ■

C=¿ Consumption

■

I =¿ Gross Private Domestic Investment

■

G=¿ Government Purchases

■

Ex=¿ Exports and

ℑ=¿ Imports

● The Keynesian Model ○ Two-Sector Model ■ Household spending and business spending ■ Two-sector focus: C+I ■ Two spending equations to graph ○ Example: ■ Calculate one-sector equilibrium ■ Calculate two-sector equilibrium ■ Graph the model ■

C=100+0.75 Y D

■

I =200

■

C+ I =100+ 0.75 Y D + 200

■

C+I =Y D

■

Y D =300+0.75 Y D

■

0.25 Y D =300

■

Y D =1200

○ Another Example: ■ Calculate one-sector equilibrium ■ Calculate two-sector equilibrium ■ Graph the model ■

C=400+ 0.80Y D

■

I =300

■

C+ I =400+0.80 Y D +300

■

C+I =Y D

■

Y D =700+0.80 Y D

■

0.20 Y D =700❑

■

Y D =3500

○ Something to think about… ■ When C=100+0.75 Y D

and I =200 ,

● One-sector equilibrium: 400 ● Two-sector equilibrium: 1200 ■ When C=400+ 0.80Y D and I =300 , ● One-sector equilibrium: 2000 ● Two-sector equilibrium: 3500 ● The Multiplier Effect: the amplified effect of a change in autonomous spending on the equilibrium level of income. ○ Multiplier ¿

1 1−MPC

○ Example: ■ When C=100+0.75 Y D ■ Multiplier ¿

1 =4 1−0.75

■ When C=400+ 0.80Y D ■ Multiplier ¿

Monday, March 27, 2017 ● Three-Sector Model

1 =5 1−0.80

○ Households, Businesses, and Government ○ Three-sector focus:

C+I +G

○ Three spending equations to graph ● What about taxes? ○ So far we assumed no taxes ○ Income and Disposable Income have been interchangeable concepts…until now. ○

Y D =Y −T

○ Disposable Income = Income - Taxes ● Three-Sector Example ○ Calculate the multiplier ○ Calculate one and two-sector equilibria ○ Graph the model ○ Calculate the three-sector equilibrium ○

C=1250+0.5 Y D

○

I =250

○

G=500

○

T =500

○ Multiplier ¿ 1/(1−MPC ) ■

¿ 1/(1−0.50)

■

¿ 1/0.50

■

¿2

○ Multiplier ¿ ■

Δ Equil . Income Δ Auto Spending

Δ Equil . Income=Multiplier ⋅ Δ Auto Spending

■

C=1250+0.50 Y D , I=250

■ One sector equilibrium:

2.0 ⋅1250=2500

■ Two sector equilibrium:

2.0 ⋅1500=3000 EQUILIBRIUM

SPENDING

C+I C

INCOME

■

C+ I +G=1250+ 0.5Y D +250+500

■

C+I +G=Y

■ Equilibrium is in terms of Y but consumption is expressed in ● So we also need:

Y D =Y −T

■

C+I +G=1250+ 0.5Y D +250+500

■

C+I +G=2000+ 0.5(Y −T )

■

C+I +G=2000+ 0.5(Y −500)

■

C+ I +G=2000+ 0.5Y −250

■

C+ I +G=1750+ 0.5Y

YD

Monday, April 10, 2017 ● Termites: Believe that the national debt will be more of an issue in the future ○ Not a cyclical phenomenon ○ What about external debt? ○ What did we buy? ○ Demographics of Entitlements ● Internal Debt: The U.S. government debt (Treasury bonds) held by U.S. households and U.S. institutions ● External Debt: The U.S. government debt (Treasury bonds) held by foreign households and foreign institutions ● Do we now have… ○ High-tech railways? ○ Infrastructure? ○ Universal Health Care? ○ Tuition-free higher education? ○ Renewable energy? ● No. So what did we buy? ○ Largest military ○ Tax cuts ● Military Expenditures Nation

Spent

Share

USA

569.0

36.5%

China

214.8

13.1%

Saudi Arabia

87.2

5.3%

Russia

66.4

4.1%

United Kingdom

55.5

3.4%

India

51.3

3.1%

France

50.9

3.1%

Japan

40.9

2.5%

● Entitlements ○ Social Security is a “pay-as-you-go” system ● Functions of Money ○ Medium of Exchange

Wednesday, April 19, 2017 ● T Accounts ○ Also known as “Balance Sheets” ○ The two sides must always balance ○ Assets vs. Liabilities + Net Worth ○ Net Worth is also called “Bank Capital” ● Balance Sheets ○ Assets are possessions of value ○ Liabilities are outstanding obligations ○ Net Worth is the residual amount necessary to achieve balance ● Balance Sheet: Individual ASSETS

LIABILITIES + NET WORTH

$500 Cash $1,000 Checking Account $5,000 Car Loan $10,500 Car $2,500 VISA Loan $4,500 Net Worth Total: $12,000

Total: $12,000

● Balance Sheet: My Bank ASSETS

LIABILITIES + NET WORTH

$200,000 Cash (reserves) $1,000,000 Checking Accounts $600,000 Loans $400,000 Bonds $200,000 Net Worth Total: $1,200,000

Wednesday, April 26, 2017 ● Solvency: ○ Assets are not enough to pay off liabilities ● Moral Hazard: ○ Decision-maker is not accountable ○ YOU decide, but I am responsible ○ Often occurs with insurance

Total: $1,200,000

○ Sometimes called the Agency Problem ● Tools of Monetary Policy: ○ Set the Required Reserve Ratio ■ Don’t often use it because it affects all banks and is not very precise ○ Establish the Discount Rate ■ Mostly symbolic, banks aren’t supposed to use it often ○ Conduct Open Market Operations ■ When the Federal Reserve either buys bonds from banks and gives them reserves in exchange, or the Fed sells bonds to banks and uses that as an excuse to draw reserves out of the banking market ● Money Multiplier = ○ 1 / required reserve ratio ● Potential Deposit Creation = ○ money multiplier * excess reserves ● FOMC: ○ Federal Open Market Committee

rrr = .25 ASSETS

LIABILITIES + NW

Cash

$ 800,000

Deposits

$ 1,000,000

Loans

$ 250,000

Bank Capital

$ 200,000

Bonds

$ 150,000 TOTAL: $ 1,200,000

TOTAL: $ 1,200,000

a.) What are the required reserves of this bank? $ 250,000 b.) What are the excess reserves of this bank? $ 550,000 c.) Calculate the money multiplier. 4 d.) Assume that the FOMC uses expansionary open market operations and that this bank participates completely. Draw the new balance sheet. ASSETS

LIABILITIES + NW

Cash

$ 950,000

Deposits

$ 1,000,000

Loans

$ 250,000

Bank Capital

$ 200,000

Bonds

$0 TOTAL: $ 1,200,000

TOTAL: $ 1,200,000

e.) Calculate the potential deposit creation. potential deposit creation = money multiplier * excess reserves money multiplier = 1/rrr money multiplier = 1/.25 money multiplier = 4 excess reserves = total reserves - required reserves excess reserves = $ 950,000 - $ 250,000 = $ 700,000 potential deposit creation = 4 * $ 700,000 $ 2,800,000

● The Macroeconomics of Monetary Policy ○ 6 Steps: 1. The Fed employs policy tools… a. Cut required reserve ration b. Lower discount rate c. Fed buys bonds 2. Banks increase lending… 3. The money supply increases… 4. Interest rates decrease… 5. Low interest rates → more planned investment… 6. More planned investment = more jobs! ○ 3 Graphs:...