Chapter 1: Simple Frameworks of Macroeconomics

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Chapter 1 Simple Frameworks of Macroeconomics

• Kornkarun Kungpanidchakul, Ph.D.
• Macroeconomics
• MS Finance
• Chulalongkorn University, Spring 2008

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Reading lists

• Any undergraduate macroeconomic textbooks.

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National Income Account

• Gross Domestic Product (GDP)
• The total value of the current production of
  final goods and service within the national
  territory during a given period of time.
• GDP C I G X M

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National Income Account

• Gross National Product (GNP)
• The total value of income that domestic residents
  receive in a given of time.
• GNP GDP NFD
• where NFD is net factor income (payments)
  received from abroad.

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Real vs Nominal Variables

• Consumer price index
• Denote Pct as a weighted average of all prices of
  the consumption goods at time t.
• wi as athe weights of each good
• Then,
• Pct w1 (P1t/p10) wN (PNt/pN0)
• Pct is called the consumer price index (CPI) or
  the consumption price deflator.

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Real vs Nominal Variables

• Real GDP
• Given P GDP price deflator
• Q real GDP
• GDP P.Q

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Flows vs Stocks

• A flow is an economic magnitude measured as a
  rate per unit of time.
• A stock is a magnitude measured at a point of
  time.

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The static AS-AD model

• Aggregate supply (AS)
• The total amount of output that firms and
  household choose to provide given wages and
  prices
• The demand for labor
• Suppose that the capital stock is fixed, the
  production function can be written as
• Q F(L,K)

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The static AS-AD model

• We consider the nicely convex technology in
  which
• 1. MPL gt0 and MPK gt 0
• 2. and
• 3. CRS technology
• Profit maximization problem
• Max pf(K,L) wL
• FOC MPL w/p
• Therefore, MPL is the demand for labor.
• LD LD(w/p,K)

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The static AD-AS model

• The supply of labor
• Suppose that C set of consumption goods
• R 1-Ls leisure
• Households maximization problem is
• Max U(C, 1-Ls)
• s.t. C (w/p) Ls
• FOC MRS w/p

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The static AD-AS model

• Is the supply of labor curve is always upward
  sloping?
• We can decompose the price effect into
• Substitution effect The higher wage makes people
  substitute leisure for consumption goods.
• Income effect The higher wage makes people
  richer and increase the consumption of leisure
  (which is a normal good).

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The static AD-AS model

• If SE gt IE, supply curve has positive slope.
• If SE lt IE, supply curve has negative slope
  (normally when wage is really high).

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The static AD-AS model

• The classical approach to aggregate supply
• Assumptions
• nominal wage is fully flexible.
• The expectation is perfect foresight.
• Labor is always fully employed.
• AS is always the vertical line at the full
  employment level.

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The static AD-AS model

• The Classical Aggregate Supply

Q
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The static AD-AS model

• The Keynesian approach to aggregate supply
• Assumption
• The nominal wages and prices do not adjust
  quickly.

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The static AD-AS model

• Suppose that the nominal wage is fixed by a labor
  contract. The real wage then varies inversely
  with price level. As price increases, the demand
  for labor increases so as the output supply.
  Therefore AS curve is upward sloping until the
  full employment level.

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The static AD-AS model

• Keynesian Aggregate Supply
• Qs Qs(w/p, K)

Q
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The static AD-AS model

• Extreme Keynesian
• When MPL is constant and the nominal wage is
  fixed, AS is horizontal.

P
AS
Q
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The static AD-AS model

• Aggregate Demand (AD)
• QD C I G

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The static AD-AS model

• Classical approach Upward shift in AD leads to
  a change in price only.

P
AS
AD
AD
Qf
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The static AD-AS model

• Keynesian Approach An increase in AD raise both
  price and output.

P
AS
AD
AD
Q