lOMoARcPSD|11911780
Macroeconomics I: European perspective
Introductory lecture
Macroeconomics
- The big picture
- What happens to (parts of) entire economies?
- Income, growth, unemployment, inflation, etc.
- Relationships between these variables
- Globalisation
o Goods, services, capital, people
- Economic shocks
- Government policies
- Importance of institutions
o European Union, exchange rate mechanism, labour markets, etc.
Output and time
“The most important goal of macroeconomics is to develop an understanding of what makes income
differ between countries and what makes them grow or fluctuate over time” (Gartner, p. 36)
- Analysing equilibrium
- Comparing equilibriums
- How do countries move between equilibriums?
- Different time frames
o Different processes
o Different variables
o Different policies
Short and long run
- Analysis and explanations depend on time frame
- Key: what do we assume about prices?
Quantity equation MxV = PxY
(V assumed fixed)
Long run: Y determined by production factors ΔM =ΔP
Short run: Y determined by M
ΔM = ΔY P assumed fixed
Aggregate supply curve
Two cases;
, lOMoARcPSD|11911780
Chapter 2: Booms and Recessions
- Short run analysis
- How to explain booms and recessions?
- Look at aggregate demand!
o Fluctuations in aggregate demand explain deviations of economy from
potential income (see next slide)
- John Maynard Keynes
o General Theory of Employment, Interest and Money (1936)
- Government can (and should) influence economy by influencing aggregate demand
Different types of income Y
Demand side analysis
Ignore price effects: everything that is demanded is supplied at the same price -> horizontal supply
curve
To analyse the functioning of the economy we can focus on demand.
Circular flow model
, lOMoARcPSD|11911780
Income = expenditure
Keynesian cross
The Keynesian cross contains two lines. The 45° line measures actual expenditure which always
equals income. At points above this line, desired demand exceeds output; at points below, the
opposite is true. The aggregate expenditure line indicates the sum of all spending plans. Both lines
cross in A, meaning that here spending plans are perfectly compatible with income.
, lOMoARcPSD|11911780
Fiscal policy
- Government can try to influence Y
- Fiscal policy
o Government expenditure
o Tax rate
- Big breakthrough of this type of Keynesian thinking
- Effect of policy is larger than size of policy
- Multiplier effect
Small changes in AE can have large effects on income
Triggers for booms and recessions
Chapter 3: IS-LM model
Investments play a key role
So we need to know the interest rate:
- Introduction of money market to better understand goods market
- Money market gives a new policy tool: Monetary
policy Short run analysis = fixed P ΔM = ΔY
Money market: demand (1)
- Market for money: demand and supply
- Price of money: interest rate
- What determines demand for money Ld?
o (Wealth ≠ money!)
- Demand for liquidity: money as means of exchange
- Income (Y) positive effect
- ↑ Y → ↑ Consumption → ↑ Ld
Money market: demand (2)
Macroeconomics I: European perspective
Introductory lecture
Macroeconomics
- The big picture
- What happens to (parts of) entire economies?
- Income, growth, unemployment, inflation, etc.
- Relationships between these variables
- Globalisation
o Goods, services, capital, people
- Economic shocks
- Government policies
- Importance of institutions
o European Union, exchange rate mechanism, labour markets, etc.
Output and time
“The most important goal of macroeconomics is to develop an understanding of what makes income
differ between countries and what makes them grow or fluctuate over time” (Gartner, p. 36)
- Analysing equilibrium
- Comparing equilibriums
- How do countries move between equilibriums?
- Different time frames
o Different processes
o Different variables
o Different policies
Short and long run
- Analysis and explanations depend on time frame
- Key: what do we assume about prices?
Quantity equation MxV = PxY
(V assumed fixed)
Long run: Y determined by production factors ΔM =ΔP
Short run: Y determined by M
ΔM = ΔY P assumed fixed
Aggregate supply curve
Two cases;
, lOMoARcPSD|11911780
Chapter 2: Booms and Recessions
- Short run analysis
- How to explain booms and recessions?
- Look at aggregate demand!
o Fluctuations in aggregate demand explain deviations of economy from
potential income (see next slide)
- John Maynard Keynes
o General Theory of Employment, Interest and Money (1936)
- Government can (and should) influence economy by influencing aggregate demand
Different types of income Y
Demand side analysis
Ignore price effects: everything that is demanded is supplied at the same price -> horizontal supply
curve
To analyse the functioning of the economy we can focus on demand.
Circular flow model
, lOMoARcPSD|11911780
Income = expenditure
Keynesian cross
The Keynesian cross contains two lines. The 45° line measures actual expenditure which always
equals income. At points above this line, desired demand exceeds output; at points below, the
opposite is true. The aggregate expenditure line indicates the sum of all spending plans. Both lines
cross in A, meaning that here spending plans are perfectly compatible with income.
, lOMoARcPSD|11911780
Fiscal policy
- Government can try to influence Y
- Fiscal policy
o Government expenditure
o Tax rate
- Big breakthrough of this type of Keynesian thinking
- Effect of policy is larger than size of policy
- Multiplier effect
Small changes in AE can have large effects on income
Triggers for booms and recessions
Chapter 3: IS-LM model
Investments play a key role
So we need to know the interest rate:
- Introduction of money market to better understand goods market
- Money market gives a new policy tool: Monetary
policy Short run analysis = fixed P ΔM = ΔY
Money market: demand (1)
- Market for money: demand and supply
- Price of money: interest rate
- What determines demand for money Ld?
o (Wealth ≠ money!)
- Demand for liquidity: money as means of exchange
- Income (Y) positive effect
- ↑ Y → ↑ Consumption → ↑ Ld
Money market: demand (2)
