@K.R.Bhattarai, Business School, University of Hull 1 Economic Modelling Lecture 1 Introduction to...

@K.R.Bhattarai, Business School, University of Hull

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Economic Modelling

Lecture 1Introduction to Economic ModellingOutline of the SyllabusBasic skills required for the Module


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Economics Modelling (26214)Lectures and Tutorial Meetings and Office Hours

Lectures Day Time Room

Monday 2:15 WI-S 25 Tuesday 4: 15 Loten- LRD

Wednesday 12:15 Larkin-LTATutorials

Day Time RoomTuesday 3:15 WI-S10

Thursday 9:15 WI-S 26Office hours:

Monday 12:05 - 2:05 369 WilberforceTuesday 1:05 - 3:05 369 Wilberforce

Midterm Exam Thursday March 4, 2004Essay Due Thursday April 1 2004 by 4 PM (hand in at School Office)

Reading Week Starts February 23rd.


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What is an Economic Model?• An abstract map of an economy• Way of systematic thinking on

– how the value of one variable determines the value of another variable.– How one set of variables determine another set of variables

• Language that economists speakA Model contains

– endogenous variables– exogenous variables– Parameters– Assumptions– Solutions

Representation of model: Diagrams and equations– linear or non-linear, single or multiple equations, – static or dynamic or strategic– Theoretical (abstract) or appliedUsed of Model : analysis of behaviour, facts or evaluation of a

policy


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Major Economic Questions

• Why levels and rate of growth of income are different over time and in different countries?

• What determines aggregate demand and aggregate supply in an economy in the short run?

• How do households and firms make their consumption and investment decisions?

• How can fiscal and monetary policy measures taken by the government affect decision of households and firms in an economy?

• What causes fluctuations in income, employment, prices, revenue and spending of government, imports and exports in economy?

• What kind of models can explain making of economic policy for higher rate of growth and for stability of an economy?

• What is the link between home and foreign economies? How to be most competitive and efficient in allocating scarce resources in an economy?


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Quarterly GDP in the UK: ONS(NAVIDATA)


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7

1960 1970 1980 1990 2000

0

20

40Algeria Ghana

1960 1970 1980 1990 2000

0

5UnitedKingdom UnitedStates

1960 1970 1980 1990 2000

0.0

2.5

5.0

7.5Germany France

1960 1970 1980 1990 2000

-5

0

5

10India

1960 1970 1980 1990 2000

-20

0

20China

1960 1970 1980 1990 2000

0

10Japan Korea

1960 1970 1980 1990 2000

0

10Singapore Malaysia

1960 1970 1980 1990 2000

0

5

10 Netherlands Ireland

Variation in Growth Rates Across Economies

Graphics Using Givewin (Doornik and Hendry (2001)) and Data from the World Bank CD (start/applications/Economics)


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Module Contents

Analysis of Economic growthAnalysis of Macroeconomic Fluctuation

– Analysis of Macroeconomic Fluctuations using the IS-LM, AS-AD Models

– Unemployment and Inflation

Fiscal and Monetary policy for internal and external stabilityRole of Financial Market in the EconomyExchange rate and Balance of PaymentMicro-foundation on Consumption and Investment and

general equilibrium impacts of taxesPolicy game


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Module Requirements

• Activities: 22 Lectures; 10 TutorialsSmall in-class mock tests and quizzes

Assessment• Course Work counts 50 percent of the module marks

In class Mid-term exam counts 25 percent will be held on Thursday March 4, 2004

Term paper counts 25 percent Due Thursday April 1, 2004

• Final Exam counts 50 percent (After Easter between April 26 -May 10)

• Reassessment by two hours’ written exam


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An Overview of Decision Makers and Players in an Economy

HouseholdsConsumers

Firms – InvestorsProducers

Banks –Central Bank

Commercial BanksStock Market

Financial Institutions

Trade Unions Employer

Unions

Merchants and Traders

–Wholesalers–Retailers

Revenue – Tax Collector

Treasury –Allocation of Public Funds

Economy:The Big Market

(prices and quantities)

Rest of the World (ROW) –

Trading PartnersMultilateral Organisation


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Economy(p, w, y, c, l, L)

Firms (producers) Max π(LS)

Households (consumers)Max U(C,L)

Labour supply, L

Wage payment, wL

Supply of Goods

Payments for goods, p.y

1lcUMax1 LSlwLSpc

0;0;0 LSlc

wLDpyMax LDy

0;0 LDy

Market p and w such thatY = CLD = LSLS +l = L

Micro-Foundation to Macro VariablesGeneral Equilibrium with a representative household and firm


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Personal disposable

income

Personal incomeNational

income

NDP

GDP

C

Indirect taxes

Depreciation

I

G

X-Z

GDP, GNP, National and Disposable Incomes


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Keynesian Static Model of National Income

Y = C + I + G ; C = a0 + a1(Y-T)Endogenous variables Y, C and Exogenous variables G, IParameters: a0 and a1.

C =200 + 0.8*(Y-T) ; T =20; G=20; I =30 Solving the model: Y = (a0 - a1T+I+G)/(1-a1)Y =200 +0.8*(Y-T) +I +GY-0.8Y = 200 -0.8*(20) +30+200.2 Y =200-16 +50Y =234/0.2 = 5*(234) = 1170C = 200+0.8*(1170-20) = 1120

Checking the validity of the solution:Y =1170 =1120+20+30 = C + I + GMULTIPLIER = (1/(1-0.8))=5


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Keynesian Dynamic Model of National Income

Yt= Ct + It + Gt Current consumption depends on past income

Ct =200 + 0.8*(Yt-1 -Tt-1)

Tt-1 =20; Gt =20; It =30; Yt-1 = 500

Yt =200 +0.8*(500-20) +30 +20

Yt = 200 +384 +30+20

Yt =200+384 +50 = 634Assume Tt, It , Gt remain same for all years

Yt+1 = 200 +0.8*(634-20) +30 +20 = 741Solve this model for another 20 years.


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Macroeconomic Policy

• Fiscal Policytaxesexpenditure debt

• Monetary Policy

interest rate/ M-supply

exchange rate/trade

stock market• Growth/supply side


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Minimum Mathematical Skills Required in this Module

• Diagrams to represent one or two equations• Basic Algebra: Addition, Subtraction, multiplication and division with

calculator and excel• Solution of Simultaneous equations• Graphs and Charts in excel and Givewin• Six rules of approximation• Five rules of log• Four rules of differential• Power rule in algebraic expressions• Calculations using spreadsheets• Modelling Strategic moves (about the end of the term)

– Normal, Extensive form of a GAME– Dominant Strategy and Nash equilibrium– Dynamic Game: Subgame perfect equilibrium


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Six rules of approximation for small numbers

eieir 1

111

LWY

gg 111

rr

1ln

WLY ggg

L

Yy

LYy ggg

ngg n 11

I. Log

II. Product

III. Division

IV. Growth of a product

V. Growth of a Ratio

X

nXn

XXXS

1

11

....2

1VI. Sum of a geometric Series


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Five Rules of log

I. Power Rule

II. Product Rule

III. Quotient Rule

IV. Log of Exponentials

KY lnln KY

PYR PYR lnlnln

L

Yy LYy lnlnln

gtt eYY 0 gtYYt 0lnln

V. Differentiation of log with respect to time

t

tt

Y

dY

dt

Yd

ln


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Four Rules of Differentiation

I. Power Rule

II. Product Rule

III. Quotient Rule

IV. Chain Rule

1 KK

YKY

PYR dYPdPYdR

L

Yy L

Y

L

dL

L

dY

L

YdLdYLdy

2

5.0LY 2

50

p

wL

pwL

pwLpw

L

L

Y

pw

Y

502505.0 5.0

5.02

50

p

wY


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Core and Recommended Text

• Core TextsBlanchard, Oliver (2003) Macroeconomics, Third Edition,

Prentice Hall. ISBN 0-13-033772-2; http://www.prenhall.com/blanchard

Other Good texts:• Gartner Manfred, Macroeconomics, Prentice Hall.• Mankiw, G. N.(2003) Macroeconomics, Fifth Edition,

Worth Publishers, New York.• Miles David and Andrew Scott (MS) Macroeconomics:

Understanding the Wealth of Nations, John Wiley and Sons, Inc, 2002. ISBN 0-47084288-1.

• Romp Graham (1997) Game Theory, Oxford University Press. Chapters 1-10.

http://www.prenhall.com/blanchard

http://www.prenhall.com/blanchard


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