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Macroeconomics precourse – Part 1Academic Year 2013-2014

Course PresentationThis course aims to prepare students for the Macroeconomics course of the MSc in BA. It provides the essential background in macroeconomics

PAOLO PAESANI Office: Room B6, 3RD floor, Building B Telephone: 06-72595701 E-mail: paolo.paesani@uniroma2.itOffice hours: to be agreed

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MACROECONOMICS

Macroeconomics is a branch of economic theory that studies the functioning of the economic system of a nation as a whole and its connections with other economic systems.

Economic system = Households + Non financial Companies + Financial Intermediaries + Government (including the central bank)

Orthodox approach: Microeconomics (study of single elements) as the basis of macroeconomics (study of the whole)

Heterdox approach: I’ll tell you about it next time !

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SOCIO-ECONOMIC CONTEXT• Well-defined property rights over available resources;• Freedom to put available resources to the best (most profitable) use as

judged by the owner (resource allocation);• Property rights protection;• Freedom to transfer property rights in a regulated and organised way

(Voluntary exchange);• Price-based resource allocation;• Capitalist economy;• Open economy;• Government as a relevant macroeconomic actor• Money as medium of exchange, means of payment, unit of account and

store of value.

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THE ECONOMIC SYSTEM

Mankiw (2010)

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Government as a part of the economic system 1. Purchases goods and services from the

private sector (linkage with the market for goods and services);

2. Hires workers and rents capital goods from the private sector which it uses in combination with intermediate goods and services to produce public goods (linkage with the market for factors of production);

3. Taxes houselds and firms (direct taxation, indirect taxation, excises and fees) (TAX)

4. Transfers money to houselds and firms (pensions, unemployment benefits, subsidies)

GOVERNMENT AS A PART OF THE ECONOMIC SYSTEM

Mankiw (2011)

GOVERNMENT

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Financial system (institutions and markets related to the circulation of money and credit) :

1. Central bank; 2. Monetary financial institutions (normal

banks);3. Non monetary financial intermediaries

(investment and pension funds, insurance companies, rating agencies, investement banks ….)

4. Money markets (Short-term financial assets)

5. Financial markets (bonds, shares, derivatives, forex, commodities)

FINANCIAL SYSTEM AS A PART OF THE ECONOMIC SYSTEM

GOVERNMENT

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Every economic system is linked to the others through multiple channels:

1. International trade of goods and services (Exports and Imports);

2. International mobility of factors of production (migration, foreign direct investment);

3. Private international financial flows (portfolio investment, forex transactions)

4. Public international financial flows (management of official forex reserves, interntional aid, international transfers)

THE GLOBAL ECONOMIC SYSTEM

GOVERNMENT

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GROSS DOMESTIC PRODUCT

Gross Domestic Product (GDP, Y) is the nominal value of all the final goods and services produced within a country over a given period of time evaluated at market prices.

1. nominal value = measured in terms of money2. Final goods and services = goos and services produced over a given

period of time and NOT USED to produce other goods and services during the same period of time.

3. Produced = Trading of second hand goods is not part of GDP4. Within a country = National dimension5. Given period of time = Usually One year (flow variable)6. Market prices = Only final goods and services regularly bought and

sold in a market contribute to GDP.

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GROSS DOMESTIC PRODUCT

Primary sectorAGRICULTURE

Secondary sectorINDUSTRY

Tertiary sectorSERVICES

Consumers

Wheat Raw Bread

Packaged bread

50EUR

100EUR

150EUR

Total value of goods and services = 300 EURValue of intermediate goods and services = 150 EURGDP = 150 EURGross National Income = 50 + (100-50) + (150 – 100) = 150 EUR

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GROSS NATIONAL PRODUCT

Gross National Product (GNP) is the nominal market value of all the final goods and services produced within a country or a abroad over a given period of time by national factors of production.

GNP = GDP + NFI

NFI = NET FOREIGN INCOMES = (Income of domestic labour and capital employed abroad) – (Income of foreign labour and capital employed in the country)

Nationality + Residence matter

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NATIONAL INCOME

Gross National Income (GNI) is equal to Gross National Income minus Indirect Taxation (ex. VAT)

GNI = GNP - VAT

Hint: When you buy anything (eg. a book) , 20% of the price you pay is VAT and is trasferred to the State, the rest compensates factors of production employed to produce it.

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Mankiw (2011)

OTHER MEASURES OF INCOME

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GDP PER CAPITA

Dividing GDP by the country’s population (POP) we obtain GDP per-capita. GDP per capita can be taken as a rough measure of the economic welfare of a country’s residents.

GDP per capita = GDP / POP

GDP per capita is an average that tells us nothing about distribution. Economists and statisticians have developed specific indicators for that (e.g. Lorenz Curve, Gini coefficient, …)

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GDP PER CAPITA

Source: BNP_perhoofd_2012_%281%29.PNG

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GDP = AGGREGATE DEMAND

Y = C + I + G + X – M

Mankiw (2011)

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AGGREGATE DEMAND: CONSUMPTION

Aggregate consumption depends on:

1. Current disposable income (Ydisp = Y – TAX + TRA) dC/dYdisp > 02. Expected disposable income dC/dYexp > 03. Inflation (?), Real interest rate < 0 (?)4. Wealth = Financial assets + Real assets > 05. Income distribution , Consumer credit ….

Ydisp – C(t) = S(t) = Private Savings

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AGGREGATE DEMAND: PRIVATE INVESTMENT

Aggregate investment depends on:

1. Expected profits + attitude towards risk 2. Expected aggregate demand3. Inflation (?), Real interest rate < 0 4. Credit + financial factors

K(t+1) – K(t) = I(t) – dK(t) = Net investementK(t) = Aggregate Stock of capital , 0< d <1 depreciation rate

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AGGREGATE DEMAND: GOVERNMENT PURCHASES

Government purchases depend on:

1. Size of the public sector2. Fiscal policy decisions

G(t) + TRA(t) – TAX(t) = Government budget deficitGBD = change in public debt + monetary financing of BD

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AGGREGATE DEMAND: NEXT EXPORTS

Net Exports depend on:1. Nominal exchange rate E (amount of foreign currency per unit of domestic

currency) dNX / dE < 02. Domestic price level P dNX / dP < 03. Foreign price level P* dNX / dP* > 04. Domestic GDP Y dNX / dY < 05. Foreign GDP Y* dNX / dY* > 06. Barriers to international trade7. Quality, National specificities …

NX (t) + NFI(t) + NFTRA(t) + FDI(t) + PRMK(t) + dRES (t) + EO(t) = 0Balance of payments

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DECOMPOSING GDP

Y = PQ where Y = Nominal GDP, P = GDP deflator, Q = real GDP

Mankiw (2011)

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INFLATION

Inflation rate = Rate of change of the GDP deflator over time

Π = [P(t) – P(t-1)] / P(t-1)

1. Π > 0 = Moderate Inflation2. Π = 0 (approx.) = Stable prices3. Π < 0 = Deflation4. Π >> 0 = High Inflation5. Π >>>>>> … 0 = Hyper-inflation

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INFLATION AND THE PURCHASING POWER OF MONEY

1/P can be taken as an indicator of the purchasing power of money (amount of goods which can be purchased spending 1 euro)

1. M/P = Real Money balances2. W/P = Real wage

Inflation erodes the purchasing power of money. As such creditors and people on fixed income fear it while debtors and people on floating income do not (if their income move at the place of inflation).

Interesting link on the effects of inflation:http://203.200.22.249:8080/jspui/bitstream

/123456789/2209/1/A_tract_on_monetary_reform.pdf

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Mankiw (2011)

MEASURING INFLATION

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GROWTH

Inflation rate = Rate of change of the real GDP over time

Γ = [Q(t) – Q(t-1)] / Q(t-1)

1. Π > 0 = Growth2. Π = 0 (approx.) = Stagnation3. Π < 0 = Recession

Growth theory is one of the main branches of macroeconomics

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Mankiw (2011)

REAL GDP AND GROWTH

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Mankiw (2011)

REAL GDP AND GROWTH

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REFERENCE

Mankiw, G.N. (2010) Brief Principles of Macroeconomics, 6° ed.,