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UNC-Chapel Hill ECON 101 - A Macroeconomic Model

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1Econ 101 M. SalemiEcon 101 M. SalemiA Macroeconomic ModelA Macroeconomic ModelNewsNewsReview: The Effect of the real rate of Review: The Effect of the real rate of interest on investment.interest on investment.What is a Macroeconomic Model?What is a Macroeconomic Model?The Aggregate Demand ScheduleThe Aggregate Demand ScheduleThe Potential Output ScheduleThe Potential Output ScheduleUsing the Model to Predict Unemployment Using the Model to Predict Unemployment and Inflation.and Inflation.Mixed Spending News (New York Times)Mixed Spending News (New York Times)Econ 101 M. SalemiEcon 101 M. SalemiWhat is a Macroeconomic Model?What is a Macroeconomic Model?A model is a simplified description that A model is a simplified description that captures the essential elements of a captures the essential elements of a situation and allows us to analyze them in situation and allows us to analyze them in a logical way.a logical way.A macro model is a simplified description of A macro model is a simplified description of the forces that determine equilibrium the forces that determine equilibrium levels of national output, inflation, levels of national output, inflation, unemployment and the real rate of unemployment and the real rate of interest.interest.Econ 101 M. SalemiEcon 101 M. SalemiWhat is a Macroeconomic Model?What is a Macroeconomic Model?A Macroeconomic model may be A Macroeconomic model may be represented by a system of equations. represented by a system of equations. The equations are solved simultaneously to The equations are solved simultaneously to predict equilibrium values for output, predict equilibrium values for output, inflation, and other macro variables.inflation, and other macro variables.The model is used to predict the effects on The model is used to predict the effects on the economy of different shocks and the economy of different shocks and changes in monetary and fiscal policy.changes in monetary and fiscal policy.2Econ 101 M. SalemiEcon 101 M. SalemiWhat is a Macroeconomic Model?What is a Macroeconomic Model?There are lots of different macroeconomic There are lots of different macroeconomic models because models because ……Economists disagree about the relative Economists disagree about the relative importance of forces at work on the importance of forces at work on the economy.economy.Economists disagree about the Economists disagree about the ““mechanismsmechanisms””through which those forces through which those forces affect output, inflation, unemployment, affect output, inflation, unemployment, and the real interest rate.and the real interest rate.Econ 101 M. SalemiEcon 101 M. SalemiWhat is a Macroeconomic Model?What is a Macroeconomic Model?We will adopt a very simple model that can We will adopt a very simple model that can be represented by two schedules be represented by two schedules presented in a single diagram.presented in a single diagram.The model represents mainstream thinking.The model represents mainstream thinking.The model is designed to help us think The model is designed to help us think about monetary policy in a logical way.about monetary policy in a logical way.If you undertake further study in economics, If you undertake further study in economics, you will learn models that are more you will learn models that are more detailed.detailed.Econ 101 M. SalemiEcon 101 M. SalemiAggregate Demand ScheduleAggregate Demand ScheduleAggregate Demand is measured in constant Aggregate Demand is measured in constant dollars and equals C + I + G + NXdollars and equals C + I + G + NX,Where Where C C = Household Consumption= Household ConsumptionI I = Investment= InvestmentG G = Government Spending= Government SpendingNXNX= Net Exports = Net Exports Econ 101 M. SalemiEcon 101 M. SalemiAggregate Demand is inversely related Aggregate Demand is inversely related to the real rate of interest (to the real rate of interest (r r ) because:) because:Consumption falls when r r rises because a higher real rate implies a higher cost of financing consumer durable purchases and a higher reward for saving.Investment spending falls when r r rises because r r is a cost of investing.Net exports fall when r r rises because an increase in r r leads to an appreciation of the dollar making exports more expensive and imports cheaper.3Econ 101 M. SalemiEcon 101 M. SalemiAggregate Demand is Inversely Aggregate Demand is Inversely Related to the Real Rate of Interest.Related to the Real Rate of Interest.rY = C+I+G+NXr0Y0Real GDPEcon 101 M. SalemiEcon 101 M. SalemiPotential Output SchedulePotential Output SchedulePotential output is the output level Potential output is the output level associated with full employment of labor associated with full employment of labor and capital.and capital.Potential output does not vary with the real Potential output does not vary with the real rate of interest.rate of interest.Potential output increases over time as the Potential output increases over time as the economy grows.economy grows.Econ 101 M. SalemiEcon 101 M. SalemiPotential Output (Potential Output (Y Y P P ) Does Not ) Does Not Vary with the Real Rate of Interest.Vary with the Real Rate of Interest.rReal GDPY P Econ 101 M. SalemiEcon 101 M. SalemiAggregate Demand and Aggregate Demand and Potential OutputPotential OutputrY = C+I+G+NXr perfectReal GDPY PY PE4Econ 101 M. SalemiEcon 101 M. SalemiIf the real rate is rIf the real rate is r0, 0, aggregate demand aggregate demand will not support potential output.will not support potential output.rY = C+I+G+NXr0Y0Real GDPY P Y PEEcon 101 M. SalemiEcon 101 M. SalemiAccounting for Inflation in the ModelAccounting for Inflation in the ModelInflation tends to increase when the Inflation tends to increase when the economy operates above potential output.economy operates above potential output.Inflation tends to remain unchanged when Inflation tends to remain unchanged when the economy is below but not too far the economy is below but not too far below potential output.below potential output.Inflation tends to fall when the economy is Inflation tends to fall when the economy is far below potential output.far below potential output.Econ 101 M. SalemiEcon 101 M. SalemiAccounting for InflationAccounting for InflationWhen the economy is operating at or above When the economy is operating at or above potential, resources are very scarce.potential, resources are very scarce.When resources are very scarce, their When


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