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MIT 14 02 - Recitation

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114.02 RecitationBySamer HajYehia2The Short RunI. Course IntroductionII. Mathematical BackgroundIII. Real vs. Nominal & Growth RateIV. National AccountV. Government BudgetVI. Basic Macroeconomic Model–Kenyes ModelVII. The Investment Saving EquilibriumVIII.The IS CurveIX. LM CurveX. IS-LM Model3I. Course Introductiona) Course Strategyb) Course Outlinesc) Macro vs. Microd) Why Are You Taking Macroeconomics?4I(a) Course Strategy• Define the important concepts, magnitudes and questions in the real world.• Learn alternative theories suggesting answers and explaining behavior.• Evaluate data to test and then choose among theories.• Put you in position to have a serious opinion on important topics.5I(b) Macro vs. Micro• Microeconomics examines the economic behavior of individual households and firms-- their responses to prices, income, tastes, opportunities and other fundamental variables.• Macroeconomics examines the sum of microeconomic actions, their dynamics & interactions.• Therefore Macro must be fully compatible with Micro in its explanations of behavior: to trust any Macro answer, you must be sure of each of its Micro roots. Usually, this requires common sense and introspection.• The power and elegance of Macro is its ability to confront important questions, resolve paradoxes, explain past and predict future dynamics.• Why is there so much controversy about macro theory and policy and so little about micro?• Macro hits us in the pocketbook through its policy prescriptions so we may want certain answers to be true even if not.• Macro gets intimately involved in politically sensitive issues, and only religious arguments are more emotional than political debates.• The media cares about these issues and wants to find/exaggerate controversy to sell itself.6I(c) Why Are You Taking Macroeconomics?• Possible reasons:• It’s required for economics majors.• You’ve heard it’s as good a way as any to meet distribution requirements in the social sciences since this will at least involve mathematics.• Economist jokes are better than lawyer or computer nerd jokes.• You want to call in to talk- show radio hosts and sound important.• Better reasons:• You know that, today or tomorrow, you will really need the macroeconomic analysis skills as:¾ An investor:¾ a politician¾ a manager or employee¾ an intellectually curious person7• Your interest might be as following:¾ An investor:9 Where are interest rates headed?9 Which sectors of the economy will do best and worst during the next quarter, year, and decade?9 What will be the distinguishing differences across countries.¾ A politician9 What determines interest rates and what are appropriate monetarytargets?9 What are the appropriate taxes to raise?9 How will the level and composition of the budget affect family incomes?9 How will international trade impact jobs, inflation and credit?9 What is the cost of low inflation or low unemployment?8¾ a manager or employee9 What growth will my current markets provide if I maintain my share?9 Can I raise my prices as rapidly as my costs?9 What opportunities are emerging in the developing nations?¾ a manager or employee9 Why do cycles exist/ persist in all economies?9 Are macro relationships stable?9 Can nonlinear mathematics and chaos physics help to understand economics?9 How can growth and environmental concerns be reconciled?9I(d) Course Outlines• Output- level, growth, trend, fluctuations (recessions and expansions).• Great Depression• Stagflation in the 1970s• Current long expansion and low unemployment• High stock markets and bubbles• From budget deficit to budget surplus• Who is Greenspan? Why is he worry? Why we care?• Asian 1980’s miracle and 1990’s crisis and the political consequences• Russia and Latin America financial crises• European Community (EC)• Foreign trade• Financial markets• Globalization10II. Mathematical backgrounda) Linearityb) Curve shiftingc) Adjacent or Stacked Graphsd) Changes and Logarithme) Elasticity11II(a) LinearityYtβαCtFor simplicity, we usually assume linearity only to get the notion and intuition (specially the sign and factors that affect the endogenous variables).• Example:C = D + E Y E= wC/wY12II(b) Curves, which way do they shift?13II(c) Adjacent or Stacked Graphs14II(d) Changes and Logarithm()YttYtYtYtYRY≡∂∂≡−−−≡•11 tZtYtXtWtZtYtXtW−+=⇒=• / if YtYtYdY∆=−−≡•)1( ttitYAtCeiYAtttεγβεγβ )ln( )ln( )ln( )ln( C if t+−+=⇒=•−15II(e) Elasticity• DefinitionKC,Y=The percentage change of C due to one percentage change in Y= % ∆C / % ∆Y = [∆C/C] / [∆Y/Y]ηC,Y= [∆C/∆Y]*[Y/C] = MPC * Y/C -How is it represented in the graph?• If the economic theory assumes an exponential model (instead of previous linear model), then:•Ct= A YtEit-γeHt16• Therefore, in order to estimate our theoretical model we can run log_log model:9 ln(Ct) = Ln(A) + β ln(Yt) - γ ln(it) + εt–where: β = ∂ ln(Ct) / ∂ ln(Yt) • Which means that, instead of assuming a constant propensity to consume (and increasing elasticity of consumption with respect to the disposal income) as in the linear model, the exponential model assumes a constant elasticity of consumption with respect to the disposal income (and decreasing propensity to consume).• Proof: Apply the chain rule:9β = [∂ ln(Ct) / ∂C] * [∂C/∂Y] * [∂Y / ∂ ln(Yt)]= [1/C] * [∂C/∂Y] * [Y / 1]= [∂C/∂Y] * [Y / C]= KC,YCtYt17III. Real vs. Nominal & Growth Ratea) An Exerciseb) Nominal vs. Real180.25600.1550Orange0.3200.115Bananap1993q1993p1981q1981III(a). An exercise19You are required to calculate:1. Paasche:a) Indexb) Average Annual Inflation Rate2. Laspeyres:a) Indexb) Average Annual Inflation Rate3. GDP Average Annual Growth Rate:a) Nominalb) Real20You have 5 minutesCan we start???21220.25600.1550Orange0.3200.115Bananap1993q1993p1981q198123III(b). Nominal vs. Real• Real quantity is measured in terms of number of physical units, no matter how its money value was changed.• Nominal value is measured in terms of its money value, no matter how its number of physical units was changed.Case I Case II Case IIICars1,000 1,020 1000 ?Price100 100 102 ?Total nominal value100,000 102,000 102,000 102,000Real change2% 0% ?Nominal change2% 2% 2%Price inflation0% 2% ?Year 1 Year 224Notice:• Inflation ≡ π ≡≡dP/P ≡ (Pt–Pt-1) / Pt-1• There is more than one


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MIT 14 02 - Recitation

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