IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

IMPORTANT ISSUES IN MACROECONOMICS

  • Why does the cost of living keep rising?
  • Why are millions of people unemployed, even when the economy is booming?
  • Why are there recessions? Can the government do anything to combat recessions? Should it??
  • What is the government budget deficit? How does it affect the economy?
  • Why do the economies have such a huge trade deficit?
  • Why are so many countries poor?
  • What policies might help them grow out of poverty?

GROSS DOMESTIC PRODUCT OF PAKISTAN

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

900,000 800,000 700,000 600,000 500,000 400,000 300,000 200,000 100,000 0

Years

WHY LEARN MACROECONOMICS? 1- The macro economy affects society’s well-being e-g unemployment and social problems. Each one-point increase in the unemployment rate is associated with:

  • 920 more suicides
  • 650 more homicides
  • 4000 more people admitted to state mental institutions
  • 3300 more people sent to state prisons
  • 37,000 more deaths

• increases in domestic violence and homelessness

2- The macro economy affects your well-being e-g unemployment and earnings growth, interest rates and mortgage payments etc.

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

%

Unemployment and Earnings Growth

5 4 3 2 1 0 -1 -2 -3 -4 -5

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

1965 1975 1985 1995

growth rate of inflation-adjusted hourly earnings

change in Unemployment rate

Interest rates and rental payments

For a Rs.320, 000; 3-year mortgage

Date Actual rate on 3year financing Monthly payment Annual payment
May 2003 8.50% Rs.10,021 Rs. 120,252
May 2004 7.25% Rs. 9,839 Rs. 118,068

3- The macro economy affects politics & current events e-g inflation and unemployment in election years.

INFLATION AND UNEMPLOYMENT IN ELECTION YEARS

Year Unemployment rate inflation rate
1976 7.7% 5.8%
1980 7.1% 13.5%
1984 7.5% 4.3%
1988 5.5% 4.1%
1992 7.5% 3.0%
1996 5.4% 3.3%
2000 4.0% 3.4%

ECONOMIC MODELS

These are simplified versions of a more complex reality. These are used to:

  • show the relationships between economic variables
  • explain the economy’s behavior
  • devise policies to improve economic performance

THE SUPPLY & DEMAND FOR NEW CARS

The model of supply & demand for new cars explains the factors that determine the price of cars and the quantity sold. This model assumes that the market is competitive i-e each buyer and seller is too small to affect the market price. The variables include in this model are: Qd = Quantity of cars that buyers demand Qs = Quantity that producers supply P = Price of new cars Y = Aggregate income Ps = Price of steel (an input)

THE DEMAND FOR CARS

Demand equation can be written as: Qd = D (P, Y) This equation shows that the quantity of cars consumers demand is related to the price of cars and aggregate income. General functional notation shows only that the variables are related i- e Qd = D (P, Y). A specific functional form shows the precise quantitative relationship.

Examples:

1) Qd = D(P,Y) = 60 – 10P + 2Y

2) Qd = D(P,Y) = 0.3Y / P Functional form can be multiplicative, additive, in the form of division or any algebraic expression. These functional forms can be shown in the form of graph. The demand curve shows the relationship between quantity demanded and price, other things equal. The demand curve shows that there is an inverse relationship between quantity demanded and price as shown in the figure below.

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

Q Quantity of cars

THE SUPPLY FOR CARS

Supply equation shows that the quantity of cars producers supply is related to the price of cars and price of steel. General functional notation shows only that the variables are related i-e QS = S (P, Ps). The supply curve shows the relationship between quantity supplied and price, other things equal. The supply curve shows that there is positive relationship between quantity supplied and price as shown in the figure below.

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

Q

Quantity of cars

EQUILIBRIUM IN MARKET FOR CARS

The upward sloping supply curve and downward sloping demand curve give rise to equilibrium.

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

Q

Quantity of Cars

THE EFFECTS OF AN INCREASE IN INCOME

An increase in income increases the quantity of cars consumers demand at each price which increases the equilibrium price and quantity.

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

Q1 Q2 Quantity of cars

THE EFFECTS OF AN INCREASE IN PRICE OF STEEL

An increase in price of steel (Ps) reduces the quantity of cars producers supply at each price which increases the market price and reduces the quantity.

macroeconomics  IMPORTANCE OF MACROECONOMICS & ECONOMIC MODELS:

ENDOGENOUS VS. EXOGENOUS VARIABLES Endogenous variable is a variable that is identified within the workings of the model. Also termed a dependent variable, an endogenous variable is in essence the “output” of the model.

Exogenous variable is a variable that is identified outside the workings of the model. Also termed an independent variable, an exogenous variable is in essence the “input” of the model. The values of endogenous variables are determined in the model whereas the values of exogenous variables are determined outside the model. In the model of supply & demand for cars: Endogenous variables are: P, Qd, Qs Exogenous variables are: Y, Ps Macroeconomists try to tackle different macroeconomic issues through multitude of models.

PRICES – FLEXIBLE VERSUS STICKY Flexible prices mean that prices adjust in the long run in response to market shortages or surpluses. This condition is most important for long-run macroeconomic activity and long-run aggregate market analysis. In particular, flexible prices are the key reason for the vertical slope of the long-run aggregate supply curve. This proposition is also central to original classical theory of macroeconomics and to modern variations, including rational expectations, new classical theory, and supply-side economics.

Sticky prices mean that some prices adjust slowly in response to market shortages or surpluses. This condition is most important for macroeconomic activity in the short run and short-run aggregate market analysis. In particular, sticky (also termed rigid or inflexible) prices are a key reason underlying the positive slope of the short-run aggregate supply curve. Prices tend to be the most sticky in resource markets, especially labor markets, and the least sticky in financial markets, with product markets falling somewhere in between.

Market clearing is an assumption that prices are flexible and adjust to equate supply and demand. In the short run, many prices are sticky i.e.; they adjust only sluggishly in response to supply/demand imbalances.

VN:F [1.9.14_1148]
Rating: 0.0/10 (0 votes cast)
VN:F [1.9.14_1148]
Rating: +1 (from 1 vote)