Intermediate macroeconomics
0 INTRODUCTION : CH1 & 2
MACROECONOMIC MODELS
Exogenous variables -> model -> endogenous variables
Ex. : simple model with S , D and E
- >exogenous: aggregate income (Y) + price of materials
- >endogenous: equilibrium P and Q curves
BRIEF HISTORY OF MACROECONOMIC THOUGHT
Prior to 1930s : ‘the classical view:
− T he economy’s total production/(GDP)/AS comes only from the supply side: shifts in the
AS driven by how much labor, capital and technology is available
− D was seen as irrelevant because they believed D will always adjust to equal S: the
income from produced goods gives people the purchasing power
- >you didn’t need to worry about “not enough demand” because it was assumed to
a utomatically match production
=>Policymakers should not interfere much (with monetary or fiscal policy: as long as they
g uarantee price and wage flexibility, the market will adjust on its own
,1930s – Great Depression and ‘birth of macroeconomics’
U .S. unemployment rates around 25%, U.S. production fell by nearly 30%, with a spread to other
countries ->challenge the classical view: despite declining prices and wages, unemployment kept
on rising and U.S. production kept on falling
➢ need of theories and policy recommendations to get out of the economic downturned:
macroeconomics arose as a seperate field within economics
➢ J ohn Maynard Keynes’ publication of the General Theory (1936) = often seen as the true
birth of macroeconomics
- AD matters
- F iscal and monetary policy needed to stabilize the economy
- Prices & wages are not flexible but:
W ages are sticky: workers don’t always accept pay cuts + prices are sticky:
businesses might keep them fixed for long periods
- >instead of the economy automatically adjusting unemployment + recessions
1940s – 1960s – ‘post-war Keynesian synthesis’
● A
fter World War II, Keynes’ business cycle theories were extended and formalized:
- IS-LM model (Hicks, Modigliani): a model of the demand side
IS=investment-saving ; LM= Liquidity preference-Money Supply
R : interest rates -> here demand for money (how much cash people want to hold)
e quals the supply of money provided by the CB
- Phillips-curve (1958): inflation and unemployment
- Post-Keynesianism: more radical interpretation of Keynes’ theory
● + economists started constructing formalized models of long-run economic growth: Solow
model + swan model
,C hallenges to Keynesianism
● Stagflation: high inflation and low economic growth/high unemployment Keynesian
Phillips-curve theories were unable to explain this
● Monetarism and Milton Friedman:
- quantity theory of money: Inflation = a monetary phenomenon Phillips-curve
- permanent income hypothesis: Consumption is driven by permanent income, not
disposable income
- the Lucas critique: Econometric Keynesian models are structurally flawed, they don’t
reliably predict the effects of new policies because economic agents’ expectations
a nd behavior change in response to policy shifts
Q uantitative models of the business cycle (1980s – …)
● R eal business cycle (RBC) models: quantitative models where business cycles are driven
by supply-side shocks (e.g. Kydland & Prescott paper)
● New Keynesian (NK) models (1990s – …): extension of the RBC models with Keynesian
e lements, primarily wage and price rigidities (e.g. Gali)
● Heterogeneous-agent NK-models (2010s – …): people in the economy are different from
e ach other (heterogeneous), might have different levels of income, wealth, or preferences.
U nlike older models where everyone is assumed to be the same. This matters for
business cycle dynamics and demand- and supply- side shocks
Modern long-run growth theories (1980s – …)
● E
ndogenous growth theory (1980s – 1990s):e conomic growth happens from within the economy
itself, rather than relying solely on external factors (like new discoveries or natural
resources)
- Endogenous Technical Progress (Romer): technical progress (innovation and technology
improvements) comes from within the economy itself, rather than being something
e xternal
- human capital (Romer-Mankiw-Weil model): education and skills of workers are critical
f or long-term economic growth, its not just about having more workers
- Schumpeterian Creative Destruction Dynamics: old technologies or industries are
destroyed or replaced by new and better ones (ex. Smartphones, which keeps the
e conomy dynamic
● C limate growth models (1990s): extensions of long-run growth models by incorporating
g reenhouse gas emissions and climate damages (e.g. Nordhaus-models)
, Modern business cycle models (2010s – …)
● N
ew Keynesian models (NK) could not account for the Great Financial Crisis of 2008 –>
2009 Introduction of financial frictions and behavioral elements into the New Keynesian
f ramework
1 NATIONAL INCOME: CH 3 & 4
SUPPLY OF GOODS AND SERVICES
F actors of production: L (Labor), K (capital)
Properties of production functiuon: Y = F(K,L):
- C onstant returns to scale: an increase in the factors of
production of x% causes an increase in production of x%:
zY = F(zK,zL)
- Diminishing marginal products: the increase in production
f rom raising labor or capital declines as the labor or capital
s tock is higher
C obb-Douglas production function
A = technology, K = capital, L = labor
INCOME ACROSS THE FACTORS OF PRODUCTION
National income= value of produced goods and services (GDP)
- >is distributed across K and L
Empirical measurement: Macroeconomists assume that the share of L and K in NI is constant
over time, which is true for after WWII -> ! some economists claim that the rise of AI will change
this in the future
(The capital share has equaled around 25% sinceWWII. The labor share iscalculated as the
residual (=around 75%))
0 INTRODUCTION : CH1 & 2
MACROECONOMIC MODELS
Exogenous variables -> model -> endogenous variables
Ex. : simple model with S , D and E
- >exogenous: aggregate income (Y) + price of materials
- >endogenous: equilibrium P and Q curves
BRIEF HISTORY OF MACROECONOMIC THOUGHT
Prior to 1930s : ‘the classical view:
− T he economy’s total production/(GDP)/AS comes only from the supply side: shifts in the
AS driven by how much labor, capital and technology is available
− D was seen as irrelevant because they believed D will always adjust to equal S: the
income from produced goods gives people the purchasing power
- >you didn’t need to worry about “not enough demand” because it was assumed to
a utomatically match production
=>Policymakers should not interfere much (with monetary or fiscal policy: as long as they
g uarantee price and wage flexibility, the market will adjust on its own
,1930s – Great Depression and ‘birth of macroeconomics’
U .S. unemployment rates around 25%, U.S. production fell by nearly 30%, with a spread to other
countries ->challenge the classical view: despite declining prices and wages, unemployment kept
on rising and U.S. production kept on falling
➢ need of theories and policy recommendations to get out of the economic downturned:
macroeconomics arose as a seperate field within economics
➢ J ohn Maynard Keynes’ publication of the General Theory (1936) = often seen as the true
birth of macroeconomics
- AD matters
- F iscal and monetary policy needed to stabilize the economy
- Prices & wages are not flexible but:
W ages are sticky: workers don’t always accept pay cuts + prices are sticky:
businesses might keep them fixed for long periods
- >instead of the economy automatically adjusting unemployment + recessions
1940s – 1960s – ‘post-war Keynesian synthesis’
● A
fter World War II, Keynes’ business cycle theories were extended and formalized:
- IS-LM model (Hicks, Modigliani): a model of the demand side
IS=investment-saving ; LM= Liquidity preference-Money Supply
R : interest rates -> here demand for money (how much cash people want to hold)
e quals the supply of money provided by the CB
- Phillips-curve (1958): inflation and unemployment
- Post-Keynesianism: more radical interpretation of Keynes’ theory
● + economists started constructing formalized models of long-run economic growth: Solow
model + swan model
,C hallenges to Keynesianism
● Stagflation: high inflation and low economic growth/high unemployment Keynesian
Phillips-curve theories were unable to explain this
● Monetarism and Milton Friedman:
- quantity theory of money: Inflation = a monetary phenomenon Phillips-curve
- permanent income hypothesis: Consumption is driven by permanent income, not
disposable income
- the Lucas critique: Econometric Keynesian models are structurally flawed, they don’t
reliably predict the effects of new policies because economic agents’ expectations
a nd behavior change in response to policy shifts
Q uantitative models of the business cycle (1980s – …)
● R eal business cycle (RBC) models: quantitative models where business cycles are driven
by supply-side shocks (e.g. Kydland & Prescott paper)
● New Keynesian (NK) models (1990s – …): extension of the RBC models with Keynesian
e lements, primarily wage and price rigidities (e.g. Gali)
● Heterogeneous-agent NK-models (2010s – …): people in the economy are different from
e ach other (heterogeneous), might have different levels of income, wealth, or preferences.
U nlike older models where everyone is assumed to be the same. This matters for
business cycle dynamics and demand- and supply- side shocks
Modern long-run growth theories (1980s – …)
● E
ndogenous growth theory (1980s – 1990s):e conomic growth happens from within the economy
itself, rather than relying solely on external factors (like new discoveries or natural
resources)
- Endogenous Technical Progress (Romer): technical progress (innovation and technology
improvements) comes from within the economy itself, rather than being something
e xternal
- human capital (Romer-Mankiw-Weil model): education and skills of workers are critical
f or long-term economic growth, its not just about having more workers
- Schumpeterian Creative Destruction Dynamics: old technologies or industries are
destroyed or replaced by new and better ones (ex. Smartphones, which keeps the
e conomy dynamic
● C limate growth models (1990s): extensions of long-run growth models by incorporating
g reenhouse gas emissions and climate damages (e.g. Nordhaus-models)
, Modern business cycle models (2010s – …)
● N
ew Keynesian models (NK) could not account for the Great Financial Crisis of 2008 –>
2009 Introduction of financial frictions and behavioral elements into the New Keynesian
f ramework
1 NATIONAL INCOME: CH 3 & 4
SUPPLY OF GOODS AND SERVICES
F actors of production: L (Labor), K (capital)
Properties of production functiuon: Y = F(K,L):
- C onstant returns to scale: an increase in the factors of
production of x% causes an increase in production of x%:
zY = F(zK,zL)
- Diminishing marginal products: the increase in production
f rom raising labor or capital declines as the labor or capital
s tock is higher
C obb-Douglas production function
A = technology, K = capital, L = labor
INCOME ACROSS THE FACTORS OF PRODUCTION
National income= value of produced goods and services (GDP)
- >is distributed across K and L
Empirical measurement: Macroeconomists assume that the share of L and K in NI is constant
over time, which is true for after WWII -> ! some economists claim that the rise of AI will change
this in the future
(The capital share has equaled around 25% sinceWWII. The labor share iscalculated as the
residual (=around 75%))
