ECON3301: Intermediate Macroeconomics - Tripod.comforoughfarrokhzad.tripod.com/sitebuildercontent/sitebuilderfiles/... · ECON3301: Intermediate Macroeconomics . ... Robert J. Barro

SMU, Sobey School of Business Fall 2011

ECON3301: Intermediate Macroeconomics

Course Description

ECON3301.2: Intermediate Macroeconomics 2

This course studies the macroeconomic (aggregate) structure of a national economy within a global context with a focus on Canadian economy.

The course is an introduction to the macroeconomic models while it covers also empirical facts and policy issues.

The school of thought corresponding to this course is Real Businesss Cycles (RBC), it will be contrasted with others as necessary.

Instructor

3

Dr. Maryam Dilmaghani Office: 348 Sobey Building

Phone: (902) 420-6242 Email: [email protected] Webpage: http://www.neuropsyconomics.com/

Office Hours Tuesdays and Thursdays: 3:00 p.m. to 5:00 p.m. and Wednesdays: 1:00

p.m. to 3:00 p.m. In case you cannot make the designated hours email me for an

appointment.

ECON3301.2: Intermediate Macroeconomics

mailto:[email protected]�

http://www.neuropsyconomics.com/�

Textbooks


Required Textbook:

Macroeconomics A Modern Approach , 1st Edition

Robert J. Barro - Harvard University Apostolos Serletis - University of Calgary

Additional readings and handouts will be assigned and posted in

Blackboard.

Course Facebook Page


Facebook news feed for this course: http://www.facebook.com/pages/Economics-3307-

3301/266358326707810

The news articles related to this course will be posted in this page along a short commentary or discussion question. The topics covered in this course will allow the students to effectively follow such news article by the end of the term

http://www.facebook.com/pages/Economics-3307-3301/266358326707810�

http://www.facebook.com/pages/Economics-3307-3301/266358326707810�

Grading Scheme

6

1. Two Assignments 25%

2. Midterm (70 minutes, October 18th : tentative) 25%

3. Final Examination 50%

4. Bonus points from in-class popup quizzes 5%



Just Warm-up!

8

What is Education?


What is Education...

Albert Einstein: “Education is what remains after one has forgotten everything

he learned in school.”

9

Einstein on his 72nd birthday , 1951


10

What is Teaching?


What is Teaching...

Albert Einstein: “Teaching should be such that what is offered is perceived as

a valuable gift and not as a hard duty.” “I never teach my pupils; I only attempt to provide the

conditions in which they can learn.”

11 ECON3301.2: Intermediate Macroeconomics

12

What is Understanding?


What is Understanding...

13

Albert Einstein: “You do not really understand something unless you can

explain it to your grandmother.”


Questioning...

14

Albert Einstein: “The important thing is not to stop questioning. Curiosity has

its own reason for existing.”


Value of Science...

15

Albert Einstein: “One thing I have learned in a long life: that all our science,

measured against reality, is primitive and childlike and yet it is the most precious thing we have.”


Practical Advice

16

Attending the lectures helps knowing important points and possible misunderstandings that may arise when you do the readings.

Many problem sets will be provided and exams will draw upon them. Practicing them is a key to a good grade.

Come to my office hours and ask your questions regularly.

Please share your suggestions with me.


Introduction


Chapter 1 is set to answer the following question:

Why Study Macroeconomics?

Question


The financial crisis of 2007 is considered by economists the worst financial crisis since the Great Depression (1930s).

It was triggered by a liquidity shortfall in the US banking system causing , and has resulted in the collapse of large financial institutions, banks and stock markets around the world.

How do you compare the collapse of Stock Market (Financial Crisis) with the collapse of Production Plants and Production Factor shortage (e.g. Oil Shock)?

Macro and Economic Theory


Real business cycle theory (RBC theory) are a class of macroeconomic models in which business cycle fluctuations to a large extent can be accounted for by real (in contrast to nominal) shocks.

Unlike other theories of the business cycle, RBC theory sees recessions and periods of economic growth as the response to changes in the real economic environment.

Hence, government should concentrate on the long-run structural policies and not intervene through discretionary fiscal or monetary policy to smooth out economic short-term fluctuations.


Real Business Cycle Theory vs. Keynesian Economics

Left to Right: Kydland, Prescott, Keynes, Krugman, Stiglitz

http://upload.wikimedia.org/wikipedia/commons/e/e8/Kydland.jpg�

http://upload.wikimedia.org/wikipedia/commons/4/4b/Edward_C._Prescott.jpg�

http://upload.wikimedia.org/wikipedia/commons/8/85/Keynes.gif�

http://upload.wikimedia.org/wikipedia/commons/4/48/Paul_Krugman-press_conference_Dec_07th,_2008-8.jpg�

http://upload.wikimedia.org/wikipedia/commons/2/26/Joseph_Stiglitz.jpg�

Real Business Cycles


RBC is a class of macroeconomic models in which business cycle fluctuations to a large extent can be accounted for by real (in contrast to nominal) shocks.

Unlike other leading theories, RBC theory sees recessions and periods of economic growth as the efficient response to exogenous changes in the real economic environment. That is, the level of national output necessarily maximizes expected utility.

Hence, government should therefore concentrate on the long-run structural policy changes and not intervene through discretionary fiscal or monetary policy designed to actively smooth out economic short-term fluctuations

Other Macro Theories


Monetarism

Keynesian Economics

Recall the text by Krugman, in this course we will be doing ‘Regular’ Macroeconomics, meaning RBC.

Keynesian and Monetarist Macro are referred to as ‘Irregular’ ones.

Business Cycles vs. Growth-1


http://upload.wikimedia.org/wikipedia/en/8/8d/Businesscycle_figure2.jpg�

Business Cycles vs. Growth-2


http://upload.wikimedia.org/wikipedia/en/1/1e/Businesscycle_figure3.jpg�

Nominal vs. Real


What is the difference between Nominal and Real?


An Important Message of This Course:

The Difference (and relationship) between Real and Nominal Economic Indicators


http://www.ufollow.com/authors/paul.krugman/

See for Stiglitz http://www2.gsb.columbia.edu/faculty/jstiglitz/index.cfm

Money and Interest Rates


(Nominal) Interest rates are the price of Money

Prior to 1980, the rate of money growth and the interest rate on long-term bonds were closely tied

Since then, the relationship is less clear but still an important determinant of interest rates

Monetary and Fiscal Policy


Monetary policy is the management of the money supply and interest rates Conducted by the Bank of Canada

Fiscal policy is government spending and taxation Budget deficit/surplus is the excess of expenditures/revenue over

revenues/expenditures for a particular year Any deficit must be financed by borrowing

Money and Interest Rates


(Nominal) Interest rates are the price of Money

Prior to 1980, the rate of money growth and the interest rate on long-term bonds were closely tied

Since then, the relationship is less clear but still an important determinant of interest rates

Money Growth and Interest Rates


Money and Inflation


Aggregate price level is the average price of goods and services in an economy. A continual rise in the price level (inflation) affects all economic players

Data shows a connection between the money supply and the price level

Fiscal Policy


International Finance


In International Finance saving and borrowing occurs among sovereign states, usually each having their own currency.

Increasing integration of financial markets: Canadian companies borrow in foreign markets and foreign markets borrow from Canada

Banks and other financial institutions increasingly international – foreign exposures.

Foreign Exchange Market


The foreign exchange market is where one country’s currency is exchanged for another

The exchange rate is the price of one country’s currency in terms of another

Appreciation (depreciation) is a rise (fall) in the value of a country’s currency

Foreign Exchange Market


For 1 CAD: ... USD

The Importance International Financial System


Larger capital flows between countries ⇒ Greater importance of foreign financial systems on domestic economy.

Potentially larger role for international institutions (e.g. IMF)

Importance of the choice of Exchange Rate Regime (Fix versus Floating).

Return to discussion of International Financial Systems in Chapter 19 onwards.

Main Approach


Simplified Microeconomic-based approach to the demand for assets

Partial equilibrium framework (basic supply and demand approach to understand behavior in financial markets)

Complementary models dealing with issues such as transactions cost and asymmetric information applied to financial structure

Use of real world data in combination with simplified models (taught through experiments)

Learning Tools


Theory and Applications

Case studies and numerical exercises Special-interest boxes

Financial News boxes

Economic Experiments

Pictures from Left to Right: Keynes, Hayek, Barro

ECON3301-Fall 2011

Intermediate Macroeconomics: Introduction

Copyright © 2010 by Nelson Education Limited 2

C h a p t e r 1 Thinking About Macroeconomics

Copyright © 2010 by Nelson Education Limited

What Macroeconomics is about?

3

An Economy as a collection of individual decision makers (mainly household and firms) is studied through aggregate level of economic variables such as total output (Gross Domestic Product: GDP), Unemployment rate, Price level, Nominal interest rates and Exchange rate.

The purpose is to gain information about the current trends and future state of the economy as well as the impact of different policy options.


GDP-1

4

A measure of economic activity in a given economy.

How to calculate GDP and its accounting definition?

It will be discussed in Chapter 2.

The accounting definition for all economic variables and we see in the following slides will be covered in Chapter 2.


GDP-2

5

Dark times...


GDP Growth Rate

6

Growth rate of real GDP for year t = ( Yt− Yt−1)/ Yt−1 Multiply by 100 to get the growth rate of real GDP in percent per

year.


GDP Growth Rate

7


Unemployment Rate

8


Price Level-1

9


Inflation Rate

10

Inflation rate for year t = ( Pt− P t−1)/ Pt−1 Multiply by 100 to get the inflation rate in percent per year.


Inflation Rate over time

11


GDP, USA

12


GDP Growth, USA

13


Unemployment Rate, USA

14

Great Depression


Inflation Rate, USA

15


Economic Models-1

16

What is an Economic Model?

An abstract construct to represent reality (in economics mainly markets) in a simplified way to be used as a guide in the understanding of the matter under consideration.

Question for you: What is the difference between a Map and a Model?


Economic Models-2

17

Endogenous variables are the ones that we want the model to explain.

Exogenous variables are the ones that a model takes as given

and does not attempt to explain.


Macroeconomic Models

18

Disequilibrium is a discrepancy between the quantities (of goods/labor) demanded and supplied.

New Keynesian model argues that some prices are sticky and move

only slowly to equate the quantities of goods demanded and supplied.

This course: Equilibrium business-cycle model - Basic market-clearing model of economic fluctuations (Regular Macroeconomics!)

It is based on Microeconomic principles, making Macroeconomics driven from Microeconomics as opposed to a parallel framework independently created.


Question : How would you judge New Keynesian models in light of this news article?

19

Copyright © 2010 by Nelson Education Limited 20

Review: Market Economy Models


Questions...

What is a Market?

How can we characterise a Market?

21


Market and its characterisation

22

Market is a stance, sellers and buyers meet to exchange goods and/or services that are not free (have a price).

Market need not be a location.

Exchange can be made without using money.

In Economics, Market is characterised by Supply and Demand.

There are as many markets as we define distinct goods and services.


Demand

23

Questions:

How can we characterise Demand for good x?


Demand is...

24

A Function specifying quantity demanded for every given price as well as a number of other variables for a given period of time.

Law of Demand postulates that the relationship between the quantity demanded and good’s own price is negative.

What are the variables that impact quantity demanded for a given good besides its own price?


Other Factors

25

Tastes and preferences

Disposable income

Prices of related goods (Substitutes and Complements)

Expectations about future

Population size and composition


Representation of Demand

26

Mathematical Function Curve Schedule

Price Quantity

90 dollars 5 units

80 dollars 10 units

60 dollars 20 units


Demand Curve-1

27

0 10 20 30 40 500

10

20

30

40

50

60

70

80

90

100

Quantity

Price

Linear Demand Curve

Maximum Willingness to Pay (WTP)


Changes in Demand-1

28

0 10 20 30 40 50 600

20

40

60

80

100

120

Quantity

Price

Demand Curve Shift

Increase in Disposable income: Shift to the Right.


Changes in Demand-2

29

0 10 20 30 40 500

10

20

30

40

50

60

70

80

90

100

Quantity

Price

Linear Demand Shift

Fall in Disposable income: Shift to the Left.


Demand-3

30

How to illustrate Change in Demand (Demand Curve Shift)?

As a rule:

(i) Shift to the left means fall in quantity demanded for any given price

(ii) Shift to the right means increase in quantity demanded for any given price


Supply is...

31

A Function specifying quantity supplied for every given price; as well as a number of other variables for a given period of time.

Law of supply postulates that that the relationship between the quantity supplied and good’s own price is positive.

What are the variables that impact quantity supplied for a given good besides its own price?


Other Factors

32

Costs of production (price of inputs and state of technology)

Price of other goods

Taxes and subsidies

Market structure (number of suppliers)


Supply Curve-1

33

0 10 20 30 40 500

10

20

30

40

50

60

70

80

90

100

Quantity

Price

Linear Supply Curve

Minimum Willingness to Accept (WTA)


Market Equilibrium-1

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Market Equilibrium is an economic concept characterised by a pair of Price and Quantity such that market clears with no excess demand and no excess supply.

• Excess Demand= Quantity Demanded greater than Quantity Supplied

• Excess Supply= Quantity Supplied greater than Quantity Demanded

The main quality of Equilibrium is that in the absence of any change it remains at its current state.


Market Equilibrium-2

35

0 100 200 300 400 500 600 700 800 9000

200

400

600

800

1000

Q of Bond

Price

Q* Quantity

P*

Equilibrium


Disequilibrium

36

If a market is in disequilibrium it means at the current price there are either excess demand (quantity demanded being larger than quantity supplied) or excess supply (quantity supplied being larger than quantity demanded).

Price adjustment is the mechanism through which Equilibrium is re-established.


Market Adjustment to Changes-1

37

What will happen in the market for Coffee if:

The available income of the households increases?



38

1. Demand Curve shifts to the right;

2. At the old price market will be in disequilibrium with Excess demand;

3. Excess Demand ⟾ Upward pressure on Price ⟾ Price starts increasing;

4. As price increase ⟾ Quantity demanded falls (law of demand) and quantity supplied rises (law of supply) until they are again equal (at a new pair of price and quantity): these are movements of the curves;



39

0 100 200 300 400 500 600 700 800 900 1000 11000

200

400

600

800

1000

Q of Bond

PriceNew Equilibrium

Excess Demand

Quntity


Exercise : Supply and Demand

40

Supply and Demand for a unit of coffee is given below:

Maximum Willingness to Pay (Max WTP) or Maximum price consumer may pay and the y-axis intercept of Demand Curve= $900

Minimum Willingness to Accept (Min WTA) or Minimum price producer may accept and the y-axis intercept of Supply Curve=$ 200


Quantity Demanded

41

If Market Price is

Quantity demand is

$1000 0

$700 ?

$500 ?

$100 800 units

Q and P cannot be negative!


Quantity Supplied

42

If Market Price is

Quantity Supplied is

$900 1100 units

$700 ?

$500 ? $100 0

Q and P cannot be negative!


Market Equilibrium

43

At the Equilibrium: Pd=Ps =P* And Qd=Qs=Q *

So: 900-Q*=200+Q* 2 Q*=700; Q*=350 P*=200+350=550


Illustration

44

0 100 200 300 400 500 600 700 800 900 1000 11000

200

400

600

800

1000

Quantity

Price


Exercise : Shift in Demand

45

Suppose households’ income increases. If their demand for a Coffee has been Qd= 900-Pd the which option can be the new demand?

(i) Pd= 900-2Qd (ii) Pd= 1200-Qd (iii) Pd= 900- 0.5Qd (iv) Pd= 600-Qd


Market Equilibrium

46


So: 1200-Q*=200+Q* 2 Q*=1000; Q*=500 P*=200+500=700


Illustration

47

0 100 200 300 400 500 600 700 800 900 1000 11000

200

400

600

800

1000

Quantity

Price

Demand shift to the right New Equilibrium: Price and Q rise


Adjustment Mechanism

48

1. Demand Curve shifts to the right: Pd= 1200-Qd 550= 1200-Qd

Qd =1200-550=650

2. At the old price (....) market will be in disequilibrium with Excess

demand (new quantity demanded is ....units while it used to be .....units);


4. As price increase ⟾ Quantity demanded falls and quantity supplied rises until they are again equal (at a new pair of price and quantity);



49

1. Demand Curve shifts to the right: Pd= 1200-Qd

2. At the old price ($550) market will be in disequilibrium with Excess demand (new quantity demanded is 650 units while it used to be 350 units);


4. As price increase ⟾ Quantity demanded falls and quantity supplied rises until they are again equal (at a new pair of price and quantity);


Exercise : Shift in Supply

50

Suppose the coffee producers receives a subsidy. If their supply has been Ps= 200+Qs the which option can be the new supply?

(i) Ps= 200+2Qs (ii) Ps= 300-Qs (iii) Ps= 200+ 0.5Qs (iv) Ps= 100+Qs


Market Equilibrium

51


So: 900-Q*=100+Q* 2 Q*=800; Q*=400 P*=100+400=500


Illustration

52

0 100 200 300 400 500 600 700 800 900 1000 11000

200

400

600

800

1000

Quantity

Price

Supply shift to the right New Equilibrium: Price Falls and Q rises



53

1. Demand Curve shifts to the right: Ps= 100+Qs

Old: Ps= 200+Qs

2. At the old price (....) market will be in disequilibrium with Excess Supply (new quantity supplied is ....units while it used to be ....units);

3. Excess Supply ⟾ Downward pressure on Price ⟾ Price starts falling;

4. As price falls ⟾ Quantity demanded rises and quantity supplied falls until they are again equal (at a new pair of price and quantity);



54

1. Demand Curve shifts to the right: Ps= 100+Qs

2. At the old price ($550) market will be in disequilibrium with Excess Supply (new quantity supplied is 450 units while it used to be 350 units);

3. Excess Supply ⟾ Downward pressure on Price ⟾ Price starts falling;

4. As price falls ⟾ Quantity demanded rises and quantity supplied falls until they are again equal (at a new pair of price and quantity);


Economic Models-3

55


Economic Models-4: The Coffee Market

56



57



58


Economic Models: The Coffee Market

59



60


Economic Models: The Coffee Market

61

Irregular Economics - NYTimes.com

http://krugman.blogs.nytimes.com/2011/08/25/irregular-economics/?pagemode=print[08/09/2011 10:26:04 AM]

Copyright 2011 The New York Times Company Privacy Policy NYTimes.com 620 Eighth Avenue New York, NY 10018

AUGUST 25, 2011, 5:47 PM

Irregular Economics

I’m a bit late to this, but via Mark Thoma, David Glasner has a take-down of Robert Barro’s latest op-ed,in which Barro dismisses Keynesian economics for not being like “regular economics.”

As Glasner says, there’s something deeply weird about asking “where’s the market failure?” in the face ofmassive unemployment, huge unused capacity, an economy producing less than it did three and a halfyears ago despite population growth and advancing technology. Of course there’s some kind of marketfailure, which means that there’s nothing at all odd about asserting that better policy can yield freelunches.

More generally, the existence of business cycles is hardly a trivial feature of real economies. You can try toexplain those cycles in terms of “regular economics” — that’s what real business cycle theory is all about —but that effort has been a dismal failure, even if the practitioners refuse to admit it. The desperate effortsto find something Obama has done that explains why the economy plunged are in effect a demonstrationof the hollowness of that whole approach.

But I want to add something more: why, exactly, are we supposed to have such faith in “regulareconomics”? What is the compelling evidence that the vision of a competitive, efficient economy allocatingresources to the right uses is actually a good description of the world we live in?

I mean, it’s a lovely model, and one I, like everyone else in economics, use a lot. But I would not have saidthat it’s a model backed by lots of evidence. We do know that demand curves generally slope down; it’s alot harder to give good examples of supply curves that slope up (as a textbook author, believe me, I’velooked); and it’s a very long way from there to the vision of Pareto efficiency and all that which Barrowants us to take as the true economics. Realistically, imperfect competition, market failure, and more areeverywhere.

Meanwhile, there’s actually a lot of evidence for a broadly Keynesian view of the world. Not, to be fair, forfiscal policy, mainly because clean fiscal experiments are rare. But there’s huge evidence for sticky prices,lots of evidence that monetary shocks have real effects — and it’s hard to produce a coherent model inwhich that’s true that doesn’t also leave room for fiscal policy.

In short, there’s no reason at all to consider microeconomics the “real” economics and macroeconomicssome kind of flaky impostor. Yes, micro is a lot more rigorous — but if it’s rigorously wrong, who cares?

http://www.nytimes.com/ref/membercenter/help/copyright.html

http://www.nytco.com/

http://www.nytimes.com/privacy

http://www.nytimes.com/

http://krugman.blogs.nytimes.com/

http://economistsview.typepad.com/economistsview/2011/08/glasner-barro-on-keynesian-economics-vs-regular-economics.html

http://uneasymoney.com/2011/08/24/barro-on-keynesian-economics-vs-regular-economics/

ECON3301- Fall 2011

Intermediate Macroeconomics: Chapter 2

http://upload.wikimedia.org/wikipedia/commons/f/fa/GDP_PPP_Per_Capita_IMF_2008.png�

2 2

C h a p t e r 2 National-Income Accounting:

Gross Domestic Product and the Price Level

Gross Domestic Product

3

"Gross" means that GDP measures production regardless of the various uses to which that production can be put. Production can be used for immediate consumption, for investment in new fixed assets or inventories, or for replacing depreciated fixed assets.

"Domestic" means that GDP measures production that takes place within the country's borders. In the expenditure-method equation given in the next slides, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports).

3

Nominal GDP

4

Nominal GDP measures the dollar (or euro, etc.) value of all the goods and services that an economy produces during a specified period, such as a year.

Flow variable - it measures the dollar amount of goods produced

per unit of time, such as a year.

Real GDP

5

Calculating Real GDP Multiply each year’s quantity of output of each good by the

price of the good in a base year. GDP in constant dollars Chain-weighted real GDP

We need to use a kind of price index to compute real

GDP.

Prices

6

Consumer Price Index (CPI) Producer Price Index (PPI)

Calculations

7

Nominal GDP/Implicit price level= real GDP

A choice must be made on the price level to use.

Calculation of GDP-1

8

GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach.

The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total.

The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things.

8


9

The Expenditure approach is most commonly used.

Can you think of possible practical shortcomings of the other approaches (Income, Output)?

9

GDP by Expenditure

10

Personal Consumption Expenditures Gross Private Domestic Investment Government purchases of Goods and Services Exports and Imports

Example: the expenditure method: GDP = Value of private consumption (C) + Value of gross investment (I)

+ Value of government spending (G) + Value of exports in national currency –imports

GDP as a Welfare Measure

11

GDP does not: Consider changes in income distribution

Include non-market goods.

Assign value to leisure.

Consider environmental damage.

12

13

Measuring GDP by Income

14

National Income – Income earned by factors of production.

Relationship Between GDP and National Income

15

National Income by Sector

16

Nation. Inc. by Sector

17

18

19

20

Chapter 3, preliminaries

Economic Growth: Definition

21

Economic growth is the increase of aggregate production in a given economy.

Economic Growth is the increase of per capita gross domestic product (GDP) as a measure of aggregate income. Usually, the annual rate of change in real GDP is taken as the indicator of the annual rate of growth.

Canadian Growth in the past 30 years

22

GDP & Growth

23

How can we measure Economic Growth? Economic Growth is the increase of per capita gross domestic

product (GDP) as a measure of aggregate income.

Usually, the annual rate of change in real GDP is taken as the indicator of the annual rate of growth.

23

GDP & Economic Growth-1

24

Main factors behind Economics Growth

Economic growth is primarily driven by improvements in productivity, which involves producing more goods and services with the same inputs of labour, capital, energy and materials.

Human and Social capital improvements is also being more often used.

24

GDP & Economic Growth-2

25

Over long periods of time, even small rates of annual growth can have large effects through compounding. A growth rate of 2.5% per annum will lead to a doubling of GDP within 29 years, whilst a growth rate of 8% per annum (experienced by some Four Asian Tigers) will lead to a doubling of GDP within 10 years. This exponential characteristic can exacerbate differences across nations.

Short-run versus long-run considerations

Economists draw a distinction between short-term economic stabilization and long-term economic growth. The topic of economic growth is primarily concerned with the long run. The short-run variation of economic growth is termed the business cycle.

25

Canadian Growth in the past 30 years: Comments-1

26

In general positive, with a long-run average of about 2.5%

3 Recessions with growth being negative:

Oil shock of early 1980s

Gulf war of early 1990s

Recent Financial Crisis (2007)

European (Russian) Economic Crisis (the grey area): fall in growth rate but not becoming negative.


27

The rate of growth does not seem to increase, but falls, even when one abstracts from the business cycles.

Vulnerability of Industrial Countries to Oil

Canadian economy is very much tied to the US economy.

28

GDP Growth: How good of a measure is for the economic

performance of a country?

The answer is not just economic, it also entails addressing some philosophical and moral issues....

Shortcomings of GDP as an indicator of Growth

29

Wealth distribution Non-market transactions Underground economy Environmental Quality Technological progress and quality improvements

30

31

What do you think reading this news article?

Kuznets Curve

32

A Kuznets curve is the graphical representation of Simon Kuznets's discovery that economic inequality increases over time while a country is developing, then after a certain average income is attained, inequality begins to decrease.

Inspired by Kuznets’ insight the relationship between income per capita and environmental degradation is represented by Environmental Kuznets Curve (EKC) which is an inverse U shape curve.

Simon Kuznets

Kuznets Curve: One country over time

33

Income Inequality

Income/capita

Development stage Developed stage

Kuznets Curve: All countries viewed at given time (eg 2011)

34

Income Inequality

Income/capita

Developing Countries Developed Countries

Kuznets Curve

35

Degradation

The inverse U-shape relationship between environmental degradation and income per capita: EKC.

Income/capita

Developing Countries Developed Countries

Population Distribution by Income-1

36

Percent Population without Safe Water

$100 per cap. $10000 per cap.

100

Income/capita


37

Concentration Urban Con. Particulate Matters


1800

Income/capita


38

Concentration Urban Con. Particulate Matters


1800

Income/capita

39

Summary In practice, GDP refers to the market value of all final goods and services produced within a country in a given period. GDP per capita and its changes over time is often considered an indicator of a country's standard of living and economic growth.

Economic Growth: Other Questions

40

Can an Economy Grow forever? (It means Average GDP increases forever).

If constant growth is impossible, then can a level of GDP remain sustainable? (It means the economic conditions do not improve but do not deteriorate either).

These questions relate to the Sustainability of Economic Growth.

We will see some theoretical answers…

41

Next Slides are Related to Chapter 3

Economic Growth: Main Theories

42

Principal Theories of Economic Growth Exogenous growth model (Solow–Swan growth model) Ramsey-Cass-Koopmans model Endogenous growth theory Technological Progress and Sustainability

The Ramsey model differs from the Solow model in that it explicitly models the choice of consumption at a point in time and so endogenizes the saving rate.

42

Steady State

43

A steady state economy is an economy of relatively stable size. In growth models, the steady state is the long-run outcome of the model.

The economy may start away from its steady state, it gradually moves toward it.

A steady state economy, therefore, aims for stable or mildly fluctuating levels in population and consumption of energy and materials.

Saving/investment equals depreciation and consumption per capita remain constant (and birth rates equal death rates).

Economic Growth: Main Theories-2

44

0 1 2 3 4 50.0

0.5

1.0

1.5

2.0

K

Output

Investment as portion of output

Output


45

0 1 2 3 4 50.0

0.5

1.0

1.5

2.0

K

Output

Economic Growth: Comment-1

46

What is halting economic growth?

Decreasing Marginal product of inputs. It means that as the level of inputs employed increases their unit-contribution to output falls.

The rationale is that not all the inputs can increase: some natural resources are in fixed supply.


47

Some economists argue that with technological progress, the limitation can be overcome.

The shortcoming of this argument is that the degree of substitution between natural resource inputs and technological substitutes are not exact.

Also, it relies on assuming future technologies but it is not concretely said how and when.

Question

48

Can Economic Growth and Sustainability be compatible?

48

Economic Growth: Sustainability-1

49

Important Questions:

The composition of GDP can indicate how sustainable an economy is.

Resource dependence is one of the main indicator of un-sustainability of GDP.

What is the solution in face of Resource Dependence?

Sustainability Criteria: Main definitions

50

Weak sustainability Inter-temporal well-being is maintained based on strong assumptions

of substitution between resources. An example is Hartwick rule.

Strong sustainability The value of remaining stock of natural capital should be maintained.

Environmental sustainability The physical flow of individual resources should be maintained.

Hartwick Rule

51

John Hartwick (1977)

o He argued maintaining “capital base” from which current and future consumption (therefore well-being) level are derived leads to sustainability.

o He also showed that this can be achieved if:

o The scarcity rent from exhaustible resource is invested in another form of capital then the level of consumption can be maintained constant through generations.

o This proposition falls into the category of weak sustainability.

Weak and Strong Sustainability

52

How realistic is the assumption of substitutability between natural and other forms of capital?

What considerations are important in deciding the degree of substitutability between capitals?

52

Natural Resource Curse

53

The resource curse refers to the paradox that countries with an abundance of natural resources, specifically non-renewable resources (minerals and fuels), tend to have less economic growth and worse development outcomes than countries with fewer natural resources.

Different reasons suggested: decline in the competitiveness of other economic sectors; volatility of revenues from the natural resource, government mismanagement of resources, or corrupt institutions (possibly due to the easily diverted revenue from extractive activities).

ECON3301- Fall 2011

Intermediate Macroeconomics: Chapter 2

Frank Ramsey (1903 -1930) was a British mathematician who also made significant and precocious contributions to philosophy and economics.

Topic 1: Economic Growth and GDP Economic growth in Canada

GDP and its composition in Canada

Sustainability of Economic Growth in Canada

Composition of Canadian GDP over time Cross provincial difference in the composition of GDP

2

Economic Growth: Definition Economic growth is the increase of aggregate production in a

given economy.

Economic Growth is the increase of per capita gross domestic product (GDP) as a measure of aggregate income. Usually, the annual rate of change in real GDP is taken as the indicator of the annual rate of growth.

3

Canadian Growth in the past 30 years

GDP & Growth

5

How can we measure Economic Growth? Economic Growth is the increase of per capita gross domestic

product (GDP) as a measure of aggregate income.

Usually, the annual rate of change in real GDP is taken as the indicator of the annual rate of growth.

In practice, GDP refers to the market value of all final goods and services produced within a country in a given period. GDP per capita and its changes over time is often considered an indicator of a country's standard of living and economic growth.

5


6

GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach.

The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things.

.

6


7

The income approach works on the principle that the incomes of the productive factors ("producers," colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.

Example: the expenditure method: GDP = Value of private consumption (C) + Value of gross investment (I)

+ Value of government spending (G) + Value of exports in national currency –imports

7


8


"Domestic" means that GDP measures production that takes place within the country's borders. In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports).

8


9


"Domestic" means that GDP measures production that takes place within the country's borders. In the expenditure-method equation given above, the exports-minus-imports term is necessary in order to null out expenditures on things not produced in the country (imports) and add in things produced but not sold in the country (exports).

9

GDP & Economic Growth

10

Shortcomings of GDP as an indicator of Growth Wealth distribution

Non-market transactions

Underground economy

Non-monetary economy

Quality improvements and inclusion of new products

Main factors behind Economics Growth

Economic growth is primarily driven by improvements in productivity, which involves producing more goods and services with the same inputs of labour, capital, energy and materials.

10


11

Over long periods of time, even small rates of annual growth can have large effects through compounding. A growth rate of 2.5% per annum will lead to a doubling of GDP within 29 years, whilst a growth rate of 8% per annum (experienced by some Four Asian Tigers) will lead to a doubling of GDP within 10 years. This exponential characteristic can exacerbate differences across nations.

Short-run versus long-run considerations

Economists draw a distinction between short-term economic stabilization and long-term economic growth. The topic of economic growth is primarily concerned with the long run. The short-run variation of economic growth is termed the business cycle.

11


12

Principal Theories of Economic Growth Exogenous growth model (Solow–Swan growth model) Ramsey-Cass-Koopmans model Endogenous growth theory

The Ramsey model differs from the Solow model in that it explicitly models the choice of consumption at a point in time and so endogenizes the saving rate.

12

In general positive, with a long-run average of about 2.5%

3 Recessions with growth being negative:

Oil shock of early 1980s

Gulf war of early 1990s

Recent Financial Crisis (2007)

European (Russian) Economic Crisis (the grey area): fall in growth rate but not becoming negative.

13


The rate of growth does not seem to increase, but falls, even when one abstracts from the business cycles.

Vulnerability of Industrial Countries to Oil

Canadian economy is very much tied to the US economy.

14


Economic Growth: Main Theories

New Classic Models Ramsey Growth Model

Solow Growth Model

Newer Theories Technological Progress and Sustainability

15

Economic Growth: Main Questions

Can an Economy Grow forever?

(It means Average GDP increases forever).

If constant growth is impossible, then can a level of GDP remain sustainable?

(It means the economic conditions do not improve but do not deteriorate either).

These questions relate to the Sustainability of Economic Growth…

16


Hence, it is reasonable to think that there might be limitation to growth.

The alternative question is whether the Steady State level of output can be maintained (is not going to fall).

While theoretical answers are similar to those brought about for growth, in practice and in the medium-run, it depends of the composition of GDP in a given country (economy).

17

Steady State A steady state economy is an economy of relatively stable size. In

growth models, the steady state is the long-run outcome of the model.

The economy may start away from its steady state, it gradually moves toward it.

A steady state economy, therefore, aims for stable or mildly fluctuating levels in population and consumption of energy and materials.

Saving/investment equals depreciation and consumption per capita remain constant (and birth rates equal death rates).

18


19

0 1 2 3 4 50.0

0.5

1.0

1.5

2.0

K

Output

Investment as portion of output

Output


20

0 1 2 3 4 50.0

0.5

1.0

1.5

2.0

K

Output


What is halting economic growth?

Decreasing Marginal product of inputs. It means that as the level of inputs employed increases their unit-contribution to output falls.

The rationale is that not all the inputs can increase: some natural resources are in fixed supply.

21


Some economists argue that with technological progress, the limitation can be overcome.

The shortcoming of this argument is that the degree of substitution between natural resource inputs and technological substitutes are not exact.

Also, it relies on assuming future technologies but it is not concretely said how and when.

22

Question

23

Can Economic Growth and Sustainability be compatible?

23

Economic Growth: Sustainability-1

Important Questions:

The composition of GDP can indicate how sustainable an economy is.

Resource dependence is one of the main indicator of un-sustainability of GDP.

What is the solution in face of Resource Dependence?

24

Sustainability Criteria: Main definitions Weak sustainability Inter-temporal well-being is maintained based on strong assumptions

of substitution between resources. An example is Hartwick rule.

Strong sustainability The value of remaining stock of natural capital should be maintained.

Environmental sustainability The physical flow of individual resources should be maintained.

25

Hartwick Rule John Hartwick (1977)

o He argued maintaining “capital base” from which current and future consumption (therefore well-being) level are derived leads to sustainability.

o He also showed that this can be achieved if:

o The scarcity rent from exhaustible resource is invested in another form of capital then the level of consumption can be maintained constant through generations.

o This proposition falls into the category of weak sustainability.

26

Weak and Strong Sustainability

How realistic is the assumption of substitutability between natural and other forms of capital?

What considerations are important in deciding the degree of substitutability between capitals?

27 27

Natural Resource Curse

The resource curse refers to the paradox that countries with an abundance of natural resources, specifically non-renewable resources (minerals and fuels), tend to have less economic growth and worse development outcomes than countries with fewer natural resources.

Different reasons suggested: decline in the competitiveness of other economic sectors; volatility of revenues from the natural resource, government mismanagement of resources, or corrupt institutions (possibly due to the easily diverted revenue from extractive activities).

28

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