ECON7021 Introduction to the Macroeconomy
Introduction to the Macroeconomy
Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: THEend8_
Introduction to ECON7021
Topic 1: Introduction to the Macroeconomy
• Introduction to macroeconomic modelling
• Review of key economic indicators
– GDP and economic growth
– Inflation
– Unemployment rate
Respondents as of 8 am on Monday, 19 February: 24 students
Respondents as of 3:15 pm on Monday, 19 February: 41 students
Example of an Economic Model:
Supply and Demand of New Cars
• Suppose we are interested in examining how various events will affect the
price and quantity of new cars in a particular market.
• Let us assume that the market is perfectly competitive:
‒ Many buyers and sellers, so no one has market power.
‒ All sellers sell identical products.
‒ Perfect information, etc.
• Variables:
‒ : Quantity of cars that buyers demand
‒ ௌ: Quantity of cars that producers supply
‒ : Price of cars
‒ : Aggregate income of buyers
‒ ௌ: Price of steel (a key production input for cars)
17
Example of an Economic Model (continued):
Demand for Cars
• Demand equation: = ,
Relationship between quantity demanded,
price and income.
• As in introductory microeconomics, the
demand curve is the relationship between
quantity demanded and price, all else being
equal (including income).
• Notice that terminology in economics is quite
specific at times.
D
18
P
Price
of cars
Q
Quantity
of cars
Digression: Functional Notation
Demand equation: = (, )
• This general functional notation shows that the quantity demanded () is
‒ determined by a demand function () that takes as inputs the price of cars () and aggregate
income ().
‒ Thus, it shows is related to and .
• One possible specific functional form for the demand function: , = 60 − 10 + 2
• But we need not specify a specific functional form.
‒ Because for example, we might not know the exact impact of a $1 price increase on the quantity
demanded.
‒ But so long as we expect price and output to affect quantity demanded, we can write (, ) to
indicate this.
19
Example of an Economic Model (continued):
Supply of Cars
• Supply equation: ௌ = , ௌ
Relationship between quantity supplied,
price and price of steel.
• As in introductory microeconomics, the
supply curve is the relationship between
quantity supplied and price, all else being
equal (including the steel price).
Q
Quantity
of cars
P
Price
of cars S
20
Example of an Economic Model (continued):
Market Equilibrium
• In our model of perfect competition, we
assume that market equilibrium is where
demand meets supply.
• That is, at the equilibrium price ∗,
(∗, ) = ௌ(∗, ௌ).
• Notice that the (equilibrium) market price
and market quantities and ௌ are
determined entirely within the model. Thus,
, and ௌ are endogenous variables.
• Income and the steel price ௌ are given –
determined by forces outside the model –
since the model has nothing to say about
how these are determined. Hence, and ௌ
are exogenous variables.
S
D
Equilibrium
Price
Equilibrium
Quantity
21
P
Price
of cars
Q
Quantity
of cars
Example: Impact of an Increase in Income
S
ଵ
• Demand equation: = ,
Our theory supposes that an increase in income
will increase the quantity demanded, holding
prices constant.
• An increase in the exogenous variable income
( ↑) will cause the demand curve to shift right.
• Our model predicts that an increase in
(exogenous) income will cause increases in both
endogenous variables: price and quantity
(ௌ, ).
ଶ
ଵ ଶ
22
P
Price
of cars
Q
Quantity
of cars
Use of Multiple Models
• No single model can address all the issues we care about.
• For example, our supply-demand model of the car market:
‒ can tell us how a fall in aggregate income affects the price and quantity of cars
‒ cannot tell us why aggregate income falls
• In this course, you will learn different macroeconomic models for studying different
issues such as unemployment, inflation, and long-run growth.
• For each new model introduced in this course, you should keep track of:
‒ its assumptions,
‒ which variables are endogenous and which are exogenous, and
‒ the questions it can help us understand and those it cannot.
• This is very important as you will be required to decide by yourself on the
appropriate models to employ when analysing a real-world issue. 23
Key Economic Indicators: Australia
Snapshot as of 8 February 2024
Source: Reserve Bank of Australia (RBA)
24
Gross Domestic Product
Definition: Gross domestic product of an economy is the market value of all final
goods and services (G&S) produced in the economy in a given period of time.
• Market value – measured using market prices.
‒ The market value of a product is the market price of that product.
• Final good and service – purchased for use by the end-user.
‒ For example, a loaf of bread I purchased for my breakfast is a final good. However, the same loaf
purchased by a café to make sandwiches for sale is not.
• Produced in the economy
‒ Includes only domestic production – excludes imports.
• In a given period of time
‒ Excludes the sale of goods produced in previous periods.
‒ For example, the sale of a house constructed in 2021 is not included in the GDP for 2022.
25
Different Approaches to Measuring GDP
GDP can be calculated in three different ways:
1. Expenditure method: Total expenditure on domestically-produced final G&S.
= + + +
2. Income method: Total income earned by domestically-located factors of production.
= +
3. Value-added (production) method: Sum of value added by all firms where value added by
firm i is = − .
=
Equivalence of methods 1 and 2:
$1 spent by a buyer (expenditure) must result in $1 of income to the seller.
26
Circular Flow Example
Households Firms
1 Bread
Labour
Expenditure
($10)
Wages ($7)
Dividend = Profits = $10 - $7 =$3
Total household income
= Wages + Dividend
= $10
= Expenditure
27
• We distinguish between two different types of economic variables:
stocks and flows.
• A stock is a quantity measured at a point in time.
(For example, there is $10,000 in my savings account today.)
• A flow is a quantity measured per unit of time.
(For example, I save $1,000 per month.)
• Stocks and flows are related.
‒ Stocks are often flows accumulated over time.
(For example, my savings account balance today is the
sum of my $1,000 savings per month over the
last 10 months).
Stocks vs. Flows
28
Investment vs Capital
Note: Investment is spending on new capital.
Example (assuming no depreciation):
• 1/1/2021:
Economy has $30 trillion worth of capital.
• During 2021:
Investment = $3 trillion
• 1/1/2022:
Economy will have $33 trillion worth of capital.
29
Real vs Nominal GDP
• Recall that GDP is the market value of all final goods and services produced
in a country.
• Nominal GDP measures these values using current prices.
(For example, nominal GDP for 2020 is calculated using prices from 2020).
‒ Increases in nominal GDP can be due to:
‒ Increases in prices (inflation) – do not contribute to better living standards.
‒ Increases in output – do contribute to better living standards.
• Real GDP measures these values using the prices of a given base year.
‒ The impact of inflation (change in the price level) has been removed when we use real
GDP.
‒ Real GDP reflects changes in the actual quantity of goods and services produced in the
economy.