Welcome to Macro 220

• Lecturer: Rod Duncan

• Office: C2-G20

• Contact: rduncan@csu.edu.au

• Lectures: C2-G2 1pm to 2:50pm

• Tutorials: C2-215 1pm to 1:50pm

• Consult: 10am-12am, 3pm-5pm Tues

2pm-5pm Thurs

Forms of economics

• Microeconomics- the study of individual decision-making– “Should I go to college

or find a job?”– “Should I rob this

bank?”– “Why are there so

many brands of margarine?”

• Macroeconomics- the study of the behaviour of large-scale economic variables– “What determines

output in an economy?”

– “What happens when the interest rate rises?”

Economics as story-telling

• In a story, we have X happens, then Y happens, then Z happens.

• In an economic story or model, we have X happens which causes Y to happen which causes Z to happen.

• There is still a sequence and a flow of events, but the causation is stricter in the economic story-telling.

Kobe, the naughty dog

Modelling Kobe

• Kobe likes to unmake the bed (Z).

• Kobe likes treats (X).

• We assume that more treats will lead to fewer unmade beds.

(Not a very good) Model: X↑ → Z↓

• We can use this model to explain the past or to predict the future.

Components of a model

• Variables- i.e. output of economy, inflation rate, interest rates, or the unemployment rate

• Relationships between the variables- i.e. when interest rates rise, investment falls or more complicated forms

Example: market for ice cream

• Variables: D is demand for ice cream, S is supply of ice cream, P is price of ice cream, Y is income of people who buy ice cream, T is average temperature and I is prices of all inputs to make ice cream.

• Relationships: Then we say D is falling in P, S rising in P, D rising in Y and in T and S falling in I.

• Equilibrium in ice cream market requires that quantity of ice cream sold is equal to quantity of ice cream bought.

Example: market for ice cream

• Equilibrium: D (P, Y, T) = S (P, I)

• Holding Y, T and I constant, we will then have our standard demand-supply model.

• Important! Nothing about the behaviour of the model depends on the meanings of the variables- what D is or what T is.

• We are free to re-label our model, as long as the relationships remain true.

Re-labelling

• We are free to re-label “D” and “S” as cars, books, electricity, illicit drugs or even marriage partners. We just have to also re-label P, Y, T and I and be sure that the relationships still hold true.

• Behaviour of the re-labelled model is exactly the same as for the ice cream market model.

Aggregate demand model

• Re-label D as demand for all goods and services, S as supply of all goods and services, P as the average price, T as net exports and I as government red tape. Be sure that the relationships still hold true!

• We now have a macro model! We will be re-labelling P as interest rates later on in this class and calling it the IS-LM model.

Questions to ask yourself?

• What are the variables in this model?

• What are the relationships between the variables? (Often in the form of an equation or a graph.)

Macroeconomic variables

• National output- gross domestic (or national) product (GDP)

• Interest rates- usually a Treasury bond of some fixed duration rate- there are lots of interest rates

• Unemployment rate• Inflation rate• Exports and imports • Current account deficit/surplus• Government budget deficit/surplus• Household savings• And many, many others.

Some Australian economic historyAustralian GDP 1950-1995

0

100 000

200 000

300 000

400 000

500 000

600 000

1950 1960 1970 1980 1990 2000

Mil

lio

n A

$

GDP

GDP Change

Real GDP

Australian Business CycleAust Business Cycle

-4

-2

0

2

4

6

8

10

1950 1960 1970 1980 1990 2000

% Ch RGDP

UnemploymentUnemployment over the Business Cycle

-4

-2

0

2

4

6

8

10

12

1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995

Pe

rce

nt

(%)

Unemployment

Change in GDP

InflationConsumer Price Inflation

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

Sep

-70

Sep

-72

Sep

-74

Sep

-76

Sep

-78

Sep

-80

Sep

-82

Sep

-84

Sep

-86

Sep

-88

Sep

-90

Sep

-92

Sep

-94

Sep

-96

Sep

-98

Sep

-00

Sep

-02

Sep

-04

Inflation

Interest Rates

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

Jan-

70

Jan-

73

Jan-

76

Jan-

79

Jan-

82

Jan-

85

Jan-

88

Jan-

91

Jan-

94

Jan-

97

Jan-

00

Jan-

03

Bank Interest Rates

Current Account Deficit

-20

-15

-10

-5

0

5

10

CAD % GDP