Université d’Orléans Institut d’Economie d’Orléans
Licence 1, Economie-Gestion, mention Européenne
Macroeconomics
Rémi Bazillier
[email protected] http://remi.bazillier.free.fr
Contents 1 Introduction 1.1 Stock or Flows? . . . . 1.2 True or false? . . . . . 1.3 GDP . . . . . . . . . . 1.4 GDP and wealth . . . 1.5 Measuring GDP . . . . 1.6 Nominal and real GDP 1.7 GDP deflator . . . . . 1.8 Chain indexes . . . . .
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1 1 1 2 2 2 3 3 4
2 Consumption 2.1 Keynesian consumption function . . . . . . . . 2.2 Consumption and households’ available income 2.3 Permanent income hypothesis . . . . . . . . . . 2.4 Life cycle hypothesis . . . . . . . . . . . . . . .
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5 5 6 6 7
3 Investment 3.1 Demand and investment . . . . . . . . . . . . . . . . . . . . . 3.2 Investment’s decision . . . . . . . . . . . . . . . . . . . . . . .
8 8 9
4 The 4.1 4.2 4.3 4.4
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Goods market The equilibrium . . . . . . . . . The Multiplier . . . . . . . . . The balanced budget multiplier Automatic stabilizers . . . . . .
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10 10 10 11 12
5 Financial markets 13 5.1 Demand for money . . . . . . . . . . . . . . . . . . . . . . . . 13 5.2 Bond prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 5.3 The interest rate . . . . . . . . . . . . . . . . . . . . . . . . . 14 ii
6 The 6.1 6.2 6.3 6.4
IS-LM model The IS curve . . The LM curve . . The IS-LM model The IS-LM model
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15 15 16 16 17
Chapter 1
Introduction 1.1
Stock or Flows?
• The wealth of an individual • Number of unemployed • Trade deficit • Level of investments • Public debt • Number of workers who have lost their job • Level of capital in the economy *** The following exercises are taken from: Blanchard (2011), “Macroeconomics, fifth edition”, eds. Pearson.
1.2
True or false?
• The share of labor income in GDP is much larger than the share of capital income • French GDP was 29 times higher in 1999 than it was in 1960 • When the unemployment rate is high, the participation rate is also likely to be high 1
• The rate of unemployment tends to fall during expansions and rise during recessions • If Japanese CPI is currently at 108 and American CPI is at 104, then inflation rate is higher in Japan than in the US • The inflation rate measured using the CPI is a better index of inflation than the one computed using GDP deflator
1.3
GDP
Suppose that GDP is measured by summing final value of all goods and services produced. Determine the effect of the following transactions. 1. A consumer buys e100 worth of fish from a fisherman. Fishes are consumed at home. 2. A seafoo restaurant buys e100 worth of fish from a fisherman. 3. Air France buys a new plane from Airbus for e200 billions. 4. The Greek national airline buys a plane from Airbus for e200 billions. 5. Air France sells a plane to Gerard Depardieu for e100 billions.
1.4
GDP and wealth
Instead of cooking for your dinner, you work one hour more, earn 12 e and buy your dinner 10 e. 1. Does the measured GDP increase? If yes, how much is the increase? 2. How much should increase the “true” GDP?
1.5
Measuring GDP
1. A silver mining company pays its workers e200 000, invests in a new machine-tool for 50000 and mines 75 kg of gold. The silver is then sold to a jewelry manufacturer for e300 000. 2. The jewelry manufacturer pays its employees e250 000 buys e300000 of silver, and makes silver necklaces directly sold to consumers for e1 million.
3. A third firm pays its employees for e30000, buys for e10000 of raw materials and sells a machine-tool to the silver mining company for e50000 4. The last firm sells for e10000 of raw materials to the firm specialized in raw material. • Calculate the GDP using the production approach. • Calculate the added-value for each step of production. Calculate the GDP using the added-value approach. • Give levels of wages and profit. Calculate the GDP using the income approach.
1.6
Nominal and real GDP
The economy can be summarized by the following table. Year Cars Oranges Computers
2009 Quantity 10 1000 4
2009 Price 2000 1 1000
2010 Quantity 12 1000 6
2010 Price 3000 1 500
1. What is nominal GDP in 2009 and 2010? What is the growth rate of the nominal GDP? 2. Using 2009 as the reference year, what is the real GDP in 2009 and 2010? 3. Same question using 2010 as the reference year. 4. True or False? The real growth rate changes with the reference year.
1.7
GDP deflator
You will use data from the previous example. 1. Suppose that we use 2009 prices as a basis to calculate real GDP in 2009 and 2010. Calculate the GDP deflator for 2009 and 2010, and the inflation rate 2009-2010.
2. Suppose that we use 2010 prices as a basis to calculate real GDP in 2009 and 2010. Calculate the GDP deflator for 2009 and 2010, and the inflation rate 2009-2010. 3. Why are the two inflation rate different? Which one is true? Justify your answer.
1.8
Chain indexes
As shown in exercises 1.6 and 1.7, the choice of the reference year has an influence on some results. To avoid this problem, chain indexes can be used. The reference year is always the previous year. 1. Using data from exercise 1.6, calculate the real GDP using the previous year as the reference year. 2. What is the growth rate of GDP? 3. What is the GDP deflator? What is the inflation rate calculated using this method?
Chapter 2
Consumption 2.1
Keynesian consumption function
In a country, the general consumption function is given by the following equation: C = 0.7Y + 3
(2.1)
with C the level of consumption and Y the national income. 1. How does Keynes define the saving? Determine the saving function. 2. Draw on the same graph the consumption line and the saving line (for Y between 0 and 30). Find the breaking point (the level of income characterized by C = S). What does the value 3 represent? 3. Give the average propensity to consume (APC) and the marginal propensity to consume (MPC). How do these propensities move when Y rises? Show them on the previous graph for Y = 1, Y = 10, Y = 30 4. When income rises, how does the spread between national income and global consumption move? 5. What does mean a consumption function determined by the following equation? C = 0.7Y − 3
5
(2.2)
2.2
Consumption and households’ available income
In a country, the consumption function is given by the following equation: C = CO + cYd
(2.3)
Where Yd is the households’ available income. 1. Give the relation between aggregated consumption and national income when the State puts in place a lump-sum system of taxes (T0 ) 2. Same question if the State puts in place a lump-sum tax (T0 ) and a flat-rate tax tY (with 0 < t < 1 the tax rate). 3. Same question if the State puts in place a lump-sum tax, a flat-rate tax and redistributes social transfers, proportional to the level of income (θY , with θ the transfer rate), and redistributes also a lump-sum transfer (T r0 ). 4. For each system of taxes and transfers defined in the previous questions, give the effect on the average and marginal propensities to consume.
2.3
Permanent income hypothesis
Here is the income level observed in a country during 10 years. Year 10 Y
0 11 10000
1
2
3
4
5
6
7
8
9
11000
13000
12000
9000
10000
12000
13000
10000
8000
1. The permanent income Y P is given by the income average of the current year and the three previous years. Calculate this permanent income for years 4 to 10 . 2. Calculate the transitory income Y T for the same years. 3. The consumption is a function of the permanent income: Ct = 0.9YtP . What is the marginal propensity to consume the permanent income? And the average propensity to consume the permanent income? Calculate the consumption for years 4 to 10. 4. Calculate the average propensity to consume the current income. Comment its evolution. Why this evolution is contrary to the Keynesian assumptions?
2.4
Life cycle hypothesis
Mr. X starts his professional life at 20 years old, without any initial capital. He earns e36000 yearly until he retires at 65 years old. His life expectancy is 80 years old. We suppose that his saving is not remunerated and there is no pension system. 1. If he spends his income constantly all over his life, what is his annual consumption? Calculate his average propensity to consume during his active years, his level of annual saving and the available capital when he retires. 2. How does his saving and consumption behavior change if the pension age is post-pone to 70 years-old? 3. What is the level of consumption for Ms. Y who earns the same wage but whose life expectancy is 85 years-old. Comment. 4. We now suppose that Mr. X receives e300000 of inheritance and does not want to give inheritance to his children after his death. Calculate consumption and saving levels and compare them with the ones obtained in the first question. Comment.
Chapter 3
Investment 3.1
Demand and investment
We suppose that the demand of consumption goods is given by the following table: Year Demand
0 1000
1 1000
2 1100
3 1500
4 1600
5 1500
6 1000
7 700
8 700
9 900
In year 0, the production capacity usage rate is 100%. Fixed capital is e4000. The capital coefficient (the ratio of capital/demand) is constant over time. Equipments goods are not depreciated over time. Production is immediatly adjusted to the demand at each period.
1. Calculate the capital coefficient. What hypothesis should be made in order to ensure that this coefficient keeps constant over time? 2. Calculate the investment for each period. How do firms can make “negative investments”? at the firm level? at the sector level? at the national level? 3. On the same graph, draw the curve of demand and investment. Comment. 4. What would be the consequences of a stronger mechanization of the production process?
8
10 1000
11 1000
3.2
Investment’s decision
You should analyze two projects of investments.
Life expectancy Anticipated income (per year) Initial cost
Project A 5 years 100 400
Project B 2 years 200 350
Firms can borrow or make financial investment at a 5% interest rate. 1. Calculate the net present value of both projects. 2. Calculate the internal rate of return of project B. 3. Which project should be chosen? Why? 4. Let’s now suppose that the cost of borrowing increases. The interest rate is 10%. The remuneration of financial investments is unchanged (5%). Give the net present value of both projects (1) if the firm finances it through internal financing, (2) if the firm has to borrow. Comment.
Chapter 4
The Goods market The following exercises are taken from: Blanchard (2011), “Macroeconomics, fifth edition”, eds. Pearson.
4.1
The equilibrium
The economy has the following characteristics:
C = 160 + 0.6Yd
(4.1)
I = 150
(4.2)
G = 150
(4.3)
T = 100
(4.4)
1. Find the equilibrium GDP Y 2. Find the disposable income Yd 3. Find the consumption C 4. Assume that G is now equal to 110. Solve for equilibrium output. Compute total demand. Is it equal to production? Explain. 5. Is the sum of private and public saving equal investment? explain.
4.2
The Multiplier
The economy has the following characteristics: 10
C = C0 + cYd
(4.5)
I=I
(4.6)
G=G
(4.7)
T =T
(4.8)
1. Give the analytical value of Y 2. What is the government spendings multiplier? 3. What is the tax multiplier? 4. The government has two policy options to boost growth: increasing government spendings or decreasing taxes. Which policies would be more efficient in this case? Why?
4.3
The balanced budget multiplier
For both political and macroeconomic reasons, governments are often reluctant to run budget deficits. Here we examine whether policies changes in G and T that maintain a balanced budget are macroeconomically neutral. The economy has the following characteristics: C = C0 + cYd
(4.9)
I=I
(4.10)
G=G
(4.11)
T =T
(4.12)
1. Give the level of Y at the equilibrium (same that for the last exercice) 2. Suppose that G and T increase by ine unit each. What is the change in equilibrium GDP? Are balanced budget changes in G and T macroeconomically neutral? 3. How does the specific value of the propensity to consume affect your answer? Why?
4.4
Automatic stabilizers
So far, we have assumed that the policy variables G and T are independent of the level of income. In the real World, however, it is not the case. Taxes typically depend on the level of income and so tend to be higher when income is higher. Here, we examine how this automatic responses of taxes can help reduce the impact of changes in autonomous spending on output. The economy has the following characteristics:
C = C0 + cYd
(4.13)
T = t0 + tY
(4.14)
G=G
(4.15)
I=I
(4.16)
0
