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Published on September 12, 2007

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Macroeconomic TheoryEcon 302U. of WisconsinCharles Engel:  Macroeconomic Theory Econ 302 U. of Wisconsin Charles Engel Course Objectives:  Course Objectives Macroeconomic models – we analyze the economy, rather than learning 'facts'. Building blocks of macro models The economy as a whole – markets interacting Analytical approach to economic problems 'Exogenous' variables vs. 'endogenous' variables 'Fallacy of composition' Policy as a scientific study rather than a political debate What Macroeconomics is About:  What Macroeconomics is About We will examine aggregate economic variables: GDP, the unemployment rate, inflation, the trade balance, etc. To look at aggregate variables, we need to aggregate individual variables in a simple way. We ignore many individual differences among households and firms. Short run and Long run:  Short run and Long run In economics, there is not a single model for everything. We use different (but related) models to study the very long run, the long run, and the short run Very long run – why do some economies grow more than others over decades? Long run – what determines prices and employment when the price mechanism is at work? Short run – what determines prices and employment when wages and prices do not adjust immediately? Mathematical functions:  Mathematical functions We use functional notation when we want to express the idea that one variable is determined by other variables. For example, supply of pizzas is a function of the price of pizzas and the price of materials: In this example, the quantity supplied of pizza is the 'endogenous' variable in the pizza supply model. The price of pizza and the price of materials are 'exogenous' for the pizza maker. She cannot influence those prices (assuming that she is not a monopoly seller of pizza!) More on Endogenous and Exogenous variables:  More on Endogenous and Exogenous variables Variables that are exogenous in some models might be endogenous in other models. For example, in many macro models, we might take the share of income earned by females vs. males as exogenous. But some economic models are designed exactly to explain those shares. In some cases, a variable is exogenous in the building block of a more general model, but endogenous in the general model. Price of pizza is exogenous for the pizza supplier, but determined within our model of the pizza market. The Pizza market:  The Pizza market We can take the equations for supply of pizza, demand for pizza, and market equilibrium: P and Pm are exogenous for the pizza supplier. P and Y are exogenous for the pizza demander. These three equations together determine Qs, Qd, and P endogenously. The exogenous variables for the pizza market are Pm and Y. Macroeconomic example:  Macroeconomic example We will model aggregate consumption as depending on 'disposable' income: For consumers in this model, income and taxes are exogenous. But aggregate income will be determined in our macro model. In most of our macro models, aggregate taxes will be exogenous, but sometimes they will be endogenous. In most of our models of consumers, income is exogenous, but sometimes it is endogenous. Income depends on how many hours we work, for example. Readings:  Readings Macroeconomics, 6th edition by N. Gregory Mankiw Short readings from Federal Reserve Bank economists. These are available on the course web page: www.ssc.wisc.edu/~cengel/Econ302/Econ302.htm Course Requirements:  Course Requirements Homework – assigned on Monday, due in section at the end of the week: 10% of grade 1st mid-term: Wednesday, October 11. 25% of grade. 2nd mid-term: Wednesday, November 15. 25% of grade Final exam: Saturday, December 23, 12:25 pm. 40% of grade. Note the late date!!! Class attendance – good for your grade! Contact information:  Contact information My office: 7460 Social Sciences Building Office hours: MW, 11AM – noon; 1:30-2:30 pm Phone: 262-3697 E-mail: cengel@ssc.wisc.edu Preview of Readings and Topics:  Preview of Readings and Topics Ch. 1, The Science of Macroeconomics Ch. 2, The Data of Macroeconomics Fernald, J. and S. Wang. 'Shifting Data: A Challenge for Monetary Policymakers.' Economic Letter, Federal Reserve Bank of San Francisco, Dec. 9, 2005. Ch. 3, National Income: Where Does It Come From and Where Does It Go? Kliesen, K. 'Do We Have a Saving Crisis?' The Regional Economist, Federal Reserve Bank of St. Louis, July 2005. Walsh, C. 'The Productivity and Jobs Connection: The Long and the Short Run of It.' Economic Letter, Federal Reserve Bank of San Francisco, July 16, 2004. More preview:  More preview Ch. 4, Money and Inflation Anderson, R. 'Inflation’s Economic Cost: How Large? How Certain?' The Regional Economist, Federal Reserve Bank of St. Louis, July 2006. Ch. 5, The Open Economy Coughlin, C.; M. Pakko; and, W. Poole. 'How Dangerous Is the U.S. Current Account Deficit?' The Regional Economist, Federal Reserve Bank of St. Louis, April 2006. Ch. 6, Unemployment Wu, T. 'Two Measures of Employment: How Different Are They?' Economic Letter, Federal Reserve Bank of San Francisco, Aug. 27, 2004. Valletta, R., and J. Hodges. 'Age and Education Effects on the Unemployment Rate.' Economic Letter, Federal Reserve Bank of San Francisco, July 15, 2005. More preview:  More preview Ch. 7, Economic Growth I: Capital Accumulation and Population Growth Gomme, P., and P. Rupert. 'Per Capita Income Growth and Disparity in the United States, 1929-2003.' Economic Commentary, Federal Reserve Bank of Cleveland, Aug. 15, 2004. Ch. 8, Economic Growth II: Technology, Empirics, and Policy Lansing, K. 'Spendthrift Nation.' Economic Letter, Federal Reserve Bank of San Francisco, Nov. 10, 2005. Daly, M., and F. Furlong. 'Gains in U.S. Productivity: Stopgap Measures or Lasting Change?' Economic Letter, Federal Reserve Bank of San Francisco, March 11, 2005. Ch. 9, Introduction to Economic Fluctuations Trehan, B. 'Why Has Output Become Less Volatile?' Economic Letter, Federal Reserve Bank of San Francisco, Sept. 16, 2005. More preview:  More preview Ch. 10, Aggregate Demand I: Building the IS-LM Model Krainer, j. 'Residential Investment over the Real Estate Cycle.' Economic Letter, Federal Reserve Bank of San Francisco, June 30, 2006. Ch. 11, Aggregate Demand II: Applying the IS-LM Model Altig, D. 'When Is a Rate Hike Not Tighter Policy?' Economic Commentary, Federal Reserve Bank of Cleveland, Aug. 1, 2004. Ch. 12, The Open Economy Revisited: The Mundell-Fleming Model and the Exchange-Rate Regime Glick, R. 'Does Europe’s Path to Monetary Union Provide Lessons for East Asia?' Economic Letter, Federal Reserve Bank of San Francisco, Aug. 12, 2005. More preview:  More preview Ch. 13, Aggregate Supply and the Short-run Tradeoff between Inflation and Unemployment Fernald, J., and B. Trehan. 'Why Hasn’t the Jump in Oil Prices Led to a Recession?' Economic Letter, Federal Reserve Bank of San Francisco, Nov. 18, 2005. Trehan, B. 'Oil Price Shocks and Inflation.' Economic Letter, Federal Reserve Bank of San Francisco, Oct. 28, 2005. Ch. 14, Stabilization Policy Carlstrom, C., and T. Fuerst. 'The Taylor Rule: A Guidepost for Monetary Policy?' Economic Commentary, Federal Reserve Bank of Cleveland, July 2003. More preview:  More preview Ch. 15, Government Debt Leduc, S. 'Deficit-Financed Tax Cuts and Interest Rates.' Business Review, Federal Reserve Bank of Philadelphia, Q2 2004. Jones, C. 'The Fiscal Problems of the 21st Century.' Economic Letter, Federal Reserve Bank of San Francisco, Sept. 19, 2003. Ch. 16, Consumption Kliesen, K. 'Survey Says Families are Digging Deeper into Debt.' The Regional Economist, Federal Reserve Bank of St. Louis, July 2006. Ch. 17, Investment McCarthy, J. 'What Investment Patterns across Equipment and Industries Tell Us about the Recent Investment Boom and Bust.' Current Issues in Economics and Finance, Federal Reserve Bank of New York, May 2004. More preview:  More preview Ch. 18, Money Supply and Money Demand Davies, P. 'Right on Target: A Behind-the-Scenes Look at Open Market Operations, the Fed’s Big Stick of Monetary Policy.' The Region, Federal Reserve Bank of Minneapolis, December 2004. ------------------------------------------------------------------- Timetable for readings will be posted on the course website. It will be updated frequently to match our progress during the semester. The current posting is not a 'guarantee' of what will be covered during the semester or on each test. Mathematics:  Mathematics We’ll use algebra and calculus The book puts a lot of the math in footnotes and chapter appendixes. Our lectures will use more math. Graphs are a way to do math. But sometimes it is too hard to represent models with graphs. Then we use math. This moves us closer to what professional economists do. Algebra:  Algebra Review how to solve endogenous variables. Solve for P and Q, in terms of Pm and Y: a, b, c, d, e, and f are 'parameters'. For example, e tells us how much demand falls when the price rises. Here is the solution: Review this A lot of information is embedded in these solutions. Calculus:  Calculus Partial derivative. For example, the effect of a change in pizza price on the quantity of pizza supplied, holding the price of materials constant: is a function of P and Pm. That is, the effect of P on supply is not a constant, but depends on P and Pm. At particular prices P0 and Pm0: or or or Taylor-series expansion:  Taylor-series expansion Take a 'linear' approximation to a function, approximated near some initial point: Or, as a 'total differential': Linearize model and solve it:  Linearize model and solve it Model Linearize: Solution:

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