Intermediate Macroeconomics 2201: Lecture 1

Macroeconomics
Monday 01/04

Macroeconomics

sound advice of the form: 

If

you want to

achieve this, you should do this.

Macroeconomics is the discipline that studies economies in a dynamic setting.
economy is seen (and modelled) as a

Since the beginning of the XX century,

An

developed economies started to gather lots

me-

(and lots) of macreoeconomic data. These

chanical system and the ultimate goal of the

data are used try to formulate general theo-

discipline is to describe this system by a set

of equations.

ries to understand, explain and forecast the

The resulting equations are

future data. Unfortunately, the experimen-

then used to study of wide range of inter-

tal approach that is so useful in hard sci-

esting questions such as, for example:

ences is not viable for us.

Simply

Why some countries are rich and others

put, it is not possible to subject a whole

are poor?

country to a controlled environment in order to isolate the eects of a single variable

Why some countries experience hyper-

on the behavior of the whole system.

ination?

Why?

We

need to learn as we go, and therefore there is

Why do we have expansions and reces-

a huge advantage in keeping things as sim-

sions?

ple as possible.

This principle is know as

Occam's razor: the probability of a theory

Can we do something to avoid reces-

being correct is directly proportional to its

sions?

simplicity. We'll pay attention to this principle and consequently we shall try and for-

Since by denition the state of the econ-

mulate the simplest possible model that (1)

omy as a whole aects everyone it is no sur-

makes sense and (2) is useful to understand

prise that macroeconomic issues give raise

to heated debates.

real world data.

Although the politics

of decision making are very interesting and

Be aware, though, that the model that we

one

extremely important to understand a how

will study in this class is only

real-life policies are implemented, it is not

plest possible indeed) of the many that are

our present focus to consider these issues.

out there.

Rather

macroe-

nomics is an active area of research to this

conomists is to provide policymakers with

very day, and therefore you should not be

the

approach

taken

by

(the sim-

As a matter of fact, macroeco-

Building Models

macroeconomies work. As you should learn

The

most

to walk before you try to run, the model

nomics is to make things better which

that we will learn is a good starting point

means a lot of things. Ideally we'd like to

for more complete and satisfying models of

have an economy that runs at full employ-

the macroeconomy.

ment without any ination or income uc-

mis-directed to believe that what you learn

in this class, is

the nal truth

about how
important

goal

of

macroeco-

tuations (i.e. we'd like to have the economy

always

at the best possible). Is this set of

goals reasonable?

Macroeconomic history

Can we make this hap-

pen? To address these questions we make

use of

models,

which are thinking tools de-

One of the goals of this class is to get you up

signed to boost our understanding of the

to date with the current state of the world

relationships between the quantities of in-

economy.

It is therefore necessary that

terest. A model can be thought of as noth-

you know what has happened in the past

ing more than a structured way of thinking

century.

of a particular problem.

There are three data series that

are of particular importance for Macroeconomists: income (Y ), ination ( ), and

Figure 4: The logic of a model

unemployment (U ).

Exogenous
Variables

Look at Figures 1, 2, and 3 (at the end

of the notes). These are the salient points

Model

Endogenous
Variables

about these important data:

1. real GDP (i.e. income) rises over time
2. real GDP rises over time with alternat-

Economic models make use of mathemat-

ing phases of extraordinary growth (ex-

ics and logic.

pansions) and of lower (possibly neg-

fairly complicated, but we will keep this

ative) growth (depressions or reces-

aspect of the problem to its most basic

sions).

form possible. The other side of the issue,

though, i.e.

The mathematics can be

the logic behind what we do,

3. ination is highly volatile, and since

cannot be simplied too much. In its most

the 50's we haven't experienced any de-

basic form, the logic of a model can be de-

ations.

picted as in Figure 4.s

As all of human knowledge involves

4. there is no trend in either ination or

we need to use appropriate jargon: look at

unemployment rates.
5. the economy has

ployment.

words

Figure 4 and imagine the Model as a machine that takes inputs and produces out-

never been at full em-

puts.

Every model has two types of vari-

ables: the exogenous variables are those

2

that the model does

not

try to explain but

First o you should notice that there are

rather that it takes as inputs. The endoge-

two actors involved: a buyer and a seller.

nous variables are those variables that

Second you should notice that they

the model tries to explain and that conse-

an exchange. It should come quite naturally

quently are outputs of the model.

to hack the problem now: we will describe

agree on

Be very careful not to feed back the re-

the behavior of the seller, the behavior of

sults to the model again: you would be mis-

the buyer and nally we will characterize

using a particular model and your conclu-

agreement between them.

We start by modelling the the demand

sions would be logically inconsistent. I have

side. Imagine that the buyer has a mental

seen this happening many times!

schedule relating prices to quantities:

3.1

example (s)he might be thinking:

A Simple Model

price is

Q,

for

If the

I want to buy a certain quan-

P + dP

From Microeconomics you should know the

tity

basic model of supply and demand. We will

want only

use this familiar example to illustrate the

sumer will demand more of a specic good

logic behind a model. Suppose you observe

if aggregate income,

a market in the real world; what you ac-

be justied by assuming that when some-

tually see is a series of quantities and the

one becomes richer, they will demand a big-

prices that seller and buyer have agreed to

ger quantity of any particular good. To de-

exchange for.

scribe this thought process concisely we use

For example you might jot

but if the price is

Q dQ,

etc....

Y,

then I

Also, the con-

is high:

this can

function, that is, a mathematical rule that

down on a notebook the following informa-

tion:

describes how much the buyer is willing to

d
buy at any given price. Denoting with Q

9.00 am:
9.02 am:
9.05 am:
[...]
5.00 pm:

Market opens
Smith sells 900 units to Jones for $32.3
Jones sells 450 units to Johnson for $33.0

the quantity that the buyer is willing to purchase when the price is
is

Market closes.

Y,

we can model the demand side of the

Qd = D(|{z}
P , |{z}
Y )

nancial markets (where usually the good ex-

changed are stocks and you don't get to see

D(, )

an anonymous trading process). In its most

tice the minus and plus signs under

a (de-

model is better suited for scien-

tic purposes.

and

is

decreasing

in

and

increasing

in

Y.

into pieces. The key feature of an analytical model

consists of breaking a complex object (like a mar-

1 Analytical is a word that derives from the

respectively? They mean that the function

scriptive) model of the market. Usually, an

greek

has two inputs (price and income)

and one output (quantity demanded). No-

essential meaning, such a detailed account

is

This statement means that the function

who is buying and who is selling, i.e. it is

analytical

and the income

market by writing the following

Such a log is known as book in the -

of minute-by-minute transactions

ket) into a set of parts that interact with each other

(analusis) which means to break

(buyers, sellers, and prices).

Qd = D(|{z}
P , |{z}
Y )

Therefore

is a compact

Last remark: in general the fact that you

in a certain market is systematically related

ters involved in the function; for example

to

and

Y,

that when the price increases

not

as

variables

list say
does

and

+
notation to say that the quantity demanded

of a function

mean that there are no other let-

if I write

people demand less, and that when income

Qd (P, Y ) = k 10P + 2Y

increases people demand more. We can also

describe this concept graphically:

it means that

denotes a parameter of

the function. You can think parameters as

something in between general and explicit
denitions for functions.
Now let's nish modelling the market and
let's turn to the supply side. The supplier
has to produce the goods, and in order to do

D(P, Y )

so she has to incur in the production costs:

if the price of the good is too low the sup-

plier cannot break even and she will decide

not to enter the market: supply equals 0.

You

should

be

somewhat

familiar

to

As the price increases the supplier will want

the conventions involved in writing down

generic and specic functions.

to supply more and more as she makes more

In general

prots. Therefore we can think the supplier

a single letter of the alphabet (sometimes

as having a mental schedule that associates

the Greek alphabet) denotes a function, and

to every price a quantity that she would be

generally the convention is case sensitive

(i.e.

and

willing to supply. As before we use a func-

are dierent functions ). The

tion:

letter denoting the function may or may not

be followed by a list of

variables

function depends on: so

f (x, y)

we have a function
variables

a function

nition

Qs = S(|{z}
P , |{z}
C )

that the

This means that the quantity supplied in

s
the market Q depends systematically on

that depends on two

y . Declaring that we have

Q = D(P, Y ) is a general deand
d

the price

form that we use while studying theory. An

increasing

is something like the fol-

C.

P.

When the costs of pros

is

decreasing

in

Q
C.

Again we can represents these facts graph-

We will use explicit denitions in the nu-

ically

merical exercises.

As a nal step we need to insure that

2 Oftentimes we exploit this convention by meanis the rst derivative of

in

decreases, therefore

Qd = 60 10P + 2Y

and on the production costs

duction increase, prots decrease and

lowing

ing that

When the price of the good increases, so

s
do prots and Q increases, therefore S is

of the function: this is typically the

explicit denition

means that

the decision of the buyer is compatible with

F ()

the decision of the seller: we need that the

S(P, C)

P
D(P, Y )
Q

two people involved select the same quantity and price. Mathematically we write the

equilibrium condition as follows

Qd = Qs .
At this point we can make sense of

one

of

the entries in our book: we'd be observing

quantity Q sold at price P .

Question 1 Homework 1.

This model

has 2 endogenous variables and 2 exogenous

variable (it is slightly dierent from the
book!): which variables are endogenous and
which ones are exogenous in this model?

Summary

Here's what you should have learned in this

lecture:

What is Macroeconomics (Look at the

very rst sentence of this handout for
a compact denition).

Some stylized facts about

The concept of modelling and the dif-

Y,

and

U.

ference between exogenous and endogenous variables.

How to read/write the denition of

functions.

Figure 1: Income

Figure 2: Ination

Figure 3: Unemployment