FOREIGN TRADE UNIVERSITY Department of Macroeconomics MACROECONOMICS I Assoc Prof., PhD Hoang Xuan Binh A PowerPointTutorial to Accompany macroeconomics, 5th ed N Gregory Mankiw CHAPTER I: Introduction Lecture programme Introduction Module title: Macroeconomics I Semester: I Year 2015-2016 Level: Undergraduate Module Convenor: Hoang Xuan Binh Office hours: 15 -17 on Monday Tel: 844-32595158 ext 228 Cellphone: 0912782608 Email:binhhx@ftu.edu.com INTRODUCTION Module Context: The module is designed especially for students taking Macroeconomics at FTU It is intended to provide students with an understanding of important macroeconomic factors and variables The course analyses how macroeconomic variables operate;and it develops an understandings of the international money and financial market, in or outflows of capital The course also draws on the debates in real economy and tries to use both old and new theories to understand them Introduction Module aims and objectives: 1.To familiarise the students with some of the most important macroeconomic variables in the economy, for example GDP,GNP,CPI,PPI… 2.To introduce students to some important macroeconomic policies including fiscal and monetary policies 3.To examine some different cases in term of using macroeconomic policies to develop economy Introduction Learning outcomes By the end of this module it is expected that students: 1.will have an understanding of how important macroeconomic variables are interacting in the economy 2.will be able to interpret such variables and events as GDP,GNP,CPI or inflation,unemployment… and relate them to changes of other variables and events in the economy 3.will be ready to explain significant events in real economy by using economic theories 4.will be familiar with current debates on openeconomy and able to make a critical assessment of the various arguments which are put forward Teaching and learning methods: In class contact hours there will be lectures, discussions and assistance with students’assignment work,reading and using books During the seminars the students will be expected to discuss the provided topics on the problems of real economy Assessment methods: There is a written assignment and final examination It is worthy 30% and 60% respectively Class participation is 10% Suggested Supplementary Reading Mankiw, Principles of Economics Mankiw, Macroeconomics 5th ed , Sloman J., (2003), Economics, 5th ed Lecture programme Chapter: Introduction lecture programme Chapter2:The Data of Macroeconomics Chapter3:Aggregate Demand and Fiscal policy Chapter4:Money and Monetary policy Chapter5:Inflation and unemployment Presentation assignment Chapter6:Economic growth Chapter 7: The Open economy Revision I.Introduction Everyone is concerned about macroeconomics lately We wonder why some countries are growing faster than others and why inflation fluctuates Why? Because the state of the macroeconomy affects everyone in many ways It plays a significant role in the political sphere while also affecting public policy and social well-being There is much discussion of recessions periods in which real GDP falls mildly and depressions, concerns with issues such as inflation, unemployment, monetary and fiscal policies Economists use models to understand what goes on in the economy Here are two important points about models: endogenous variables and exogenous variables Endogenous variables are those which the model tries to explain Exogenous variables are those variables that a model takes as given In short, endogenous are variables within a model, and exogenous are the variables outside the model Price Supply P* Q* This is the most famous economic model It describes the ubiquitous relationship Demand between buyers and sellers in the market The point of Quantity intersection is called an equilibrium In order for the U.S to pay for its imports of goods and services and securities from Japan, it must supply dollars which are then converted into yen by the foreign S E C & I V R Securities E S & exchange S D O O G market DemandYEN SupplyYEN Goods and Services Foreign Foreign Exchange Exchange Market Market Supply$ Demand$ & ES I T I R U SEC In order for Japan to pay for its imports of goods and services and securities from the U.S., it must supply yen which are then converted into dollars by the foreign exchange market The exchange rate between two countries is the price at which residents of those countries trade with each other -relative price of the currency of two countries -denoted as e -relative price of the goods of two countries -sometimes called the terms of trade -denoted as ε The nominal exchange rate is the relative price of the currency of two countries For example, if the exchange rate between the U.S dollar and the Japanese yen is 120 yen per dollar, then you can exchange dollar for 120 yen in world markets for foreign currency A Japanese who wants to obtain dollars would pay 120 yen for each dollar he bought An American who wants to obtain yen would get 120 yen for each dollar he paid When people refer to “the exchange rate” between two countries, they usually mean the nominal exchange rate Suppose that there is an increase in the demand for U.S goods and services How will this affect the nominal exchange rate? S$ e e1 e0 A B D$ $ Dollar Value of Transactions D$ shifts rightward and increases the nominal exchange rate, e This is known as appreciation of the dollar Events which decrease the demand for the dollar, and thus $ D ′ decrease e would be a depreciation of the dollar ε The real exchange rate is the relative price of the goods of two countries That is, the real exchange rate tells us the rate at which we can trade the goods of one country for the goods of another To see the difference between the real and nominal exchange rates, consider a single good produced in many countries: cars Suppose an American car costs $10,000 and a similar Japanese car costs 2,400,000 yen To compare the prices of the two cars, we must convert them into a common currency If a dollar is worth 120 yen, then the American car costs 1,200,000 yen Comparing the price of the American car (1,200,000 yen) and the price of the Japanese car (2,400,000 yen), we conclude that the American car costs one-half of what the Japanese car costs In other words, at current prices, we can exchange American cars for Japanese car ε We can summarize our calculation as follows: Real Exchange Rate = (120 yen/dollar) × (10,000 dollars/American car) (2,400,000 yen/Japanese Car) = 0.5 Japanese Car American Car At these prices, and this exchange rate, we obtain one-half of a Japanese car per American car More generally, we can write this calculation as Real Exchange Rate = Nominal Exchange Rate × Price of Domestic Good Price of Foreign Good The rate at which we exchange foreign and domestic goods depends on the prices of the goods in the local currencies and on the rate at which the currencies are exchanged Real Exchange Rate Nominal Exchange Rate Ratio of Price Levels ε = e × (P/P*) Note: P is the price level of the domestic country (measured in the domestic currency) and P* is the price level of the foreign country (measured in the foreign currency) Real Exchange Rate Nominal Exchange Rate Ratio of Price Levels ε = e × (P/P*) The real exchange rate between two countries is computed from the nominal exchange rate and the price levels in the two countries If the real exchange rate is high, foreign goods are relatively cheap, and domestic goods are relatively expensive If the real exchange rate is low, foreign goods are relatively expensive, and domestic goods are relatively cheap How does the level of prices effect exchange rates? It doesn’t All changes in a nation’s price level will be fully incorporated into the nominal exchange rate It is the law of one price applied to the international marketplace Purchasing Power Parity suggests that nominal exchange rate movements primarily reflect differences in price levels of nations It states that if international arbitrage is possible, then a dollar must have the same purchasing power in every country Purchasing Power Parity does not always hold because some goods are not easily traded, and sometimes traded goods are not always perfect substitutes– but it does give us reason to expect that fluctuations in the real exchange rate will be small and short-lived Real exchange rate, ε S-I The law of one price applied to the international marketplace suggests that net exports are highly sensitive to small movements in the real exchange rate This high sensitivity is reflected here with a very flat net-exports schedule NX(ε) Net Exports, NX Real exchange rate, ε The relationship between the real exchange rate and net exports is negative: the lower the real S-I exchange rate, the less expensive are domestic goods relative to foreign goods, and thus the greater are our net exports The real exchange rate is determined by the intersection of the vertical line representing saving minus investment and downward-sloping net exports schedule Here the quantity of dollars NX(ε) supplied for net foreign investment equals the Net Exports, NX quantity of dollars demanded for the net exports of goods and services Real exchange rate, ε S2-I ε2 ε1 NX2 S1-I Expansionary fiscal policy at home, such as an increase in government purchases G or a cut in taxes, reduces national saving The fall in saving reduces the supply of dollars to be exchanged into foreign currency, from S1-I to S2-I This shift raises the equilibrium real exchange rate from ε1 to ε2 NX(ε) A reduction in saving reduces NX1 Net Exports, NXthe supply of dollars which causes the real exchange rate to rise and causes net exports to fall Real exchange rate, ε S-I(r1*) S-I (r2*) Expansionary fiscal policy abroad reduces world saving and raises the world interest rate from r1* to r2* ε1 ε2 NX1 The increase in the world interest rate reduces investment at home, which in turn raises the supply of dollars to be exchanged into foreign currencies As a result, the equilibrium NX(ε) real exchange rate falls from ε1 to ε2 NX2 Net Exports, NX Real exchange rate, ε S-I2 ε2 ε1 NX2 S-I1 An increase in investment demand raises the quantity of domestic investment from I1 to I2 As a result, the supply of dollars to be exchanged into foreign currencies falls from S-I1 to S-I2 This fall in supply raises the equilibrium real exchange NX(ε) rate from ε1 to ε2 NX1 Net Exports, NX