Macroeconomic Theory
Introduction
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
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Macroeconomic models help us in framing key questions
that face macroeconomists:
How are the levels of output and employment are
determined and why they fluctuate?
Why does inflation occur and when should we worry about
it?
How does government policy affects inflation and
unemployment?
Why unemployment is high for lengthy periods in some
countries than others?
How do trade, international financial markets and exchange
rates affect employment and inflation?
Why are some countries are rich and others are poor?
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Assumptions and terminology
 A special feature of macroeconomics is that the behavior
of different agents has to be taken into account
simultaneously:
 Actions of households (to enter the labor force, to spend,
to save ..etc)
 Actions of firms (set wages, invest .. etc)
 Actions will be sensitive to government actions (T, G,
interest policy), current economic variables and
expectations of these variables such as tax, wages…etc.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 Aggregate supply side:
refers to the supply of goods and services. The supply side
consists of:
 Factors of production
 Technology
 The way which incomes (workers and firms) are
determined
 Aggregate demand side
Refers to aggregate demand for goods and services and
consists of:
 C, I, and G
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 C is the expenditure of individuals on goods and services
(durable or non-durables)
 I expenditures of capital goods mostly by firms. New
housing and spending by the government on machinery
are also I.
 G on salaries, purchase of goods and services.
 Short run (months)
 A period during which aggregate demand, output and
employment can change but before prices and wages
respond to the change in output and employment
(assuming they are given), i.e., they are fixed or sticky or
rigid.
 Assuming that wages and prices are given can also refer to
the case when they change by a constant amount.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 Therefore in the short run, wages and prices or their rate of
change do not respond to changes in the level of output, it
also means that it is the aggregate demand that determines
the level of output and employment.
 Medium run
 The period during which wages and prices can respond to
changes in output and employment. The supply side of the
economy adjusts to establish a medium run equilibrium in
which inflation is constant.
 Capital stock (and technology) and the labor force
(population and migration, i.e., the supply side of the labor
market) are also constant.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
 The attention is focused on the behavior of wages and
price setters. No upward or downward pressure on wages
or prices.
 Long run: investigates the consequences of changes in
technology such as productivity growth. The growth
theory. Here we allow for population, physical capital and
technology to change.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Fluctuations in output and employment
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Fluctuations in output and employment
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Europe VS USA
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Fluctuations in output and employment
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Fluctuations in output and employment
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
JUNE 2014
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Public debt
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Public debt
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Public debt
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Public debt
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Inflation and Monetary Policy
 Monetary policy in some countries was directed at
reducing unemp, in other countries to an inflation target.
 Suppose that the CB policy is to set interest rates so as to
steer the economy to a low target rate of inflation. In
response to inflation it would put up interest rate, which ↓
AD as I(investment) ↓ due to higher interest rate, this in
turn ↓ emp and inflationary pressures.
 Fig 1.5 provides a schematic overview of the short and
medium run macro model.
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Figure 1.5
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University
Fluctuations in output and employment
Macroeconomic Theory
Prof. M. El-Sakka
CBA. Kuwait University