Macroeconomics and trade Indhold Lectures ............................................................................................................................................................. 2 IS-LM fundamentals 23/10-2020 ................................................................................................................... 2 IS-LM continued 26/10-2020 ......................................................................................................................... 3 Improvements on PP ................................................................................................................................. 4 IS-LM in an open economy 2/11-2020 .......................................................................................................... 4 Midterm ..................................................................................................................................................... 5 Improvements on PP ................................................................................................................................. 5 Chapters............................................................................................................................................................. 6 Chapter 3: The Goods Market ....................................................................................................................... 6 Chapter 4: Financial Markets......................................................................................................................... 7 Chapter 5: Goods and Financial Markets: The IS-LM Model ......................................................................... 8 Chapter 7: The Labor Market ........................................................................................................................ 9 Chapter 8: The Phillips Curve, the Natural Rate of Unemployment, and Inflation ....................................... 9 Chapter 9: From the Short to the Medium Run: The IS-LM-PC Model ....................................................... 10 Chapter 17: Openness in Goods and Financial Markets.............................................................................. 11 Chapter 18: The Goods Market in an Open Economy ................................................................................. 13 Chapter 19: Output, the Interest Rate, and the Exchange Rate.................................................................. 15 Chapter 20: Exchange Rate Regimes ........................................................................................................... 16 Trade ................................................................................................................................................................ 17 Ricardian Model (pp. 89 to 113) .................................................................................................................. 17 Specific-Factor Model (pp. 128 to 153) ....................................................................................................... 19 The Heckscher-Ohlin Model (pp. 167 to 180) ............................................................................................. 20 Leontief’s Paradox (pp. 181 to 193) ............................................................................................................ 22 Stolper-Samuelson Theorem (pp. 195 to 202) ............................................................................................ 23 Effect of Immigrations and FDI .................................................................................................................... 23 Imperfect Competition (pp. 276 to ) ........................................................................................................... 25 Monopolistic Competition (pp. 278 to 287) ............................................................................................ 25 Gravity Equation (pp. 299 to 306) ............................................................................................................... 27 Lectures IS-LM fundamentals 23/10-2020 Expectations: - Identify the core concepts in macroeconomics and international trade theories and models. Apply relevant theories and models to the study of global trade flows Analyze developments in macroeconomic and international trade drivers. The core is the models. Math can help you understand them. Closed economy πΊπ·π = πΆ + πΌ + πΊ Trade balance = π − πΌπ Demand of goods π = πΆ + πΌ + πΊ + π − πΌπ Endogenous variable depends on other variables. Exogenous variable is given. Multiplier effect: IS curve: IS-LM continued 26/10-2020 The demand for money, ππ is equal to the nominal income $π times the decreasing function of interest rate i: ππ = $π πΏ(π) This can be cleared from inflation to get real values by dividing by price level: π π = π πΏ(π) The LM, liquidity preference – money supply, curve is flat because the central banks control the Policy Fiscal expansion Curve movement IS curve shifts to the right Fiscal contraction IS curve shifts to the left Monetary expansion LM curve shifts downwards Monetary contraction LM curve shifts upwards How Lower taxes/Higher government spending Higher taxes/lower government spending Central bank lower interest rate Central bank increase interest rate Effect Higher output. Same interest level. Lower output. Same interest level. Higher output. Higher demand. Lower output. Less demand. Improvements on PP 1. 2. 3. 4. 5. 6. Use arrows to show cause and effect. Include and comment on quotes if they are very import. Improve design. Include model and equation (best if it is one that fits) Keep structure of Macro economy, trade policy, international trade, and shipping. Charts are good but should be made correct with names on axis and so on. Further, they should be used with thought. IS-LM in an open economy 2/11-2020 Commodity super cycles are coursed by slow change in supply side compared to demand side. Trade policy might be: - Quotas. Taxes. Bans. Trade agreements. Geopolitics. Security policy. International trade might be: - Trade shifts. Trade interdependency. Open economy: This was mostly about currency and exchange rate. Appreciate -> Currency becomes worth more/stronger. Import increase and export decrease. Depreciate -> Currency becomes worth less/weaker. Import decrease and export increase. Revaluation -> Currency is pegged to another and then moved to a stronger value. Import increase and export decrease. Devaluation -> Currency is pegged to another and then moved to a weaker value. Import decrease and export increase. Midterm Short introduction -> what is it all about. Add layers. Humor in non-factual places. Use other articles to support. Improvements on PP Short general introduction is a coherent text. More words to the models. Find articles and include. Chapters Chapter 3: The Goods Market Demand for goods: π = πΆ + πΌ + πΊ + π − πΌπ Net export/Trade balance – Can create a trade surplus or trade deficit: π − πΌπ For the following chapters we assume a closed economy. π =πΆ+πΌ+πΊ Consumption πΆ = π0 + π1 (π − π) Here endogenous variable and therefor explained within the model. Investment πΌ = πΌΜ Here exogenous variable and therefore just taken as given. Government Spending This one is an exogenous variable as well. But government spending might also influence taxes, T. Replacing C and I in the earlier equation for demand we get: π = π0 + π1 (π − π) + πΌ Μ + πΊ With production being equal to demand, π = π, we get: π = π0 + π1 (π − π) + πΌ Μ + πΊ We can isolate Y to be: 1 π = 1−π (π0 + πΌ Μ + πΊ − π1 π) 1 The first part is the multiplier and the bracket the autonomous spending. Savings equal investments π = ππ· − πΆ = π − π − πΆ Substitute π = πΆ + πΌ + πΊ and mix letters till you get πΌ = π + (π − πΊ), investments are equal to savings of consumers and the government. This is called the IS-relation. Private savings can be substituted and hereby 1 (π0 + πΌ Μ + πΊ − π1 π). we are able to find π = 1−π1 Chapter 4: Financial Markets When talking equilibrium in the financial markets it is normally based on the quantity of money available and the interest rate. ππ = $π πΏ(π) Demand for money is equal to nominal income times the decreasing power of the interest rate. How to determine an interest rate: Central banks can control the supply of money. They can buy bonds for money they just printed to increase the supply and they can sell bonds to earn money that they then can remove from the money supply. Liquidity trap – When increasing the amount of money in circulation does not decrease interest rates. Chapter 5: Goods and Financial Markets: The IS-LM Model This chapter takes the knowledge of the last two and combine them: π = πΆ(π − π) + πΌ(π, π) + πΊ Further the equation for money must be rewritten to fit real value instead of nominal value: π π = π πΏ(π) What we should get from this chapter is that the central banks can change interest rate (by changing supply of money) and the government can use fiscal policy to change taxes and government spending. In terms these are two tools to influence the GDP. It is important to note that the central bank and the government might have other goals that they can achieve using these. Chapter 7: The Labor Market Current Population Survey, CPS, are surveys carried out to figure out the number of employed, unemployed, and out of the labor market. Bargaining power of workers is a combination of how much it cost for the firm to get rid of them and how easy it is to find a new worker. π = ππ πΉ(π’, π§) - ππ is expected price level. π’ is unemployment rate. π§ is everything else affecting the wage. The labor market has a connection to IS-LM by the number of people working increase output level: π = π΄π - A is output per worker. N is employment. A can be set to be any unit and therefore it can be equal to 1. That means. π=π Price is found by the markup: π = (1 + π)π If we assume that nominal wages depend on the price level by that moment instead of the expected price level: π = π πΉ(π’, π§) π = πΉ(π’, π§) π We substitute p: π (1+π)π 1 = πΉ(π’, π§) = 1+π This is the Price-setting relation. Change in markup can change the PS curve. The Wage-setting relation is π = π πΉ(π’, π§). Change in unemployment benefit and natural rate of unemployment (structural rate of unemployment) can shift the WS curve. Chapter 8: The Phillips Curve, the Natural Rate of Unemployment, and Inflation We assume this form for the function F: πΉ(π’, π§) = 1 − πΌπ’ + π§ After a lot of putting letters around we get the important function of: ππ‘ = (1 − π)πΜ + πππ‘−1 + (π + π§) − πΌπ’π‘ The inflation rates this year is equal to the expected inflation rate plus m and z minus the level of unemployment. When π is close to 0 the inflation rate depends more on the level of unemployment. The closer π gets to 1 the more it depends on last year’s inflation rate. At a level of 1 unemployment level influences the change in inflation instead of the exact level of it. ππ‘ − ππ‘−1 = −πΌ(π’π‘ − π’π ) Chapter 9: From the Short to the Medium Run: The IS-LM-PC Model Figure 1, The IS-LM-PC Model, p. 198 I love you Figure 2, The Deflation Spiral, p. 204 Chapter 17: Openness in Goods and Financial Markets Introduces import and export. Further, how to choose whether to buy domestic or foreign goods (price and exchange rate). Appreciate -> Currency becomes worth more/stronger. Import increase and export decrease. Depreciate -> Currency becomes worth less/weaker. Import decrease and export increase. Revaluation -> Currency is pegged to another and then moved to a stronger value. Import increase and export decrease. Devaluation -> Currency is pegged to another and then moved to a weaker value. Import decrease and export increase. Real exchange rate: π= πΈπ π∗ E is price of domestic currency in terms of foreign currency. P is price of domestic product. EP is therefore price of domestic product in foreign currency. π∗ is price of foreign goods in foreign currency. Bilateral Exchange rate is the exchange rate between two currencies. Multilateral Exchange rate is the exchange rate between more than two currencies. Current Account Balance is the sum of net payments. The countries surplus or deficit in terms of trade balance, net income, and net transfers. Capital account balance is the difference in foreign countries holding domestic currency/assets and your country holding foreign currency/assets. Statistical discrepancy is the difference in current account balance and capital account balance. Expected returns from bonds from different countries: Figure 3, Expected Returns from Holding One-Year U.S. Bonds versus One-Year U.K. Bonds, p. 382 Chapter 18: The Goods Market in an Open Economy Figure 4, The Demand for Domestic Goods and Net Export, p. 392 π = πΆ(π − π) + πΌ(π, π) + πΊ − πΌπ(π,π) π + π(π ∗ , π) ½ Figure 5, The Effect of an Increase in Foreign Demand, p. 396 Fiscal policy: - Expansionary -> Increase domestic demand -> Increase import -> Decrease net exports. Contractionary -> Decrease domestic demand -> Decrease import -> Increase net exports. Marshall-Lerner condition for the trade balance to improve with a depreciation change in export and import must be high enough to compensate the increased price in imports. Import and export does not change the moment a depreciation happens. This leads the weaker domestic currency to increase the amount of domestic currency used to import. Therefore, net export decrease before it gets better with a depreciation. Current account balance is equal to saving minus investment: πΆπ΄ = π + (π − πΊ) − πΌ Chapter 19: Output, the Interest Rate, and the Exchange Rate π = πΆ(π − π) + πΌ(π, π) + πΊ + ππ(π, π ∗ , π) Exchange rate affected by interest rates: 1+π πΈ = 1+π∗ πΈ π 1+π π IS: π = πΆ(π − π) + πΌ(π, π) + πΊ + ππ (π, π ∗ , 1+π∗ πΈ ) LM: π = π Figure 6, IS-LM in an Open Economy, p. 418 European Monetary System, EMS, a system where European countries pegged their currency to the Deutsche Mark worked well until Germany were united. Chapter 20: Exchange Rate Regimes Common Currency Areas are areas where a single currency is used. This is optimal in two cases: - The countries in the area must experience the same or similar shocks. A high factor mobility. If the production and people easily move around the area they can seek out places of growth. Hard pegs, dollarization, and currency board… Trade Reasons for trade: - Proximity / Cost of transport Resources (Natural endowments, labor, land, capital) Absolut advantage (One country is better at something) Comparative advantage (The difference in relative cost proportions between products differ between countries) Ricardian Model (pp. 89 to 113) Home (green) has lower relative cost of wheat (1 cloth to 2 wheat). Foreign (yellow) has lower relative cost of cloth (1 wheat to 1 cloth). Home has comparative advantages on wheat and foreign has on cloth. Home Production and Consumption with and without trade - Green is home production and consumption without trade. Prices are relative to what they can produce. Red is home production and consumption with trade. The relative price for wheat in the world market is higher than the relative cost in the home country. Therefore, home is better of producing - only wheat. They can sell it and get a better exchange rate for cloth than before. B is home production and C is consumption. The blue line to the right shows as relative price of wheat increase beyond the home relative price, they start to increase export. Foreign Production and Consumption with and without trade - - Yellow is foreign production and consumption without trade. Prices are relative to what they can produce. Red is home production and consumption with trade. The relative price for wheat in the world market is lower than the relative cost in foreign. Therefore, foreign is better of producing only cloth. They can sell it and get a better exchange rate for wheat than before. B is home production and C is consumption. The blue line to the right shows as relative price of wheat decrease beyond the foreign relative price, they start to increase import. International trade equilibrium Specific-Factor Model (pp. 128 to 153) Assumption: - Diminishing marginal product of labor. Capital and land are fixed factors. Specific-Factor Model for home country with and without trade - Green is without trade. PPF (Product Possibilities frontier) meet highest utility in A. Red is with trade. World market has higher relative price of manufacturing and Home specializes in manufacturing. Home produce at B and consume at C for higher utility. Wages and the impact of price changes - Blue is original equilibrium of labor and wages. A price increase in manufacturing makes ππ shift upwards. This creates a new equilibrium in B. Wages do not increase as much as the price increase. Labor in manufacturing increase and decrease in agriculture. - - Change in real wage: “This inequality means that the amount of the manufactured good that can be purchased with the wage has fallen, so the real wage in terms of the manufactured good W/PM has decreased” Change in real earnings of capital and landowners: “An increase in the relative price of an industry’s output will increase the real rental earned by the factor specific to that industry but will decrease the real rental of factors specific to other industries.” The Heckscher-Ohlin Model (pp. 167 to 180) Assumptions: - Factors can move freely between sectors and therefore earn the same in all industries. One production is labor intensive and the other capital. One country has more labor and the other more capital. Outputs can be traded freely. Technology is the same across countries. Consumer has same consumption habits between countries and incomes. No trade view of both Home and Foreign PPF - Blue is home and show that they can produce more of the capital heavy computers. Yellow is foreign and show that they can produce more of the labor heavy shoes. Home country production, consumption, and export - Blue on a is the PPF. Price for computers are higher on world market so they produce B and consume C. The second graph show how they export the difference between B and C at world market prices. Foreign country production, consumption, and export - Yellow is the PPF. Price for computers are lower on world market so they produce B and consume C. The second graph show how they export the difference between B and C at world market prices. World market equilibrium for computers Leontief’s Paradox (pp. 181 to 193) The HO model does not work perfectly. This is because its assumptions do not fit the world: - Technologies differs across countries. Land is not set to be a factor. The difference between high- and low-skill labor. A capital heavy country can produce agriculture because their labor might be much more skilled compared to the labor heavy country. Stolper-Samuelson Theorem (pp. 195 to 202) - Dark blue is original wage/rental level, it is the mean of the labor-capital ratio of the different countries. Now, the relative price of computers rises, so demand at this price level decrease. From earlier, we know that when prices increase the relative wages decrease. At lower wage costs, you want to increase the labor-capital ratio. An increase in price will lead to an increase in the most used factor for that commodities. Price increasement in computers will lead to higher rental on capital and decreased wages. Effect of Immigrations and FDI Immigration Immigrations -> More workers -> Wages decrease. Immigration effect on shoe and computer industry Immigration affects the PPF FDI (Foreign Direct Investments) Affects capital instead of labor. Would generate same effects for capital and rental as immigrants do for labor and wages. Imperfect Competition (pp. 276 to ) Demand Curves for Duopoly Monopolistic Competition (pp. 278 to 287) Assumptions: - Similar but differentiated goods. Many firms in the industry. Increasing returns to scale. Freely enter and exit. Zero economic benefit in long run. Short-Run Monopolistic Competition Equilibrium Without Trade - Production stops when marginal revenue hits marginal costs. Long-Run Monopolistic Competition Equilibrium Without Trade π1 shows what happens with demand if a single firm lowers his/her price. π·/(π π΄ ) shows what happens if all firms lower their price. Short-Run Monopolistic Competition Equilibrium with Trade Long-Run Monopolistic Competition Equilibrium with Trade Gravity Equation (pp. 299 to 306) Larger economies trade more. The closer to economies to each other the more they trade. Just like gravity pull and objects. πππππ = π΅ ∗ πΊπ·π1 ∗ πΊπ·π2 πππ π‘ππππ B is a catch-all variable for tariffs (negative effect), quotas (negative effect), administrative rules and regulations (negative), geographical factors (positive or negative), culture (more distinct cultures are negative). Free trade Multiple organizations and agreements have been put into play to keep the world as open to free trade as possible. To mention 2: GATT, general agreement on tariffs and trade. WTO, world trade organization. CS and PS with free trade. Tariffs Small country Large country A large country can affect world demand considerably therefore they gain the area of c and e in tariff revenue. PS increase by a, but CS loses A, B, C and D. If e is larger than b and d then the country gains on the tariff but the world welfare decrease.
