Economic Modelling
Lecture 1
Introduction to Economic Modelling
Outline of the Syllabus
Basic skills required for the Module
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Economics Modelling (26214)
Lectures and Tutorial Meetings and Office Hours
Lectures
Day
Monday
Tuesday
Wednesday
Time
2:15
4: 15
12:15
Room
WI-S 25
Loten- LRD
Larkin-LTA
Tutorials
Day
Tuesday
Thursday
Time
3:15
9:15
Room
WI-S10
WI-S 26
Office hours:
Monday
Tuesday
Midterm Exam
Essay Due
12:05 - 2:05
1:05 - 3:05
369 Wilberforce
369 Wilberforce
Thursday March 4, 2004
Thursday April 1 2004 by 4 PM
(hand in at School Office)
Reading Week Starts February 23rd.
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What is an Economic Model?
• An abstract map of an economy
• Way of systematic thinking on
– how the value of one variable determines the value of another
variable.
– How one set of variables determine another set of variables
• Language that economists speak
A Model contains
–
–
–
–
–
endogenous variables
exogenous variables
Parameters
Assumptions
Solutions
Representation of model: Diagrams and equations
– linear or non-linear, single or multiple equations,
– static or dynamic or strategic
– Theoretical (abstract) or applied
Business
School,
Used of Model @K.R.Bhattarai,
: analysis
of
behaviour,
facts or
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evaluation of a policy
3
Major Economic Questions
• Why levels and rate of growth of income are different
over time and in different countries?
• What determines aggregate demand and aggregate
supply in an economy in the short run?
• How do households and firms make their consumption
and investment decisions?
• How can fiscal and monetary policy measures taken by
the government affect decision of households and firms
in an economy?
• What causes fluctuations in income, employment, prices,
revenue and spending of government, imports and
exports in economy?
• What kind of models can explain making of economic
policy for higher rate of growth and for stability of an
economy?
• What is the link between home and foreign economies?
@K.R.Bhattarai, Business
School,
How to be most competitive
and efficient
in allocating 4
of Hull
scarce resources in anUniversity
economy?
Quarterly GDP in the UK: ONS(NAVIDATA)
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Variation in Growth Rates Across Economies
40
Algeria
Ghana
UnitedKingdom
20
5
0
0
1960
7.5
5.0
2.5
0.0
1960
20
1970
Germany
1980
1990
2000
France
1960
10
UnitedStates
1970
1980
1990
2000
1970
1980
1990
2000
1980
1990
2000
1980
1990
2000
India
5
0
-5
1970
1980
1990
2000
China
1960
10
Japan
Korea
0
0
-20
1960
10
1970
Singapore
1980
1990
2000
Malaysia
1960
10
1970
Netherlands
Ireland
5
0
0
1960
1970
1980
1990
2000
1960
1970
Graphics Using Givewin (Doornik
and Hendry (2001)) and
@K.R.Bhattarai, Business School,
Data from the World Bank CD (start/applications/Economics)
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Module Contents
Analysis of Economic growth
Analysis of Macroeconomic Fluctuation
– Analysis of Macroeconomic Fluctuations using the IS-LM, AS-AD
Models
– Unemployment and Inflation
Fiscal and Monetary policy for internal and external stability
Role of Financial Market in the Economy
Exchange rate and Balance of Payment
Micro-foundation on Consumption and Investment and
general equilibrium impacts of taxes
Policy game
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Module Requirements
• Activities: 22 Lectures; 10 Tutorials
Small in-class mock tests and quizzes
Assessment
• Course Work counts 50 percent of the module marks
In class Mid-term exam counts 25 percent
will be held on Thursday March 4, 2004
Term paper counts 25 percent
Due Thursday April 1, 2004
• Final Exam counts 50 percent
(After Easter between April 26 -May 10)
• Reassessment by two hours’ written exam
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An Overview of Decision Makers and Players in an Economy
Households
Consumers
Rest of the World
(ROW) –
Trading Partners
Multilateral
Organisation
Economy:
The Big Market
Treasury –
Allocation of
Public Funds
(prices and quantities)
Revenue –
Tax Collector
Firms –
Investors
Producers
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Banks –
Central Bank
Commercial Banks
Stock Market
Financial Institutions
Trade Unions
Employer
Unions
Merchants and
Traders
–Wholesalers
–Retailers
10
Micro-Foundation to Macro Variables
General Equilibrium with a representative household and firm
Market p and w
such that
Y=C
LD = LS
LS +l = L
Households
(consumers)
Max U(C,L)
Wage payment, wL
Labour supply, L
Economy
(p, w, y, c, l, L)
Firms
(producers)
Max π(LS)
Payments for goods, p.y
Max U  c  l 1
l  LS  1
pc  wLS  
c  0; l  0; LS  0
Supply of Goods
Max   py  wLD
y  LD 

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y  0; LD  0
11
GDP, GNP, National and Disposable Incomes
X-Z
Depreciation
G
Indirect
taxes
I
GDP
NDP
C
National
income
@K.R.Bhattarai, Business School,
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Personal
income
Personal
disposable
income
12
Keynesian Static Model of National Income
Y = C + I + G ; C = a0 + a1(Y-T)
Endogenous variables Y, C and Exogenous variables G, I
Parameters: a0 and a1.
C =200 + 0.8*(Y-T) ; T =20; G=20; I =30
Solving the model:
Y = (a0 - a1T+I+G)/(1-a1)
Y =200 +0.8*(Y-T) +I +G
Y-0.8Y = 200 -0.8*(20) +30+20
0.2 Y =200-16 +50
Y =234/0.2 = 5*(234) = 1170
C = 200+0.8*(1170-20) = 1120
Checking the validity of the solution:
Y =1170 =1120+20+30 = C + I + G
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MULTIPLIER = (1/(1-0.8))=5
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Keynesian Dynamic Model of National Income
Yt= Ct + It + Gt
Current consumption depends on past income
Ct =200 + 0.8*(Yt-1 -Tt-1)
Tt-1 =20; Gt =20; It =30; Yt-1 = 500
Yt =200 +0.8*(500-20) +30 +20
Yt = 200 +384 +30+20
Yt =200+384 +50 = 634
Assume Tt, It , Gt remain same for all years
Yt+1 = 200 +0.8*(634-20) +30 +20 = 741
Solve this model@K.R.Bhattarai,
for another
20 years.
Business School,
University of Hull
14
Macroeconomic Policy
• Fiscal Policy
taxes
expenditure
debt
• Monetary Policy
interest rate/ M-supply
exchange rate/trade
stock market
• Growth/supply side
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Minimum Mathematical Skills Required in this Module
• Diagrams to represent one or two equations
• Basic Algebra: Addition, Subtraction, multiplication and division with
calculator and excel
• Solution of Simultaneous equations
• Graphs and Charts in excel and Givewin
• Six rules of approximation
• Five rules of log
• Four rules of differential
• Power rule in algebraic expressions
• Calculations using spreadsheets
• Modelling Strategic moves (about the end of the term)
– Normal, Extensive form of a GAME
– Dominant Strategy and Nash equilibrium
– Dynamic Game: Subgame perfect equilibrium
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Six rules of approximation for small numbers
I. Log
II. Product
III. Division
ln1 r   r
n
1   1  g   1    g  1  g   1  ng
e


1

i
1 r 
 1 i  
e

1 




IV. Growth of a product
V. Growth of a Ratio
Y  LW
Y
y
L
VI. Sum of a geometric Series
gY  g L  gW
g y  gY  g L
S Business
1  XSchool,
X
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2
 ....  X
n

1 X
n 1
17
1 X
Five Rules of log
I. Power Rule
Y K
II. Product Rule
III. Quotient Rule

ln Y    ln K 
R  PY
ln  y   ln Y   ln L
Y
y
L
IV. Log of Exponentials
ln R  ln Y   ln P
Yt  Y0 e gt
ln Yt   ln Y0   gt
V. Differentiation of log with respect to time
d ln Yt  dYt

dt@K.R.Bhattarai,
Yt Business School,
University of Hull
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Four Rules of Differentiation
I. Power Rule
Y K
II. Product Rule
III. Quotient Rule
IV. Chain Rule

R  PY
Y
 K  1
K
dR  Y  dP  P  dY
Y dy  L  dY  dL  Y  dY  dL Y
y
2
L
L
L L
L
Y L
0.5
 w
L  50 
 p
2
  w
Y  50 
  p 
2 0 .5



Y
Y L
 50 
0.5

 0.5L 50  2w p    w p 
w p  L w p 
L
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Core and Recommended Text
• Core Texts
Blanchard, Oliver (2003) Macroeconomics, Third Edition,
Prentice Hall. ISBN 0-13-033772-2;
http://www.prenhall.com/blanchard
Other Good texts:
• Gartner Manfred, Macroeconomics, Prentice Hall.
• Mankiw, G. N.(2003) Macroeconomics, Fifth Edition,
Worth Publishers, New York.
• Miles David and Andrew Scott (MS) Macroeconomics:
Understanding the Wealth of Nations, John Wiley and
Sons, Inc, 2002. ISBN 0-47084288-1.
• Romp Graham (1997) Game Theory, Oxford University
Press. Chapters 1-10.
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Your Comments and Suggestions
What is appealing to you?
What is not appealing or difficult for you?
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