Economic Modelling

1. Economic Modelling Lecture 1 Introduction to Economic Modelling Outline of the Syllabus Basic skills required for the Module @K.R.Bhattarai, Business School, University of Hull

2. Economics Modelling (26214)Lectures and Tutorial Meetings and Office Hours Lectures Day Time Room Monday 2:15 WI-S 25 Tuesday 4: 15 Loten- LRD Wednesday 12:15 Larkin-LTA Tutorials Day Time Room Tuesday 3:15 WI-S10 Thursday 9:15 WI-S 26 Office hours: Monday 12:05 - 2:05 369 Wilberforce Tuesday 1:05 - 3:05 369 Wilberforce Midterm Exam Thursday March 4, 2004 Essay Due Thursday April 1 2004 by 4 PM (hand in at School Office) Reading Week Starts February 23rd. @K.R.Bhattarai, Business School, University of Hull

3. 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 Used of Model : analysis of behaviour, facts or evaluation of a policy @K.R.Bhattarai, Business School, University of Hull

4. 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? How to be most competitive and efficient in allocating scarce resources in an economy? @K.R.Bhattarai, Business School, University of Hull

5. Quarterly GDP in the UK: ONS(NAVIDATA) @K.R.Bhattarai, Business School, University of Hull

6. @K.R.Bhattarai, Business School, University of Hull

7. Variation in Growth Rates Across Economies Graphics Using Givewin (Doornik and Hendry (2001)) and Data from the World Bank CD (start/applications/Economics) @K.R.Bhattarai, Business School, University of Hull

8. 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 @K.R.Bhattarai, Business School, University of Hull

9. 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 @K.R.Bhattarai, Business School, University of Hull

10. An Overview of Decision Makers and Players in an Economy Households Consumers Rest of the World (ROW) – Trading Partners Multilateral Organisation Banks – Central Bank Commercial Banks Stock Market Financial Institutions Economy: The Big Market (prices and quantities) Treasury – Allocation of Public Funds Trade Unions Employer Unions Firms – Investors Producers Revenue – Tax Collector • Merchants and Traders • Wholesalers • Retailers @K.R.Bhattarai, Business School, University of Hull

11. 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 Wage payment, wL Labour supply, L Economy (p, w, y, c, l, L) Households (consumers) Max U(C,L) Firms (producers) Max π(LS) Payments for goods, p.y Supply of Goods @K.R.Bhattarai, Business School, University of Hull

12. X-Z Depreciation Indirect G taxes I GDP NDP Personal Personal National income disposable C income income GDP, GNP, National and Disposable Incomes @K.R.Bhattarai, Business School, University of Hull

13. 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 MULTIPLIER = (1/(1-0.8))=5 @K.R.Bhattarai, Business School, University of Hull

14. 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 for another 20 years. @K.R.Bhattarai, Business School, University of Hull

15. Macroeconomic Policy • Fiscal Policy taxes expenditure debt • Monetary Policy interest rate/ M-supply exchange rate/trade stock market • Growth/supply side @K.R.Bhattarai, Business School, University of Hull

16. 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 @K.R.Bhattarai, Business School, University of Hull

17. Six rules of approximation for small numbers I. Log II. Product III. Division IV. Growth of a product V. Growth of a Ratio VI. Sum of a geometric Series @K.R.Bhattarai, Business School, University of Hull

18. Five Rules of log I. Power Rule II. Product Rule III. Quotient Rule IV. Log of Exponentials V. Differentiation of log with respect to time @K.R.Bhattarai, Business School, University of Hull

19. Four Rules of Differentiation I. Power Rule II. Product Rule III. Quotient Rule IV. Chain Rule @K.R.Bhattarai, Business School, University of Hull

20. 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. @K.R.Bhattarai, Business School, University of Hull

21. Your Comments and Suggestions What is appealing to you? What is not appealing or difficult for you? @K.R.Bhattarai, Business School, University of Hull