Macroeconomic Models

In developing countries, the development of a well-functioning infrastructure is more important than the development of new technology.

Macroeconomics is concerned with the growth of the economy, and employment and income generation
So, it studies the behaviour of the economy as a whole
Macroeconomics studies:
Significance of total output
Rates of inflation and unemployment
Booms and recessions
Essence of Balance of payments and
Exchange rates

Macroeconomics analyses:
Short-run behaviour of the economy
Medium-run fluctuations of the economy, and
Long-run economic growth
Macroeconomics analyses short, medium and long run impact of policies like:
Consumption and investment policies
Changes in wages and prices
Monetary and fiscal policies
Money stock, budget, interest rates, and the national debt
Foreign exchange rate and the trade balance

Objective of macroeconomic analysis are:
To understand how the macro-economy works
How to make the economy perform better
Great macroeconomists suggest to intervene in economy
Such economists are as for example:
John Maynard Keynes
Milton Friedman of the University of Chicago and the Hoover Institution
Franco Modigliani and Robert Solow of M.I.T
James Tobin of Yale University

Some economists are sceptical about intervene in economy and discourage intervention in economy
Such economists are:
Robert Barro, Martin Feldstein, and N. Gregory Mankiw of Harvard University
Nobel laureate Robert Lucas and Thomas Sargent of the University of Chicago
Olivier Blanchard of MIT., Robert Hall, and John Taylor of Stanford University

2. MACROECONOMIC MODELS
Macroeconomics organised in three models
Each of these models have different time frame
The Models are:
Long run model
Medium run model
Short run model

Long run Model
Long run model studies long run behaviour of the economy
Long run model discusses growth theory
It focuses on growth of productive capacity
In the Long run model the level of productivity determines:
Output, fluctuation in demand that determines price and inflation

In the long-run:
Per capita GDP is constant
Per capita capital in constant, and
Full employment is achieved
So, if the long-run demand increases:
Firms have no possibility to increase supply (because of full employment)
Hence, if in the long run demand increases:
Output remains unchanged
Only price increases
Hence, in the long run aggregate supply curve is Vertical (Slide-9)

Figure-1: Supply in the Long run growth model
P Price Level
P1
P0
0 Yo Y Output/Income

Short run model
Short run model studies short run behaviour of the economy
It analyses level of output and unemployment
It analyses quantity of output that firms are willing to supply at a given price level
If in short-run demand increases, firms increase supply
Firms use this opportunity to achieve gain
They keep price unchanged and increase supply
So, in short-run aggregate supply curve remains horizontal (Slide-11)

Figure- 2: Supply in the short run growth model
P Price Level
P1 AS
0 Y Output, Income

Medium run model
Medium run model studies medium run behaviour of the economy
It studies how economy grows from short run to long run
In the medium run model productive capacity could be increased
In medium run growth theory the adjustment process of the economy from the short run to the long run has been discussed.
Medium run growth theory begins with the supply side of the economy.
It discusses the adjustment mechanism of the aggregate supply and price

In Figure-3 (Slide-14) illustrates the medium run supply curves
Figure-3 shows the long run and short run aggregate supply curve.
It has been assumed that in medium run aggregate supply curve rotates counter clockwise.
In medium run model the aggregate supply curve transforms with the time from horizontal to vertical curve.
During the shift the output as well as the price increase

Figure-3: Medium run growth model
t∝
t3
t2
t1
AS at t = 0
O Y1 Y Output

Justification of the division in time
frame
Nearly all economists accept these models
However, there is less agreement about time frame for short and medium run model
There is different opinion in respect of time frame of models

3. LONG RUN GROWTH MODEL
Long run growth model analyses how investment in technology leads to increase living standard
Long run growth model ignores recessions, booms and short run fluctuation
It is assumed that labour, capitals, raw materials and so on are fully employed in the long run

Level of output in long run model
Level of output is determined by the supply of the production factors
Aggregate supply and aggregate demand determine relation between price and output
Supply curve (AS) gives quantity of output the firms are willing to supply at a price
Position of the aggregate supply curve depends on productive capacity of economy

Demand in the long run model
Aggregate demand curve (AD) gives level of output at which goods markets and money markets are in equilibrium at a price level
Position of aggregate demand curve depends on monetary and fiscal policy and the level of consumer confidence
Intersection of aggregate supply and demand determines price and quantity
In the long run growth model, the supply curve is vertical
Supply cannot be increased in the long run

4. THE SHORT RUN MODEL
In short run model
Output fluctuates
Aggregate supply curve is flat
Price is not affected by the level of output
Output is determined by aggregate demand
5. THE MEDIUM RUN
Medium run model describes:
How economy shifts from short run to long run
How aggregate demand pushes output above
How prices rise
How aggregate supply curve to move upward

What are the different macroeconomic models?
Discuss the different macroeconomic models.
Explain graphics how different stages of economic development are explained by the macroeconomic models