Week 1 - Review and Introduction

This week we start our study of how the main macroeconomic variables of a country behave. The main goal of the week is for you to get familiar with the concepts and tools that we will be using over the rest of the course.

The single most important variable of our analysis of macroeconomics will be income (or output). This week we review what income is, why is it that output and income are the same. In order to do so, we will use the circular flow diagram. 

Then, we try to give a first answer to the question of what determines the level of output of a country. The answer to this question is that output depends on capital (K) and labor (L). The reason is the same as in microeconomics: the production of goods requires factors of production, the more factors of production, the more output an economy will be able to produce. This implies that the supply of goods and services is constant, fixed, at the level of output that our factors of production allow us to produce (natural level of output). In the long run, we can only produce more if we improve our capital or labor. The consequence of this is that the aggregate supply function of the economy (the relation between prices and output) in the long run can be represented as a vertical line fixed at the natural level of output.

We then focus on an specific type of production function called Cobb-Douglas production function. This production function is relatively simple and easy to work with and will be very useful to understand the main theoretical concepts described in the readings. Many of our applications this week will use this type of function.

Then we review the demand for goods and services. We review the concepts of consumption, investment and public expenditures.

We also explain the concept of equilibrium between aggregate demand and supply and what brings supply and demand together.  

Finally, we review the effects of different shocks to the economy in the long run. The long run in our course is a period of time defined as more than a year, but less than a decade. In future weeks, we will study fluctuations in the short run (less than a year) and changes in the very long run (decades). This week, however we only focus on what we call the long run.

We analyze the effects on the economy in the long run of changes in consumption, investment and government purchases. The main conclusion of this week is that in the long run none of this shocks affect the level of output. They only affect the distribution of output among different groups in the economy. This is because the aggregate supply is vertical. 

 

To Do: