ECON1102 W1 Lecture Slide

Roadmap Fields of Macro Growth
ECON 1401: Macro Lecture 1
Nalini Prasad
UNSW Australia
September 3, 2015
ECON 1401: Macro Lecture 1 1

Roadmap
Macro versus Microeconomics... Why separate the two?
The various sub-fields of Macroeconomics
Topic 1: Economic Growth
Roadmap ECON 1401: Macro Lecture 1 2

Micro versus Macro
Microeconomists: wrong about the little things
Macroeconomists: wrong about things in general

Micro versus Macro
Microeconomists: wrong about the little things
Macroeconomists: wrong about things in general
Microeconomics: Questions keeps changing but the answer always

boils down to marginal revenue equals marginal cost.
Macroeconomics: Questions stay the same but the answers keep

changing all the time.

Micro versus Macro: The Textbook difference:
- Micro studies questions dealing with individual decision making,

individual firms, and individual markets.
- Individual Agents in the economy making allocations/decisions of
scarce resources
- Macro studies questions dealing with decision making at the
societal level, the interaction of all firms, the interaction of all
markets, and the interaction of all these things with government.
- There is broad overlap between Macro and Micro.

Micro versus Macro
Macro and Micro topics are also separated due to the Fallacy of
Composition
1. The fallacy of composition is when one infers something to be true

about a whole by analyzing only a single part.
2. Solutions and explanations of individual behavior do not necessarily

aggregate to provide solutions for society as a whole.

Micro versus Macro
Practical Example 1: Parking on campus
- Parking is hard to find on campus after 9 AM.

- The solution for the individual is to arrive earlier than 9 AM.
- This is of course is not a solution for everyone.

Micro versus Macro
Practical Example 1: Parking on campus
- Parking is hard to find on campus after 9 AM.

- The solution for the individual is to arrive earlier than 9 AM.
- This is of course is not a solution for everyone.
Practical Example 2: AFL match
- If someone stands up out of his seat at an AFL match, he/she can

see better.
- But if everyone stands up, can they all see better? (Not a solution
for the aggregate.)

Micro versus Macro
Economic Example: The Paradox of Thrift
- Saving money is universally a behavior that is encouraged and

considered prudent for individuals.
- However, it is by definition the case that one persons spending is

another persons income.
- Therefore, if everyone decided to increase the amount they save at

the same time, then (aggregate) spending would fall.
- The fall in spending results in a fall in (aggregate) income and hence

a fall in saving.
- Some caveats apply.
- Thus, prudent behavior by an individual may not be prudent for an

entire economy.

Micro versus Macro

The Fields of Macro
Economic Growth - increase in the living standards over a long

period of time, spanning decades or centuries
- Why are some countries poor and others rich?
- Are there policies that can make a poor country rich?
- How can you make a rich country grow faster?
- How are the benefits of growth distributed?
- Inequality
Fields of Macro ECON 1401: Macro Lecture 1 9

The Fields of Macro

Business Cycles - fluctuations in aggregate production, trade and
activity over short horizon (years, months)
- What is the cause of the business cycle?
- Can the government ameliorate the cycle? (fiscal policy) (example)
- What is the role of inflation in the business cycle?
- How should a government tax and spend?
- What is the cause, cost, and benefit of inflation?
- There are also growth questions regarding inflation.
- Can a central bank affect the business cycle? (monetary policy)

(example)
- What determines short run interest rates?
- Is it possible to forecast the business cycle?

The Fields of Macro
Finance and International Finance
- How do you price an asset like a stock or a bond?
- Are financial markets well behaved?
- How should financial markets be regulated?
- How are exchange rates determined?
- How can governments or central bank policy affect exchange rates?
- What determines the flow of capital across countries?
Monetary economics, public economics, labour economics, etc...

Journal of Economic Literature classification link

Topic 1: Economic Growth
Growth ECON 1401: Macro Lecture 1 12

Growth
An Inquiry into the Nature and Causes of the Wealth of Nations
- Published in 1776, by Adam Smith
- Therefore, the oldest and perhaps most fundamental questions in

economics are what causes economic growth? and what explains
the observed differences in growth between countries?

Economic Growth and Standard of Living

Different rates of growth and Rule of 70

World Distribution of Real GDP
Data to consider: World distribution of per capita GDP in 1960 vs.

2000
The question: What happened to
- growth rate in per capita GDP between 1960 and 2000?
- income inequality among citizens of the world?

World Distribution of Real GDP 1960

World Distribution of Real GDP 2000

World Distribution of Growth Rates
World average=1.8 per cent

Seoul 1965

Seoul 1965

Seoul Today

Some Definitions
- Poverty: A person has a low standard of living. An individual is

living in poverty if they have less than a $ 1 per day to live on.
- Inequality: Describes the unequal distribution of incomes across

individuals at a point in time. One common measure of inequality is
the fraction of a countrys income received by the poorest 20% of the
income distribution.

World Income Distribution (1970)
Fraction of world population under poverty line= 20%

World Income Distribution (2000)
Fraction of world population under poverty line= 7%

Growth questions
What factors caused some countries to grow fast and others to grow
slow over periods such as 1960 to 2000? (East Asia vs. Sub-Sahara)
How did countries such as the US and other OECD members sustain
growth rates of real GDP per person of around 2% per year for a
century or more?
What can policymakers do to increase growth rates of real GDP per
person?

The West and the Rest
Figure: Source: Maddison 2008.

Figure: Source: Maddison 2008 (link)

Figure: Source: Maddison 2008

Figure: Source: My Calculations

Figure: Source: My Calculations

There are two prominent hypotheses to explain the divergence

between the West and Rest that have been debated over the last
twenty years:
- Geography - famously summarized in Guns, Germs, and Steel - Jared

Diamond (1997)
- Institutions - summarized recently in Why Nations Fail - Daron

Acemoglu and James Robinson (2012)


Geography: Guns, Germs, and Steel - by Jared Diamond
- Eurasia - particularly the Mediterranean and the Middle East - had a

geographical advantage in the availability of plants (rich in protein
and better for storage) and animals that could be domesticated (eg.
horses, sheep, cows, etc.) .
- Domestication of many different types of livestock & urbanization

had a strange benefit... Disease/Germs.
- Eurasia east-west orientation of Europe allowed for easy trade of

ideas, animals, plants, and disease.
- Eurasian geography made it hard for a single government to rule.

The fragmentation allowed for competition among governments that
spurred innovation... Guns and Steel
- Example of problem created in absence of government competition:

China prohibited the building of multi-masted ocean going vessels in
the late 1400s.
The crux of the argument is that European geography explains why

the West industrialized first.
The critiques of the geography hypothesis and Guns, Germs, and

Steel:
Many technological innovations that promote growth actually

originated in the East (eg. Printing, guns, and the compass)
Therefore, critics would say it is not geography, but rather

institutions.

The Institutions Hypothesis in Why Nations Fail (Acemoglu and

Robinson)
- Until 1500 income per capita was roughly equal, but started to
diverge across countries.
- Some nations had inclusive institutions that protected property

rights and allowed all people to participate in growth.
- Other nations had extractive institutions that allowed a small elite

to control the economic and political systems and uses its power to
extract wealth from the society at everyone elses expense.
(example)
- Therefore, the institutions that were in place in a country after

the year 1500 explain differences in growth today (link)

What are some features of inclusive institutions?

What are some features of inclusive institutions?

secure property rights
law and order
markets and state support (public services and regulation) for
markets
open to relatively free entry of new businesses
access to education and opportunity for the great majority of citizens,
create incentives for investment and innovation and a level-playing
field


The Reversal of Fortunes Hypothesis (Acemoglu, Johnson, and
Robinson 2002)
- Negative relationship between countries that were relatively rich in

1500 and economic prosperity today.
- An illustration of the role of institutions
- Europeans began intervening in government all over the world

beginning in the year 1500
- In the rich countries that they colonized, they mostly set up

extractive regimes. Example: India, South America
- In the poor countries that they colonized, they mostly set up inclusive
regimes with strong property rights. Example: Australia, North
America
- This caused a reversal of fortunes, where among countries that were

colonized in 1500, those that were rich are now relatively poor and
countries that were relatively poor are now rich.
- Geography cannot account for these differences.

Figure: Source: Acemoglu, Johnson, and Robinson 2002. Population density

they argue is a proxy for income.

Geography and Institutions
The truth is most likely that both geography and institutions matter.
However, most economists prefer the institutions story.
- Jared Diamond got a PhD in Physiology and works now in the field
of Geography.
- Acemoglu, Johnson, and Robinson are economists
Economists prefer institutions because if institutions cause growth,

then it is possible to make poor countries rich by changing
institutions.
Interview with Acemoglu link

How do you fix a poor country?
Can a poor country start over?

Does Democracy Cause Growth?
A recent debate over whether democracy causes growth
- The debate is over the direction of causality
Democracy Growth
Growth Democracy
- Richer countries also tend to become more democratic

Figure: Source: Rodrick 1999

Figure: Source: Papaioannou and Siourounis 2008

Figure: Source: Papaioannou and Siourounis 2008
Short-run transition costs, but long run stabilization to growth.

There is not a real consensus among experts about this question.
- China is held up as an argument on both sides.
- China is not democratic but has grown at an incredibly fast pace.
- However, Chinas growth came at a time when people were given

more freedoms in a move towards a more democratic society.
- Either way, China is an interesting natural experiment.

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Roadmap Fields of Macro Growth

ECON 1401: Macro Lecture 1

ECON 1401: Macro Lecture 1 1

Macro versus Microeconomics... Why separate the two?

The various sub-fields of Macroeconomics

Topic 1: Economic Growth

Roadmap ECON 1401: Macro Lecture 1 2

Micro versus Macro

Microeconomists: wrong about the little things

Macroeconomists: wrong about things in general

Roadmap ECON 1401: Macro Lecture 1 3

Micro versus Macro

Microeconomists: wrong about the little things

Macroeconomists: wrong about things in general

Microeconomics: Questions keeps changing but the answer always

Macroeconomics: Questions stay the same but the answers keep

Roadmap ECON 1401: Macro Lecture 1 3

Micro versus Macro: The Textbook difference:

- Micro studies questions dealing with individual decision making,

Roadmap ECON 1401: Macro Lecture 1 4

Micro versus Macro

1. The fallacy of composition is when one infers something to be true

2. Solutions and explanations of individual behavior do not necessarily

Roadmap ECON 1401: Macro Lecture 1 5

Micro versus Macro

Practical Example 1: Parking on campus

- Parking is hard to find on campus after 9 AM.

Roadmap ECON 1401: Macro Lecture 1 6

Micro versus Macro

Practical Example 1: Parking on campus

- Parking is hard to find on campus after 9 AM.

Practical Example 2: AFL match

- If someone stands up out of his seat at an AFL match, he/she can

Roadmap ECON 1401: Macro Lecture 1 6

Micro versus Macro

Economic Example: The Paradox of Thrift

- Saving money is universally a behavior that is encouraged and

- However, it is by definition the case that one persons spending is

- Therefore, if everyone decided to increase the amount they save at

- The fall in spending results in a fall in (aggregate) income and hence

- Some caveats apply.

- Thus, prudent behavior by an individual may not be prudent for an

Roadmap ECON 1401: Macro Lecture 1 7

Micro versus Macro

Roadmap ECON 1401: Macro Lecture 1 8

The Fields of Macro

Economic Growth - increase in the living standards over a long

- Why are some countries poor and others rich?

- Are there policies that can make a poor country rich?

- How can you make a rich country grow faster?

- How are the benefits of growth distributed?

Fields of Macro ECON 1401: Macro Lecture 1 9

The Fields of Macro

- What is the cause of the business cycle?

- Can the government ameliorate the cycle? (fiscal policy) (example)

- What is the role of inflation in the business cycle?

- How should a government tax and spend?

- What is the cause, cost, and benefit of inflation?

- There are also growth questions regarding inflation.

- Can a central bank affect the business cycle? (monetary policy)

- What determines short run interest rates?

- Is it possible to forecast the business cycle?

Fields of Macro ECON 1401: Macro Lecture 1 10