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Macroeconomic models and policy

9 December, 2015 - 15:14

The PPF diagrams illustrate the main dimensions of macroeconomics: capacity output, growth in capacity output and business cycle fluctuations in actual output relative to capacity. But these diagrams do not offer explanations and analysis of macroeconomic activity. We need a macroeconomic model to understand and evaluate the causes and consequences of business cycle fluctuations.As we shall see, these models are based on explanations of expenditure decisions by households and business, financial market conditions, production costs and producer pricing decisions at different levels of output. Models also capture the objectives fiscal and monetary policies and provide a framework for policy evaluation. A full macroeconomic model integrates different sector behaviours and the feedback across sectors that can moderate or amplify the effects of changes in one sector on national output and employment.

Similarly, an economic growth model provides explanations of the sources and patterns of economic growth. Demographics, labour market structures and institutions, household expenditure and saving decisions, business decisions to spend on new plant and equipment and on research and development, government policies in support of education, research, patent protection, competition and international trade conditions interact in the growth process. They drive the growth in the size and productivity of the labour force, the growth in the capital stock, and the advances in technology that are the keys to growth in aggregate output and output per person.