Introduction to

Economics II
5th lecture
First: an opportunity for Hungarian-speakers
• a lecture by Dr. Attila Fábián (as part of the TDK lecture series)
• title in Hungarian: Regionális gazdaságfejlesztés
• topics covered (in Hungarian): Ipariparkok és vállalkozások;
Hálózatfejlesztés és egyetemi innovációs ökoszisztémák;
Városfejlesztés és területi tőke kapcsolatok; Smart cities
• venue: E. I. 41
• time: 2024.03.19 (Tuesday) 11:30-13:00 (90 mins)
Catching Up (with last
week’s theme)
• Government expenditures
• Calculations
Government
Expenditures
The third actor: the government
• Where is their income from?
 Taxes (both from households and firms).

Government expenditures are the transfers + the purchases:

• transfers can go to households/individuals or to firms too
• we denote government purchases with: G

The government budget: the balance of government revenue and expenditure.

 Taxes should be equal to, or greater than transfers and purchases, otherwise
there is a deficit.
Government purchases
 municipal/regional, state, and local levels

 part of our GDP  but: GDP includes only government purchases of

goods and services; it excludes spending on transfer payments

• (because transfer payments are not purchases of current goods or

services)

 the official government budget includes transfer payments

Practice: calculations
Introduction to the tasks
We will solve 3 tasks.
We operate in Keynesian models, with 2 or 3 actors constituting the economy.
• 2 actors mean: only households and firms
Y=C+I
• 3 actors: adding the government
Y=C+I+G
We will also need:
C = C0 + ĉ * Y
I = I0 − a ∗ i
Task 1 (two actors)
Details:
• In a Keynesian economy, MPC (or ĉ) = 0.8.
• The value of autonomous consumption is 500.
• The value of autonomous investment is 300.
•a=2
• The interest rate is 5%.
Questions:
• What is the equilibrium income (Y)?
• What is the value of consumption in the equilibrium (C)?
Solution
 For two actors: Y = C + I (in the equilibrium)
 Further, we need the equations:
C = C0 + ĉ * Y and I = I0 − a ∗ i
 We can substitute some of the letters with numbers:
Y = 500 + 0,8*Y + 300 – 2 * 5 = 790 + 0,8Y
 Thus we can get a result for the income (Y):
0,2Y = 790  Y = 3950
 Inserting the income value into the consumption equation yields a value for C:
C = 500 + 0,8 * 3950 = 3660
Task 2 (two actors)
Details:
• In a Keynesian economy, MPC = 0.8.
• The investment function is I = 500 - 20i.
• The interest rate is 10%.
• The value of autonomous consumption is 100.

Question:
• What is the value of consumption (C) in the equilibrium?
Solution
 For two actors: Y = C + I (in the equilibrium)
 We can calculate the value of investment:
I = 500 – 20i and i = 10%  I = 500 – 20*10 = 500 – 200 = 300
 Regarding consumption, we can make substitutions in the equation:
C = C0 + MPC * Y and C0 = 100, moreover: MCP = 0,8
 C = 100 + 0,8Y
 Now we can calculate the equilibium income.
Solution (continued)
 Calculating the income:
Y=C+I
Y = 100 + 0,8Y + 300
Y = 400 + 0,8Y
0,2Y = 400
Y = 2000
 The value of income (Y) can be used in the consumption function:
C = C0 + MPC * Y = 100 + 0,8 * 2000 = 100 + 1600 = 1700

Just to be sure:
Y = C + I , thus 2000 = 1700 + 300
Task 3 (three actors)
Details:
In a Keynesian economy, MPC = 0.6.
The investment function is I = 200 - 10i.
The interest rate is 15%.
The value of autonomous consumption is 300.
The state spends 50 units.

Question:
What is the consumption (C) for macro-income (Y)?
Solution
 The question refers to consumption (C), but we can only calculate Y at first.
C0 = 300 MPC = 0,6 I = 200 – 10i i = 15% G = 50
 We can calculate the investment part:
I = 200 – 10 * 15 = 200 – 150 = 50
 From here:
Y = C + I + G = 300 + 0,6Y + 50 + 50
Y = 400 + 0,6Y
0,4Y = 400
Y = 1000
 C = 300 + 0,6 * 1000 = 900
The next big topic

Business Cycles
Defining business cycles
Business cycles characterize all market economies.
But what are business cycles?
Upward and downward movements (economy-wide fluctuations)
in total national output, inflation, interest rates, income and
employment.
How long do business cycles last?
Timeframe: A period of 2 to 10 years.
Economic expansion / boom
 An upward trend in the business
cycle, characterized by an increase
in production and employment,
which in turn causes an increase in
the incomes and spending of
households and businesses.
Defining recessions (contractions in the
economy)
In short and general terms:
 A recession is a downturn of a business cycle.
More precisely:
 A recurring period of significant decline in total output (= real GDP),
real income, employment, industrial production, and wholesale-retail
sales, usually lasting from 6 to 12 months and marked by contractions in
many sectors of the economy.
Overall condition:
 A recession occurs when real GDP has declined for two consecutive
calendar quarters.
Bust and depression
„Bust” in economics:
 The time period when economic
growth decreases rapidly.
Depression:
 A recession that is large in both
scale (decline in real GDP of at least
10% in a given year) and duration (3
or more years).
The phases - illustrated
The basic causes and features of
business cycles
What causes business fluctuations? short-term fluctuations are being
called “cycles” ↔ the actual pattern
According to Keynesian economics… is irregular
The forces of aggregate demand.
• No exact formula can be used to
predict the duration and timing of
Changes in aggregate demand
impact (in the short run): business cycles. ~ weather
• the overall levels of output
• Individual business cycles are not
• employment
identical, but often share
• prices
similarities.
U.S. example: 1920-2010
 General characteristics of recessions
Investment usually falls sharply. + Consumer purchases often decline sharply.

Businesses slow production lines, real GDP falls.

Employment usually falls As output falls, inflation slows. +

The demand for
sharply in the early stages. crude/intermediary materials
declines, and materials’ prices
Business profits fall, tumble.
stock prices fall.
 The central bank begins to lower short-term interest rates to stimulate investment, other
interest rates decline as well.
Business cycle theories
Exogenous vs. internal cycles – two
explanation categories
EXOGENOUS THEORIES ENDOGENOUS THEORIES
The sources of the business cycle are in The causing mechanisms are within
the fluctuations of factors outside the the economic system itself.
economic system.
 wars, revolutions  Every expansion breeds
recession and contraction, and
 elections every contraction breeds revival
 oil prices and expansion.
 population migrations  (mostly originating in the
 discoveries of new resources financial sector, e.g. investor
 scientific breakthroughs,
behavior)
technological innovations
 climate change, the weather
Panics
• characteristic of the US, in the nineteenth century
(frenzies of investment speculation in canals, land, and
railroads)
• “animal spirits” took over
 railroads were overbuilt
 land prices rose too high
 people took on too much debt
Bankruptcy  bank failures  a run on the banks 
banking crisis. Run on Berlin Bank
when war declared,
Bank runs can also occur in the form of self-fulfilling 1914
prophecies.
 Hyperinflation
Example 1: Germany in 1923
 high inflation  hyperinflation
– the result of an overheated economy • The government was unable to meet its
financial obligations through taxing and
borrowing, so it turned to the monetary
Definition: When prices rise at 100 percent printing press.  By the end of 1923,
or more per month. currency was printed with more and more
digits, and the largest banknote in circulation
was for 25 billion marks!
Example 2: Hungary in 1946
• The largest denomination bill ever issued:
100 quintillion (1020) pengő
 Central banks today are more vigilant in
their defense against inflation.
Economic bubbles
Definition:
A market phenomenon characterized
by surges in asset prices to levels
significantly above the fundamental
value of that asset.
Economic bubbles’ nature:
Bubbles are often hard to detect in real
time because there is disagreement
over the fundamental value of the
asset.
Bubbles – example I.
DOT-COM BUBBLE / TECH BUBBLE
• speculative boom in the late 1990s
• reason: a phenomenal pattern of growth and innovation in the “new-economy”
sectors—including software, the Internet, and the newly invented dot.com companies
Bubbles – example II.
U.S. HOUSING BUBBLE - 2008

The innovation was the process of financial “securitization”:

 A financial instrument, such as a simple home
mortgage, is sliced and diced, repackaged, and then sold on
securities markets. (securities = fungible/replaceable and
tradable financial instruments)
Rating agencies failed to provide accurate ratings of the
riskiness of these new securities.
The worst examples were “subprime mortgages”:
 mortgages provided to people for the entire value of a
house on the basis of little or no documentation of their
income and job status.
(Two related, recommended movies)
Do you have any
questions?
Thank you for your kind attention.