In the last few lectures, we've looked at growth theory and the stakes involved in getting the basics wrong. We saw the Solow model's predictions about sustained capital accumulation (): keep population growth low, keep savings () and therefore investment() rather high, and try to curb depreciation on assets. Technical progress and human capital move the economy forward, potentially stimulating convergence of growth rates.
Now we'll move onto a micro-founded macro model developed in the later chapters of the Barro book. The basic idea is to specify four markets inside the economy: the products market, the bond market, the money market, and the labour market. We'll build our macroeconomic equilibria from behavioural assumptions about the actors in the model: households and firms. Households are assumed to want to maximise their incomes from all of these markets, subject to a budget constraint. Firms want to maximise profits. Their interactions, along with the usual macroeconomic accounting identities, such as , give us the macroeconomic equilibrium, called a general equilibrium.
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