4. Modern Mainstream Macroeconomic Models

In the first part of this book, we conclude that modern mainstream macroeconomics model is deeply rooted in the NCM theoretical framework. Thus, it is widely cited as the NCM/DSGE model. In this chapter, we derive the fundamentals of the NCM/DSGE model with greater details. The major features of these models, such as intertemporal utility maximization, short-term nominal rigidities and heterogeneities in the production sector, are maintained in the new model we are going to build, as shown in the following chapters. Models derived in the previous chapter are based on the assumption that each market is completely competitive, meaning that there is no nominal rigidity in the economy. Under such a condition, price responds instantly to any innovation, driving the economy back to its equilibrium. Such strong assumption limits the reach and accuracy of these models in macroeconomic analysis. To improve, economists introduce price rigidities into the original RBC/DSGE models. As a result, the NCM/DSGE models emerged. The mechanism that is often referred to as the staggered pricing has become one of the standard mechanisms in the NCM/DSGE models. This chapter consists of three sections. In the first section, we derive the economic behaviours of the manufacturers, including final goods packer and intermediate goods producers. The Calvo pricing mechanism that gives rise to the price rigidity is discussed. The second section examines the household sector, and the general equilibrium is discussed in the third section.