Macroeconomics I

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• Macroeconomics I
• Reviews
• As of November 24, 2006

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Economic Model

• Generally, expressed in a set of equations
• Example Q d D (P, Y ), Q s D (P, Pm),

The values of endogenous variables are
determined in the model. The values of
exogenous variables are determined outside the
model the model takes their values behavior as
given.

• No single model can answer all questions.
• Always keep in mind
• what kinds of assumptions are used
• what variables are endogenous/exogenous.

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Images of the three periods
Boom
Recession
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The Key Variables of the Economy
MPKR/P, MPLW/P Y (W/P)L (R/P)K
Y-C-T
Y-C-GSI(r)
T-G
Y CIG
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Distribution of National Income (Ch. 3)
1. The production function has the property of
constant returns to scale (CRS).
diminishing marginal product of labor (capital)
2. To maximize profits, firms hire L or K MPL
Real wage (W/P) MPK Real rental price of
capital (R/P)
? Demand of labor (capital) has a
downward slope
Supply of labor (capital) is vertical (fixed)
Since the production function is CRS, all output
(Y) is fully distributed to workers (MPLL) and
capital owners (MPKK)
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Demand for Goods and Services (Ch. 3)
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Equilibrium in a Closed Economy (Ch. 3)
The real interest rate adjusts so that the
investment equal the saving.
I(r) S Y-C-G National Saving
(Y-T-C) (T-G) Private saving Public
saving
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Money Demand (Ch. 4)
M/P L(i, Y) L(rpe, Y)

• Negatively on the nominal interest rate (rpe)
• Higher nominal interest rate raises the
  opportunity cost of holding money ( the cost of
  giving up interest), so less demand for money.

• Positively on the output (Y)
• Higher output leads to more transactions, so
  more demand for the convenience of holding money
  (money is the asset most easily used to make
  transactions)

• In a special case,
• M/P kY ?? MVPY (The quantity theory of
  money)
• k is constant is equivalent to constant
  velocity (V)
• Note that
• change in M change in V change in P
  change in Y

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Money, Prices and Inflation Rates (Ch. 4)
M is given by central bank
change in price level (P)Inflation rate (p)
M/P L(i, Y)
Fisher equation i r pe
Money demand function L(i, Y)
Money (M) does not affect the real variables such
as Y and r. (Monetary Neutrality)
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Equilibrium in a Small Open Economy (Ch. 5)
The real exchange rate adjusts so that the net
capital outflow equal the net exports. (r is
fixed at the world interest rate r)
S - I(r) CF NX(e)

• Nominal exchange rate e e(P/P)
• ? change in e change in e (p-p)

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Unemployment (Ch. 6)

• The natural rate of unemployment (the
  unemployment rate toward which the economy
  gravitates in the long run) is not zero because
  of
• Frictional unemployment
• It takes time for workers to search for their
  jobs
• A sectoral shift, a change in the composition of
  demand among industries or regions, often causes
  it.
• The unemployment insurance raises it.
• Structural unemployment
• The real-wage remains above the equilibrium
• level of labor market (real-wage rigidity)
  because
• Minimum-wage law
• Unions and collective bargaining
• Efficiency wages High wages make workers more
  productive, so firms pay higher wages.

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The Solow Model (Ch. 7)
y f(k) Dk sf(k) dk
1. If kltk, Dkgt0, thus economy grows (k?? y?)
2. With the same steady state, a lower output
causes a faster growth rate
3. A higher saving rate yields a higher
steady-state output, but cannot generate
persistent growth.
4. Among the steady states, the Golden Rule level
of capital kgold (where MPKd) is optimal
because it maximizes the steady state consumption
c
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Keynesian cross, Liquidity preference, IS-LM and
AD-AS (Ch.9-11)
Y C(Y-T) I(r) G
M/P L(rpe, Y)
IS curve for given G, T, pairs of (Y, r)
satisfying Y C(Y-T) I(r) G
LM curve for given M, P, pe, pairs of (Y, r)
satisfying M/P L(rpe, Y)
AD curve for given T, G, M, pe, pairs of (Y, P)
satisfying both Y C(Y-T) I(r) G and M/P
L(rpe, Y)
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Summary of the AD-AS model (Ch. 9)

• How to analyze the effects of policies or events
  by the AD-AS model
• Find how the SRAS curve shifts by the shocks.
• Find how the AD curve shifts.
• Find both the new short-run equilibrium and the
  new long-run equilibrium.
• Tell how the output (Y) and the price level (P)
  move in the short run
• Tell how the output (Y) and the price level (P)
  move in the long run

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The IS-LM model (Ch.10)

• How to analyze the effects of policies or events
  by the IS-LM model
• Find how the IS curve and/or the LM curve shift.
• Find how the output (Y) and the real interest
  rate (r) move.
• Find how the investment (I) changes by the change
  in real interest rate (r), and how the
  consumption (C) changes by the change in
  disposable income (Y-T).
• Consumption positively depends on the disposable
  income.
• Investment negatively depends on the real
  interest rate.

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Shift in the IS curve

• How to derive the shift in IS curve by policies
  or events.
• Pick up a real interest (r) and the output (Y)
  corresponding to the r.
• Think whether C(Y-T)I(r)G increases or
  decreases.
• Find how the planned expenditure (E) shifts in
  the Keynesian cross.
• From the Keynesian cross, find the new output,
  then plot new point (Y, r).
• Find how the IS curve shifts in the IS-LM model.

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Shift in the LM curve

• How to derive the shift in LM curve by policies
  or events.
• Pick up an output (Y) and the real interest rate
  (r) corresponding to the Y.
• Think whether L(rpe, Y) increases or
  decreases, and find how L shifts.
• Find how the real monetary balances (M/P) shifts.
• Find the new real interest rate, then plot the
  new point (Y, r).
• Find how the LM curve shifts in the IS-LM model.

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IS-LM and the AD-AS model (Ch. 11)

• How to analyze the effects by the IS-LM and the
  AD-AS model
• Find how the AD curve and/or the SRAS curve
  shift, and find the new SR price level (PSR).
• Find what happens to (Y, r, C, I) in the short
  run by the IS-LM model.
• Find the new LR price level (PLR) by the AD-AS
  model.
• Shift the LM curve until the equilibrium becomes
  YYLR. At this point, PPLR.
• Find what happens to (Y, r, C, I) in the long run
  by the IS-LM model.