macroeconomics first partial, Appunti di Macroeconomia

Scarica macroeconomics first partial e più Appunti in PDF di Macroeconomia solo su Docsity! Chapter 1-18 Macroeconomics is the study of the economy as a whole, addresses many topical issues. Ex: recessions, government borrow, unemployment, financial crises … Macroeconomics affects livelihood, welfare and politics. MACRO MICRO -Looks at all markets together -considers general equilibrium -Looks at one or few markets at a time -considers partial equilibrium Modern macroeconomics is founded on a microeconomic understanding of behaviour. KEY VARIABLES Gross Domestic product- Inflation- Unemployment rate- Economic models are simplified versions of a more complex reality (irrelevant details are stripped away). We use these models to explain relationship between variables, economy's behaviour and devise policies to improve economic performance. Economists use different models to examine different issues. SUPPLY AND DEMAND FOR NEW CARS We base the model on the assumption that the market is competitive Demand and supply can be described through a function. These functional notations can be: General functional notations--> only shows the variables that are related- Specific functional forms--> shows the precise quantitative relationship. If this specification is correct it allows quantitative predictions. - where Y is the aggregated income Where Ps is the price of still If these two are fixed, then supply and demand will look as in the graph. If income increases… Similarly, if price steel increases, quantity produced will decrease. At the original price demand would be higher than supply. To find equilibrium the price will increase. while price will increase. Demand shifts to the right. The equilibrium changes. Supply shifts to the left. THE SCIENCE OF MACROECONOMICS martedì 13 febbraio 2024 15:14 CHAPTER 1 Pagina 1 Macroeconomic events and performance arise from many microeconomic transactions, so macroeconomics uses many of the tools of microeconomics ENDOGENOUS VARIABLES--> these values are determined within the model. For example moving parts of the model mechanism. (price, demand, supply) EXOGENOUS VARIABLES--> these values are determined outside the model (parameter). For example the external parameters given and adjusted. (income, price of steel) Demand = quantity demanded as a function of price Quantity demanded= quantity of goods exchanged in an equilibrium, a number. Ex: Exogenous variables that affect supply and demand for phones Demand--> income, taxes, tariff- Supply--> wages, price of materials, transportation cost, energy cost, war in taiwan (iphone)- No single model can address all the issues we care about. Ex: models can tell us what happens if exogenous variables change, but not why they change. For each model we should keep in mind Its assumptions- Which variables are exogenous/endogenous- The questions it can help understand and those it cannot. - ”All models are wrong, but some are useful.” – George Box In the long-run, prices are flexible--> MARKET CLEARING. Prices adjust to equate supply and demand, without delay. In the short-run, prices are sticky. They adjust sluggishly in response to changes in supply or demand. Ex: many labour contracts have fixed wages for the first years. This means that demand may not equal supply. CHAPTER 1 Pagina 2 COST OF LIVING--> Inflation rate = percentage increase in the overall level of prices. How rapidly prices are increasing The two possible measures of inflation are the GDP deflator and CPI (we also have the PCE deflator). GDP DEFLATOR For good i = 1, 2, 3: Pit = the market price of good i in month t, Qit = the quantity of good i produced in month t, NGDPt = Nominal GDP in month t, RGDPt = Real GDP in month t. CONSUMER PRICE INDEX (CPI) It turns the prices of many goods and services into a single index measuring the overall level of prices. It is calculated as the price of a basket of goods relative to the price of the same basket in a base year. Ex. CPI may overstate inflation, because Substitution bias-->It does not take substitution of goods into account, as it uses fixed weight- Introduction og new goods-->It does not take the introduction of new goods into account, that would make consumers better off - Unmeasured changes in quality-->Quality improvements increase the value of money- The differences with another measure of prices (GDP deflator) are: CPI measures the prices of goods bought by consumers, not also those bought by firms/government- CPI also includes goods not produced domestically but imported and bought by costumers.- CPI is computed using a fixed basket of goods (Laspeyres index). GDP deflator allows the basket to change as the composition of the GDP changes (Paasche index). - Neither is clearly superior. PERSONAL CONSUMPTION EXPENDITURE DEFLATOR (PCE) --> nominal consumer spending / real consumer spending. (The C component of GDP)  It is similar to the CPI as it includes consumer spending and imported consumer goods. Iit is similar to the GDP deflator as the basket considered changes over time. UNEMPLOYMENT RATE An adult can fall into one of three categories: Employed--> employees, own businesses, unpaid workers of a family business- Unemployed--> not employed, available for work, actively trying to find a job- Not in the labour force--> full-time students, homamakers, retiree, discouraged workers- Labour force= employed + unemployed --> amount of labour available to produce• Unemployment rate= unemployed / labour force• Labour force participation rate= labour force / adult population (15 to 64) * 100• 2012--> 200 + 150= 350 2013--> 220 + 150= 370 2014--> 240 + 160= 400 2015--> 260 + 150= 410 CPI= 1 CPI= 370/350= 1,06 CPI= 400/350= 1,14 CPI=410/350= 1,17 n.a. r= 0,06/1= 0,06= 6% r= 0,085= 8,5% r= 0,02=2% CHAPTER 2 Pagina 5 HOW TO WORK WITH PERCENTAGE CHANGES EXAMPLE. If your hourly wage rises 5% and you work 7% more hours, then your wage income rises approximately 12% EXAMPLE. Recall the GDP deflator = NGDP/RGDP. If NGDP rises 9% and RGDP rises 4%, then the inflation rate is approximately 5% CHAPTER SUMMARY Gross Domestic Product (GDP) measures both total income and total expenditure on the economy’s output of goods & services. Nominal GDP values output at current prices; real GDP output at constant prices. values • Changes in output affect both measures, but changes in prices only affect nominal GDP. • GDP is the sum of consumption, investment, government purchases, and net exports• The rate of inflation describes how rapidly prices increase over time. The overall level of prices can be measured by either: the Consumer Price Index (CPI), the price of a fixed basket of goods purchased by the typical consumer; or • the GDP deflator , the ratio of nominal to real GDP; or • the Personal Consumption Expenditure (PCE) deflator, which is like the GDP deflator but just for the consumption component of GDP. • The unemployment rate is the fraction of the labour force that is not employed. People who would like to work, but are not currently working.• CHAPTER 2 Pagina 6 1) 2010 nominal GDP: sum of p*Q, i.e. 200*2 + 200*3 = 400 + 600 = 1000 2010 real GDP: the same = 1000 (as 2010 is the base year) 2018, nominal: 250*4 + 500 * 4 = 3000 2018, real: 250*2 + 500*3 = 2000 (uses 2010 prices) GDP deflator = NGDP/RGDP. So 2010: 1, trivially. 2018: 3000/2000=1,5 Inflation = (GDPdef(2018) - 1) = 0,5, or 50%. 2) An economy has 60 people: 25 have full-time jobs• 10 have a part-time job• 5 have 2 part-time jobs• 10 would like to work and are looking for jobs• 10 are discouraged and have stopped looking for work.• What is the labour force in the economy? What is the unemployment rate, and the labour force participation rate? The population is P = 60. The labour force is all the people working and looking for work, or LF = 50. Labour force participation rate is LF/P = 5/6 or approx 83% There are U = 10 unemployed people (the ones still looking for work). The unemployment rate is U/LF = 10/50 = 20%. EXERCISES domenica 18 febbraio 2024 16:04 CHAPTER 2 Pagina 7 COBB-DOUGLAS PRODUCTION FUNCTION This function describes how actual economis turn capital and labour into output. capital income = MPK * K = αY- Labor Income = MPL * L = (1−α)Y- Where α is a constant and measures capital's share of income--> what share of income goes to capital and what share goes to labour. The function is Where A represents the level of technology Where Y K is the average capital productivity (output per unit of capital)- Where s the average labour productivity (output per worker)- An increase in the amount of capital raises the MPL and reduces the MPK. Similarly, an increase in the amount of labor reduces the MPL and raises the MPK. A technological advance that increases the parameter A raises the marginal product of both factors proportionately. The factor shares depend only on the parameter α and . α is capital’s share of income- (1-α) is labour's share of income- The factor shares depend only on the parameter α, not on the amounts of capital or labor or on the state of technology as measured by the parameter A. CLIMATE CHANGE Climate change is one of the main issues of 21st century. It is an anthropogenic (man-made) factor. It is mainly caused by energy and the burning of fossil fuel that lead to the emission of carbon dioxide. Carbon dioxide traps heat, which raises the earth's average temperature, leading to more general changes in the climate. Our current societies are adapted to the existing climate. Now climate is changing and we are not used to it. High temperatures reduces productivity of agriculture and workers, could also have adverse health impacts. - Rising sea levels may gradually force coastal residents to move (large fraction of total population)- Climate change is an economic problem. Production function Two additional factors--> Energy and Damages(percentage) - Y = (1 - D(CO2))F(K, L, E) Higher COS increases D- Higher energy increases output- Higher CO2 levels reduce the productivity of the economy Reduce overall GDP- Reduce wages and rents--> - WHAT TO DO Reduce CO2 concentration. However to reduce emission we need to reduce energy consumption. Trade off between avoiding climate change and generating economic output. - Switch to renewable sources, whicha re becoming cheaper and cheaper- CHAPTER 3 Pagina 10 Thus, equilibrium is The only variable is the real interest rate, which will change to match supply National saving does not depend on interest rate (r) , thus it is always vertical. Price of funds--> real interest rate Demand COMPONENTS (a closed economy's output is used for): C = consumption - consumer demand for goods and services- I = investment - demand for investment goods- G = government spending - government demand for goods and services- Assumptions for consumption (the function is upward sloping) Disposable income available to purchase--> income - taxes (Y - T)- Consumption depends on disposable income only --> C = C(Y - T), with C'>1- Consumption increases as income increases--> The marginal propensity to consume (MPC) is the change in C when disposable income increases by one euro. It is equal to the slope of the consumption function. MPC = C / (Y−T). - Ex. If the MPC is 0.7, then households spend 70 cents of each additional dollar of disposable income on consumer goods and services and save 30 cents. Assumption for investment (The function is downward sloping) Investment I depends on the real estate rate r--> I = I(r), If the interest rate rises, fewer investment projects are profitable, and the quantity of investment goods demanded falls. - The real interest rate equals: The cost of borrowing▪ The opportunity cost of using one's own funds to finance investment spending▪ Thus if the rate goes down, investment goes up (downward slope) - Assumption for government spending We assume that government spending G and total taxes T are exogenous variables (fixed, given)- Budget surplus if T>G--> (T– G) = public saving○ Budget deficit if T<G--> (G– T) = public dissaving.○ Balanced budged if T=G--> public saving is equal to T-G=0○ Governments can finance deficits by borrowing, i.e., by issuing Treasury bonds (called Bot, Btp, Cct in Italy, Bund in Germany, T-Bills in the US). EQUILIBRIUM The aggregated demand is The aggregated supply is how do financial markets fit into the model? THE LOANABLE FUNDS MARKET Mechanism through which the real interest rate adjusts to equate supply. Demand for funds--> comes from investments, it depends negatively on r (the higher r, the lower investments) (same curve as investment) Supply of funds--> coming from saving. Could be: private (households that make bank deposit) --> disposable income - consumption = (Y - T) - C- public (if it does not spend all that tax revenue received)--> taxes - government spending = T - G- National saving (S - it is the supply of loanable funds)--> private + public = (Y - T) - C + T - G = Y - C - G- Y - C(Y - T) - G = I(r) CHAPTER 3 Pagina 11 EQUILIBRIUM THE ROLE OF r Real interest rate r adjusts to equilibrate both markets simultaneously: Loanable funds market equilibrium implies Y– C– G = I.• Add (C + G) to both sides to get Y = C + I + G (goods market equilibrium)• Thus: At the equilibrium interest rate, households’ desire to save balances firms’ desire to invest, and the quantity of loanable funds supplied equals the quantity demanded. CHANGES IN SAVING Δ = Δ − Δ − ΔG Δ Change in consumption is given by MPC*(ΔY - ΔT) , which is equal to MPC* ΔY +MPC* ΔT• PUTTING THE MODEL TO USE We can test how the model works by: Modifying the exogenous variables and see how the endogenous respond- Comparing the behaviour of data- Or, if we trust the model, we can make predictions- This process is known as comparative statics. To master a model you need to know the nature of the variables, the definition of the curves, their slope and the things that can shift the curve. Things that shift the saving curve Public saving--> fiscal policy: changes in G or T- Private saving preferences ○ tax laws that affect saving (taxes on interest income/replace income tax with cunsumption tax) ○ - Things that shift the investment curve: technological innovations--> To take advantage some innovations, firms must buy new investment goods (e.g. the ICT revolution) - Tax laws that affect investment- CASE STUDY: the reagan deficits National savings were reduced because Government spending were increased, while taxes were decreased. The curve thus shifts to the left, causing the real interest rate to rise. To match saving the level of investment falls. The loanable funds model is a fine good approximation of reality, as long as the intermediation works well. A decrease in national saving causes the interest rate to rise and investment to fall. An increase in investment demand causes the interest rate to rise, but does not affect the equilibrium level of investment if the supply of loanable funds is fixed. CHAPTER 3 Pagina 12 We assume three possible scenario, in all of which C=$1000 NO BANKS--> as there are no banks, there are no deposits, D= 0 , M = C = 1000- 100-PERCENT-->Initially C= 1000, D= 0, M = 1000. If households deposit 1000, then C=0, D=1000, M=1000. This means that this system has no impact on the size of money supply. - FRACTIONALl--> suppose banks hold 20% of deposit and lend out the rest. If the deposit is 1000, a bank will keep 200 as reserves and lend out 800. the money supply has increased, as M = 800 + 1000=1800. this means that in this model, banks create money. - The total money supply = (1/rr) * C rr=reserve-deposit ratio (in this case 20%) A fractional-reserve banking system creates money, but it doesn’t create wealth--> Bank loans give borrowers some new money and an equal amount of new debt, that they will eventually have to pay. Thus they are not richer. The process of transferring funds from savers to borrowers is called financial intermediation. Many institution act as financial intermediaries (stock market, bond market, banking system). However, only banks have the legal authority to create assets, thus influencing the money supply. BANK CAPITAL, LEVERAGE, AND CAPITAL REQUIREMENTS In order to open a bank, financial resources are needed. These are: Bank capital--> resources bank's owners have put into the bank. This is not productive capital (like machines), it should be called equity. It adjusts to equate the two sides of the balance sheet. • C= assets - liabilities Balance sheet The banking system relies on: Leverage--> the use of borrowed money to supplement existing funds for purpose of investment. Ex. I already had 100, but I borrow another 400, so I invest 500. - Leverage ratio--> ratio of the banks tot al assets to the bank's capital. Ex: 1000/50=20 - Being highly leveraged makes banks vulnerable. --> If the value of the loans I make recess, the bank capital decreases, risking bankrupcy (insolvency). Note that banks’ liabilities include debt. This debt might be an asset for another bank. After a bankruptcy, the debt may not be paid back in full, making the asset's value of other bank fall. Bankruptcies of banks can cascade and lead to a banking crisis. To reduce the likelihood of crises occurring, bank capital is regulated. Capital requirement is the minimum amount of capital mandated by regulators (in relation to assets) • It is intended to ensure banks will be able to pay off depositors. This requirement is higher for banks that hold more risky assets. Securities--> ownership stakes in other firms, shares - Debt--> loans from other financial institutions- CHAPTER 4 Pagina 15 HOW CENTRAL BANKS INFLUENCE THE SUPPLY OF MONEY The model has three exogenous variables: Monetary base B--> total amount of dollars held by the public and by banks. It is controlled by the central bank. B = C + R - Reserve-deposit ratio rr--> fraction of deposits that banks hold in reserve. rr= R/D- Currency-deposit ratio cr--> amount of currency C people hold as a fraction of their holdings of demand deposits D. it is based on preference. cr=C/D - M = C + D = m *B = (cr+1) / (cr+rr) * B The money supply is proportional to the monetary base. The factor of proportionality is the money multiplier, the increase in money supply resulting from one-dollar increase in the monetary base. HOW CHANGES IN VARIABLES AFFECT THE MONEY SUPPLY If monetary base changes by ∆B, then ∆M = m * ∆B - If rr < 1, then m > 1, thus the money supply increases--> The lower the reserve–deposit ratio, the more loans banks make, and the more money banks create from every dollar of reserves. - If cr increases, m will decrease, leading to a fall in M--> If households deposit less of their money, then banks can’t make as many loans, so the banking system won’t be able to create as much money - THE INSTRUMENTS OF MONETARY POLICY The FED controls the Money supply indirectly, using various instruments. These can either influence: The monetary base- The reserve-deposit ratio and therefore the money multiplier- How fthe fed changes the monetary base Open-market operations--> buying bonds from the public to increase hte monetary base; selling bonds to the public to reduce the monetary base/supply. - Lender of last resort--> lending to banks through the discount window. The Fed charges a discount rate on these types of loans: the lower the rate, the more banks will borrow leading to an increase in the monetary base/supply. - How the fed changes the reserve-deposit ratio Reserve requirements--> regulation that impose a minimum reserve-deposit ratio on banks. An increase in reserve requirements tends to raise the reserve–deposit ratio and thus lower the money multiplier and the money supply. (not effective as now banls excess reserves). - Interest on reserves--> the interest that the Fed pays on the reserves on deposit at banks. The higher the interest, the more reserve will choose to hold. This will lead to a lower money multiplier, thus a lower money supply. - PROBLEMS IN MONETARY CONTROL The Fed has substantial power to influence the money supply, but it cannot control the money supply perfectlY--> the money supply sometimes moves in ways the Fed does not intend. MODEL OF MONEY SUPPLY venerdì 1 marzo 2024 10:49 CHAPTER 4 Pagina 16 Suppose that banks hold 10% of deposits as reserves and lend out the rest. There is €1m of currency that is initially at circulation. a. If consumers deposit all their currency into a bank, how much will the money supply be in a fractional-reserve banking system? b. Now suppose that the currency-deposit ratio is 20%, that is, consumers also want to hold some currency. What is the money multiplier? c. What is the money supply in this case? d. Why is the money supply lower if the currency-deposit ratio is higher? a. With 10% being held as reserves, and without currence held by consumers, in the limit the money supply will be €1m/0.1 = €10m. b. With a currency-deposit ratio of 0.2, and a reserve-deposit ratio of 0.1, the money multiplier is (0.2 + 1) /(0.1 + 0.1) = 1.2 / 0.3 = 4. c. The money supply is M = m B = €4m. d. If consumers want to hold more currency, the banks receive less deposits and thus they are less able to amplify the monetary base. The Trusted and Reliable Bank of Lalalandia (TRBL) holds, as assets: €500m of securities, €400m of mortgages, and €100m of reserves. Its liabilities include €200m of deposits by individual customers, and €700m of debt to other banks. a. (1 pt.) How much equity do the bank owners have? b. (1 pt.) What is the leverage ratio? c. (1 pt.) It turns out that there has been a huge bubble in house prices. The bubble bursts, and as house prices collapse, the value of the mortgages held by TRBM falls by 50%. What happens to the owners’ equity? Explain briefly. d. (1 pt.) Prudence Knowitall, a famous economics professor, wrote a column a few years earlier, warning of the housing bubble and advocating for a 15% capital requirement on banks. If the asset base had been the same, would this have helped? Why or why not? a. Total assets A = 500 + 400 + 100. Total liabilities L = 200 + 700. Equity E = A - L = 1000 - 900 = 100. b. Leverage ratio equals A / E = 10. c. If mortgages fall in value by 50%,, there are €200m of mortgages after the crash. Assets are 500 + 200 + 100 = 800. Liabilities 900 exceed assets 800, so equity is wiped out -- the bank defaults. d. With 15% capital requirement, if assets had been the same (and with the same composition) then equity would have been 150, so that liabilities would have been A - E = 850. The housing crash would still have led to asset value falling to 800. The bank is still bankrupt, so following the advice would not have helped. EXERCISES lunedì 4 marzo 2024 18:01 CHAPTER 4 Pagina 17 TWO REAL INTEREST RATES Notation: π = actual inflation rate, however, this is not know ultil observed.- E π=expected inflation rate - There are two real interests rates: i - E π--> ex ante real interest rate: the real interest rate people expect at the time they buy a bond or take out a loan - i - π--> ex post real interest rate: the real interest rate actually realized. - MONEY DEMAND The quantity theory is based on a simple money demand function: it assumes that the demand for real money balances is proportional to income. Here we add another determinant of the quantity of money demanded— the nominal interest rate. THE COST OF HOLDING MONEY Holding money has an opportunity cost: it is what you give up by holding money rather than bonds. You loose the real interest rate return r on bonds- The purchasing power of M is reduced by π- Thus, the Total expected opportunity cost: i = r + Eπ --> which is the nominal itnerest rate So the demand for real money balances depends on both income and nominal interest rate. Real money demand: (“L” is used for the money demand function because money is the most liquid asset). It depends: Negatively on i--> the higher the opportunity cost, the lower demand- Positively on Y (income)--> the higher income, the higher demand- = , ( +E , ) --> When people are deciding whether to hold money or bonds, they don’t know what inflation will turn out to be. Hence, the nominal interest rate relevant for money demand is the expected nominal interest rate r + Eπ To reach equilibrium P adjusts to ensure that the equation holds. CHANGES If the money supply changes, P changes by the same proportion. ( + E , Y do not change).- In the long run, people dont consistently over- or under- forecast inflation- In the short run, E may change. If it increases, it will lead to a higher nominal rate and price, but lower demand. - EQUILIBRIUM--> π The price level depends on a weighted average of the current money supply and the money supply expected to prevail in the future. Inflation is driven by both current growth in the money supply and its expected future growth. CHAPTER 5 Pagina 20 SOCIAL COST OF INFLATION A common misperception is that inflation reduces real wages (purchasing power), making us poorer. However, the real wage actually depends on MPL, not on how much money the governmetn prints. The statement is true only in the short run, when nominal wages are fixed by contract. In the long run real wage is determined by labour supply and MPL, not the price level or inflation rate. In the classical view, a change in the price level is like a change in the units of measurement. If everything is mroe expensive, so is your wage--> nothing really changes. Your economic well-being depends on relative prices, not the overall price level. Why is it then a social cost? The social costs of inflation can be grouped into two categories: Costs when inflation is expected Menu cost are cost (to firms) of changing prices--> the higher the rate of inflation, the more often restaurants have to print new menus. ▪ They arise from: Cost of printing new menus- Time spent trying to decide on what the new prices should be- Other costs due to price changes- Variability to relative prices--> leads to price distorsions and microeconomic inefficiencies in the allocation of resources. ▪ Tax--> inflation can distort the way taxes are levied▪ Inconvenience--> Inflation makes it harder to compare nominal values from different time periods. This complicates long-range financial planning. ▪ 1. Costs when inflation is different from what people had expected Redistribution--> many long-term contracts do not take inflation into cosnideration, they are based on expected inflation Eπ. If π turns out different from Eπ, then some gain at others' expense. ▪ Increased uncertainty--> The more variable the rate of inflation, the greater the uncertainty that both debtors and creditors face. Because most people are risk averse - they dislike uncertainty - the unpredictability caused by highly variable inflation hurts almost everyone. ▪ 2. BENEFIT OF INFLATION Some economists believe that a little bit of inflation - 2 or 3 percent per year - can be a good thing. Why? Nominal wages are rarely reduced, even when the equilibrium real wage falls. Inflation allows the real wages to reach equilibrium levels without nominal wage cuts. Without inflation, the real wage will be stuck above the equilibrium level, resulting in higher unemployment. Moderate inflation can improve the functioning of labor markets HYPERINFLATION Hyperinflation is a very high rate of inflation, such as > 50% per month. All the costs of moderate inflation described above become HUGE under hyperinflation. Money ceases to function as a store of value, and may not serve its other functions (unit of account, medium of exchange). - People may conduct transactions with barter (baratto) or a stable foreign currency- Hyperinflation is caused by excessive money supply growth. When the central bank prints money, the price level rises. If it prints money rapidly enough, the result is hyperinflation. To stop the hyperinflation, the central bank must reduce the rate of money growth Most hyperinflations begin when the government has inadequate tax revenue to pay for its spending. Although the government might prefer to finance this budget deficit by issuing debt, it may find itself unable to borrow, perhaps because lenders view the government as a bad credit risk (credibility is crucial). To cover the deficit, the government turns to the only mechanism at its disposal - the printing press. The result is rapid money growth and hyperinflation. CHAPTER 5 Pagina 21 THE CLASSICAL DICHOTOMY Based on the theoretical separation of real and nominal variables in the classical model, which implies nominal variables do not affect real variables. Real variables--> measured in physical units (quanitties, relative prices) Quantity of output produced; ○ Real wage: output earned per hour of work; ○ Real interest rate: output earned in the future by lending one unit of output today.○ - Nominal variable--> measured in money units Nominal wage: euros per hour of work; ○ Nominal interest rate: euros earned in the future by lending one euro today; ○ Price level○ - This implies neutrality of money--> changes in the money supply do not affect real variables. In the real world, money is approximately neutral in the long-run. (Real things are determined only by other real things while they effect nominal things. Nominal things do not affect real things. ) CHAPTER 5 Pagina 22 This means that the supply of loanable funds (national saving) is fixed as it does not depend on interest rate. The demand for loanable funds (level of investment) is determined by the world interest rate. HOW POLICIES INFLUENCE TRADE BALANCE FISCAL POLICY AT HOME--> starting from balanced trade, a change in fiscal policy that reduces national saving (increase in G or decrease in T) leads to a trade deficit. 1. FISCAL POLICY ABROAD--> starting from balanced trade, an increase in the world interest rate due to a fiscal expansion abroad leads to a trade surplus 2. SHIFTS IN INVESTMENT DEMAND--> an outward shift in the investment (higher investment) schedule causes a trade deficit. (investment must be financed abroad). 3. Deficit may represent low saving and a growing foreign debt. However, it could also be a sign of economic development. The difference between saving and investment determines net capital outflow and net exports CHAPTER 6 Pagina 25 We now extend the analysis by considering the prices that apply to these transactions. The exchange rate between two countries is the price at which residents trade with each other.- Nominal exchange rate (e)--> the relative price of domestic currency in terms of foreign currency (how many dollars you can get per euro) Rise in the exchange rate--> appreciation of the currency (strengthening)- Fall in the exchange rate--> depreciation of the currency (weakening)- Real exchange rate (ε)--> the relative price of domestic goods (whole output) in terms of foreign goods (how many italian big macs for usa big macs). Also called terms of trade. The rate at which we exchange foreign and domestic goods depends on the prices of the goods in the local currencies and on the rate at which the currencies are exchanged. Thus, If the real exchange rate is high, foreign goods are relatively cheap, and domestic goods are relatively expensive--> net exports will be low If the real exchange rate is low, foreign goods are relatively expensive, and domestic goods are relatively cheap--> net exports will be high There is an inverse relationship between net exports and ε (the higher the first, the lwoer the second) --> net exports function NX=NX(ε) HOW IS ε DETERMINED The accounting identity says--> NX = S - I S depends on domestic factors (fixed)- I depends on world interest rate- So ε must adjust to ensure than NX(ε)= S - I(r*) HOW POLICIES INFLUENCE THE RATE FISCAL POLICY AT HOME1. P = domestic price P*= foreign price At the equilibrium real exchange rate, the supply of dollars available from the net capital outflow balances the demand for dollars by foreigners buying this country’s net exports. An increase in G or decrease in T (fiscal expansion), reduces saving (the supply of dollars falls). This causes the exchange rate to rise and net exports to decreases (trade deficit) EXCHANGE RATES lunedì 11 marzo 2024 17:49 CHAPTER 6 Pagina 26 FISCAL POLICY ABROAD2. INCREASE IN INVESTMENT DEMAND3. TRADE POLICIES--> these are policies to directly influence the amount of goods and services exported or imported. Often in order to protect domestic industries from foreigners competition with tax on foreign imports or amount restrictions. 4. DETERMINANTS OF NOMINAL EXCHANGE RATE %change in e = %change in ε + %change in P* - %change in P, which is equal to %change in e = %change in ε + (π* - π) difference in the inflation rates US and EU AS LARGE OPEN ECONOMIES We have considered coles and small open economies. Large open economies like the US and Eu fall between these two extremes. The results from large open economy analysis are a mixture of the results for the closed & small open economy cases. Fiscal expansion abroad raises r*, thus decreasing investments. This increases savings, thus also the net capital outflows and the supply of domestic currency abroad. The real exchange rate falls and nex exports increase (trade surplus). Increase in investment demand causes saving to decrease. The exchange rate raises causing net exports to fall. If imports decrease, net exports rise, shifting the demand right. This policy does not affect the supply of domestic currency, so S - I remain fixed. However, the real exchange rate still rises. CHAPTER 6 Pagina 27 WAGE RIGIDITY--> failure of wages to adjust to alevel at which labour supply equals labour demand. - If the real wage is stuck above the market-clearing level we have: Structual unemployment is the unemployment resulting from wage rigidity and job rationing. It causes a mismatch between the number of people who want to work and the number of jobs available. Wage rigidity is caused by: MINIMUM-WAGE LAWS--> minimum wage firms have to pay their employees.• The minimum wage may exceed the equilibrium wage of unskilled workers, especially teenagers (usually get payd through experience/skills). Advocates of a higher minimum wage view it as a way to raise the income of the working poor. Opponents of a higher minimum wage claim that it is not the best way to help the working poor. MONOPOLY POWER OF UNIONS--> The wages of unionized workers are determined not by the equilibrium of supply and demand but by bargaining between union leaders and firm management. When the union wage exceeds the equilibrium wage, unemployment results • EFFICIENCY WAGES--> based on the assumption that higher wages increase worker productivity by: Attracting higher quality job applicants○ Increasing work effort○ Reducing turnover, which is costly to firms○ Improving health of workers (in poor countries)○ • In such situations, firms willingly pay above-equilibrium wages to raise productivity, causing structural unemployment. THE DURATION OF UNEMPLOYMENT Short term unemployment is likely to be frictional and unavoidable- Long term unemployment is likely to be structural - Knowing this is important because it can help us craft policies that are more likely to work. If the goal is to substantially lower the natural rate of unemployment, policies must aim at the long-term unemployed because these individuals account for a large amount of unemployment. CHANGES IN THE LABOUR FORCE Until now, we have assumed that the labour force is fixed. However, movements into and out of the labour force are important. Defining who is inside and outside of it is not always easy: Discouraged workers--> workers who have given up on looking for a job and are considered out of the labor force • Marginally attached workers--> persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached • WHY IS UNEMPLOYMENT RISING IN EUROPE? Mix of two factors: Long-standing policy of generous benefits to unemployed workers• Fall in the demand for unskilled workers relative to skilled ones--> As the wages of unskilled workers fall, more workers view the dole as their best available option. The result is higher unemployment • CHAPTER 7 Pagina 30 a. Explain briefly why the steady state condition is given by the equation sE = fU. b. Suppose that the rate of separations is 5% per month, and the rate of job finding is 20% per month. What is the equilibrium unemployment rate? c. Suppose at the beginning of January, the labour force is 1000 people. The labour market is in steady state. How many people are unemployed? d. A pension reform lowers pensions. 200 pensioners return to the labour force on the 2nd of January. Initially, they are of course unemployed. Compute the unemployment at the beginning of February and of June. a. sE gives the flow of people from employment into the pool of the unemployed. fU gives the flow of the people from that pool back into employment. When the two are equal, the number of unemployed and employed people does not change. b. s = .05, f = .20. The unemployment rate in equilibrium is s/(s+f) = .05 / (.05 + .20) = .05/.25 = 20%. c. With the labour market in steady state, 20% of 1000 people is 200 people. d. After the reform, there are 400 unemployed people, 800 employed. Feb: 20% of 400 = 80 people have found a job. 5% of 800 people = 40 people have lost one. So E = 800 + 80 - 40 = 840, U = 400 - 80 + 40 = 360. U/L = 360 / 1.200 = 30%. Mar: 20% of 360 = 72 have found a job; 5% of 840 = 42 have lost one. E = 840 + 30 = 870, U = 360 - 30 = 330. Apr: 20% of 330 = 66 find a job, 5% of 870 = 44 lose one. E = 870 + 22 = 892, U = 330 - 22 = 308. May: 62 find a job, 45 lose one. E = 909, U = 291. June: 58 find a job, 45 lose one. E = 922, U = 278. Unemployment rate = U/L = 278/1200 = 23%. Notice how the economy gradually adjusts back into equilibrium. An economy reliant on manufacturing experiences a sectoral shift, with demand for the manufacturing products falling and demand for services increasing. The two sectors require different skillsets. a. What happens to the rate of job finding? b. What happens to the rate of separations? c. What happens to the unemployment rate? a. The manufacturing sector has fewer job openings. There are more job openings in services. However, the current population may be specialised for manufacturing and thus be unable to exploit the opportunities. So at least at first the rate of job finding might fall. But it depends on how rapidly the manufacturing declines, and the services expand, relative to each other. b. The rate of separations increases in the manufacturing sector. In the service sector, the rate of separations probably does not increase -- with higher demand, existing service sector firm probably hang on to all the existing labour they have. c. What happens to the unemployment rate depends on what happens to f/s. So if f falls, and s rises, then the unemployment rate can be expected to increase. EXERCISES mercoledì 13 marzo 2024 14:04 CHAPTER 7 Pagina 31 Economic growth raises living standards and reduces poverty--> Anything that effects the long-run rate of economic growth – even by a tiny amount – will have huge effects on living standards in the long run. Neoclassical Theory of economic growth THE SOLOW GROWTH MODEL This theory looks at the determinants of economic growth and the standard of living in the long run. Differences with the classical model (chapter 3) Capital K is no longer fixed--> investment causes it to grow, depreciation causes it to shrink. Thus, this model takes into consideration the effects of TIME. It is a dynamic model. - Labour L is no longer fixed--> population growth causes it to grow. We still start with a fixed labor force- The consumption function is simpler as it is the cost of putting in dynamics- No government spending G or taxation T - Cosmetic differences- We are still in a closed economy SUPPLY FOR GOODS The production function is Y = f(K,L), we assum the function has constant return to scale zY=F(zK, zL) If we set z = 1/L, we get we can define Y/L as the output per worker y and K/L as the capital per worker k, thus y= f(k,1) ---> y = f(k) where f(k)= F(k,1) DEMAND FOR GOODS The demand for good per worker comes from consumption and investment y = c + i (per worker national income identity) c= C/L --> consumption per worker- i= I/L--> investment per worker- This model assumes that each worker Saves a fraction of their income s - saving rate (exogenous)- Consumes a fraction of their income (1-s)- Thus, consumption can be expressed as c= (1-s)*y If we substitute and rearrange the national income identity we get that investment equal savings i=sy=sf(k) The amount of output per worker y is determined by the amount of capital per worker. If k increases by 1 unit, y increases by MPK units. MPK=f(k+1)−f(k) For any given capital stock k, the production function y=f(k) determines how much output the economy produces, and the saving rate s determines the allocation of that output between consumption and investment. CAPITAL ACCUMULATION & POPULATION GROWTH giovedì 14 marzo 2024 10:45 CHAPTER 8 Pagina 32 We now consider population growth in the Solow model. We assume that the population (thus, the labour force) grow at rate n (exogenous). The growth in the number of workers causes capital per worker to fall, as the existing capital stock is spread more thinly over a larger population of workers. The break-even investment is the amount of investment (per capita) necessary to keep k constant. It is denoted as (δ + n)*k. It includes: Δk--> to replace the capital that wears out- nk--> to equip new workers with capital- The EQUATION OF MOTION WITH POPULATION GROWTH becomes Δk = sf(k) - (δ + n)*k Per capita GDP does not change in the long run, but as population grows the total GDP increases as well. POPULATION GROWTH: ALTERNATIVES PERSPECTIVES Malthusian model--> Predicts population growth will outstrip Earth’s ability to produce food, leading to the impoverishment of humanity. Malthus neglected the effects of technological progress. - Kremerian model--> Population growth contributes to economic growth. More people = more geniuses, scientists, and engineers, so faster technological progress. Historically, regions with larger populations have enjoyed faster growth. - An increase in n causes an increase in break even investment, leading to a lower steady state level of k When sf(k) is equal to (δ + n)*k , we are in the steady-state condition POPULATION GROWTH giovedì 14 marzo 2024 12:05 CHAPTER 8 Pagina 35 Consider the Solow growth model. a. Explain the intuition behind the Solow growth model steady state condition is given by sf(k*) = delta k*. Suppose that the production function is F(K) = K1/3L2/3. b. Compute the production function for per-capita output, f(k). NOTE: you can write powers with the notation ^, i.e. xn can be written "x^n", or you can use the superscript option in the text editor. c. Suppose the depreciation rate is delta = 10% per year. If the saving rate is s = 10%, what is the steady- state capital stock? d. If the saving rate is instead s' = 20%, what is the steady state capital stock? e. Suppose the initial capital stock is k(0) = 2 (here, the argument zero refers to the 'initial time'). Describe how the capital evolves under saving rates s and s'. a. The left-hand side sf(k) gives the gross investment at capital stock k. The right-hand side, delta k, gives the depreciation when the capital stock is k. Gross investment increases the capital stock; depreciation decreases it. The steady state k* is defined as the capital stock level at which the two are the equal, so that capital stock does not move, or that DELTA k* = sf(k*) - delta k* = 0. (Note that I have emphasised the capital DELTA, which denotes differences, from the lowercase delta which is the depreciation rate.) b. F(K,L)/L = K^1/3 L^2/3 / L = K^1/3 L^(2/3 - 1) = (K/L)^1/3 = k^1/3; thus f(k) = k^1/3. c. Definition of steady state: sf(k*) = delta k*, or sk*^1/3 = delta k*. Rearrange to get k*^(1-1/3) = s/delta, or k*^2/3 = s/delta, so that k* = (s/delta)^3/2. With delta = .1, s = .1, s/delta = 1 and k* = 1. d. With s' = .2, we have s'/delta = .2/.1 = 2, and k* = 2^(3/2), which is approximately 2.83 (or 2 times the square root of 2). e. With an initial capital stock of 2: if s = .1, then the initial capital stock is above the steady state level k* = 1. The capital stock starts decreasing over time, approaching k* = 1. If instead saving is s' = .2, then the initial capital stock is lower than the steady state level k* = 2.83, so that the capital stock starts increasing over time towards k* = 2.83. EXERCISES martedì 12 marzo 2024 15:56 CHAPTER 8 Pagina 36 In the Solow model we assume technology is fixed. However, this assumption is false in the real world. The model can be modified to include exogenous technological progress. We introduce: E--> labour efficiency, it reflects society's knowledge about production methods. - It must also be noted that technological progress is labour augmenting: it increases labour efficiency at the exogenous rate g --> This increase in labour efficiency have the same effect as an increase in labour force--> we do not have more labour, but as the one we have is more efficient, output increases Y F(K, L*E) L*E --> effective number of workers- y= Y/LE--> output per effective worker- k= K/LE--> capital per effective worker - Production function per effective worker--> y=f(k)= F(K/LE,1)- Saving and investment per effective wroker--> sy = sf(k)- Because the labor force L is growing at rate n, and the efficiency of each unit of labor E is growing at rate g, the effective number of workers L×E is growing at rate n+g. is the break-even investment with population growth to keep k constant- to repleace depreciating capital- to provide capital for new workers- to provide capital for the new effective workers created by technological progress- THE EFFECTS OF TECHNOLOGICAL PROGRESS Output per worker--> Because y is constant in the steady state and E is growing at rate g, output per worker must also be growing at rate g in the steady state. - Total output--> Because y is constant in the steady state, E is growing at rate g, and L is growing at rate n, total output grows at rate n+g - According to the Solow model, only technological progress can explain sustained growth and persistently rising living standards. ECONOMIC GROWTH venerdì 15 marzo 2024 14:20 CHAPTER 9 Pagina 37