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midterm 2 313

by: Theo Friedman

midterm 2 313 Econ 313

Theo Friedman
GPA 3.72
Intermediate Macro Economics
John Voorheis

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Intermediate Macro Economics
John Voorheis
Study Guide
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This 6 page Study Guide was uploaded by Theo Friedman on Sunday May 17, 2015. The Study Guide belongs to Econ 313 at University of Oregon taught by John Voorheis in Spring 2015. Since its upload, it has received 153 views.


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Date Created: 05/17/15
Midterm 2 Econ 313 Labor market 0 The unemployment rate is U LF 0 LFPR is UEP and employment 0 population ratio is EP The household survey is designed to measure the unemployment rate The Establishment survey is designed to track employment the number ofjobs lf fewer hires the chance of an unemployed worker finding a job falls lf firms layoff workers the employed experience a higher risk of losing theirjobs Wages We now consider how wages are determined This could be done in a number of different ways 0 l Collective Bargaining is common for unionized jobs 0 l Employers will often post wages they set the wage workers can take it or leave it o I If workers have scarce skills they will often be able to negotiate for higher wages The bargaining power of a worker depends on How costly it is for the rm to replace a worker Required job skills How difficult it is for a worker to nd another job Labor market conditions W Pe F u z 39339 W denotes aggregate nominal wage Pe denotes the expected price level u denotes the unemployment rate inversely related to wages 2 denotes all other variables that are positively correlated with wages We can use this to establish a relationship between real wages and the markup over marginal cost called the pricesetting relation WP11m 0 At the natural rate of unemployment we get the natural level of employment 0 Nn L1 nun Yn L1 un o Rearranging this equation one can show that un 1 nYnL l l PS 3 Real wage WIP 3 A A l PS I W3 u u Ulnemplloymenlt rate u Aggr Supply 0 aggregate supply relation captures the effects of output on the price level 0 P Pe1 mF 1YL Z n o This gives us a relation between the price level P the expected price level Pe and output 0 the price level also depends on the markup m the size of the labor force L and the catchall 2 which includes eg unemployment benets AS A8 for expected price level Pa 7 Tl l Tl E A Price level P I I Yr Output Y Aggr Demand 0 The aggregate demand relation captures the effect of the pricelevel on equilibrium output in the goods and money markets 0 YYMPGT We can think of two equilibria then a short run equilibrium where Pe is fixed and a medium run equilibria where Pe is flexible short run Pe isn39t equal to the true price Price level P Output Y Medium run wage setters revise expectations 1amp3quot AS39 Price level P p AFT PE i l v w v Output Y In the short run 0 l Output can be above or below the natural level of output 0 l Changes in any of the variables that enter the AS or AD relation lead to changes in output and to changes in the price level In the medium run 0 l Output returns to the natural level of output 0 I This adjustment works through changes in the price level 0 I When output is above the natural level of output the price level increases which decreases demand and output Monetary policy 0 In the short run expansionary monetary policy decreases interest ratesand increases output It also slightly increases prices 0 I As time goes on however wage setters adjust their price expectationslf monetary policy pushed output past its natural rate then the AS curve will shift up as price expectations catch up with real prices 0 I In the medium run output cannot be pushed above its natural rate lnfact the only medium run effect is an increase in prices Deficit reduction EIHZI Price level P 39 rI urlput rill L i i39 it Interest rate i urlputg if Philpis Curve Let 1T denote the inflation rate and 1Te denote the expected inflationrate Then with some annoying algebra one can show that o 1T1Temzdu Substituting 1Te 0 into Equation 2 yields 0 1Tt m z dUt wageprice spiral Low unemployment leads to higher nominal wages This leads firms to increase prices and a higher price level An increase in the price level leads workers to ask for higher wages nexttime wages are set The higher nominal wage leads to further increases in the price leveletc ThPONT that before about 1960inflation was more likely tooscillate around 0 After 1960 inflation is bothconsistently positive and morepersistent 1Tt 91Tt 1 m z out If 9 0 then we just have the original Phillips Curve lf 0 lt e lt 1 then inflation depends on last periods inflation but on aless than one for one basis For 9 1 As the value of 9 increased fromO to 1 the original Phillips curverelationship disappeared This relation is often called the expectations augmented Phillips curve 1Tt 39th1 dUt Un c When unemployment is above its natural rate inflation is decreasingwhen unemployment is below its natural rate inflation is increasing At Ut Un inflation isn t changing Hence another name for the natural rate of unemployment is oftenthe NAIRU the nonaccelerating inflation rate of unemployment since 1970 in the US the average rateof unemployment required to keep inflation constant has been equalto 6 Neutrality of Money lf unemployment is at it s natural level then the aggregate demandrelation becomes Yn YMP G T 0 Let gM be the growth rate of money Assume that 1T the growth rate of prices inflation is above zero Then AM P O gt 1T gM o In the medium run the rate of inflation is determined by the rate of money growth Nothing about the Phillips curve relationship we ve studied requires itto be constant over time nor across different countries he natural rate of unemployment depends on factors that affectwages 2 firms markups over marginal cost m and the response of inflation to unemploymentThere s no reason these are the same across countries Lucas Critique estimates of relationships from past data may notaccurately predict future outcomes if people s expectations change Wage lndexation a provision thatautomatically adjusts wages for inflation o This leads to a stronger response of inflation to unemployment the PhillipsCurve relation breaks downwhen there is deflation Expectations Nominla vs Interest rate real interest rates 0 Real interest rates are expressed in terms of units of goods 0 if we borrow 1 unit of goods at a real interest rate ofr 005 we agree to pay back 1 r 1 05 units of goods in the future 0 nominal interest rates are real interest rates adjust for expected ination 1 r1 i 1 et1 R i 1T t1 investment will depend on the real interest rate ri we The interest rate that central banks can affect is the nominal interest ratel The interest rate that affects output is the real interest ratel So the effectiveness of monetary policy depends on how changes in the nominal interest rate translate into changes in the real interest rate Discounted present values 0 the value ofnunits of goods next year in terms of today39sconsumption is n1r o the present value of consuming n units in two periods 11rt1rt1 n o The expected discounted present value of a flow of consumption is Vzt11 rt zet1 11 rt 1 ret1 zet2 households care only about consumption ofgoodsso they discount by the real interest rate VYeLTeL 11 ret YetTet 1 1 ret1 ret1 Yet2 Tet2 assume that consumption depends on both current disposable income as well as the discounted present value of future disposable income CCYt Tt VYeLTeL


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