Week 8 Notes
Week 8 Notes Econ 322
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This 3 page Class Notes was uploaded by Tulsi on Thursday March 3, 2016. The Class Notes belongs to Econ 322 at University of South Carolina taught by Hauk in Spring 2016. Since its upload, it has received 17 views. For similar materials see Intermediate Macroeconomics in Economcs at University of South Carolina.
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Date Created: 03/03/16
Week 8 Notes Thursday, March 3, 2016:55 PM LM r NCO-Net Capital Outflow (Savings - Investment = NCO = NX) r -decreasing function of domestic interest rate (r) -increasing function of world interest rates (r*) -NCO(r,r*) IS NCO Y NCO Open trade, some capital mobility IS: Y = C + I(r) + G + NX(e(r)) LM: M/P = L(r,Y) e -Net Exports is an decreasing function of the exchange rate -The exchange rate is a positive function of the interest rate -Investment is a decreasing function of interest rate NX(e) NCO NX, NCO Fiscal Policy: Government spending increases Monetary Policy: Increase money supply -IS Shifts right -LM shifts right -Y increases -Y increases -r increases -r decreases -Domestic Investment decreases -Domestic Investment increases -Net Capital Outflow decreases -Net Capital Outflow increases -exchange rate increases -exchange rate decreases -Net Exports decrease -Net Exports increase -2 crowding out effects -less investment -less net exports r = r* + Week 8 Page 1 r = r* + Types of Risk: -Political Risk -Default Risk -Exchange Rate Risk SHORT RUN LM*: M/P = L(r* + If -both curves will be affected -r goes up -IS* shifts left -LM* shifts right because Y goes up to offset rise in r -e decreases due to both shifts -In the short run, GDP (Y) goes up -Decrease in e causes net exports to increase -Investment is decreasing due to increase in r -NX increases enough to offset decrease in investment IS*: Y = C+I(r* + IN THE LONG RUN -It is not a good idea to be seen as a risky country and investments will eventually settle down or decrease Flexible Exchange Rate Fixed Exchange Rate -Independent monetary policy -Lower Exchange rate risk -increase in foreign investment -increase in foreign trade 3 policy choices CAN'T HAVE ALL 3 AT SAME TIME, ONLY 2 -Free capital flows -fixed exchange rates -independent monetary policy United States: free capital flows/independent monetary policy China: independent monetary policy/fixed exchange rate Hong Kong: fixed exchange rate/free capital flows 3/3/16 If a large, foreign country raises taxes: -interest rate in foreign country falls -world interest rate falls -domestic interest rate falls -domestic investment increases -Savings/Investment curve shifts left -€ increases and Net exports decreases If prices are higher than expected, Y would be greater than Y If prices are lower than expected, Y would be less than Y If people expect higher prices, SRAS will shift up If people expect lower prices, SRAS will shift down Week 8 Page 2 Sticky Price Model Firms' desired price (p): Some firms have sticky prices: Some: fraction of firms s (0<s<1) These firms set prices based on expectations about the economy psticky E[P] + a(E[Y] -Y) Assume E[Y] = Y psticky E[P] Some firms have flexible prices 0<1-s<1 These firms update prices based on current macroeconomic variables pflex P + a(Y-Y) Actual Aggregate Price Level (P) P = s*psticky (1-s)pflex *substitute above equations* P = s*E[P] + (1-s)[P + a(Y-Y)] *do a lot of algebra and manipulation that Hauk will not test* End up with: Y + If s = 1 (all firms have sticky prices) -SRAS is horizontal If s = 0 (all firms have flexible prices) -SRAS is vertical The more firms have flexible prices, the steeper the slope of SRAS Imperfect Information Model -All firms have flexible prices -Not all firms have good information about the economy, especially at aggregate price level -firms have trouble distinguishing between relative price change and general price change Week 8 Page 3
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