Intermediate Macroeconomic Theory
Intermediate Macroeconomic Theory ECON 302
Popular in Course
Popular in Economcs
This 13 page Class Notes was uploaded by April Jerde on Thursday September 17, 2015. The Class Notes belongs to ECON 302 at University of Wisconsin - Madison taught by Staff in Fall. Since its upload, it has received 8 views. For similar materials see /class/205163/econ-302-university-of-wisconsin-madison in Economcs at University of Wisconsin - Madison.
Reviews for Intermediate Macroeconomic Theory
Report this Material
What is Karma?
Karma is the currency of StudySoup.
Date Created: 09/17/15
1 Costs of Inflation a ShoeLeather Costs As in ation occurs it becomes more costly to consumers hold cash As such individuals want to save their money or make purchases as soon as they are paid and hold less cash thus requiring more trips to the store or the bank and having individuals wear out their shoe leather Because individuals don t want to hold cash they must also go to the bank more often to make withdrawals in order to make purchases This causes individuals to transfer time into these efforts instead of working and leisure thus reducing the overall happiness of individuals and also lowering the production of the economy b Menu Costs As in ation occurs it becomes more costly to producers to have the same prices With each passing day the prices fall in real terms and as such producers must adjust their prices in order to hold the real price constant Changing the sticker price of products is referred to menu costs which is clear for restaurants However for other producers these costs may include changing the sticker prices on items or the shelf changing the costs that ring up in the computer system and printing new catalogs or price lists c Greater Variability in Relative Prices Since everyone is unlikely to change their menus on the same day the relative prices will continue to uctuate Thus individuals will have a harder time making decisions as each time they go shopping they will either search out prices again or make a decision on limited information it Tax Law Taxes are based on nominal earnings and as such the desired real cutoffs of current tax laws will change with in ation Distortion occurs to consumers in the form of paying taxes on nominal gains even though there may be zero real gains e General Inconvenience f Redistribution of Wealth with unexpected inflation Contracts are set for nominal interest rates and as such when unexpected in ation occurs there is s change in the real interest rate of those contracts With higher unexpected in ation borrowers gain in the form of paying back lower real interest rates Lenders on the other hand loose in the form of receiving lower real interest rates 2 Unemployment a Frictional Unemployment i Friction unemployment is considered shortterm that occurs as a result of the time it takes individuals to look for a new job ii Is affected by government policies like unemployment insurance positively related job training negatively related and job information negatively related b Structural Unemployment i Structural unemployment is considered longterm and results from wage rigidity and job rationing ii Minimum Wage Laws can be such that the marginal product is less than the minimum wage creating an excess supply of laborers iii Monopoly power of unions can also cause a similar excess supply of laborers as the bargaining power of the union commands a higher than normal wage iv Ef ciency Wage is a wage that is higher than the market clearing equilibrium wage which is assumed to be the economy wide marginal product of labor with identical workers The higher wage is paid by the employers to increase productivity and ef ciency The increased productivity as a result of the ef ciency wage more than pays for the relative increase in the wage thus increasing profits Reasons for an Ef ciency Wage Morale Higher wages may increase the moral of workers and thus promote higher productivity Selection Higher wages allow the employers to attract better workers and be more choosey in the hiring process Adverse Selection TumoverTraining Costs Higher wages likely reduce worker turnover as there is less incentive to look for a job elsewhere Lower turnover reduces training costs Work Harder As the wage is greater than the average wage the cost of losing the job becomes greater and thus gives workers an incentive to work harder and make sure they do not lose that job Moral Hazard Health Ifthe average marginal product is so low that workers cannot healthily live on it an ef ciency wage will increase production by allowing workers to become healthier and avoid illness and be stronger O O O 0 Examples of Ef ciency Wages in Real Life Q Costco 39nttn 39 on com 2020 Business storvidl362779 9 Minimum Wage Differences across state lines httpwww nvtimes com 2007011 lusl 39 39 html r1quot J 391ampnuf 39 quot J 39 12041 318702fol46f39YgVu47ElZOt8 2 3 Review Material a Chapter 1 l Terms Macroeconomics Real GDP In ation and de ation Unemployment Recession Depression Models b Chapter 2 l Terms Gross Domestic Product GDP Consumer Price Index CPI Unemployment Rate National income accounting Stocks and ows Value added Imputed value Nominal versus real GDP GDP de ator National Income accounts identity Consumption Investment Government purchases Net Exports Labor Force Laborforce participation rate c Chapter 3 l Terms Factors of Production Production function Constant returns to scale Factor prices Competition Pro t Marginal product of labor Diminishing marginal product Real wage Marginal product of capital Real rental price of capital Economic pro t versus accounting pro t CobbDouglas production function Disposable Income Consumption Function Marginal Propensity to Consume Endogenous Variables Exogenous variables Market Clearing Flexible and sticky prices Microeconomics ii Formulas Q Qd Prices Income ii Formulas Real GDP base price x quantity Nominal GDP price x quantity GDP de ator Nominal GDPReal GDP Y C I G NX NNP GNP 7 Depreciation NI NNP 7 Indirect Business Taxes PI NI 7 corporate pro ts 7 social Insurance contributions 7 net interest 7 dividends government transfers to individuals personal interest income DPI PI 7 taxes Unemployment Rate Unemployed Labor Force 100 LFPR labor force adult population 100 Interest Rate Nominal Interest Rate Real Interest Rate National Savings Private Savings Public Saving Loanable Funds Crowding Out ii Formulas K xed L xed Y F KL is xed Pro t PY 7 WL 7 RK MPL FKLl 7 FKL MPL W P pro t max MPK FK1L 7 FKL MPK R P pro t max FKL AKalphaL1alpha Capital Income alphaY MPKK Labor Income l alphaY MPLL MPL lalpha Y L MPK alpha Y K Y C I G C CYT d Chapter 4 i Terms In ation Hyperin ation Money Store of value Unit of account Medium of exchange Fiat money Commodity money Gold standard Money supply Monetary policy Central bank Federal Reserve Openmarket operations Currency Demand deposits Quantity equation Transactions velocity of money Income velocity of money Real money balances 2 Chapter 6 i Terms Natural rate of unemployment Frictional unemployment Sectoral shift Unemployment insurance Wage rigidity Structural unemployment Insiders verses outsiders I Ir G xed T xed Y C SPT SIg T 7 G S SPSg S I in equilibrium Money demand function Quantity theory of money Seigniorage Nominal and real interest rates Fisher equation and sher effect Ex ante and ex post real interest rates Shoeleather costs Menu costs Real and nominal variables Classical dichotomy Monetary neutrality ii Formulas Quantity Equation MVPY MPdkY V1k r i 7 TE i r 71 MP LiY Lr 71 Y Ef ciency wages Discourage workers ii Formulas LUE fUsE ULssf 1 List of Review Material as taken from Mankiw Macroeconomics a Chapter 1 i Terms Macroeconomics Real GDP In ation and de ation Unemployment Recession Depression Models b Chapter 2 i Terms Gross Domestic Product GDP Consumer Price Index CPI Unemployment Rate National income accounting Stocks and ows Value added Imputed value Nominal versus real GDP GDP de ator National Income accounts identity Consumption Investment Government purchases Net Exports Labor Force Laborforce participation rate c Chapter 3 i Terms Factors of Production Production function Constant returns to scale Factor prices Competition Pro t Marginal product of labor Diminishing marginal product Real wage Marginal product of capital Real rental price of capital Economic pro t versus accounting pro t CobbDouglas production function Disposable Income Consumption Function Endogenous Variables Exogenous variables Market Clearing Flexible and sticky prices Microeconomics ii F ormalas Q Qd Prices Income ii F ormalas Real GDP base price x quantity Nominal GDP price x quantity GDP de ator Nominal GDPReal GDP Y C I G NX NNP GNP 7 Depreciation NI NNP 7 Indirect Business Taxes PI NI 7 corporate pro ts 7 social Insurance contributions 7 net interest 7 dividends government transfers to individuals personal interest income DPI PI 7 taxes Unemployment Rate Unemployed Labor Force 100 LFPR labor force adult population 100 Marginal Propensity to Consume Interest Rate Nominal Interest Rate Real Interest Rate National Savings Private Savings Public Saving Loanable Funds Crowding Out ii Formulas K xed L xed Y F K L is xed Pro t PY 7 WL 7 RK MPL F K L1 7 F K L MPL W P pro t max MPK F K1 L 7 F K L MPK R P pro t max F K L 7 AK L139 Capital Income alphaY MPKK Labor Income l alphaY MPLL d Chapter 4 i Terms In ation Hyperin ation Money Store of value Unit of account Medium of exchange Fiat money Commodity money Gold standard Money supply Monetary policy Central bank Federal Reserve Openmarket operations Currency Demand deposits Quantity equation Transactions velocity of money Income velocity of money Real money balances e Chapter 5 i Terms Net Exports Trade Balance Net Capital out ow Trade Surplus and Trade De cit Balanced Trade Small open economy World interest Rate Nominal exchange rate Real exchange rate Purchasingpower parity MPL lalpha Y L MPK alpha Y K Y C I G C CYT I Ir G xed T xed Y C SPT Sg T 7 G S SPSg S I in equilibrium Money demand function Quantity theory of money Seigniorage Nominal and real interest rates Fisher equation and sher effect Ex ante and ex post real interest rates Shoe leather costs Menu costs Real and nominal variables Classical dichotomy Monetary neutrality ii Formulas Quantity Equation Mv7 PT Mv7PY MP dkY v7 1k r i 7 TE i r 71 MP 7 L i Y 7 Lr 71 Y ii Formulas Net Exports YCd1dGdEX C 7 Cd Cf I 7 Id If G 7 Gd Gf Y 7 CCf IIf GGf EX YCIGEX7CfIfGf YCIGEX7IM Y C I G NX SINX Small Open Economy f Chapter 6 l Terms Natural rate of unemployment Frictional unemployment Sectoral shift Unemployment insurance Wage rigidity Structural unemployment Insiders verses outsiders g Chapter 7 l Terms Solow Growth Model Steady State Golden Rule level of capital ii Formulas Solow Model YF K L YLF KL l yf k MPK fkl f k yci c ls y y ls yi h Chapter 8 l Terms Ef ciency of Labor Laboraugmenting technological progress ii Formulas Solow Model YF K LE rr Y 7 F K L xed C7 CYT 17 Ir NX 7 SIr F K L 7 AK L139 MPK 7 1A KL 391 se PP es PP NX 7 NX s AeA s 7I TE Ef ciency wages Discourage workers ii Formulas L U E fU sE U L s s f i sy sf k Aki75ksfk75k Steady State Ak 0 sfk 7 5k kfk s5 Golden Rule cf k 5k MPK5 Population Growth Ak i 7 5n k sf k 7 5n k cf k 5n k MPK5n MPK 7 5 n Ak sf k 7 5ng k cf k 5ng k MPK5ng MPK 7 5 ng l Chapter 9 l Terms Okun s Law Leading indicators Aggregate Demand Aggregate Supply Shocks Demand Shocks j Chapter 10 l Terms ISLM Model IS curve LM curve Keynesian cross Govemmentpurchases multiplier Tax multiplier Theory of liquidity preferences k Chapter 11 l Terms Monetary transmission Mechanism Pigou effect Debtde ation theory l Chapter 13 l Terms Stickyprice model Stickywage model Imperfectinformation model Phillips curve Adaptive expectations Demandpull in ation Costpush in ation Sacrifice ratio Rational expectations Naturalrate hypothesis Hysteresis Supply Shocks Stabilization Policy ii Formulas MVPY MP MP d kY YF K L f1xed ii Formulas ECIG CCYT YE CYTIrG AYAG11MPC AYAT MPClMPC MP S M P MP d LrY MP S mgr ii Formulas Y CYTIin G MP LiY ii Formulas Y Ym PPe P P a YY P PC ls a s YY W m P6 WP 03 PeP L LdWP Y F L TE nei u7uquotv TE 7I175u7uquotv Economics 302 Spring 2005 Practice Questions for Chapter 3 Multiple Choice Questions for a Quick Review 1 2 E 4 UI 0 A competitive rm a Is a price taker in both the output and the product markets b Is a price taker in the output market but not the product market c Is a price taker in the product market but not the output market d Is not a price taker in either the product nor the output market A production function is a mathematical statement that a Relates the level of output to the level of inputs used b Expresses the relationship between the prices of factors of production and the level of output produced c Expresses the relationship between the amount of inputs used and the prices of those inputs d May have the property of increasing returns to scale or constant returns to scale but not the property of decreasing returns to scale Aggregate income in an economy is a Equal to the total number of dollars earned by workers b Always equal to aggregate production in that economy c Equivalent to the dollar amount of payments made to owners of capital d Equal to the total number of dollars earned as pro ts by rm owners Constant returns to scale occurs when a The production function is linearly homogenous b The exponents of capital and labor in the production function sum to one c A doubling of inputs results in a doubling of output d All of the above Firms should continue to hire labor up to that point where a The marginal product of labor is just greater than the market wage rate b The market wage rate is just greater than the marginal product of labor c The marginal product of labor for the last unit of labor is just equal to the real wage rate d The marginal product of labor for the last unit of labor is just equal to the price of the output According to Euler s Theorem total output is equal to the sum of all factor payments provided that a Each factor of production is paid a real wage equal to its marginal product b The production function is linearly homogenous that is it has constant returns to scale gt1 9 0 O c Equal amounts of capital and labor are used d a and b d All of the above Which of the following transactions is not counted as investment in the national income accounts a A homeowner purchases a new washer and dryer for their home b A homeowner purchases a new computer for their children c A museum purchases a painting by Van Gogh for 40 million d A homeowner purchases a new home built during the current calendar year Which of the following statements is true Total saving is equal to the sum of private saving plus public saving Public saving is equal to G 7 T Private saving is equal to Y 7 C 7 G Private saving is equal to Y 7 C 7 G 7 T 9 0quotm Which of the following statements is true If national saving is not dependent upon the level of interest rate then an increase in government spending holding everything else constant must a Increase the interest rate b Decrease the interest rate c Reduce the budget deficit d Increase the level of private investment Which of the following statements is true If national saving is not dependent upon the level of interest rate then a decrease in taxes holding everything else constant must Increase the interest rate Decrease the interest rate Have no effect on the interest rate May increase or decrease the interest rate depending upon how businesses alter their investment spending in response to the decrease in taxes 999 If the consumption function is C 100 5Y 7 T then if disposable income decreases by 500 then consumption will a Increase by 250 b Decrease by 500 c Increase by 500 d Decrease by 250 Ifthe consumption function is C 100 5Y 7 T and Y 4000 and T 500 then the marginal propensity to consumer equals a 1750 b 1850 c 5 d 2000 13 A CobbDouglas production function Problems 1 a Exhibits constant returns to scale b Is a production function that has a constant ratio of labor income to capital income c Exhibits diminishing marginal productivity of labor d Exhibits diminishing marginal productivity of capital e All of the above Suppose you operate a rm with a xed amount of capital K 4 units where capital costs 10unit In addition to the capital you use you also employ labor L You also know the relationship between the factors you employ and the output Y you produce can be summarliEed in the following equation L YFKLAK 2 where A has a value of 2 You also know that the output produced by this competitive firm is sold for 10 per unit and that the nominal wage is equal to rm in the table below a of Units of Marginal Product of Marginal Nominal Real Wage Workers Output Labor approximation Product of Wage using the change in Labor output divided by the calculate change in labor using calculus l x x 2 3 4 5 9 16 25 36 b Graph this firm s production function Make sure you label the axes in your graph c Draw a second graph beneath your first graph and label the horizontal axis with the same units as the horizontal axis from the first graph On this second graph plot out the f1rm s marginal product of labor Label the vertical axis appropriately d Does this firm experience diminishing marginal product of labor as it expands its use of labor e What level of labor should this firm employ And what is the real wage rate at this level of production f Why should this firm not hire 16 workers Explain your answer Why should this rm not hire 2 workers Explain your answer What happens to the f1rm s demand for labor if the product price increases holding everything else constant What happens to the f1rm s demand for labor if the nominal wage rate decrease holding everything else constant j What happens to the f1rm s demand for labor if the value of A increases holding everything else constant P Q 2 Suppose you have a CobbDouglas production function described by the equation below Y 5K14L34 a Complete the following table 400 b Does constant returns to scale allow for rounding error Can you provide a mathematical proof of this based on the lecture material If this firm decides to hire 50 workers what must the value of the real wage equal If this firm decides to hire 200 units of capital what must the value of the real rental price of capital equal oo D f If this firm hires 50 workers and 200 units of capital what is labor s share of output g If this firm hires 50 workers and 200 units of capital what is capital s share of output h Does this sum of the value you found in f and the value you found in g sum to the value of output allow for rounding error 3 Suppose you are given a consumption function C 100 8Y 7 T a b Is the given consumption function a linear function with respect to disposable income Explain your answer 4 5 c What is the marginal propensity to save Provide a mathematical proof for your answer d What does the slope of the consumption function tell you Suppose that there are two factors of production K and L that are fully employed in the economy we are studying The following production function describes this closed economy which is operating at full employment Y constant Y FK L 1000 In addition to this information you know that 0 Consumption spending equals 100 when disposable income is zero and that the marginal propensity to consume is equal to 75 0 Investment is an inverse function of the interest rate r and that when the interest rate increases by 1 percentage point investment falls by 20 0 Investment is equal to 400 when the interest rate is zero 0 Government spending is constant at 100 0 Taxes are constant at 50 What is the level of consumption in this economy What is the level of private saving in this economy What is the level of public saving in this economy What is the level of national public plus private saving in this economy Write an equation expressing the investment function for this economy What is the value of investment for this economy in equilibrium What must the equilibrium interest rate by for this economy wrung96x Use the economy described in problem 4 to answer this question a Suppose government spending increases to 150 What will be the effect of this change on this economy Explain your answer b How does a graph of saving and investment change with the events described in a Now instead of events described in a suppose the government increased taxes to 100 What will be the effect ofthis change on this economy Explain your answer How does a graph of saving and investment change with the events described in c Does fiscal policy have the potential to alter the level of aggregate output in the Classical Model What would happen in this model if there was a exogenous change in investment demand assume we are back with the initial model no changes in G or T such that investment is now 50 more at every interest rate How does a graph of saving and investment change with the events described in f 0 3 1 D quot1 0