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Intermediate Macroeconomic Theory

by: Cristian Dicki

Intermediate Macroeconomic Theory ECON 3133

Marketplace > University of Oklahoma > Economcs > ECON 3133 > Intermediate Macroeconomic Theory
Cristian Dicki
GPA 3.83


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This 42 page Class Notes was uploaded by Cristian Dicki on Monday October 26, 2015. The Class Notes belongs to ECON 3133 at University of Oklahoma taught by Staff in Fall. Since its upload, it has received 19 views. For similar materials see /class/229250/econ-3133-university-of-oklahoma in Economcs at University of Oklahoma.


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Date Created: 10/26/15
Lecture 4 ECON 313302 September 6 2005 Coverage Chapter 3 Reading assignment Continue reading chapter 3 Class questions 1 We speci ed behavioral equations associated with demand and supply for the components of GDP a Fquot C Write down the behavioral equations for both demand and supply Demandfor GDP at time t c0 cth l G clYt Supplyfor GDP at time t Y Solve for equilibrium output Y CO CIIE Fj FG FCIYt gtYt7c1Yt CO CIJZ Fj FG gt17c1z c07c1T 116 gtj c07clz iG1 17c1 You are provided the following information Behavioral equation for consumption Ct 20000 5YD1 where YDt is disposable income Behavioral equation for investment It20000 Behavioral equation for government spending Gt 20000 Use this information to solve for equilibrium output as a function of taxes First let s calculate the demand for GDP Demandfor GDP at time t20 0005Y 5T20 00020 000 60 0005Y 5T Supply ofGDP at time tY Equilibrium output results from setting these two equations equal to each other anal solving for Y Y 7 60000 5Y 7 5T gt SY 60000 7 ST gt Y 7 120000 7 T d Refer to part c Provide the following quantities 1 Autonomous spending when taxes are equal to 10000 and autonomous spending when taxes are equal to 20000 ii ii39 From above we have the following for demand Demand 60000 5Y 5T When taxes are 10000 Demand 60000 5Y7 5000 55000 5Y Thus autonomous spending the component of demand independent ofoutput is 55 000 When taxes are 20000 Demand 60000 5Y7 10000 50000 5Y Thus autonomous spending is 50 000 when taxes are 20 000 The taxation multiplier and government spending multiplier Here we don t need to know the level of taxation to figure out the taxation multiplier Since equilibrium output is given by 1 17c1 Y t c0 7 CIT i G the taxation multiplier the coef cient in front of taxes is 7 5 7 175 1 17 c1 since the marginal propensity to consume c1 is 050 Conversely the government spending multiplier is given by The level of equilibrium output when taxes are equal to 10000 and when taxes are equal to 20000 We can use theformulafrom 1c above to determine equilibrium output When taxes are 10 000 we have Y 120000 10000 110000 When taxes are 20000 we have Yr 51200007 520000 100000 e p1 at the actual points associated with the demand for GDP on a 2 dimensional graph for both levels oftaxa on Let incomeoutput appeai the graph indicate how a change in taxes affects the graph and equiiihnuin Below Ipzotpieeise paintsfm both demand ewes A end 172 seen deezine m Equilibrium Gulpul Supply Demand Pmducuan Denindi 125mm Demindz 1 mm mm mama 1 0 i i 7SEIEIE i i mm 1 ZSEIEIE 1 i 25min snhnn 75min mama izsnnn mcame Lecture 20 ECON 313302 November 10 2005 Reading assignment Chapter 7 Class questions 1 N From our model in chapters 35 we know that a change in scal policy only affected the IS curve As seen in class today however a change in scal policy was followed by a change in the prices For example shortly after expansionary scal policy is implemented the LM curve shifted slightly back and to the left Why did the LM curve shift The LM curve did NOT shift because of a change in fiscal policy For example expansionary fiscal policy leads to a shift in the IS curve causing aggregate demand to increase As aggregate demand increases prices increase This increase in prices leads to a reduction in the real supply of money causing a slight backward shift in the LM curve De ne money neutrality Money neutrality refers to the e ects of monetary policy on medium run output and interest rates In particular according to our model changes in monetary policy only impacts prices with no effect on medium run output or interest rates 3 Consider an economy operating at full employment For each of the following policies below indicate the immediate and medium run effects on prices output unemployment and interest rates It is not necessary to use graphs Expansionary Monetary Policy Contractionary Monetary Policy Expansionary Fiscal Policy Contractionary Fiscal Policy Short Run P Increase X Increase U Decrease i Decrease Short Run P Decrease X Decrease U Increase i Increase Short Run P Increase X Increase U Decrease i Increase Short Run P Decrease X Decrease U Increase i Decrease Medium Run P Increase Sharply Y Back to Y N U Back to U N 139 Back to original level Medium Run P Decrease sharply Y Back to Y N U Back to UN 139 Back to original level Medium Run P Increase Sharply Y Back to Y N U Back to U N 139 Increase Sharply Medium Run P Decrease Sharply Y Back to Y N U Back to U N i Decrease Sharply Lecture 18 ECON 313302 October 29 2005 Reading assignment Chapter 7 1 Aggregate supply a You are given the following information futztl2ut Further suppose that the labor force is equal to 100000 and expected prices are 100 Calculate the natural rate of output aka full employment or potential GDP Below plot the aggregate supply curve Recall that the natural rate of unemployment uN was related to the natural level of employment NN and full employment GDP YN as follows 7 LF 7ND 17 NN 17 YN LF LF LFi Note that last part follows from the aggregate production function since Y N As part of the previous assignment we showed that the natural rate of unemployment was 010 using the information above Thus since the size of the labor force is 1 00 000 people we have MN 0101YN gt 10000 100000 7 YN gt YN 90000 Thus the natural rate of output is 90000 Now to plot the aggregate supply curve we calculate the equilibrium wage rate We have from wage setting labor supply W1 Pf12u Y gtW 10017217 t 100000 Y gtW 100 71 Y 50000 gtW 7100 500 In equilibrium this wage rate must equal the wage rate observed from the price setting or labor demand condition Recall our price setting equation is given by B 125W Y2 gtB 7125 400 Pnces mu 7 A51 Nate Marthe natural rate Ufumput 15 90000 At mxspumt apectedpnces and actualpnces are Equal 1m mum x n y 2nnnn mun 40min mum mun mum mum 9 an W munnn mun o t t b Refer to the information in part a Suppose that market participants react to Hurricane Katrina by increasing their expectations of future prices to 200 What is the level of potential or full employment GDP On the same graph above plot the new aggregate supply curve Calculating the natural rate of output is as before A change in expected prices DOES NOT impact the natural rate of unemployment or the natural rate of output The rest of the setup is exactly the same as above except that we replace expected prices with 200 The wage setting condition becomes W2Pf12u Y gtW20017217 100000 Y gtW200 71 Y 50000 gtW 7200 250 The price setting equation is as before Thus in equilibrium we have R 125W Y gtB 125 7 200 Y 250 gt B t 7 250 200 These points are plotted above as AS2 ggregate demand Suppose that an of our previous assumptions about the goods and services market hold a a an t LUIuIWIILC In nm culm con dence increases consumption increase Below use ISLM analysis and A A I I I I I LUuqucuLc impacts AD rterest m r 15002 1 iscci Pm Output in am am n to cup to mmemz Ending to an oulward shx m the IScurve The result is an Y 0 Y2 AD Lecture 8 ECON 313302 September 20 2005 Coverage Chapter 4 and Chapter 5 Class questions In modeling the demand for GDP we assumed that investment was exogenous This assumption is unlikely to be true and therefore we will relax this assumption now What new assumption do we make about investment We now acknowledge that investment is related to at least two other variables we have incorporated into our model namely output Y and the interest rate i For now we will leave the relationship generic and simply write It 106quot a i where the positive sign below output indicates that an increase in output increases investment and the negative sign below interest rates indicates that an increase in interest rates decreases investment 2 De ne the following terms a The IS condition b The LM condition a The IS condition is the condition that yields equilibrium in the goods and services market at various interest rates e g equilibrium output as a function of the interest rate b The LM condition is the condition that yields equilibrium in the money market as a function of real output e g the equilibrium interest rate as a function of output 3 Suppose that we have the following behavioral equations associated with the demand for GDP Ct 300 SYDL It 15025Yt1000it Gt250 a Suppose taxes are equal to 400 Calculate the IS condition We know the IS condition is defined as equilibrium in the goods and services market as it relates to the interest rate We thus start with the demand for GDP The demand for GDP is simply the sum of consumption investment and government spending We have Demand at time t 3005Y 540015025Y 1000i250 500 75Y 1000i A before the Supply ofGDP z slmply equal 20 productlan Therefore sepplyfm GDP at mm 2 V In zqwllbrlum K500 75141000 gt 251655001000 gt 163200040001 The above expresslml m bold x 0m ISzxprzsslon when taxes are 5400 b Below in interest ratdoutput space plot the IS curve We wlsh to plot several pm My L221 choose several p01 m x t Y 2000 1 0 1 600 25 1 000 50 5 0 771252 palms are plotted below We R 7U 6H m 40 3 mm 2 2n mm m m 151 l l l l Y 25D SUD 75D mun 125D lSEIEI 17m ZUEIEI 115539 Output Lecture 7 ECON 313302 September 15 2005 Coverage Chapter 4 Reading assignment Chapter 4 Class questions 1 Please complete question number 3 in chapter 4 of your textbook page 85 The price of a bond is inversely related to the interest rate Consider a bond that paysM dollars the face value when it matures but that has a price the amount that must be paid when it is purchased of PB The interest rate i 1 am suppressing all time subscripts here is related to the price of the bond as follows gMig 1 PB a We can simply plug in the price of the bond noticing that the face value is 100 Thus we have the following interest rates i Whenf 75i gg l 2 033333 75 75 n Whenf 85i 99 l 0J7647 85 85 m When PB95 iw 3 005263 95 95 b Clearly as already noted the price of bonds and interest rates are inversely related To calculate what the price of the bond is for a given interest rate and face value we can use the expression above to solve for the price of the bond 9 iiMig PB MQM7 nygM gt PB 1 i M gt P 3 1 i Given a maturity or face value of 1 00 and an interest rate of 0 08 we have PB 100108 100108 9259 2 What are the four components of M1 amp9W9 Cash and currency Demand deposits such as a typical checking account Other checkable deposits Travelers checks 3 Actual conduct of monetary policy in the United States and real GDP a Fquot 0 3 1 D The Federal Reserve directly changes this interest rate in the conduct of monetary policy The discount rate The Federal Reserve does not directly control this interest rate but speci cally targets this rate altering the amount of money in circulation typically through open market operations in attempt to hit the desired target The Federal Funds rate Suppose that the required reserve ratio is 10 and banks choose to hold an additional 5 in excess reserves How much money is created from a 10000 initial deposit For each 1 deposited we know that of new money is l ERR RRR created where ERR is the excess reserve ratio and RRR is the required reserve ratio The deposit expansion multiplier depicted above is therefore equal to 1 156 66667 and thus the initial deposit of 1 0 000 creates 6666667 Refer to your answer in c How much money is created if banks hold nothing in excess reserves For each 1 deposited we know that of new money is ERR RRR created The deposit expansion multiplier depicted above is only dependent on required reserves since the excess reserve ratio is now set to zero Therefore the deposit expansion multiplier is equal to 11010 and thus the initial deposit of 1 0 000 creates 1 00 000 What incentives does a bank for holding excess reserves Banks have two incentives for holding excess reserves First they may hold some excess reserves to ensure that they are able to meet reserve requirements This may be especially important when credit markets are tight and where it may expensive to acquire the necessary funds from other banks to meet reserve requirements when the Fed Funds rate is high Alternatively banks will excess reserves to lend to other banks in the F eal F unals market Thus banks may some reserves for speculative reasons waiting for other banks to fall short of their reserve requirements Lecture 19 ECON 313302 November 3 2005 Reading assignment Chapter 7 1 Aggregate demand You are given the following information regarding the market for goods and services Ct 200 25YD1 Tl 200 It 150 25Yt 500it Gt 200 a Calculate the IS curve Fquot This exercise is hopefully very straightforward by now First we calculate demand for GDP which is simply the sum of the demand for consumption investment and government spending in our model This yields Demand 200 25Y 25200 150 25Y 500i200 500 5Y 500i Now to calculate the IS curve we set demand equal to supply from chapter 5 which is Y Now we get Y 500 5Yt 500i 1gt 5Y 500 500i 1gt YE 1000 1000i Suppose you are given the following information about the market for money d M 2Y2 7 80001 Pi Mf 7E7 1600 Pi 2 Pi where A7 denotes the nominal supply of money which is controlled by the Federal Reserve Calculate the LM condition Note that prices are not constant here so your LM condition should relate the equilibrium interest rate in the money market to both output and the price level Again this should be straightforward at this point We simply set money demand equal to money supply and solve for the interest rate The result 2y 380004 7 1600 P L600 P t gt 23 80004 Y 1 gt 7 12 4000 SB c We know that the aggregate demand condition is simply the relationship between output and prices as calculated through equilibrium in the ISLM model You have calculated both the IS and LM conditions above Now determine output in this market to calculate aggregate demand Hint Substitute the interest rate from the LM condition into your IS condition Your nal answer will have output on the left hand side and an expression that includes prices on the right hand side Plot the aggregate demand curve below Note do not express prices in hundreds For example the price level in the base year is 1 NOT 100 Let s plug the interest rate from the LM condition into the IS condition After all in equilibrium the interest rate from the IS condition must equal the interest rate from the LM condition This yields Y Y 1000 71000 7 L 4000 SB Y gtY0007 4 132 Y gtY l000 4 13 5Y gt L000 4 13 gtY800 P t We now wish to plot these points We will do so in the same way as before However you will know notice that the relationship is not exactly linear Thus we will choose three points Our plot will not be exact but will be approximate We choose price levels equal to 050 100 and 200 The corresponding levels of output are 1120 960 and 880 respectively These points are plotted below as AD Pnces 17 uni 7 AD ADI Luna um um Output d Suppose that Federal Reserve decreases the nominal supply of money to 1000 Calculate the new LM curve determine the new aggregate demand curve and plot the aggregate demand curve in the same space above Again calculating the LM curve is straightforward With the nominal money supply set at 1000 we have 23 380001 M t gt 23 7 w 80001 Y2L 4000 SB Now we plug this interest rate into the same IS condition as above The result Y Y100071000 7i 4000 SB Y gtYL0007 4 Pi Y gtY L000 4 P 5Y gt L000 4 P gtY800 Pi Let us again select three points Let us choose the same points as above When P is 050 100 and 200 respectively the corresponding levels of output are 1000 900 and 85 0 These points are plotted as ADZ on the same graph above Lecture 6 ECON 313302 September 13 2005 Coverage Chapter 4 Reading assignment Chapter 4 Class questions 1 Suppose the Federal Reserve wishes to increase the money supply What are three ways in which they could do so a W 9 The Federal Reserve can change the discount rate the rate the Federal Reserve charges member banks to borrow from them To specifically increase the money supply the Federal will LOWER the discount rate The Federal Reserve can change reserve requirements where the required reserve ratio is the fraction of each deposit that each member bank is required to keep as reserves in their vaults or on deposit at the Federal Reserve A DECREASE in required reserve ratio will increase the money supply The Federal Reserve most likely could implement open market operations which is the buying and selling of government bonds on the open market To increase the money supply the Fed will BUY governments bonds on the open market 2 Nominal and real GDP a Below provide the de nition for real GDP in year t in base year prices using a price index other than the GDP de ator Y YP note that we implicitly multiply by the price index in the base year which is one b Use your expression in a to provide an expression for nominal GDP as a function of real GDP and current prices Recall that nominal GDP is given by Y Thus we can rearrange the expression above to obtain the following Y YP 3 Suppose that real money demand is given by d a M Pt 4402575 Suppose that real output is equal to 100 the price level is xed and equal to l and the nominal supply of money is equal to 20 What is the equilibrium interest rate Fquot We are given real money demand above Real money supply is given by MS t LEmO P P 1 In equilibrium demand and supply are equal Thus Y025 i 20 Plugging in 1 00 for real output and solving for the interest rate yields 10025 i 20 gt 25 i20 gt 105 Suppose the Federal Reserve targets an interest rate that is two points higher than your answer in a At what level should they set the nominal money supply assuming the price level is equal to 1 The interest rate above is 5 Here the Federal Reserve will target a rate equal to 7 which is two points higher 1 f the Federal Reserve is successful in hitting their target then money demand will be 1002507 18 The Federal Reserve knows that the real supply of money must equal 18 to increase the interest rate to the desired level Since the price level is 1 the nominal supply is equal to the real supply of money Thus the Federal Reserve decreases the nominal money supply to 18 causing the desired increase in i c Below pl ot the demand and supply of real money both before the shi in supply and met lm Rate n 25 um ulsr Wm aem l l 5 an 15 szn 25 Qummy orMoney A thzflng shows o decrzmz m the mane Supplyfmm 2020 mam from 52020 18 Lectur e2 2 Novemb er17 2005 ECON 31 Readin 3302 g assignment Chapter 78 class questions 1 when um uum aquot 9 9 9mm Below quot1 Anti I TTM 39 39 quot I A as a result ofHunicane Katrina oninterest rates output pnoes and unemployment Assume that the economy is initially operating at full emp t loymen Interest Rates pnees Pies pr primal lnteresttngly the efeets ofd deehne in consumer con dence dre sender to the e eetsofeontrdettondry sedlpohey Bemuxewehavenowassmedt d onsmptton ls related to consumer eon denee d deehne in consumer con dence ye s equilibrium in the goods dndserwees rndrhet and 5 related to 0nsmptton tnvestment and government spendtng At the same ttme AD ml to ADZ The drop in dggregdte derndnd muses prtees to f terne prtees ehdnge the real money supply ls dfeeted Here prteesfdh so the red money supply increases This leads to a slight shift in the LM curve from LM to LM2 Again because the shift in the LM curve occurs because of a change in prices there is not an additional shift inAD orAS The short run e ects can be described Output has fallen from YN to Y1 prices have fallen from P1 to P1 9 unemployment has increased and interest rates have fallen from i to i 9 Notice that after the shift in AD the economy is operating at less than full employment You can also see that expected prices exceed actual prices P1egtP1 9 Thus workers will accept lower wages by adjusting their expectations of futures prices down Although the intermediate steps are not depicted here but simply given by multiple arrows the decline in expected prices will shiftAS out to the right Eventually AS will meetAD at YN and expected prices and actual prices are equal As prices fall the LM curve will continue to shift out as the real money supply expands again the nominal supply ll9 is not affected so there is not an associated shift in AD The medium run effects are such that output and unemployment return to their natural rates while prices decrease significantly all the way down to Pfinal and interest rates decrease substantially all the way to ifinal 2 Phillips curve a From the AS relationship write down the Phillips curve when futzt l 0cuzt The AS relationship is given as follows 13 PiszHZiXHl With fuz given as above it is relatively easy to show that the AS relationship can be re written as follows see the Appendix to chapter 8 7r zrf lz7aut The above is the Phillips curve relationship Fquot Suppose the expected rate of in ation is zero Write down the originaltraditional Phillip s curve Ifme0 the Phillip s curve above simply becomes 7r 20701742 Lecture 15 ECON 313302 October 13 2005 Reading assignment Chapter 6 l The labor market a Use the fact the wages tend to be inversely related to the unemployment rate write down an equation that characterizes the setting of wages in the United States Describe how each of the variables likely impacts wages The equation below is the wage setting or labor supply condition 1 2 3 VVtPtefunZt There is a positive relationship between the expected price level and wages most important thing to remember about our model Here we assume that workers care about their real wages that is the amount they can purchase with their nominal wages If prices are expected to increase in the future e g suppose you suspect your land lord is about to double your rent then you will ask for a higher nominal wage W As the unemployment rate rises for all of the reasons we discussed above the nominal wage rate W falls We use the term 2 to refer to all other variables other than the expected price level and unemployment rate that a ect wages We assume that we can express 2 such that it is positively related to the wage rate For example we often use 2 to capture unemployment I 39 If r r 39 increases in a country wages are expected to increase In a sense workers have increased bargaining power since the negative prospects a iliated with unemployment have declined b We will see that your answer on 1a above actually re ects labor supply We now turn to labor demand From microeconomics what is the pro t maximizing wage rate a rm will pay an employee From microeconomic theory we know firms will continue to hire workers as long as the extra revenue generated from hiring one extra worker exceeds the wage rate We stop once the two are equal In economics parlance we say the firms will stop hiring once the marginal revenue product of the worker MRPL is equal to the wage rate Note that marginal revenue product is simply equal to marginal revenue multiplied by marginal product Suppressing the time subscripts yields WMPRL MR MPL c List the three assumptions made about the demand for labor 1 Firms only use labor to produce goods and services 2 Technology is constant 3 All firms are monopolistically competitive such that they may be expected to charge a price slightly above their marginal cost d De ne the natural rate of unemployment The natural rate of unemployment is the unemployment rate that results when the actual price level observed in the economy is equal to the price level workers expected Pg e You are given the following information futztlut L5 1316131 Write down the function that represents labor demand and labor supply and use this information to calculate the equilibrium unemployment rate and real wage rate From above our labor supply or wage setting condition is given as WV Bzfo ttazt gt VVt Pi 1 MN The second line follows because we know that ifactual and expected prices are equal then the unemployment rate at time tis the natural rate of unemployment If we convert into base year prices then the real value ofany number is simply the nominal value divided by the current price level Thus the real wage rate is simply equal to the nominal wage rate at time tdivided by the price level at time t Dividing both sides ofthe above wage settinglabor supply equation by P yields 1 7 uN LABOR SUPPLY 2 Labor demand is much simpler From above we have Pi Wi1 1 If the real wage rate from the labor demand or price setting condition is 23 then in equilibrium the real wage rate from the labor supply or wage setting condition must also equal 23 Plugging this in for the real wage rate in the wage setting equation yields 1 2 17uNuN 3 Lecture 23 Name ECON 313302 November 22 2005 Coverage Chapter 8 Reading assignment Chapter 8 Class questions 1 Phillips curve a The expectations augmented Phillips curve was given as follows 71 ie 1Zz0mt Use our knowledge of the natural rate of unemployment to simplify the expectations augmented Phillip s curve When the economy is operating at the natural rate of unemployment expected prices and actual prices are equal Since in ation is nothing more than the percentage change in actual prices and since expected in ation is nothing more than the percentage change in expected prices it is clear that when the economy is operating at full employment actual and expected in ation are equal In the context of our model this simply implies that 72 me Thus the Phillip s curve above becomes 7r t i Zt7ozuN gt0 tzt7oiuN gt h Z2 oiuN In words 12 is equal to or times the natural rate of unemployment This allows us to simplify our Phillip s curve quite a bit Replacing 12 from the Phillip s curve in part 1c with oruN yields 2 7r 7 WN W2 2 gt i 7 D ui uN If mem1 as we have assumed the growth of in ation is negatively related to the amount unemployment at any point in time u exceeds the natural rate of unemployment uN 2 Why did the Phillip s curve relationship change As we saw in class the original Phillip s curve relationship broke down for at least two reasons First if the assumption that expected in ation is 0 is untrue then the relationship between in ation and unemployment will change A second less important reason has to do with changes in 7 or 21 Suppose you are given the following information fu241050u 112 71 Plot the Phillips curve in the space below assuming 750 From he ihcnoh above ii5 clear hazt0 Fl2 and 112 Thu5 he Phillip 5 curve imder he m5imipi0h ha 760 become5 7r O12O7050u gt7r osoiosoit T0 coh5erve 5pace b0h he Phillip 5 curve r hi5 par which i5 labeled PC and he Phillip 5 curve in he hexpar are pl0ed in he 5ame 5pace on he hex page n7 us new n 4 n 5 n e unemmuyment b Suppose 71s 71 result of an oil shock A increases to 3 Plot the new Phillip s I I I both 39 39 39 wimnlll 439 39 39 the Phillips curve in periods when Ms rising The new Phillip 5 curve become5 7r O3407050u m 0757050u2 The Phillip 5 curve here i5 pl0ed a5 PC2 in he graph above N0ice ha he Phillip 5 curve ha5 5hied Wheh he memploymem rae i5 050 50 on he r5 Phillip 5 curve ih ai0h i5 equal 0 025 25 The radii0hal Phillip 5 curve tells us that all else equal ifwe are on the first Phillip s curve and if unemployment is equal to 50 then an increase in unemployment will be accompanied with a decrease in inflation something less than 25 If 1 increases however we may find ourselves on a completely new Phillip s curve Suppose in one year we are on the first Phillip s curve with unemployment equal to 50 and inflation equal to 25 As a result of an oil shock suppose we are on PC2 the following year A point on the second Phillip s curve is 0 75 03 75 such that unemployment could increase from 5 0 to 75 while in ation increased from 25 to 3 75 Notice that along the second Phillip s curve the relationship between 72 and u is still negative However with the shift in the Phillip s curve it is possi ble for in ation and unemployment to increase simultaneously without a violation of the Phillip s curve theory As we saw this go can only part of the way to explaining the break down in the traditional Phillip s curve Lecture 25 ECON 313302 December 1 2005 Coverage Chapter 9 Class questions 1 Using the Phillip s curve relationship AS Okun s Law and the aggregate demand relationship calculate the in ation rate that exists in the medium run E In the medium run we know that the unemployment rate is at the natural rate Thus from the Phillip s curve relationship uuN If the unemployment rate is equal to the constant natural rate of unemployment then uu1 Then using the general form of Okun s Law 7quot futrl AYi y gt07 AY7g gt0AY 7g gtAY g y where gy denotes the normal growth rate of output Thus in the medium the growth rate of output is equal to the normal growth rate Finally let s solve for the inflation rate from the aggregate demand relationship DAN AM 7 n gt n oAMt 7 g where the second step comes from the fact that in the medium run the growth rate of output is equal to the normal growth rate Below with in ation on the yaXis and unemployment on the XaXis plot the relationship between in ation and unemployment in the medium run ngnmmups any quotnChange tn M2 rgy Mus ogt quotnChange tn Mlrgy have combmzd port to ofch quzsllml wrth port a Th2 lohg ruh ey supply In the medium Demonstrate on your graph the effects of an increase in the growth rate run w I wouldllkz Th2 growth rate ofch rhohty supply rh the graph oooyt rs labzlzd Clmg2 rh Mn Suppasz that the growth rate ofch rmmzy supply mcrzaszs 1W2gtM1 rh zhlscase to Clmg2 rh M2 W2 ooh 22 that the ohly o oot rs oh mcrzasz rh rh otrohfrorh ht to 70 De ne adjusted nominal money growth ofch rhohty supply and the horrhol growth rate ofoutput Accmdmg to our rhole ossurhptrohs rh the mzdlm ruh rh otroh rs olwoys touol to odyusttd horhrhol rhohty growth Lecture 1 ECON 313302 August 25 2005 Class questions 1 N E What are the four macroeconomic goals that policy makers attempt to achieve when setting policy High output Low Unemployment Stable Prices Economic Growth State the three ways in which GDP can be measured GDP can be measured in each of the following ways 1 Final market value Simply add the final market value of all products produced in a year For example the contribution of a loaf of bread to GDP is simply the market value or price of the loaf of bread 2 Sum of income We can simply track income along each stage of production remembering that the entrepreneur is the residual claimant whose income is their profit after paying costs 3 Value added At each stage of production value is added to the final value of the product Adding the value added at each stage of production will also yield GDP Suppose we wish to calculate real and nominal GDP for a hypothetical country between 2004 and 2005 The country produces hamburgers books and Natural Lite Ice in the following quantities 2004 production 10 hamburgers 3 books 20 cases of Natural Lite Ice 2005 production 5 hamburgers 3 books 50 cases of Natural Lite Ice The prices for each commodity in each year are given as follows 2004 hamburgers 2 2004 books 100 2004 Natural Lite Case 4 2005 hamburgers 3 2005 books 125 2005 Natural Lite 5 a In constant 2004 dollars what is the real value of GDP in 2005 Here we simply use prices in 2004 and apply them to the amount produced in 2005 Thus real GDP in 2005 is 25 1003 450 510 b What is the value of the GDP de ator in 2005 in chained 2004 dollars The GDP deflator is nominal GDPreal GDP First note in 2005 nominal GDP is given by 3 5125 3 5 50640 Thus the GDP deflator is 640510 12549 The value ofthe CPI in July of 1981 was 916 In contrast the value ofthe CPI in July 2005 was 1954 Calculate the in ation rate between these two time periods The in ation rate 72 between time period t and t 1 is given as follows 7 aqoo P Thus the in ation rate between July 1981 and July 2005 is 1954916916100 11332 Lecture 14 ECON 313302 October 11 2005 Coverage Chapters 6 Class questions 1 In September of 2005 we had the following Civilian Labor Force 150093000 Unemployed 7661000 Use this information to calculate the unemployment rate in September of 2005 Unemployment rate 7 661 000150 093 000 0051 or 51 2 As discussed in class what are three characteristics of the Us labor market regarding the composition of the employed unemployed and those not in the labor force a The flow in and out of employment status has been quite large On average W 9 between 1994 and 1999 roughly 15 million workers who were employed became unemployed in a given month in the United States while 1 7 million employed workers left the labor force each month In addition about 35 million left their job and found another in the same month Thus about 6 7 million workers on average left their job each month during this time period The flow in and out of unemployment status has been quite large During the same time period described above on average 18 million of the roughly 7 million unemployed workers became employed each month while 13 million unemployed workers left the labor force each month This suggests that in fact the duration of unemployment tends to be quite short on average about 3 months Finally the flow in and out of the labor force has been quite large Roughly 15 million eligible workers that were considered out of the labor force became employed each month for the same time period described above while 11 million that were out of the labor force moved into unemployment status Also note from above that a number of employed workers moved into the category out of the labor force Existing data suggests that new entrants into the labor market and retiring workers can only explain a relatively small component of the movement in and out of the labor force Thus it is very likely that a number of these workers could be categorized as discouraged workers E 4 While wages are determined differently in different countries the determination of wages across nations has two common elements What are they a Workers tend to be paid more than their reservation wage b Wages tend to move in opposite directions as the unemployment rate When the unemployment rate increases wages tend to decline Explain how the theory of bargaining and ef ciency wage theories explain the two features described in number 2 a Bargaining theories of wages assert that the wage an employee can earn is related to two factors i The ability of a worker to find another job ifthey become unemployed ii The ability of a firm to replace a given worker In other words the ability to earn wages is affected by the bargaining power of a given worker In a number of ways Barry Bonds a famous baseball player has more bargaining power than does a worker at McDonald s and thus we can safely say that Barry Bonds is expected to earn a higher wage In relation to 3 b it should be obvious that workers have less room to bargain when market conditions are poor The probability that a given worker will be able to find another job declines when the unemployment rate is high and thus we anticipate wages will move in opposite directions with unemployment b Ef ciency wage theories relate the productivity of a worker to their wages The presumption is that workers may be more productive when they are paid a higher wage In relation to the firstfact in 3a firms may pay workers more than their reservation wage for ef ciency reasons In particular if a worker is paid exactly their reservation wage then the worker is more likely to quit their job If training and replacing workers has any cost then it is sensible to pay workers a little bit more than the minimum wage that just makes them indifferent between working and not working Lecture 12 ECON 313302 October 4 2005 Coverage Chapter 5 Class questions 1 De ne crowding out Crowding out is an economic theory related to expansionary fiscal policy In particular expansionary fiscal policy is related to an increase in the size of the budget de cit Given that the deficit must be nanced through issuing government bonds an increase in the budget deficit may eventually higher interest rates Notice that this precisely what our model predicts Higher future interest rates may crowd out private physical investment 2 ISLM analysis Please ll in the following chart Policy Effect on Effect on Equilibrium Equilibrium Shift in Shift in Interest Rate Output IS Curve LM Curve EXpansionary interest rates Output IS shifts out NA Fiscal increase increases to the right Contractionary interest rates Output IS shift in NA Fiscal decrease decreases to the left EXpansionary interest rates Output NA LM shifts out Monetary decrease increases to the right Contractionary interest rates Output NA LM shifts in Monetary increase decreases to the left 1n elass we conslderedthe posslblllty ofapollcy mlx ln wluen botln scal pollcy and monetary pollcy eould be used sunultaneously Dunng tlne Cllnton F e l Reserve pursued a pollcy of decreaslng tneu target on tlne Federal Funds rate At tlne same tune tlne Cllnton administration attenn tedto decrease tlne slze ofthe budget de elttluougln scal pollcy Below use ISLM analysls tolndteate tlne ovenall effects of tlnese polleles on lnterest rates and output Assume tlnattlne magmde of tlne effects ofthe polle es was ldentleal Use gnapnsl Expllcldy state wlnat our model predlcts happens to lnterest rates and output lumu nue ll quotWM 7712 use afcanbacnamzry scal palxcy m u sueeessuz attempt m decrease the stze uthe budget de ett wuuzd euuse the Sm ft m the 122 Ihdepehdeht afmmetarypalxcy thxs wuuzd euuse uutput and Interest rates d 1 H the Era Re stmuztuheu 51y Imp xpansmmxry mph mrypalxcy euusthg the MM m h ft m the nght e mpuet uh uutp t u guau and we end uh whether ma tzzusouted uhuve and as dtseussed m the questtuh the ewe puhetes Exactly Ifset eueh other In terms afthex 2172 uh uutput 7712 Effect uh the Interest mm 15 hut umhtguuus 7712 Interest tum clearly zlls ECON 3133 02 November 15 2005 Reading assignment Chapter 7 Class que ions 1 Suppose the economy is operating above full employment Below use both ISLM analysis and ADAS analysis to indicate how the economy will adjust wiuluutau 39 39 39 4 r39 L 39 L me 39um run mall quot w intere 1 rates unemployment and prices rnmm rates Y1 wnzcn 5 above tll employment We expectedprzce level 5 znztzally at Pei w cn 5 below tne actual przce level Workers are worse off and wzll demand a nzgner decreme In tne AS curve as rm cost zncreare A tne actual przce level 1 9 p 39 Tnz actual przces anally once PanalPernal tnere S no more need for d a fur men fallen av we retan to full employment Przces and Interest rate me wnzle unemployment me to tne natuJal rat theRu 11 allows the economy to immediately retum to full employment Below use ISLM analysis coupled with ADAS analysis to demonstrate the effects Compare and a ta lntesest rates Pnces PelP2 A H272 ME IS 20 132 A 20 AD2 As prlczsfall we get a shght lncrzasz m the real Supply ofrhohey eausrhg the LM eurve to shl out Smllm to above output returns to m whlle the wlth above ends The pohey has ah lmmzdmtz efeet whereas when we allow the eeohorhy to adjustaulomatlmlly the efeets are qultz gradual Further here we see a deehhe In both mterest rates and prlczs tth rose above Fmazzy we note theslzz ofthe Federal budget deflm There was ho efeet oh the federal budget de cltabovz Lecture 9 ECON 313302 September 22 2005 Coverage Chapter 5 Class questions 1 Suppose that we have the following behavioral equations associated with the demand for GDP E Fquot Ct 300 5YD1 It 15025Yt1000it Gt250 Suppose taxes are equal to 400 Calculate the IS condition We know the IS condition is de ned as equilibrium in the goods and services market as it relates to the interest rate We thus start with the demand for GDP The demand for GDP is simply the sum of consumption investment and government spending We have Demand at time t 3005Y 5400I5025Y 1000i250 500 75Y 1000i As before the supply of GDP is simply equal to production Therefore Supplyfor GDP at time t Y In equilibrium Y500 75Y 1000i gt 25Y500 1000i gt Y2000 4000i The above expression in bold is our IS expression when taxes are 400 Below in interest rate output space plot the IS curve We wish to plot several points Let s choose several points i i Y 0 2000 10 1600 25 1000 50 0 These points are plotted below c Suppose taxes increase to 800 Calculate the new IS curve Below 0n the same graph depict the new IS curve We calculate the new demand for GDP with taxes equal to 800 The result Demand at time t 3005Y 580015025Y 1000i250 300 75Y 1000i Now recall that supply is simply Y Thus in equilibrium we have Y 300 75Y 1000i Igt 25Yt 300 1000it 1gt Y 12007 4000 i It is easy enough to consider new points on the new IS curve 1S2 Using similar points as above we have i Y 0 1200 10 800 25 200 3 0 Note that the last point with an interest rate of 3 anal output of zero is the only point that ali ers from above These points are plotted as 1S2 below Note the inward shift in the IS curve following the contractionary fiscal policy Imam Rm 16mm m 151 2m sun 7m w r mun 125m lsnn mu mm m Output


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