Macro Analysis Quiz

In the Solow model of economic growth, investment per worker (i) as a function of the saving rate (s) and output per work (f(k)) can be expressed as

i=sf(k)

Δkt=it-(δ+m)kt

if... it = sf(k) > (δ+m)k then Δk<0 it = sf(k) < (δ+m)k then Δk<0 it = sf(k) = (δ+m)k then Δk=0 (graph in notes) -->introducing pop growth does not effect production function f(K,L)

Capital labor ratio

k= K/L

Suppose that aggregate production function is Cobb-Douglas. That is, suppose that Y=AK^a L^1-a where A>0 and 0<a<1. The MPL will be

(1-a)(Y/L) since Cobb-Douglas production function can also be written as MPL=(1-a)Y/L

Secular Stagnation

-->Slow down in W/P and Y/L Tech. advance has been slower than in the past ==>(tech slow down) Δ<A<O Model Tech Advance: Increase Tech and W/P Y=AK^a L^1-a A: captures tech. L^1-a: CRS A>O (If A increases, Output Increases) Tech increase results: ΔA>O causes ΔY>O, ΔY/L>O, ΔW/P>O, ΔL>O

According to the model developed in Mankiw's Ch. 3, when taxes are cut without any change in gov't spending

-Consumption increases -Investment decreases -The real interest rate increases

Define the nominal exchange rate and the real exchange rate.

-Nominal Exchange Rate is the foreign currency price of one U.S. dollar (e=£/$) -Real Exchange Rate measures how many units of foreign output it takes to buy a unit of U.S. output -->(relative price of the goods of two countries, rate at which nation can trade the goods of foreign country w/ goods produced domestically) E=ep/p*= [(£/$)x($/Qus)]/(£/Qgb)= Qgb/Qus Note: e=FC/$ (how many units of FC to buy a $) FC=foreign currency us=U.S gb=Great Britain

Consider the closed economy model of Mankiw, Ch.3. At the equilibrium interest rate

-The demand for goods and services equals the supply of goods and services -the quantity of loanable funds demanded equals the quantity of loanable funds supplied

Desirable Properties: suppose we hold K fixed, and vary L

-as you add workers they will be less productive, so less output -positive slope, increase L ==> increase Y -decreasing slope, ==> diminishing MPL (too much labor) MPL=ΔY/ΔL

According to the model developed in Mankiw's Ch3, when taxes are increases without any change in gov't spending

-consumption decreases -investment increases -the real interest rate decreases (b/c when C decreases, the savings will increases and since S=I that means investment will increase)

If... Δk=i-(δ+n)k How does increase in n affect steady state level of income per capital y*? (n=no population growth)

-increase in n, will decreases y* -increase in δk, will decreases K* (graph in notes) @k2, i>(δ+n)k so Δk>0 @k3, i<(δ+n)k so Δk<0 -->countries w/ higher population growth rates should have lower level of capital (income per capita)

Desirable Properties: Suppose we hold L fixed, vary K

-positive slope, increase K ==> Y -decreasing slope: diminishing MPK -MPK= ΔY/ΔK

Assume that equilibrium GDP (Y) is 5,000. Consumption (C) is given by the equation C=500+0.6(Y-T). Gov't expenditure and tax revenues are given as G=800 and T-1000, respectively. In this case, equilibrium investment is

1,300 (b/c equil investment is I=S) S=Y-C-G S=5000-[500+0.6(Y-T)]-800 S=5000-2900-800 S=1300

Foreign Exchange Market and Equi. Real Exchange Rate

1. The Market for Loanable Funds NCO=S-I Determined by rw so if... rw=ro then... NCOo=So-Io (graph in notes) -->Increase in Exchange rate has no effect on NCO, no where is real exchange rate -Think of NCO as Supply of $ to foreign market -to buy foreign asset (Japanese gov't bond) -->must sell $, Buy yuan, use yuan to buy Japanese bond (US experiences large capital inflows NCO=NX -->trade deficit when we import more than export= sending more $ abroad, $ comeback in a form of U.S. assets NCO<0 when NCO is negative we call it a net capital inflow)

Kaldor's Facts (6)

1. income per capita grows w/ no tendency to slow -->growth (Y/L)=g 2. Capital labor ratio (K/L), grows w/ no tendency to slow -->growth of (K/L)=g 3. real interest rate (r) is constant through time -->(w/p) shows trend growth 4. Y/K is constant through time 5. Capitals and labors share of Y are constant through time -->amount of gap paid towards capital and labor is constant 6. There's wide variation in growth rates of Y/L across countries @ steady state Δk=0; constant -->k=K/EL = (K/L)/E constant; then the growth rate of K/L = growth of E=g

Explain Key Long-Run trends in U.S. economy (Krugman)

1. productivity growth -->APL=Y/L, MPL=W/P ==>Avg. product of labor, how much avg worker produced in an hour 2. employment growth 3. distribution of income -->don't want extreme poverty

Increased Tariffs (graph in notes)

1. start at Eo w/ NCOo=(So-Io) NXo=NCOo 2. Impose Tariff -->Tax on imports (if taxes make imports more expensive then it decreases imports) -->Increase in tariffs ==> decrease imports = increase NX -->Reminds the same at given E NX CURVE SHIFTS UP 3. at Eo, NX1>NCOo, excess demand for dollars, (causes value of $ to be bid up, appreciation of domestic currency) Dollar appreciation causes... 4. Increase in E ==> Decreases Exports, Increases Imports ==> Decreases NX 5. Move to E1, w/ NCOo=(So-I), NXo=NCOo (constant), (back at orig. level) -Appreciation increases imports Tariff: Δr=0 no effect on interest ΔI=0 I depends on r ΔS=0 I=S ΔNCO=0 Tariff has no effect on NCO ΔE>0 Appreciation ΔNX=0 no effect on net exports Increase in E ==> decreases Exports -->Since ΔNX=0, must have decrease in Imports -Tariff -->decreases imports, -ΔE>0 --> increases imports, decreases exports

Economy will converge to a steady state, k* where Δk=0 k* is a constant

@k*, y*=f(k*) y* is a constant @k*, i*=sf(k*) i is a constant @k*, cp*=(1-s)f(k*) cp* is a constant ==>should all grow @ same rate, balanced growth path y=Y/EL = (Y/L)/E is constant; @ steady state growth (Y/L) = growth E=g i=I/EL = (I/L)/E is constant; @ steady state growth in (I/L) = growth of E=g Cp=C/EL = (C/L)/E is constant; @ steady state growth in (C/L) = growth of E=g

NX=Y-(C+I+G) NCO means (S-I) = NX graph in notes

@rw, S>I If S>I, then... NX>0 (positive) NCO>0 (positive) So... Y>(C+I+G) e: Japan in 80's and China now -->produces more stuff than it buys domestically so has to sell to the rest of the world. Uses funds to purchase foreign assets (high levels of national savings) @rw, S<I NX<0 (C+I+G)>I NCO<0 Ex: US 1900's to Now -->running large trade deficits -->Country buys more stuff than they're producing domestically, so they must pay for it by selling off your assets to foreign residents (low levels of national savings)

The president is considering placing a tariff on the import of Japanese luxury cars. Using the model presented in this chapter, discuss the economics and politics of such a policy. In particular, how would the policy affect the U.S. trade deficit? How would it affect the exchange rate? Who would be hurt by such a policy? Who would benefit?

A tariff causes ΔNX=0 and ΔE>0 @equil w/ Eo, NX=(S-I)o. A tariff will reduce import demand at any given value of E, and shifts NX curve up/right to NX. -Tariff does not affect S or I, since in equil, NX=(S-I) it follows that ΔNX=0, Equil NX remains at NX=(S-I)o. -Shift up of NX curve does affect equil E. ΔE>0 to E1. (Tariff shifts NX curve up increasing demand for dollars at Eo). -Excess demand for dollars causes appreciation. ΔE>0 until NX falls back to equil at NX=(S-I)o So, Tariff causes ΔE>0 and ΔNX=0 -->Although NX=0, the tariff on Jap autos will hurt Jap automobile producers, workers and firms. But will help domestic workers and firms in the autombile industry in U.S. -->Since E increases, U.S. exports will be more expensive abroad and so demand for US exports will fall, so tariff will hurt domestic workers and firms in all export industries -->If US restricts imports of Japanese luxury cars then for any given E, imports will be lower. -->Protectionist polices lead only to an appreciation of the real exchange rate.

Sachs discuses several fundamental social changes that have been caused by economic growth. Which of the following is not one of those changes?

A. increased state ownership of the means of production B. Increased specialization of labor C. Changes in gender roles D. Increased urbanization A

LR Equil. GDP: Output Production Function (Technology)

An existing technology that governs how much output can be produced from the available inputs

Labor Augmenting continued...

Before: y=Y/L K=k/l Now: y=Y/EL k=K/EL transformed original production function y=f(k) to y=f(K, EL) CRS in K and EL Cobb Douglas ex: y=k^a

Dynamic Behavior of k=K/EL? Δk? how does it change over time?

Before: Δk=i-(δ+n)k Steady state --> Δk=0 if i(δ+n)k to keep K/L constant investment has to: 1. replace depreciation δ 2. add new capital to match increase in labor n Now: Δk=0 if i=(δ+n+g)k g=ΔEt/Et (growth rate of labor efficiency) (steady state) Δk=0 if i=(δ+n+g)k k=K/EL to keep constant, investment has to do 3 things: 1. replace depreciation -->δ 2. additional K to match increase in L -->n 3. add more new capital to match increase in E -->(g) (graph in notes) @k*, i=(δ+n+g)k, Δk=0 STABLE STEADY STATE below k*, i>(δ+n+g)k, Δk>0 above k*, i<(δ+n+g)k, Δk<0 -->always moves back toward steady state

Change in capital stock per worker

Δk=sf(k)-(δ+n)k we substitute i for s since savings=investment

Technical Progress Y=F(K, E⋅L) (look at Ch9, P+A4)

Being able to produce more output with the same inputs a "Labor-Augmenting" technical progress: Instead of, Y=F(K,L) CRS in K and L Now use, Y=F(K, E⋅L) CRS in K and (EL) E="efficiency of labor" (index of tech.) Idea: Suppose L is constant (at 100M workers) and BUT E grows from E=1.00 to E=1.25 -->this has some effect as if L grew from 100M to 125M, E does same thing as 25% growth -Labor augments technical progress

The Open Economy in Long Run Equilibrium

Consider a small open economy (in LR) -->open to trade in goods & services -->open to international capital flows small- too small affect world interest rate (ex: small country too small to affect prices on interest rate) -->If a country has an excess demand for loanable funds it will draw funds from the world market. From the world market, too small to bid up world real interest rate

Determination of Nominal Exchange Rates

E=eP/p* %Change in E = [% change in e] + [% change in p] - [%change in p*] π-π* [%change in e]=[%change in E] - π+π*(pos % change) -->domestic inflation causes nominal depreciation of $ -->foreign inflation causes nominal appreciation of dollar

Why might an economic policymaker choose the Golden Rule level of capital?

Economic policymaker might choose Golden Rule level of capital if their goal is to maximize the social and economic well-being of individuals in society. -->Must consider consumption a substitute for social well-being since individuals do not care about amount of capital or amount of output in economy, they care about amount of goods&services they can consume -->policymaker should choose steady state w/ highest level of consumption. -->Steady state of k that maximizes consumption is Golden Rule level of capital. -->Since Golden Rule is that steady state that maximizes consumption level, policymakers try and achieve it

Basic Accounting: Goods MKT- Y=C+I+G=NX

Exports of goods & services - imports of goods & services Net exports: "trade surplus" NX>0 current account surplus "trade deficit" NX<0 current account deficit "balanced trade" NX=0 current account balance

Labor Demand

Firms maximize profits by setting MPL=W/P (real wage) MR=MC revenue=cost PxMPL=W MPL=W/P -->Since firms want to maximize profits, real MR = real MC 1. Start w/ real wage = (W/P)o firms hires Lo such that MPL(Lo)=(W/P)o 2. Suppose Δ(W/P) < 0 (real wage falls) to (W/P)1 < (W/P)o At Lo: MPL(Lo)>(W/P)1 3. Firms hire more. Increase L1, move up along production function and increase in L will decrease MPL --> as wages falls firms increase labor until they drive MPL down to real wage = Increase Lo to L1 --> MPL(L1)=(W/P)

What determines LR equil. values of GDP, real wages, employment?

For fixed K, Equil: Ls=Ld at (W/P)*, Ls=Ld=L* L* in F(L,fixed K) gives Y* Supply of Labor increases to excess supply (surplus), firms lower wage as wage falls, supply falls, goes back to equil. -As wage increases, supply goes to equil, firms want fewer workers -D will succeed S, firms will offer higher wages to attract more workers

Think of NX (net exports) as a demand for U.S. dollars in foreign market

For foreigners to buy a U.S. good, they must first buy (demand) $ in foreign market (graph) @ E*, NX=NCOo @Eo>E*, excess supply of $==>decrease in E @E1<E*, excess demand for $ ==>increase in E -->Market moves to E* where NX=NCO (theres and excess supply so NX will increase to fall at equil, and theres an excess demand for $ so NX decreases to fall to equil w/ NCO)

What is the optimal savings rate?

Highest utility = highest consumption -->People get utility from consumption not capital, not output. So, then what causes increase in consumption To increase savings, people consume less, gov't spends less, or gov't raises taxes

Constant Returns to Scale (CRS)

How does output change when you scale both inputs up simultaneously/equally? Let z > 1 (ex: z=1.1 increasing by 10%) Compare Yo=F(Lo,Ko) to Y1=F(zLo,zKo) decreased by 10% if Y1<zYo ==>then decreasing returns to scale 10% increase in K and L = less than 10% in Y (DRS) Increased by 10% if Y1>zYo ==>then increasing returns to scale 10% increase K and L = greater than 10% in Y (IRS) If Y1=zYo then CRS ==>constant return to scale if you simultaneously increase K and L, desirable for aggregate demand function

National Income accounts identity

I=sy or i=s x f(k)

According to the theory of purchasing-power parity, if Japan has low inflation and Mexico has high inflation, what will happen to the [nominal] exchange rate between Japanese yen and the Mexican peso?

If Japan has low inflation and Mexico has high inflation, then a yen will buy an increasing amount of Mexican pesos over time. This implies that yen will rise over pesos or the yen-pesos exchange rate will rise or appreciate -->If Mexico is the domestic country, then e=¥/Peso = the yen price of one peso (e=FX/$) Also, E=ePmexico/Pjapan -->If Mexican inflation>Japanese inflation then increase(Pmexico/Pjapan). Since price inflation should have no effect on E, increase(Pmexico/Pjapan) requires a decrease in e, the peso must depreciate relative to the yen. Also, the equation: %change in e= %change in E+ (π*-π) (π* is foreign inflation rate) (π is domestic interest rate) -->Since, π*<π (jap inflation ratio lower than mex) and since % change in E=0, then % change in e<0. So, Peso will depreciate relative to yen

In the Solow model, what determines the steady-state rate of growth of income per worker?

In Solow model, only tech progress can explain growth in output per worker and income, allow for tech progress, y=Y/EL is constant in steady state (E=efficiency of labor) -->If Y/EL is constant than Y/L must grow at some rate as E. So, steady state rate of growth of income per worker is determined by the rate of growth of tech ΔE/E=g -->g is labor-augmenting tech progress L is increasing at n, E is increasing at g LxE grows at rate of n+g

In the Solow model, how does the saving rate affect the steady-state level of income? How does it affect the steady-state rate of growth?

In Solow model, savings rate affects steady-state level of income positively, since a high saving rate in the economy, the level of capital stock and output will be higher. This increases steady state output which results in temporary economic growth w/ higher income -->(increase in saving raises investment and causes capital stock to grow to new steady state) While savings rate affects steady state rate of growth as the new capital stock steady state k*2 is achieved, but growth rate will settle back to old steady state level. -->Impact of higher savings rate on growth is not permanent. So higher savings influences income not growth (higher savings leads to faster growth but only temporarily, only level of income per person is influenced by savings in steady state)

Steady-State Growth

In steady state Δkt=0 (capital labor ratio is constant, not changing through time) So, kt-->k* constant If kt is constant than y*=f(kt) is constant y*=f(k*) yt-->y* is constant In steady state Y/L is constant, growth rate of Y(GDP) = growth of L growth of Y=n (GDP)=(growth rate of pop) -GDP grows at rate of population growth increase in n ==> decrease in y* growth in (Y/L) (output per worker) -->lower levels of income per capital but income per capita isn't growing, GDP will be growing faster At steady state Yt/Lt is constant, GDP(Y) growing at same rate at L -->(not at steady state, Y/L is not constant and grows through time)

In the Solow model, how does the rate of population growth affect the steady-state level of income? How does it affect the steady-state rate of growth?

In the Solow model @ steady-state equil, y=Y/L is constant. -->Growth rate of Y=growth rate of L. So rate of growth of level of income is equal to the rate of population growth

Suppose that the MPL is greater than the real wage, that is, suppose that MPL > (W/P). A profit maximizing firm will

Increase labor inputs (b/c if one extra unit of labor is greater than the wage then a firm will want to increase labor inputs)

Consider the model of long-run equilibrium presented in Ch. 3 of text. Suppose that an earthquake destroys some of the capital stock. In equil. real rental price of capital will ______ and real wage will ______

Increase, decrease. (real rental price = MPK, if earthquake destroys some capital stock, MPK rises (b/c of diminishing marginal product), so real rental price rises. Labor is now more abundant so becomes less productive and as wage falls, demand for labor by firms rises.

If an economy with no population growth or technological change has a steady-state MPK equal to 0.125, a depreciation rate of 0.1, and a saving rate of 0.225, then the steady-state capital stock:

Is less than the Golden Rule level (since MPK-depreciation > 0 0.125-0.1=0.25 then increases in capital increase consumption, so k* must be below golden rule) MPK too high, K too low

What is the Golden-rule level of capital?

Is the level of capital that maximizes steady-state consumption per capita

What is investment?

Is the purchase of new physical capital. Goods purchased to add to the capital stock

What is meant by market clearing?

Is when the price of a good adjusts to equate supply to demand (also called equilibrium price)

Labor Market

Labor supply --> price of labor is the real wage = W/P (the real return to supplying a unit of labor) -Mankiw: Labor is fixed and fully utilized so Ls curve is vertical -In Class: Positive slope, Ls curve is upward -Increase in (W/P) ==> Increase Labor force participation (if real wages go up people outside labor force may choose to go into labor force)

Golden Rule is described by the equation...

MPK=δ -->ay Golden Rule level of capital, MPK equals depreciation rate

Capital Share of Income

MPK×(K/Y) In Cobb Douglas: MPK×a(Y/K) MPK is constant at steady state (K/Y) capital output ratio is constant at steady state -->So if MPK and (K/Y) are constant at steady state, then capital share of income is also constant at steady state

NCO= Net Capital Outflows

NCO means S-I (national savings- domestic investment expenditure) NCO is how much net domestic residents invest in foreign countries Ex: -I deposit $ in Foreign bank (NCO) -I buy Japanese gov't bond (NCO since US resident purchase of foreign asset) -I buy stock in British corporation (NCO) -I buy real estate assets in Italy Since NCO means S-I, If S>I then NCO>0 (positive) (graph in notes) -Excess supply of loanable funds is "loaned" abroad at rw (world real interest rate) (country is so small that the excess supply will impact rw) Id is negative related to S on graph

What are the net capital outflow (NCO) and the trade balance (NX)? Explain how they are related

NCO refers to (S-I), difference between domestic S and domestic I. If NCO is pos than S>I so S is going abroad and economy is lending to foreigners. If NCO is neg, S<I, so I is financed from abroad and economy is borrowing from foreigners. Trade Balance, NX, is the export and import of goods&services. Net exports tells how much economy trades in goods&services. @Equilbrium, NCO=NX since (S-I)=NX and (S-I)=NCO When S>I, economy is lending abroad and has trade surplus. When S<I, economy is borrowing abroad and importing more than exporting so trade deficit

Is a trade deficit always a bad thing?

NX=(S-I) Consider improved productivity of capital 1. start r=rw @rw So>Io, NCO>0, NX>0 (initial trade surplus) 2. Suppose increase in productivity of capital (tech, innovation or liberalization of markets is something that leads to increase in production of capital) Which increase demand for new capital 3. Now @rw, So<I1, (NCO<0 capital inflow),(NX<0 trade deficit) -->country's become more productive so people want to invest in it

Policy: ΔT<0 (ΔG>0 would be similar)

NX=NCO, if NX<0 then NCO<0 domestic has to equal world real interest rate (rw) Consider effects of ΔT<O (tax cut) 1. start @rw w/ So=Io NCOo=So-Io NX=S-I=0 "balance: S(To) shifts left to S(T1) 2. ΔT<0 S=Y-C-G Tax cut: Δ(Y-T)>0 (MPC) (disposable income) ΔC>0 -->increase in consumption S<Δ -->decline in national savings, (increase in gov't expenditure very similar) Δ(S-I)<0 to (S1-Io) ΔNCO<0 to NCO1=(S1=Io) @E -->NXo>NCOo Excess demand for $ ΔE>0 increase in E (appreciation) = decrease in exports, increase in imports Tax Cut ==> ΔT<0 causes: Δs<0 ΔI=0 ΔNCO<0 ΔE>0 (appreciation of dollar) ΔNX<0 ==>(worsening of U.S. trade decline in exports, increase in imports = trade deficit)

Suppose the domestic country, a small open economy, imposes a tariff on imports. We expect that in LR equilibrium

Net exports will not change and there will be a real appreciation of the domestic currency

Suppose the domestic country, a small open economy, imposes a tariff on imports. We expect that in long-run equilbrium

Net exports will not change and there will be a real appreciation of the domestic currency

Neoclassical Theory of Distribution

Payments to factors + quantities (of factors used) employed are determined by Market Equilibrium Ls=Ld (equil.)

Investment Demand = Demand for loanable funds

Purchasing of new capital equiptment S=I To buy new capital (invest) -->firms borrow (bank loans, debt, equity) To borrow firms pay r= i-π increase r ==> increase cost of borrowing ==> decrease Id I(r) = negative relationship

What determines K? And payments to capital market equil

R= Nominal Price of K R/P= Rental Price of K Demand: Profit max MR=MC PxMPK=R -Firms hire K until MPK=R/P decrease R/P ==> increase Kd ==> decrease MPL (as rental price falls, firms get more K) Kd has negative slope (R/P) moves to (R/P)* where Kd=Ks=K fixed

Solow Growth Model

Shows how saving, pop growth, and tech. progress affect level of economy's output and its growth over time -based on production function Y=F(K,L)

If a small open economy cuts defense spending, what happens to saving, investment, the trade balance, the interest rate, and the exchange rate?

Small open economy: ΔG<0 causes... ΔS>0 ΔI=0 ΔNX>0 Δr=0 ΔE<0 I=0 b/c r=0 and investment depends on rw, and if rw is constant so is I. r=rw=world interest rate -->increase in NCO Δ(S-I)>0 from increase in saving, causes ΔE<0 =depreciation causes ΔNX>0 -->exchange rate (E) is low so domestic goods are cheap and domestic residents will purchase fewer imported goods, and foreigners will want to buy our goods. So NX>0 since quantity of our net exports will be high -->But, if E is high, domestic goods are expensive relative to foreign so domestic residents will want to buy many imported goods and foreigners buy fewer of our goods so quantity of our NX<0 will be low -->NX are a function of E

Population Growth

Suppose population grows at a constant rate, m ΔLt/Lt=m (change in pop as a % in t's current level) Modify model for population growth= Before: Δkt=it-δkt so Δk=0 where it=δkt -->capital will be constant if investment is just enough to replace δ Now: it=δkt is not enough to keep Δk=0 Now: Δkt=it-(δ+m)kt --> Δkt=sf(k)-(δ+m)k k=0 i=(δ+m)kt some investment replaces depreciation & additional investment buy new K to match up w/ new workers i=purchase/investment of new k

T1<To ΔT<O ==> Δ(Y-T)>O ==>small increase in Spri, large decrease in Spub

Tax cut increases disposable income, consumption goes up, savings decreases -tax cut crowds out private investment expenditure

If a small open economy bans the import of Japanese video game systems, what happens to saving, investment, the trade balance, the interest rate, and the exchange rate?

The ban should reduce domestic demand for imports and increase Net Exports at a given value of E. There is no effect on r, b/c r=rw and there is no reason to expect that this import restriction will affect rw @equil w/ r=rw, so I=Io and S=So NCO will be NCOo(So-Io). NX curve is NX in equil NX=NXo=(So-Io) and the equil E is Eo. -->the import restriction shifts NX curve up to NX1, increases NX at a given value of E. since r=rw is unchanged NCO remained at NCOo=(So-Io). Equil NX must be at NXo=(So-Io). So ΔE>0 to E1 Summarizing equil effects of the import ban are: ΔS=0, ΔI=0, ΔNX=0, Δr=0, ΔE>0

Marginal Product of Capital (MPK)

The increase in output that results from the marginal (one more) unit of capital MPK= ΔY/ΔK

Population Growth + Technical Change -->explain growth in Y/L

The model does not explain steady state growth kt-->k* a constant Δk=0 yt=f(kt) so kt-->k* implies yt-->y*=f(k*) -so in steady state y=Y/L (income per capita) is constant -Since L is constant, then Y is constnat Y=F(K,L) K=capital accumulation L=population growth (allows to explain growth in GDP(L) but not in K) F= technical change

How can policymakers influence a nation's saving rate?

To increase savings rate policymakers must reduce gov't budget deficit. Since National savings= private+public, an increase in public will increase NS and therefore the savings rate -->Other polices say to increase private savings by increasing return to savings, policies like reducing the taxation of interest or moving to consumption tax to motivate people to save more

LR Equil. GDP: Output Factors of Production (resources)

Two generic categories: L, K Labor: time spent working in market sector Capital: goods that are used to produce goods & services -->Mankiw assumes both are in fixed supply + fully utilizes (potential GDP, when GDP is of trend, economy functioning at full potential)

A Country experiences a reduction in productivity--that is, an adverse shock to the production function

What happens to labor demand curve? -Ld curve will shift down/left due to a fall in productivity. At any given real wage, firms will demand less labor This change in productivity will affect labor market. If labor market always remains in equil. and Ls is fixed, an adverse productivity shock causes a decrease in real wage but will have no effect on unemployment or employment This change in productivity will affect labor market of unions prevent real wages from falling, then unemployment will fall

Wage Stagnation

Why wage growth has been slow -maturing of baby boom generation -slow down in tech which slows down wages -slow down in growth of real wages from slow down in growth of tech (less tech, lower output) Tech slow down results: ΔA<O causes ΔY<O, ΔY/L<O, ΔL<O, Δ(W/P)<O

Focus on Market for Loanable FUnds

Y=C+I+G+NX (Y-C-G)-I=NX S=Y-C-G S-I=NX I=domestic investment

Focus on Goods Market

Y=C+I+G+NX NX=Y-(C+I+G) If... C+I+G > Y (expenditure>output) Then... NX<0 (negative) (need to import from rest of world) If... C+I+G<Y (extra goods and services since output is greater than expenditure) Then... NX>0 (extra stuff to sell to rest of world)

The Aggregate Production Function

Y=F(L,K) How much GDP we can get for given economy wide aggregate labor and capital

How capital labor ratio changes through time

Δkt=it-δkt Chance in capital stock = new purchase of capital - depreciation

Suppose that the aggregate production function is Cobb-Douglas. That is, suppose that Y=AK^a L^1-a where A>0 and 0<a<1. The marginal product of capital will be

a(Y/K)

The Country of Leverett is a small open economy. Suddenly, a change in world fashions makes the exports of Leverett unpopular. a. What happens to Leverett's S, I, NX, r, E? b. The citizens of Leverett like to travel abroad. How will this change in the exchange rate affect them? c. The fiscal policymakers of Leverett want to adjust taxes to maintain the exchange rate(E) at previous level. What should they do? If they do this, what are the overall effects on S, I, NX, r?

a. -->r does not change: small open economy r=r* -->S does not change: Y-C(Y-T)- G -->I does not change: I=I(r*) -->Since, NX=S-I, NX does not change either -->Since change in tastes lower NX at any given E, must be a depreciation, decrease in E, to affect the change in taste. on graph NX moves to left, shifts E down, and (S-I) is unchanged. b. Since there has been a real depreciation of domestic currency it will be more expensive to travel abroad c. Gov't wants to prevent a decline in E using taxes, since changes in tastes reduce demand for exports, it shifts NX curve to the left to NX1. -->To maintain equil E=Eo, gov't must reduce savings to (S-I) to (S1-Io) by making a tax cut ΔT<0, which causes ΔC>0 and ΔS<0 to S1<S0. ΔS<0 causes Δ(S-I)<0 and therefore ΔNX<0 in equil. Δr=0 b/c r=r* for small open economy and r* is unchanged. So, ΔS<0, ΔI=0 as Δr=0, ΔNX<0, Δ(S-I)<0, Δr=0 b/c small economy, also ΔC>0.

Why Labor Augmenting? (increasing labor/ help to increase it for ex w/ technology)

a. In model of competitive equil, MPL=W/P, MPL=r (rental price of investment) b. If technical progress is labor augmenting then MPL grows and MPK does not grow c. In data W/P (real wage) shows trend growth but r (real interest rate) does not (graph in notes)

Consumption per worker

cp=y-i steady state Cp maxed when MPK=δ max is where slope of f(k)=δk slope of production function=MPK -if MPK is too large then increase capital, if MPK is too small than decrease capital

Marginal Product of Labor (MPL)

amount of output produced by marginal (one more) unit of labor MPL = ΔY/ΔL

Krugman comparing 50's+60's to 70's + 80's Have trends continued? What explains productivity slow down?

began in early-mid 70's = productivity slow down -->growth rate (of wage) slowed -->decline in ΔY/L<0 & ΔW/P <0 & ΔL>0(labor growth) -->good employment growth -->Worsening income distribution, rich getting richer and poor getting poorer 1. Increase in Labor Supply 2. Technological stagnation (slow down) -->Income in Labor Supply, maturing of baby boom generation -->(graph in notes) An increase in Labor Supply shifts Ls to right, ΔW/P<0 to (W/P) and ΔL>0 to L1 APL=Y/L so ΔY/L<0

Consumption Function

c=(1-s)y or c=(1-s)xf(K) steady state consumption per capita

Consider the version of the Solow growth model with no population growth and no technical progress as presented in Ch8 of the text. Denote the rate of depreciation by δ. Let i=I/L, k=K/L and y=Y/L. If i<δk then we expect that "i" will be _______ and that "y" will be ______

decreasing; decreasing

In Chapter 1 of the text, Mankiw states that "According the most macroeconomists, models with ______ describe the economy in the LR, whereas models with ______ offer a better description of economy in SR.

flexible prices, sticky prices

Based on the data presented in Mankiw's Ch 3 and discussed in class, In the U.S., the growth rate of real wages from 1960 to 1973 was _______ the growth rate of real wages from 1972 to 1995

greater than

Based on the data presented in Mankiw's Ch. 3 and discussed in class, In the U.S., the growth rate of real wages from 1960 to 1972 was ___________ the growth rate of real wages from 1973 to 1995

greater than

Model w/ Tech Change

growth in (Y/L) Y=F(K,L) Y=F(K,EL) --> y=f(k) --> Cobb Douglas y=k^a Equation break down: Y=C+I El El EL y=cp+i --> cp=y-i I=sy i=sy --> i=sf(k) EL EL C=[(1-s)Y]/EL --> C/EL = (1-s)Y/EL Cp=(1-s)y or Cp=(1-s)xf(k)

Suppose that an increase in the real interest rate causes a decline in aggregate consumption. The supply of loanable funds curve will

have a positive slope (b/c S=Y-C-G -->increase in r ==> decrease in C, increase in S)

Consider the Solow model of economic growth. Denote the rate of depreciation by δ, the rate of population growth by n, and the rate of growth of labor-augmenting technical progress by g. Suppose that δ>0, n>0, and g>0. Let i= I(t)/E(t)L(t) k(t)=K(t)/E(t)L(t) c(pt)= C(t)/E(t)L(t) If, i(t)> (δ+n+g)kt then we expect that i(t) will be _______ and that c(pt) will be _______

increasing, increasing.

If an economy with no population growth or technological change has a steady-state MPK equal to 0.1, a depreciation rate of 0.08, and a saving rate of 0.125, then the steady-state capital stock:

is less than the Golden Rule level (b/c if MPK is too high, increase capital to drive MPK down)

Suppose that a country experiences an improvement in productivity that increases the MPL for any given level of labor inputs. In this case, the

labor demand curve shifts upward and to the right (b/c improvement in production ==> increase in MPL -->raises MPL, motivates firm to hire more at any given wage)

Golden Rule:

maximize steady-state equilibrium consumption per capita MPK=δ -->no longer true when you use population growth (n=0, g=0) -->*new ==>MPK =(δ+n+g)

Trade Liberalization

Δs=0 Δr=0 ΔI=0 ΔNCO=0 ΔE<0 -->ΔExports >0 (increases) ΔNX=0 -->ΔImports>0 Nx moves left to Nx1, excess supply of $ forces depreciation of dollar, (increase in exports, decline in imports)

Consider the Solow model of economic growth. An increase in the savings rate will cause steady-state equilibrium consumption per capita to

the change cannot be determined from the given information

The Golden-rule level of capital is...

the level of capital that maximizes steady state consumption per capita

The country of Eastutica has the following production function: Y=F(K,L)= K^1/2 L^1/2 Assume that Eastutica experiences no tech. progress (that is g=0). Suppose that capital depreciates at 3% per year (δ=0.03), that population growth is 5% per year (n=0.05), and that the savings rate is 12% so (s=0.12). What is the steady level of income per worker?

y=k^1/2 Change in k = s x y - (δ+n)k Change in k=0 Change in k^1/2 = sy = (δ+n)k (.12/(.03+.05)= (s/δ+m)= k^1/2 y=k^1/2 = (.12/.08) = 1.5

The natural rate of unemployment is

the rate of unemployment toward which the economy gravitates in the LR

The natural rate of unemployment is

the rate of unemployment toward which the economy gravitates in the long run

Golden Rule of Capital Accumulation

the steady-state of k that maximizes consumption

GDP per person/laborer

y= Y/L

The country of Eastutica has the following production function: Y=F(K,L)= K^1/2 L^1/2 Assume that Eastutica experiences no technical progress (that is, g=0). Suppose that capital depreciates at 3% per year (δ=0.03), that population growth is 5% per year (n=0.05), and that the savings rate is 12% so (s=0.12). What is the steady state level of income per worker?

y=k^1/2 Δk=sy-(δ+n)k Δk=0 Δk^1/2=sy=(δ+n)k (.12/.03+.05)=(s/δ+n)=k^1/2 y=k^1/2 = .12/.08=1.5 (b/c Δk=0 where it=δkt Capital will be constant if investment is just enough to replace depreciation, since investment=savings then Δkt=s⋅y-(δ+n)k i=(δ+n)kt so, since i=s then... to find k^1/2 y=k^1/2 k^1/2=(s/δ+n)