# ECO 317 Intermediate Macroeconomics

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28 Οκτ 2013 (πριν από 4 χρόνια και 6 μήνες)

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ECO 317

Intermediate Macroeconomics

Instructor

Jing Li (sounds like Lee)

7
-
year experience of teaching at US colleges

Second year at MU

Married with two kids

Teaching eco 311 as well

Expectation

Hard
-
working is expected

Cramming for exam does not work

Memorizing does not work

Understanding is the key

If you need A or B, earn it!

Required Textbook

Webpage

http://www.fsb.muohio.edu/lij14/

I use
Nihhka

only when I need to send group

jing

li
miami

university”

Six
homeworks
, 10 points

Term paper, 10 points

Three midterm exams, 60 points

Final exam, 20 points

(bonus) Attendance, worth 3 points

None of the exam is accumulative

Hot Issues

National Debt

Income gap: 1% vs. 99%

Globalization

2007
-
2009 Recession

Review

Labor (input) L is used to produce output Y

P
roduction is captured by production function

(

)

𝑌
=

(

)

Marginal
product of labor (MPL)
is
the
extra

output
that can be produced by using
one more
unit of
labor

𝑃
=
𝜕
𝑌
𝜕



+
1
,

(

,

)

Q: What is the sign of MPL?

Q: What happens to MPL as L rises?

Two Properties of MPL

𝑃
>0, so total product rises when input rises

𝑑𝑃
𝑑
<0 (decreasing or diminishing marginal
product). The extra labor becomes less and less
productive.

Graphically, the production function (total
product curve) is
upward

sloping, and becomes
flatter and flatter
.

Q: how does the marginal product curve looks
like?

Profit Maximizing

Profit = revenue

cost =
𝑃𝑌


=
𝑃



. We assume competitive market.

Profit rises when marginal revenue is greater
than marginal cost, and decreases otherwise

Profit is maximized when

marginal
revenue
= marginal cost

Mathematically, the
first order condition
is

𝑃

𝑃
=


Summary

Output does not grow if input and technology
remain constant

Wage is determined by the marginal product.

Discuss

What is the long run prospect of Japanese
economy, where both population and
technology stagnate?

Why does a doctor earn much more than a
plumber?

Cobb
-
Douglas Production Function

𝑌
=

,

=
𝐴

𝛼

1

𝛼
,
(
0
<
𝛼
<
1
)

Constant factor share in income

Marginal product is proportional to average
product

Calculus

=

1

Multivariate function

=
𝑓
(

,

)

Partial derivatives

𝜕

𝜕

,
𝜕
𝜕


Example:

=



,

𝜕
𝜕
=

1



𝜕
𝜕

=




1

Why Cobb
-
Douglas Function?

It can explain the following two facts

The shares of capital and labor incomes are
constant

Real wage grows at the same rate as average
product

The Demand Side

The supply side is captured by production
function

We need to specify the demand side in order
to find equilibrium

Demand = consumption + government
expenditure + investment

Aggregate Demand

Consumption:
𝐶
=
𝐶
𝑌



, which is fixed

Investment:
𝐼
=
𝐼
𝑟
,
𝑑𝐼
𝑑𝑟
<
0
,

which varies as
the real interest rate
𝑟

changes

Government expenditure:

=


, which is
fixed

Equilibrium

Equilibrium: supply = demand

Mathematically

𝑌

=
𝐶
𝑌



+
𝐼
𝑟
+


We can solve this equation for
𝑟
, and obtain
the equilibrium real interest rate

In short, real interest rate adjusts to
equilibrate the market

Another Perspective

Alternatively, we can study the equilibrium for
loanable funds market

At equilibrium, the supply and demand of
funds are equal:

𝑌

𝐶
𝑌





=
𝐼
𝑟

Note the supply of fund is fixed

Application

1.
Why was interest rate high in early 1980?

2.
Why was interest rate
high
in early
1990
?

Crowding Out

Chapter 3 implies that expanding government
expenditure will completely crowd out
investment

Fiscal policy is ineffective

monetary policy?

MVPY

Monetarism

In long run, price is
mainly

affected by money
supply

Inflation rate equals growth rate of money
supply if
assuming

fixed income and constant
velocity

What if those two assumptions fails?

Hyper
-
Inflation (to get
Seigniorage
)

Quantitative Easing (as a Policy Tool)

http://
S
-
k

http://
en.wikipedia.org/wiki/Quantitative_eas
ing

Classical Dichotomy

According to the
long run
classical theory,
money is neutral (monetary neutrality): the
money supply does not affect real variables

The theoretical separation of real and nominal
variables is called classical dichotomy

Real variables are studied in Chapter 3

Price is determined in
Chapter
4

They jointly determine nominal variables

Fisher
Equation

Application of Classical
Dichotomy

𝑖
=
𝑟
+

𝜋

So nominal interest rate
𝑖

is the sum of real
interest rate
𝑟

and inflation rate
𝜋
.

𝑟

is determined in chapter 3, (Figure 3
-
8)

𝜋

is determined in chapter
4, (MV=PY)

Proof

You have two options: saving a
good

and
earns
real

interest; or saving
money

and earn
nominal

interest.

There is
no arbitrage
at equilibrium:

1
+
𝑟
=
1
+
𝑖
1
+
𝜋

Fisher equation follows assuming
𝑟
𝜋
=
0

How to Forecast

Nominal Interest Rate in
Long Run
?

First determine the real interest rate

=
𝐼
𝑟

Then determine the inflation rate
𝜋
=
%
+
%

𝑌%

Finally use Fisher Equation:
𝑖
=
𝑟
+

𝜋

Nominal interest rate matters because it is a
key variable in Financial and Housing markets

A
Short

Run Theory

Consider the equilibrium in money market

Money supply =

𝑃
, a vertical line

Money (liquidity) demand =

(
𝑖
,
𝑌
)
, a
downward sloping line

At equilibrium


𝑃
=

(
𝑖
,
𝑌
)

Discuss

Dear Professor Li,

I am in your 317 class and had a question regarding interest rates. Prior
to class today I was reading an article that stated that a
main reason
why our economy has not felt the same effects of having a 70% debt to
GDP ratio is that we have lower interest rates compared to European
countries who have similar debt
-
GDP ratios
(but these countries have
higher interest rates). If our economies are similar in terms of this
ratio,
how come we have such a lower interest rate in comparison to a
country such as Spain
?

Also, thanks for an enjoyable class today.

Stephen H.

US
real

interest rate is low because high
(foreign) supply of loanable fund. Spain is
opposite

US
nominal

interest rate is low because of
quantitative easing

Review

Nominal
vs

Real

Y: Real GDP

PY: Nominal GDP

W/P: Real Wage

W: Nominal Wage

r:

Real Interest Rate

i: Nominal Interest

Rate

Classical Dichotomy

Money does not affect real variables

Real variables are determined in Chapter 3

Price is determined in Chapter 4

Review

Long Run
vs

Short Run

Long Run:
𝑴𝑽
=
𝑷𝒀

Short Run:

𝑃
=

(
𝑖
,
𝑌
)