ECO 317 Intermediate Macroeconomics

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28 Οκτ 2013 (πριν από 3 χρόνια και 9 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
email and post grade


Google “
jing

li
miami

university”

Grades


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


𝑑𝑃
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 return to scale


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


How about
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://
www.youtube.com/watch?v=PTUY16Ck
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.


Answer


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
)