„
„
A Closed-Economy One-Period
Macroeconomic Model
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 1
Government
„
„
„
„
„
This week: construct a macroeconomic model within
a closed economy
Complete the firm and consumer behaviour with the
definition of the policymaker
Construct a internally consistent macroeconomic
model
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 2
Competitive Equilibrium
Consumes an amount G to provide public goods
To finance charges T from representative agent
We are in a one-period model, so no deficits/surplus
Government budget constraint
G=T
„
Sofar: defined an environment with a representative
consumer and firm that take optimal decisions in a
static environment
„
„
„
Allow interaction between agents
Derive optimal responses of endogenous
variables w.r.t. exogenous decisions, events,
shocks
Make predictions about future
No monetary policy at the moment, only ‘fiscal
policy’
Government expenditures are ‘exogenous’
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 3
Figure 5-1 A Model Takes Exogenous Variables
and Determines Endogenous Variables
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Exogenous versus Endogenous Variables
„
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 5
Slide 4
Exogenous variables: G, z, K
Endogenous variables: C, Ns, Nd, T, Y, w
We are going to design a consistent structure
(markets clear) to assess e.g. shocks to G and
its impact on final output, consumption, labour
supply etc. decisions
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 6
1
Equilibrium
„
„
„
„
Here
Market clearing condition: demand and supply
will be on equilibrium
Competitive eq’m: environment is
characterized by price takers and optimize
their utility/profits
There is only one price: w (real wages)
Labour time is exchanged for consumption
goods: consumers supply their labour, firms
demand it
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 7
At the competitive eq’m
„
Note that dividend income (π), taxes (T) matter for
consumer’s decision to supply labour.
In eq’m T must be equal to G, and dividend income
should be equal to firm’s profits.
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
„
„
„
C, Ns are chosen optimally by the RepCon
given time and budget constraints (that in turne
determined by w, T, π)..
Nd is chosen optimally by the RepFirm to
maximize its profits given z, K, w..
Labour market clears Nd=Ns
Government budget constraint is satisfied
„
Slide 9
Equations: Firms and Production function
„
„
„
„
„
„
Simplified income-expenditure identity:
Y=C+G
RepCon’s budget constraint C=wNs+π-T
Since T=G and dividend income π=Y-wNd
ÎRewrite consumer budget constraint
„
Î C=wNs+(Y-wNd)-G
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 8
Equations: Consumer/Government
„
„
Competitive eq’m is achieved
when, given the exogenous variables G, z, and K, the
real wage w is such that, the quantity of labour the
consumer supplies is equal to the labour demand of
the firm.
When Ns=Nd in eq’m income-expenditure identity
(Y=C+G) is satisfied
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 10
Figure 5-2 The Production Function and the
Production Possibilities Frontier
In eq’m Nd=Ns=N, where N stands for eq’m
employment
Y=zF(K,N)
(Figure 2a)
In eq’m we have N=h-l
Î Y=zF(K,h-l)
(Figure 2b)
Since at the eq’m C=Y-G, we have
C=zF(K,h-l)-G
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 11
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 12
2
Production Possibilities Frontier
„
„
„
Figure 5-2 The Production Function and the
Production Possibilities Frontier
Describes technological possibilities for the
economy as a whole in terms of production
and consumption goods and leisure
Slope of the PPF is marginal rate of
transformation: (the rate at which one good
(leisure) can be converted technologically into
another (consumption good) through work
MRTl,c= MPN=-(the slope of the PPF)
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 13
Putting PPF and indifference curves together
„
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 14
Figure 5-3 Competitive Equilibrium
We need to determine the production decision
of the firm on the PPF
Labour input is chosen such that profits are
maximized (MPN=w)
Also in eq’m –PPF must be equal to real wage
„
Î MRTl,C=MPN=w
„
Figure
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 15
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 16
Pareto Optimality
„
At point J we have
„
MRSl,C=MRTl,C=MPN
„
Why?
„
Connect competitive eq’m with efficiency
„
Because the consumer and the firm face the same
market real wage in eq’m, the rate at which the
consumer is just willing to trade leisure for C is the
same as the rate at which leisure can be converted to
C using prod’n technology
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 17
Def: A competitive eq’m is Pareto optimal if
there is no way to rearrange production or to
reallocate goods so that someone is made
better off without making someone else worse
off
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 18
3
Figure 5-4 Pareto Optimality
First and Second Welfare Theorems
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 19
Sources of Social Inefficiencies
„
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
„
„
„
Slide 21
Figure 5-1 A Model Takes Exogenous Variables
and Determines Endogenous Variables
Solution to competitive equilibrium is
equivalent to social planner problem
Îbenevolent dictator!
Slide 22
Working with the model
„
Slide 23
Under complete markets paradigm Î
Equivalence between competitive equilibrium
and Pareto optimum is important here
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 20
Working with the model
Competitive eq’m may not be Pareto optimal
due to externalities
Competitive eq’m may not be Pareto optimal
due to distortionary taxation
Competitive eq’m may not be Pareto optimal if
firms are not price takers
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
First Welfare Theorem: under certain
conditions, a competitive equilibrium is Pareto
optimal (invisible hand)
Second Welfare Theorem: under certain
conditions, a Pareto optimum is a competitive
eq’m
We are most importantly interested in how a
change in an exogenous variable (G, z, K)
affects endogenous variables (Y, C, N, w)
See Figure 5
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 24
4
Figure 5-5 Using the Second Welfare Theorem
to Determine a Competitive Equilibrium
Equilibrium Effects of an Increase in Government Spending
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 25
Figure 5-6 Equilibrium Effects of an Increase in
Government Spending
Suppose a ‘shock’ to government expenditures
∆G
Î only income effect!
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Equilibrium Effects of an Increase in Government
Spending
„
Remember business cycle stylized facts
„
„
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 27
Figure 5-7 GDP, Consumption, and Government
Expenditures, 1929-1997
Model predicts procyclical E, countercyclical real
wages, C
Not too impressive
However may explain certain episodes
Slide 28
Increase in Total Factor Productivity
„
„
Slide 29
C, E, real wages procyclical
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 26
A productivity shock (z1 Î z2)
Îboth income and substitution effect
employment
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 30
5
Figure 5-8 Increase in Total Factor Productivity
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 31
Figure 5-10 Income and Substitution Effects of
an Increase in Total Factor Productivity
Figure 5-9 Competitive Equilibrium Effects of an
Increase in Total Factor Productivity
an Increase in Total Factor Productivity
„
„
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 33
an Increase in Total Factor Productivity
„
„
„
Î Ld ↑
Îw↑
ÎY↑
Î C ↑ Î but offsetting income &
substitution effects for l (can ↑ or ↓)
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 34
Figure 5.11 Deviations from Trend in Real
GDP and the Solow Residual
In actual data Y, C, real wages all increase, hours worked roughly
constant
Model tells more or less the same (also valid for employment
measure, hours worked, if substitution and income effects cancel
out in the long run)
Business Cycles
„
„
z↑
In the Long run
„
„
Slide 32
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Model predicts procyclical real wages, C, not conclusive for
employment
Not that bad!
Real Business Cycle theory
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 35
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 36
6
Figure 5.12 The Relative Price of Energy (ratio of the
producer price of fuels, related products and power to the producer price of all
commodities)
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 37
Figure 5-13 Consumption and GDP
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Figure 5-12 Employment and GDP
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 38
Figure 5-14 Deviations from Trend in the Real
Wage
Slide 39
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 40
In sum
„
„
„
Defined competitive eq’m
Complete one-period macroeconomic model
Some experiments
„
„
„
„
Government expenditures shocks (triggering only income
effects)
Total factor productivity shocks (triggering both income
and substitution effects)
Some success Complete one-period macroeconomic model
Next week: incorporate some more realism:
dynamics!
Copyright © 2002 Pearson Education, Inc. and Dr Yunus Aksoy
Slide 41
7