L4 - Markets prices and the individual’s decision problem...

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Unformatted text preview: Markets, prices, and the individual’s decision problem • Chapters 6 and 7, book 1, Chapter 2, book 2 • Markets in macroeconomy • Determination of the rental and wage rates • The individual’s budget constraint and decision problem 1 Markets in macroeconomy The goods market: Y = F ( K,L ) • Firms produce and supply (Households own firms); Households demand. The labor market: L • Firms demand; Households supply. The capital market: K • Firms demand; Households supply. The bond market: B • Households borrow (by selling bonds) and lend (by buying bonds). 2 In each market, there are many suppliers and many demanders, so the market is perfectly competitive. • Any participant’s selling or buying cannot affect the price in the market. So all participants take as given the price in the market. Markets are always cleared, i.e., demand=supply in each market. 3 Money, nominal prices, and real prices Imagine that there is one final good per date. Prices in the units of this good are real prices. • r t the real rental rate at t (rent 1 unit of good at the start of t and then get back 1 + r t units of good at the end of t ) • w t the real wage rate at t • i t the interest rate of real bonds (lend 1 unit of good at t and paying back 1 + i t units of good at t + 1 ) 4 i t = r t- δ • 1 unit of good: renting gives 1 + r t- δ at the end of t so 1 + r t- δ at the start of t + 1 . • 1 unit of good: lending gives 1 + i t at the start of t + 1 • If i t > r t- δ , then everyone lends his good in the bond market to enjoy the better rate of return. So no one rents in the rental market. So no capital input, which means MPK (which is also the rental rate) is infinite so that r t- δ is infinite. But infinite cannot be less than i t , a real number. • If i t < r t- δ , then under these rates everyone borrows in the bond market and then rent the borrowed good in the rental market, but no one supplies in the bond market. So demand=supply is impossible in the bond market....
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This note was uploaded on 04/02/2009 for the course ECON 3140 taught by Professor Mbiekop during the Spring '07 term at Cornell.

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L4 - Markets prices and the individual’s decision problem...

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