OctFlexI - Flexible Price Long Run Macro Wednesday; October...

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Unformatted text preview: Flexible Price Long Run Macro Wednesday; October 12, 2005 Announcements Midterm out during section Thursdays Section: Solving the Midterm Q will be handling all sections Outline: Long Run, Flexible Prices Investment and Savings and the determination of Interest Rates Moneyan introduction Fisher Effect Digression: mastering models To learn a model well, be sure to know: 1. Which of its variables are endogenous and which are exogenous. 2. For each curve in the diagram, know a. definition b. intuition for slope c. all the things that can shift the curve 3. Use the model to analyze the effects of each item. Demand for goods & services Components of aggregate demand: C = consumer demand for g & s I = demand for investment goods G = government demand for g & s (if closed economy: no NX ) Consumption, C def: disposable income is total income minus total taxes: Y T Consumption function: C = C ( Y T ) Shows that ( Y T ) C def: The marginal propensity to consume is the increase in C caused by a one-unit increase in disposable income. The consumption function C Y T C ( Y T ) 1 MPC The slope of the consumption function is the MPC. Investment, I The investment function is I = I ( r ), where r denotes the real interest rate , the nominal interest rate corrected for inflation. The real interest rate is z the cost of borrowing z the opportunity cost of using ones own funds to finance invest ment spending. So, r I The investment function r I I ( r ) Spending on investment goods is a downward- sloping function of the real interest rate Government spending, G G includes government spending on goods and services. G excludes transfer payments Assume government spending and total taxes are exogenous: = = and G G T T The market for goods & services The real interest rate adjusts to equate demand with supply. The real interest rate adjusts to equate demand with supply. Agg. demand: ( ) ( ) C Y T I r G + + Agg. supply: ( , ) Y F K L = Equilibrium: = ( ) ( ) Y C Y T I r G + + Guideline So thats the big picture Now, we focus on one of these variables: INVESTMENT Supply of funds: Saving The supply of loanable funds comes from saving: Households use their saving to make bank deposits, purchase bonds and other assets. These funds become available to firms to borrow to finance investment spending....
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OctFlexI - Flexible Price Long Run Macro Wednesday; October...

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