notes 3

notes 3 - EC202 Fall 09 Lecture Notes 3 Gabriele Gratton...

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Lecture Notes 3 Gabriele Gratton August 31, 2009 1 Readings Mankiw, Ch. 2.1 and 3 2 Macroeconomics. .. In the ±rst two chapters we have looked at the behavior of a single individual, Dude, and all the individuals in an economy demanding or supplying funds in the credit market. Indeed a large part of economic decision is the choice of individuals about consumption and savings, but in an economy there are ±rms who hire labor and capital and produce goods, make pro±ts and pay the two factors of production (labor and capital). Individuals have property rights over labor (their time) and capital, and then decide how and when to spend their income, buying those goods and services produced by the ±rms. It seems like a complicate in±nite cycle ² and it is, up to some extent ² but any discussion about macroeconomics have necessarily to start from taking into account all this. In this set of notes we start building our theoretical economy. 3 Households much should I save? Each household in the economy faces the same problem. For each of them and in each period, therefore, there exists a budget constraint of the form c t + s t = y t (1) where c is consumption, s is savings and y is the income available to the in- dividual in this period. We have already studied how individuals may decide between c and s , but this is not all the story. In particular, Dude can decide whether to work and for how long, since maybe his utility function depends on his leisure as well as on consumption (after all leisure is a good we consume). On the other side it is clear that his income will depend on the time it spends 1
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1 unit of time during each period of his life, and he can choose which part l to work. Said this way, his problem is to chose c (and all future c l trying to maximize his utility u ( c; 1 l ) with two constraints c t + s t = y ( l t ) (2) 0 ± l ± 1 : In most of the applications we are going to study, we will take his decision about l as ±xed, but this has not to be and from time to time we will analyze it more formally. What it is important to know now is that his income will depend on his labor supply l . More precisely, if he is receiving a wage w (notice, everything here is in real terms! this is a real wage) his income from labor is
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notes 3 - EC202 Fall 09 Lecture Notes 3 Gabriele Gratton...

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