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Williamson_3e_IM_09 - Chapter 9 A Real Intertemporal Model...

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Chapter 9 A Real Intertemporal Model with Investment Teaching Goals At first glance, students may think that much of this chapter is simply a repetition of the material in the previous chapter. Students may also get impatient with the many intricate steps of model building. I like to emphasize that the possibility of accumulating capital represents a fundamental difference to an economy. It also explains one crucial component of GDP that was characterized with its very volatile behavior: investment. In the previous chapter, average consumption must equal per capita total output less per capita government spending. For a given amount of government savings, aggregate private savings is fixed. One consumer may only reallocate consumption across time if another consumer is willing to make the complementary reallocation. Borrowing and lending can improve economic outcomes only to the extent that it can help bridge differences in consumers’ allocations of income over time. In particular, if there is a single representative consumer, this consumer is stuck with consuming her gross income net of government spending in the current period. The investment process allows the whole economy to effectively reallocate consumption across time. Try also to tie this in with the previous chapter on growth where investment was crucial. Many students try to get by with this material by rote memorization of a great many curve shifts and laundry lists of the effects of specific disturbances. However, to really understand this material, students must be able to work out the effects of disturbances on their own. I therefore encourage the students to put a good deal of effort into solving problems with the model. Often there may be a specific current political issue to which the model of this chapter may be put to use. When presenting the impact of a particular shock, always go back to the micro-foundations to explain why particular curves shift. An Alternative Graphical Presentation Chapter 9 in the text adopts the traditional approach of analyzing the effects of disturbances with the help of output supply and demand curves. Another way of presenting the same results is based on the application of the second fundamental theorem of welfare economics. This approach is developed in some detail in Chapter 5 for the case of the one-period economy. This approach is also applicable to the two-period economy. The solution to the two-period planner problem will also be a competitive equilibrium. To keep things relatively simple, consider the case in which first- and second-period employment is fixed at and , N N' respectively. First-period gross output, including the scrap value of the first-period capital stock, (1 ) , d K is equal to ( , ) (1 ) . Y zF K N d K = + Gross first-period output can be used for first-period consumption, gross investment, and government purchases. For a given amount of first-period consumption, available second-period consumption is given by: ( , ) (1 )( ) . C' z'F Y C G N d Y C G G' = +
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Chapter 9
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