Macro2_Closed_Economy

# Macro2_Closed_Economy - The Closed Economy How the real...

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The Closed Economy How the real interest rate keeps the goods market in equilibrium Y = C + I(r) + G

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Model Background This model is closed in the sense that there are no exports or imports in the model. The model does include government tax and government expenditure. If the model is out of equilibrium it is the changing real interest rate that returns the model to equilibrium. Y > C + I(r) + G => interest rate decreases => I increases until Y = C + I(r) + G. Y = C + I(r) + G The left hand side of the goods market represents supply The right hand side represents demand. Y < C + I(r) + G => interest rate increases => I decreases until Y = C + I(r) + G. Supply Demand
Building the Goods Market Model: supply side This is a long run model so output Y is determined by factor inputs (i.e. K and L) only. MPL=F(K,L+1)-F(K,L) Y=F(K,L) L Y ( , ) Y F K L = Change in Y Change in L changeinY MPL changeinL = K Y ( , ) Y F K L = Change in Y Change in K We begin with a production function. For simplicity we assume K is fixed and allow L to vary. The slope of this function is the marginal product of labour. It tells us the change in output that results when we increase labour by one unit.

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