Lecture_15_2010_M - Intermediate Macroeconomics Bruce...

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Unformatted text preview: Intermediate Macroeconomics Bruce Preston March 23, 2010 Today • Building the short-run model — The IS Curve • Microfoundations: — Today: Theory of consumption — Thursday: Investment Central Components • Description of household and firm demand for output — Consumption, Investment — Open economy: exports and imports • Description of firm supply of output • Description of policy — Monetary and fiscal policy Expenditure Identity Frames our Analysis • Recall: \ w = F w + L w + J w + H[ w 3 LP w Alternatively \ w + LP w = F w + L w + J w + H[ w Total resources = Total demands The Model • Assume: F w = ¯ d f ¯ \ w J w = ¯ d j ¯ \ w H[ w = ¯ d h{ ¯ \ w LP w = ¯ d lp ¯ \ w L w ¯ \ w = ¯ d l 3 ¯ e ( U w 3 ¯ u ) Deriving the IS Curve • Note the expenditure identity implies \ w ¯ \ w = F w ¯ \ w + L w ¯ \ w + J w ¯ \ w + H[ w ¯ \ w 3 LP w ¯ \ w = ¯ d f + ¯ d l 3 ¯ e ( U w 3 ¯ u ) + ¯ d j + ¯ d h{ 3 ¯ d lp • Letting ˜ \ w- \ w 3 ¯ \ w ¯ \ w gives ˜ \ w- \ w 3 ¯ \ w ¯ \ w = ¯ d f + ¯ d l 3 ¯ e ( U w 3 ¯ u ) + ¯ d j + ¯ d h{ 3 ¯ d lp 3 1 • Hence ˜ \ w = ¯ d 3 ¯ e ( U w 3 ¯ u ) where ¯ d = ¯ d f + ¯ d l + ¯ d j + ¯ d h{ 3 ¯ d lp 3 1 Properties of the IS Curve • Suppose the economy is at long-run equilibrium defined as ˜ \ w = 0 U w = ¯ u • Then the IS curve implies the relation ¯ d f + ¯ d l + ¯ d j + ¯ d h{ 3 ¯ d lp = 1 — which in turn generates the restriction: ¯ d = 0 ! — interpretation? Elements of a Theory of Consumption • Households are forward-looking • Consumption-savings decisions depend on some assessment of life-time resources — But how should these resources be allocated — Modigliani’s life-cycle hypothesis — Friedman’s permanent income hypothesis How Do Individuals Allocate Consumption • Could borrow heavily: consume a lot now — Repayment of debts implies little consumption later • Could save all current income: consume little now — Accumulate wealth: consume a lot in the future How Do Individuals Allocate Consumption • Could borrow heavily: consume a lot now — Repayment of debts implies little consumption later • Could save all current income: consume little now — Accumulate wealth: consume a lot in the future People typically choose neither extreme: observe “consumption smoothing” Simple Example • Individual works from age 21 to 65 (45 years) • Earns $80,000 each year • Retirement period age 66 - 80 (15 years) • Real interest rate: 0 • No initial wealth or debt • Individual desires the same consumption each period Solution • Total resources: Lifetime resources = Human wealth = Value of labor income = 45 W 80 > 000 = 3 > 600 > 000...
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Lecture_15_2010_M - Intermediate Macroeconomics Bruce...

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