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Lecture2_June7

# Lecture2_June7 - June 7 2010 The Three Macro Markets THE...

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June 7, 2010

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June 7, 2010 Intermediate Macroeconomics 2 T HE T HREE M ACRO (A GGREGATE ) M ARKETS The Three Macro Markets Goods Markets Labor Markets Capital/Savings/Funds/Asset Markets Will put micro- foundations under all three… c P labor wage capital interest rate
June 7, 2010 Intermediate Macroeconomics 3 B ASICS Introduction Consumption-Leisure Model provides foundation for Labor-market supply function Goods-market demand function An application of the basic consumer theory model… …we will put a macro interpretation on it Only one time period no “future” for which to save Notation c : consumption (“all stuff”) n : number of hours spent working per week l : number of hours leisure per week (time spent not working) P : dollar price of one unit of consumption (a nominal variable) W : hourly wage rate in terms of dollars (a nominal variable) t : tax rate on labor income “Weekly” model a detail Could have called it a daily model, a monthly model, a yearly model, … Just need to take SOME stand on the length of a “period” n + l = 168

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June 7, 2010 Intermediate Macroeconomics 4 U TILITY Model Structure Preferences u ( c , l ) with all the “usual properties” Strictly increasing in c Strictly increasing in l Diminishing marginal utility in c Diminishing marginal utility in l Plotted in good-by-good spaces: Plotted as indifference curves Utility side of consumption-leisure model no different than Chapter 1 model c u(c,l) leisure u(c,l) leisure c ( , ) 0 c u c l ( , ) 0 l u c l ( , ) 0 cc u c l ( , ) 0 ll u c l
June 7, 2010 Intermediate Macroeconomics 5 B UDGET C ONSTRAINT Model Structure Consumer must work for his income Y no longer “falls from the sky” Pc Y (1 ) Pc t Wn Y = (1- t ) Wn (all income is after-tax labor income) (1 ) (168 ) Pc t W l n = 168 - l (1 ) 168(1 ) Pc t Wl t W Rearrange Spending on consumption “Spending” on leisure A constant from the point of view of the individual (price-taker) 1 1 2 2 Pc Pc Y Spending on c 1 Spending on c 2 A constant from the point of view of the individual Simply an application/re- interpretation of our basic consumer theory model Chapter 1 budget constraint (After-tax) wage is opportunity cost of leisure, hence the “price” of leisure - opportunity costs are real economic costs / prices

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June 7, 2010 Intermediate Macroeconomics 6 C ONSUMER O PTIMZATION Model Structure Consumer’s decision problem: maximize utility subject to budget constraint bring together both cost side and benefit side Choose c and l subject to or Plot budget line Superimpose indifference map At the optimal choice (1 ) 168(1 ) Pc t Wl t W leisure c slope = -(1- t ) W / P 168 optimal choice ( c*,l* ) ( *, *) (1 ) ( *, *) l c u c l t W u c l P CONSUMPTION-LEISURE OPTIMALITY CONDITION - A key building block of modern macro models MRS (between consumption and leisure) price ratio (inclusive of taxes) IMPORTANT: the larger is (1- t ) W / P , the
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Lecture2_June7 - June 7 2010 The Three Macro Markets THE...

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