PIIBP2_LEC3_mau - Part IIB Paper 2: Business Cycle Theory...

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Unformatted text preview: Part IIB Paper 2: Business Cycle Theory LECTURE 3: Imperfect Information Lucas Supply Curve Mauricio Prado University of Cambridge 4 Mar 2011 Mauricio Prado (University of Cambridge) Part IIB P2 - Business Cycles - Lecture 3 4 Mar 2011 1 / 32 Outline of Lecture Imperfect information The Lucas imperfect information model Perfect information case Imperfect information: signal extraction The Lucas supply curve Analysis of money shocks, taking the slope of the Phillips curve as given Computation of this slope in terms of underlying parameters Empirical evidence Mauricio Prado (University of Cambridge) Part IIB P2 - Business Cycles - Lecture 3 4 Mar 2011 2 / 32 Imperfect Information and Misperceptions Incomplete nominal adjustment may occur in a market clearing setting in the presence of imperfect information Basic story behind Lucas’ islands model Monopolistic competition as in the previous model we saw (recall, there if no menu costs, money is neutral) Households produce output which is sold to other households in goods market Households occupy one island each and consist of two members: ”producer/worker” and ”salesman/shopper”. The two have limited communication during the day Producer i knows the price of his own good but cannot infer the aggregate price P when making decisions, because shopper cannot call him from the goods market (imperfect information) Mauricio Prado (University of Cambridge) Part IIB P2 - Business Cycles - Lecture 3 4 Mar 2011 3 / 32 Imperfect Information and Misperceptions Producer makes decisions based on an appropriate ”guess” of the aggregate price (signal extraction) Households (individual) demand and aggregate demand are subject to shocks When the household’s own good price changes, household cannot tell whether it is due to a change in the general price level or a change in relative prices It attributes part of it to a change in relative prices, and increases supply When everybody does the same, aggregate supply becomes upward sloping Money has real effects [Phelps, 1970], [Lucas, 1972], [Lucas, 1973] Mauricio Prado (University of Cambridge) Part IIB P2 - Business Cycles - Lecture 3 4 Mar 2011 4 / 32 Notation Y Q i P L i C i P i R i Z i M Variable (levels) Aggregate real output Real output of household i Nominal price of goods (”average” price index) Labor supply of household i Real consumption of household i Price of good produced by household i Relative price P i / P Shock to individual demand Nominal money supply (stochastic) y = q i = p = l i = c i = p i = r i = z i = m = Variable (logs) ln Y ln Q i ln P ln L i ln C i ln P i ln R i = p i- p ln Z i ln M Stochastic variables: z i ∼ N ( 0, v z ) m ∼ N ( E [ m ] , v m ) cov ( z i , z j ) = cov ( z i , m ) = Mauricio Prado (University of Cambridge) Part IIB P2 - Business Cycles - Lecture 3 4 Mar 2011 5 / 32 The Model Households and producers are the same Production function as before Q i = L i ”Profits” of producer = household income (no labour market)...
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This note was uploaded on 06/04/2011 for the course ECONOMICS paper 2 taught by Professor Prado during the Spring '11 term at Cambridge.

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PIIBP2_LEC3_mau - Part IIB Paper 2: Business Cycle Theory...

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