325_Lecture24_April27

325_Lecture24_April27 - THE FINANCIAL ACCELERATOR...

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1 T HE F INANCIAL A CCELERATOR (CONTINUED) A PRIL 27, 2011 April 27, 2011 2 O UTLINE OF F RAMEWORK Introduction Major ideas underlying Financial Accelerator Framework 1. Firms’ financial assets (i.e., stocks and bonds) matter for their ability to purchase physical assets (i.e., machines and equipment) 2. Market prices of financial assets matter for firm financing constraints 3. Government regulation affects the linkage between financial markets and real (i.e., goods and physical capital) markets through financing constraints
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2 April 27, 2011 3 F INANCIAL A CCELERATOR F RAMEWORK Model Structure ± Four Building Blocks of the Financial Accelerator Framework 1. Firm Profit Function 2. Financing Constraint 3. Government Regulation of Financial Relationships (imposition of R on financing constraint) 4. Relationship between firm profits and dividends 121 1 1 () P kS a R k ± ± ² ± 1 1 P a R k ± ± ± 23 22 2 2 2 12 2 2 2 2 11 1 1 1 1 1 01 1 21 1 (, ) ( ) ( ) 111 1 1 1 Pk Pfk n S Da Pwn Sa Pf k n S D a Pwn Pk iii i i i ³ ³³³ ² ²²³ ³ ³ ² ² ² ³ ³³ ³ ³ ³ = 0 = 0 NEXT TIME April 27, 2011 4 F IRM P ROFIT M AXIMIZATION Model Analysis Maximize two-period profits Subject to financing constraint Construct Lagrangian 2 2 2 2 2 1 1 ( ) ( ) 1 1 1 S i i i ³ ² ³ ³ ³ ³ = 0 = 0 1 1 P kk R ± ± ± >@ 2 2 2 1 1 11 1 2 1 ( ) ( ) 1 S i RS a P k k O ³ ² ³ ³ ³± ± ² ± ² Lagrange multiplier on financing constraint IMPORTANT OBSERVATION: in basic firm theory (i.e., Chapter 6), value of this multiplier was…. NJ = 0 i.e., there was no financing constraint! KEY QUESTION: What regulatory and/or market features make the financing constraint effectively “disappear” (i.e., cause NJ = 0)
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3 April 27, 2011 5 F IRM P ROFIT M AXIMIZATION Model Analysis ± FOCs with respect to n 1 , n 2 with respect to n 1 : with respect to n 2 : ± Financing constraint does not affect profit-maximizing choices of labor hiring… ± …thus same analysis from Chapter 6 of labor demand curve, etc, applies ± FOCs with respect to k 2 , a 1 ± The interesting aspects of this framework ± The heart of the financial accelerator framework Identical except for time subscripts Equation 1 Equation 2 >@ 22 2 2 2 12 2 2 11 1 1 1 1 1 01 1 21 1 11 1 2 1 (, ) ( ) ( ) 111 1 () Pfk n Pk S Da Pwn Pf k n S D a Pwn Pk Sa iii i RS a P k k O ± ±±± ² ²²± ± ± ² ± ±± ± ±³ ³ ² ³ ² April 27, 2011 6 F IRM P ROFIT M AXIMIZATION ± FOCs with respect to k 2 , a 1 with respect to k 2 : with respect to a 1 : 2 2 2 1 1 ( ) ( ) 1 S i ± ² ± ± ³ ² ³ ² 2 2 0 k P PP ii ²± ± ² 0 1 SD SR S i ± ² ³ ³ ± Equation 3 Equation 4
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4 April 27, 2011 7 F IRM P ROFIT M AXIMIZATION Model Analysis ± FOCs with respect to k 2 , a 1 with respect to k 2 : with respect to a 1 : ± Analysis of Equation 4 in isolation ± Answers the central question: under what conditions does NJ = 0?
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325_Lecture24_April27 - THE FINANCIAL ACCELERATOR...

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