Chapter7_2009

Chapter7_2009 - Disclaimer These notes were prepared based on lectures of Prof Sala-i-Martin’s 2008 Fall Course of Intermediate Macro-W3213

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Unformatted text preview: Disclaimer: These notes were prepared based on lectures of Prof Sala-i-Martin’s 2008 Fall Course of Intermediate Macro-W3213. Contents of these notes might not match completely with the current teachings in class. 7.1 C, I and the Business Cycle Investment (I) and Consumption (C) are procyclical, but I is more volatile than output. This is shown in Fig 7.1 I C Y time Fig 7.1 If we want to explain this Business Cycle, we need to talk about investment. Investment is what drives the Business Cycle. 7.2 Investment Theory In Chapter 4 we showed that households purchase consumption goods because they ENJOY them. A substantial fraction of the goods in the economy, however, are not purchased by households or private families but, rather, by firms. The firm’s decision to buy goods is different from the decision on the part of households. The reason is that firms do not buy goods because they enjoy them. They buy goods because they want to use them along with some labor in order to produce more goods. Firms buy machines, pencils, buildings, computers, cars, typewriters and so on in order to increase their productive capacity (individuals buy the same cars, computers and so on because they want to play with them). The FLOW of goods purchased by firms during year t is often called INVESTMENT and we denote it by the letter I t . Firms buy this flow of goods, I t , with two goals: to INCREASE the STOCK of productive CAPITAL available at a point in time and to REPLACE the machine. If K t is the stock of capital at time t, then the flow of purchases by firms during year t, then ? = ? ? + ? ?− 1 7.1 where ΔK t = K t- K t-1 is net investment and δK t -1 is depreciation. A realistic feature of the capital stock is that it takes some time for it to be productive. That is, between the time one decides to buy the machinery and the time the machinery is actually productive, there is a period of installation. For example, if Robinson Crusoe decides to plant a coconut tree so as to get more coconuts in the future, he will have to wait for a while after he actually plants the tree before the tree can produce any coconuts. When a firm decides to build a new plant, it will not be able to use it immediately. It will take some time to build the actual plant and it will take some time for the workers to accommodate to the new situation. Economists often call this phenomenon as “time to build”. We will reflect this idea with the assumption that the production of output at time t depends on the capital stock which was decided at time t-1: ? ? = ? ¡ ? , ? ?− 1 ¢ 7.2 This means that the capital stock that we decide to have today, K t , will not be productive until a year from now so it will be combined with the level of technology at time t+1, A t+1 , and with the workers hired at t+1, L t+1 , to produce output at t+1, Y t+1 : ? +1 ?...
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This note was uploaded on 11/10/2011 for the course ECON 3100 taught by Professor Sala-i-martin during the Spring '11 term at Columbia.

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Chapter7_2009 - Disclaimer These notes were prepared based on lectures of Prof Sala-i-Martin’s 2008 Fall Course of Intermediate Macro-W3213

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