Name: _ Date: _
1. Starting from a trade balance, if the world interest rate falls, then, holding other factors
constant, in a small open economy the amount of domestic investment will _ and
net exports will _.
A) increase; increase
1. Consumption depends _ on disposable income, and investment depends _
on the real interest rate.
A) positively; positively
B) positively; negatively
C) negatively; negatively
D) negatively; positively
2. Assume that the consumption function i
Name: _ NetID (username): _ Date: _
1. When a government spends more than it collects in taxes, it runs a:
A) trade deficit.
B) trade surplus.
C) budget surplus.
D) budget deficit.
2. Government debt equals the:
A) difference between current govern
National Savings: International Rates
Guidolin and La Jeunesse
International Household Saving Ratios (quarterly)
1980 1982 1984 1986 1988 1990 1992 1994 19
The Elastic Consumer
Up to now y was exogenous now introduce labor supply:
C + S p = w(h l) + T
C = w (h l ) + T + (1 + r)S P
w (h l ) + T
= w(h l) + T +
Problem of the Elastic Consumer
Maximize utility subjec
The Cost of Short Run Decits
What if Debt-to-GDP increases to 120% from 2009-2011
Want to reduce the debt to zero
Assume after 2011, primary decit is -3% of GDP (e.g. a surplus)
How long to pay o the debt?
The Cost of Short Run Decits
Again, our formula:
Lifetime Wealth and Labor Supply
Example: tax cuts, increase in value of stocks, . . .
Demand for Current Consumption Goods
Let C(we, r) denote consumption. Eects on the consumption of goods:
Demand of current consumption increases when
lifetime wealth in
Interest Rate and Demand for Current Consumption
increase in the real interest rate shifts the demand for current
consumption goods down
Lifetime Wealth and Demand for Current Consumption
increase in lifetime wealth shifts the demand for current consumpti
Introduce non-linear production technology and investment
Output today: Y = zF (K, N )
Output tomorrow: Y = z F (K , N )
Firm invests I so that K = (1 d)K + I
(next period capital equals depreciated current capital plus
Suppose that the production function is Cobb-Douglas:
zF (K, N ) = zK N 1
What the the optimal investment rule (as a function of d, N and
How does optimal investment depend on z , K, d, and r?
307 of 440
The Firm and Labor Demand
Optimality M PN = w (wage goes up labor demand goes down)
If z or K increase labor demand increases
The Firm and Investment Decision
Cost of $1 Investment? Reduce todays prot by 1 dollar
marginal cost of investment M C(I) = 1
Interest Rates and Labor Supply
Let N (we, r, w) denote Consumer labor supply:
Current labor supply is increasing in real wage
(from now on assume substitution larger than income eect)
dN (we, r, w)
Current labor supply decreases if lifetime wealth
The Cost of Long Run Decits
If no initial debt, then B0 = dY0 .
Substitute in time 1, then repeat:
B0 = dY0
B1 = (1 + r)dY0 + dY1
= (1 + r)dY0 + d(1 + g)Y0
= dY0 (1 + r + 1 + g)
Continuing in this way, we nd
Bt =dY0 (1 + r)t + (1 + r)t1 (1 + g)+
+ (1 + r
Government Surplus as Share of GDP
Note: Large decline in surplus since 2000
Tax Revenues as Share of GDP
Note: Large decline in tax revenues since 2000
Debt as Share of GDP
293 of 440
Note: Large increase in debt relative to GDP since 2000
Government Debt and GDP
Level of GDP essentialy represents the tax base
Debt to GDP essentially represents how much we have to tax to
pay o debt
Debt to GDP currently near 80%
Future tax liabilities are equal to 80% of current GDP!
The Cost of Long Run De
Tax Rebates of 2001
In March 2001, the U.S. economy entered a recession. In response,
the Economic Growth and Tax Relief Reconciliation Act of 2001
included a large income tax rebate program. The program sent
tax rebates, typically $300 or $600 in value,
Evidence? Israel 1983-1987
In 1983, public saving (decit) is -4% of GDP and private saving is
17% of GDP.
In 1984, a dramatic rise in budget decit reduced the public saving
to -11%. Private saving rose to 26%.
In 1985-86, budget decit is eliminated. Publi
Suppose current taxes change by t and future taxes change by
Now, think about equilibrium conditions:
Life-time Budget constraint of Govt: unchanged
Life-time budget constraint of HH: unchaged
Optimal consumption plan of hous
Eects of Tax Policy
In one period model, increase in G does not increase Y 1 for 1.
Because govt spending crowds out private consumption (Income
Also, we could not analyze taxation and spending independently.
Because G = T
In data we have bonds with dierent default risk:
Question: how would the model price dierent maturities?
Answer: lets assume that by the time the bonds ma
The Dynamic Government
Government spends and taxes in two periods
NEW: now it can borrow and save!
Budget constraint today
Budget constraint tomorrow
G + (1 + r)B = T
Life-time budget for the Government
Can you derive this?
Recall there is a government that balances budget over two period
Equilibrium in the Extended Two Period
Equilibrium in the Labor Market
Denition of equilibrium is standard
1) Consumer and Firms optimize
2) Government s
Equilibrium in the Labor Market
First step: equate demand for labor (rm) and supply of labor
We obtain the employment level: N
We obtain the wage rate: w
! recall supply of labor depends on r
Relating Employment and Output
Next step is to rel
Housing Market Example
Let ph be the price of housing in the future.
What is the marginal benet of investment in housing?
Investment increases the stock of housing and therefore increases
the value of housing services = M P K
It increases the sale value o
ModernMacroeconomics Practice:How Theory ShapingPolicy 11
zero because money turns out to be a hedge against real fluctuations, paying out
relatively more in bad times and relatively less in good times. Indeed, money turns
out to be enough of a hedg
Chapter 1 Reading Notes
Why Study Money, Banking, and Financial Markets
1. Financial Markets markets in which funds are transferred from people who have
an excess of available funds to people who have a shortage of available funds.
Economics 351 Chapter 2 Reading Notes - An Overview of the Financial System
Function of Financial Markets
1. Financial Markets perform an essential economic function of channeling funds
from households, firms, or governments that have saved surplus by spe
Economics 351 Chapter 4 Reading Notes
Understanding Interest Rates
1. Present Value
a. Cash Flow different streams of cash payments to the holder
b. Present Value (or present discounted value) a dollar paid to you one
year from now is less valuable than a
Economics 351 Chapter 3 Reading Notes What is Money?
1. Meaning of Money anything that is generally accepted in payment for
goods/services or for repayment of debts
a. Currency paper money and coins
b. Wealth total collection of pieces of property that se
Economics 351 Chapter 5 Reading Notes Behavior of Interest Rates
1. Determinants of Asset Demand
a. Wealth the total resources owned by the individual, including all
i. Ceteris Paribas, an increase in wealth raises the QD of an asset
b. Expected Re