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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
The Obama administration has taken these ideas from behavioral economics
to heart by adding provisions to the 2009 economic stimulus package requiring
employers that did not have retirement plans
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
If Carmencita plans to spend C1 in the first period, we can determine her consumption in the second period, C2. Shell have her initial wealth, W, plus whatever
income she doesnt spend in the first
CHAPTER 18 CONSUMPTION AND SAVING
475
red shaded area in panel (a) of Figure 18.8. But now every year her wealth is going
down by this amount, which is shown in panel (b), until at the end of her life when she
has exhausted all her savings. The life-cycle
CHAPTER 18 CONSUMPTION AND SAVING
473
where,
v = [1> (L - T)]
(10)
c = [(R - T)> (L - T)]
(11)
The life-cycle hypothesis comes to a conclusion that we already saw from our analysis
of intertemporal choice: changes in consumption are driven by changes in i
CHAPTER 19 INVESTMENT
503
From House Prices to Residential Investment
The residential investment IH curve in panel (b) of Figure 19.7 shows the relationship
between the relative price of housing and the construction of new homes, that is, the
flow of resi
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
rented, then the landlord earns the rent from the renter over the life of the house, and so
the houses market valuation is the expected discounted value of that rent over the life of
the house. T
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501
2. A rise in the real interest rate or a rise in the effective tax rate, which increase
the user cost of capital, lower q and therefore cause investment to fall.
3. A higher price of capital increases the replacement cost of capi
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
what Tobins q theory predicts. With soaring stock prices, Tobins q rose to very high levels,
and U.S. companies found that any new technology-related capital they put in place had values well abo
CHAPTER 19 INVESTMENT
505
income is higher, or if an increase in the number of households that will want housing bids up rent. The analysis in Figure 19.8 therefore produces the following result:
higher expected income or increases in household formation
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
Housing Prices and
Residential
Investment,
20012009
From 2001 to 2006,
housing starts rose
from around 1.5 million to a peak of
over 2 million, while
from 2006 to 2009,
they fell to around
500,00
CHAPTER 19 INVESTMENT
509
appreciation of housing prices, lowering the user cost of housing and stimulating demand.
The result is depicted in panel (a) of Figure 19.10: demand for housing increased, the
demand curve shifted to the right from D1 to D2, the
CHAPTER 19 INVESTMENT
4. Discuss the effect of the investment tax credit
made by the Obama administration on February
2009 on the level of investment in the United
States. What does empirical evidence suggest
about the link between taxes and investment?
5
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
REVIEW QUESTIONS
All questions are available in
at www.myeconlab.com.
Data on Investment Spending
1. Identify and give examples of the three components of investment spending.
The Neoclassical Th
CHAPTER 19 INVESTMENT
511
markets by selling bonds and then lending the proceeds to financial institutions that
make mortgage loans. By providing guarantees and funds to the mortgage market,
these government agencies and GSEs help lower mortgage rates, th
CHAPTER 18 CONSUMPTION AND SAVING
459
then choose C1 = W + Y1 = $50,000 + $10,000 = $60,000. From Equation 2, C2 will
be as follows:
C2 = (1 + .04)(0) + $52,000 = $52,000
We plot the combination of C2 $52,000 and C1 $60,000 as point B in Figure 18.1.
Poin
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461
2. Indifference curves slope down. Consider points W and X in Figure 18.2.
Since they sit on the same indifference curve IC1, both points make
Carmencita equally happy. Yet at point W, Carmencita spends CW in the
2
se
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
other words, we can describe the intertemporal budget constraint in Equation 3
as follows:
Present value of consumption = present value of lifetime resources
Preferences
Preferences involve ranki
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
Now lets look at what happens to saving and wealth over time. For the first fortyfive years of her life, Carmencita is saving Y - C = Y - 0.75Y = 0.25Y (i.e., a quarter of
her salary), which is d
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
income they earn in that period. That is, after optimizing, it is no longer true that the
marginal rate of substitution equals one plus the interest rate. Instead, the slope of the
indifference c
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
The reasoning behind the random walk hypothesis starts with three steps.
1. The life-cycle and permanent income hypotheses (as well the theory of
intertemporal choice) imply that consumers are fo
CHAPTER 18 CONSUMPTION AND SAVING
463
both periods. Indeed, because the real interest rate is unchanged, the slope of the
intertemporal budget line remains the same and so it shifts to the right in a parallel
fashion from IBL1 to IBL 2 in Figure 18.4. (Mo
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PART SEVEN MICROECONOMIC FOUNDATIONS OF MACROECONOMICS
Consumption Smoothing
Our analysis of consumption and wealth reveals two important facts.
1. Consumption rises when the present value of lifetime resources increases,
regardless of its source (cu
CHAPTER 17 EXCHANGE RATES AND INTERNATIONAL ECONOMIC POLICY
447
To Peg or Not to Peg
Fixed exchange rate regimes have a long history. They can take the form of fixing the
value of the domestic currency to a commodity such as gold, the key feature of the g
CHAPTER 17 EXCHANGE RATES AND INTERNATIONAL ECONOMIC POLICY
449
Nonetheless, exchange-rate pegging is highly dangerous for these countries,
because it leaves them open to speculative attacks that can have far more serious consequences for their economies
CHAPTER 17 EXCHANGE RATES AND INTERNATIONAL ECONOMIC POLICY
451
REVIEW QUESTIONS
All questions are available in
at www.myeconlab.com.
Foreign Exchange Market and Exchange Rates
1. What is the foreign exchange market?
Describe the two types of transactions
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PART SIX MACROECONOMIC POLICY
A striking example of these problems occurred when Germany reunified in 1990. In
response to concerns about inflationary pressures arising from reunification and the massive fiscal expansion required to rebuild East Germ
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PART SIX MACROECONOMIC POLICY
Exchange Rates in the Long Run
2. A Starbucks coffee sells for 10 yuan in Beijing,
China, and for $2 in Chicago.
a) Calculate the nominal exchange rate if the
law of one price holds.
b) Assume that currently the nominal
18
Consumption and Saving
Preview
From 2001 to 2007, buoyant households increased consumption expenditure at a
rapid rate of 3% a year. In 2008 and 2009, when households began to save more, consumption expenditure fell, declining at a 0.25% rate in 2008 a
CHAPTER 18 CONSUMPTION AND SAVING
457
Here, for simplicity, we denote disposable income as Y.1 For a household, current
spending is consumer expenditure, so we define saving by the identity:
S=Y-C
(1)
Taking the level of disposable income, Y, as given, we
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465
When the interest rate rises to r2, however, the slope of the budget line becomes
more negative at - (1 + r2) , so the IBL2 intertemporal budget line becomes steeper.
Because it still goes through point B, this means