eco 317 intermediate macroeconomics. instructor jing li (sounds like lee) 7-year experience of...
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ECO 317
Intermediate Macroeconomics
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Instructor
• Jing Li (sounds like Lee)• 7-year experience of teaching at US colleges • Second year at MU• Married with two kids• Teaching eco 311 as well
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Expectation
• Hard-working is expected• Cramming for exam does not work• Memorizing does not work• Understanding is the key• If you need A or B, earn it!
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Required Textbook
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Webpage
• http://www.fsb.muohio.edu/lij14/• I use Nihhka only when I need to send group
email and post grade• Google “jing li miami university”
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Grades
• Six homeworks, 10 points• Term paper, 10 points• Three midterm exams, 60 points• Final exam, 20 points• (bonus) Attendance, worth 3 points• None of the exam is accumulative
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Hot Issues
• National Debt• Income gap: 1% vs. 99%• Globalization • 2007-2009 Recession
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Review
• Labor (input) L is used to produce output Y• Production is captured by production function
• Marginal product of labor (MPL) is the extra output that can be produced by using one more unit of labor
• Q: What is the sign of MPL? • Q: What happens to MPL as L rises?
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Two Properties of MPL
• >0, so total product rises when input rises• <0 (decreasing or diminishing marginal
product). The extra labor becomes less and less productive.
• Graphically, the production function (total product curve) is upward sloping, and becomes flatter and flatter.
• Q: how does the marginal product curve looks like?
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Profit Maximizing
• Profit = revenue – cost = . We assume competitive market.
• Profit rises when marginal revenue is greater than marginal cost, and decreases otherwise
• Profit is maximized when marginal revenue = marginal cost
• Mathematically, the first order condition is
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Summary
• Output does not grow if input and technology remain constant
• Wage is determined by the marginal product.
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Discuss
• What is the long run prospect of Japanese economy, where both population and technology stagnate?
• Why does a doctor earn much more than a plumber?
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Cobb-Douglas Production Function
• Constant return to scale• Constant factor share in income• Marginal product is proportional to average
product
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Calculus
• Multivariate function • Partial derivatives
, Example: ,
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Why Cobb-Douglas Function?
• It can explain the following two facts• The shares of capital and labor incomes are
constant • Real wage grows at the same rate as average
product
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The Demand Side
• The supply side is captured by production function
• We need to specify the demand side in order to find equilibrium
• Demand = consumption + government expenditure + investment
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Aggregate Demand
• Consumption: , which is fixed• Investment: which varies as the real interest
rate changes• Government expenditure: , which is fixed
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Equilibrium
• Equilibrium: supply = demand• Mathematically
• We can solve this equation for , and obtain the equilibrium real interest rate
• In short, real interest rate adjusts to equilibrate the market
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Another Perspective
• Alternatively, we can study the equilibrium for loanable funds market
• At equilibrium, the supply and demand of funds are equal:
Note the supply of fund is fixed
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Application
1. Why was interest rate high in early 1980?
2. Why was interest rate high in early 1990?
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Crowding Out
• Chapter 3 implies that expanding government expenditure will completely crowd out investment
• Fiscal policy is ineffective• How about monetary policy?
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MVPY
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Monetarism
• In long run, price is mainly affected by money supply
• Inflation rate equals growth rate of money supply if assuming fixed income and constant velocity
• What if those two assumptions fails?
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Hyper-Inflation (to get Seigniorage)
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Quantitative Easing (as a Policy Tool)
• http://www.youtube.com/watch?v=PTUY16CkS-k
• http://en.wikipedia.org/wiki/Quantitative_easing
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Classical Dichotomy
• According to the long run classical theory, money is neutral (monetary neutrality): the money supply does not affect real variables
• The theoretical separation of real and nominal variables is called classical dichotomy
• Real variables are studied in Chapter 3• Price is determined in Chapter 4• They jointly determine nominal variables
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Fisher EquationApplication of Classical Dichotomy
So nominal interest rate is the sum of real interest rate and inflation rate . is determined in chapter 3, (Figure 3-8) is determined in chapter 4, (MV=PY)
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Proof
• You have two options: saving a good and earns real interest; or saving money and earn nominal interest.
• There is no arbitrage at equilibrium:
Fisher equation follows assuming
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How to Forecast Nominal Interest Rate in Long Run?
• First determine the real interest rate • Then determine the inflation rate • Finally use Fisher Equation: • Nominal interest rate matters because it is a
key variable in Financial and Housing markets
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A Short Run Theory
• Consider the equilibrium in money market• Money supply = , a vertical line• Money (liquidity) demand = , a downward
sloping line• At equilibrium
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DiscussDear Professor Li, I am in your 317 class and had a question regarding interest rates. Prior to class today I was reading an article that stated that a main reason why our economy has not felt the same effects of having a 70% debt to GDP ratio is that we have lower interest rates compared to European countries who have similar debt-GDP ratios(but these countries have higher interest rates). If our economies are similar in terms of this ratio, how come we have such a lower interest rate in comparison to a country such as Spain? Also, thanks for an enjoyable class today. Stephen H.
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Answer
• US real interest rate is low because high (foreign) supply of loanable fund. Spain is opposite
• US nominal interest rate is low because of quantitative easing
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Review
• Nominal vs RealY: Real GDP PY: Nominal GDP
W/P: Real Wage W: Nominal Wage
r: Real Interest Rate i: Nominal Interest Rate
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Classical Dichotomy
• Money does not affect real variables• Real variables are determined in Chapter 3• Price is determined in Chapter 4
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Review
• Long Run vs Short RunLong Run: Short Run:
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