Recitation XII Fin

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Recitation XII Fin

• Exam Review
• Exam Technique
• etc

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Exam Technique Common Mistakes in MidTerm

• Be prepared for new things
• Use the information given
• All capital was saved and no one died
• Answer the full question
• where is this economy on the graph?
• what happens to k and y immediately after the
  change? What happens during the transition? In
  the long run?

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Exam Technique Common Mistakes in MidTerm

• Distinguish between UPPERCASE and lowercase
  letters does NOT mean
• Watch signs, decimal spaces, fractions

4
Exam Technique Common Mistakes in Final

• Shifts of curves vs. Movement along curves
• What is the change in Investment?
• What is the change in QUANTITY Invested?
• IN GENERAL
• Investment refers to the CURVE Decision rule
• Quantity Invested refers to the POINT ON THE
  CURVE Optimal equilibrium outcome

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Disclaimer

• This is a brief overview
• Neither sufficient, nor indicative of the test
• This is what I think is the important bits,
• BUT
• It does not explain much, so youll have to refer
  back to your notes if you dont understand
  something
• This slideshow will be available
  atwww.columbia.edu/gpd2101/W3213

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Topics Covered
Growth
Facts about the World
See slideshow for Recitation VIII
Models
Solow-Swan
AK
Assumptions
Results and Graphs
Predictions
Comparison
Growth Accounting Technology
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Topics Covered
Business Cycles
Money
Characterization
Classical
Keynesian
Demand
Equilibrium
Supply
Labour/Leisure 1 period
Investment
Consumption/Saving - 2 periods
Government
Consumption/Saving AND Labour/Leisure Current
Period vs Future
General Equilibrium
Definition
Steps of Analysis
Keynesian Disequilibrium
Demand and Supply
Definition
Effects of Techonology shocks Temporary vs
Permanent
Steps of Analysis
Short run/Long run
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Business Cycles

• Basically, three models that build on each other
• Labor/Leisure choice in 1 period no possibility
  of saving Robinson Crusoe
• Consumption Decisions over two periods add the
  possibility of saving/borrowing
• Consumption over time Labor over time
• Demand and Supply

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Business Cycles

• Important concepts you MUST
• Understand
• Know how to show graphically
• Know the implications for decisions in the
  various periods
• In the first two models
• Wealth Effect
• Substitution Effect
• In the last
• Direct Effect
• Indirect Effect
• (both of these related to income and
  substitutions effects)
• And also
• Permanent vs Temporary changes

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Labour/Leisure choice

• What are the effects?

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Digression Exam technique

• How to make sure your Substitution effect graph
  looks nice
• 1. Draw the initial budget line, and pick the
  point

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Digression Exam technique

• How to make sure your Substitution effect graph
  looks nice
• 2. Draw the IMAGINARY budget line goes trough
  the old point, but has the new slope (steep
  enough)

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Digression Exam technique

• How to make sure your Substitution effect graph
  looks nice
• 3. NOW Draw the indifference curve of the
  ORIGINAL point, so that the IMAGINARY budget line
  is partially above it

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Digression Exam technique

• How to make sure your Substitution effect graph
  looks nice
• 4. Draw the new indifference curve of the
  substitution effect

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It has to touch In this region
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Digression Exam technique

• How to make sure your Substitution effect graph
  looks nice
• 4. Draw the new indifference curve of the
  substitution effect

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Digression Exam technique

• How to make sure your Substitution effect graph
  looks nice
• 5. show the result of the substitution effect

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Digression Exam technique

• How to make sure your Substitution effect graph
  looks nice
• 0. UNDERSTAND and KNOW the result of the
  substitution effect

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Digression Exam technique

• 6. show the TRUE new budget line

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Digression Exam technique

• 7. show the TRUE new optimal point and hence the
  wealth effect

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Digression Exam technique

• 0. UNDERSTAND and KNOW the results of the wealth
  effect

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Labour/Leisure choice

• What are the effects of a wage increase?
• The substitution effect INCREASES labor supply
• The wealth effect DECREASES labor supply
• End result ambiguous
• What do we assume for the macro economy?

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Consumption/Saving choice

• This implies a consumption function that depends
  on
• r
• PDV(Y)

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Consumption/Saving choice

• This implies a consumption function that depends
  on
• r NEGATIVELY
• PDV(Y) POSITIVELY

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Consumption/Saving choice
r
C
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Labor/Leisure choice over time

• How does our choice of when to work depend on
  wage?
• If our wage increases do we work more or less?
  Which wage?

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Labor/Leisure choice over time

• How does our choice of when to work depend on
  wage?
• If our wage increases do we work more or less?
  Which wage?
• If our current wage increases relative to our
  future wage, how is our CURRENT labor decision
  affected?

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Labor/Leisure choice over time

• We choose to work RELATIVELY more in periods
  where we are RELATIVELY more productive
• That is wt/wt1 matters, not wt alone
• Wage depends on how productive we are At, so we
  replace wt with At

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Labor/Leisure choice over time

• How does the interest rate influence how we
  allocate our labor?
• If the interest rate goes up, do we have an
  incentive to work more or less now RELATIVE to
  the future?

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Labor/Leisure choice over time

• This implies the Labor supply function is
• But we do not care about labor supply, we care
  about Y income (or consumption)
• What is our production function? (no firms)

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Labor/Leisure choice over time

• This implies the Labor supply function is
• But we do not care about labor supply, we care
  about Y income (or consumption)
• What is our production function? (no firms)

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Supply and Demand

• Production function
• Notice there are three possible things that can
  change

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Supply and Demand

• Production function - Graphically

r
C
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Partial Equilibrium
r
r
C
C
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
1
(1R)
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
1
(1R)
Real (denominated in goods)
1
(1r)
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Money Nominal vs Real
Today
Next Month
Invest
Receive back
Nominal (denominated in money)
1
(1R)
Sell good
Real (denominated in goods)
1
?
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Money Nominal vs Real
Today
Next Month
Invest
Receive back
Nominal (denominated in money)
Pt
(1R)
Sell good
Real (denominated in goods)
1
?
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
Pt
(1R)
Sell good
Real (denominated in goods)
1
?
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
Pt
Pt(1R)
Sell good
Real (denominated in goods)
1
?
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
Pt
Pt(1R)
Sell good
Buy good
Real (denominated in goods)
1
?
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
Pt
Pt(1R)
Sell good
Buy good
Real (denominated in goods)
1
Pt / Pt1(1R)
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Money Nominal vs Real
Today
Next Month
Invest
(Earn Returns)
Receive back
Nominal (denominated in money)
Pt
Pt(1R)
Sell good
Buy good
By definition of r
Real (denominated in goods)
(1r)Pt / Pt1(1R)
1
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Money Nominal vs Real
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Money Demand

• Defined by its functions
• Unit of Account Prices are in money terms
• Store of Value Money as an Asset
• Medium of Exchange Replaces Barter

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Money Demand

• Defined by its functions
• Unit of Account Prices are in money terms
• Store of Value Money as an Asset
• Medium of Exchange Replaces Barter
• How do we know how much money is desired?

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Money Demand

• Defined by its functions
• Unit of Account Prices are in money terms
• Store of Value Money as an Asset
• Medium of Exchange Replaces Barter
• How do we know how much money is desired?
• Depends on trade-offs
• Money is valuable (ease of transaction)
• But costly (lower return than other assets)

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Money Demand

• As always in economics, we consider trade-offs
• Money can be used for transactions, but
  earns no return
• Bonds earns return, but cannot be used for
  transactions

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Money Demand

• As always in economics, we consider trade-offs
• Money can be used for transactions, but
  earns no return
• Bonds earns return, but cannot be used for
  transactions
• As good economists, we know we work with
• _________ costs

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Money Demand

• As always in economics, we consider trade-offs
• Money can be used for transactions, but
  earns no return
• Bonds earns return, but cannot be used for
  transactions
• As good economists, we know we work with
• opportunity costs

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Money Demand

• Opportunity costs of holding money
• R per dollar
• Total dollars held M
• Total opportunity cost RM

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Money Demand

• Opportunity costs of holding bonds
• Cannot transact
• Since transacting has value (eliminates barter),
  we attach a cost to keeping wealth in bonds
• To simplify real cost per withdrawal f
• Number of withdrawals N
• Total NOMINAL opportunity cost PNf

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Money Demand

• Opportunity costs of holding bonds
• What does N mean in macro?

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Money Demand

• Opportunity costs of holding bonds
• What does N mean in macro?
• Relate N to M and PY
• i.e. the average amount of money you carry is
  related to how many times withdrawals are made,
  which is related to how much you wish to spend
  (in dollars) in total, which is related to your
  income (in dollars)
• M(PY/2)(1/N)
• Does this make sense?

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Money Demand

• Opportunity costs of holding bonds
• M(PY/2)(1/N)
• Or N(PY/2M)
• Total cost opportunity cost of money
  opportunity cost of bonds
• TC MR PNf
• TC MR (P²Yf/2M)
• Choose optimal M Blackboard

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Money Demand
P
Ms
M
C
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Money Supply
P
Ms
M
C
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Money Equilibrium
P
Ms
M
C
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General Equilibrium
P
r
P
r
Ms
M
Y
C
C
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Investment

• Y C I
• I amount of GDP firm buys
• Why does a firm buy GDP?
• Capital makes firm more productive

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Investment

• Y C I
• I amount of GDP firm buys
• Why does a firm buy GDP?
• Capital makes firm more productive
• How much GDP does a firm buy?

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Investment

• How much GDP does a firm buy?
• What determines desired level of Capital?
• Time to build forward looking
• Trade off

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Investment

• How much GDP does a firm buy?
• What determines desired level of Capital?
• Time to build forward looking
• Trade off
• Marginal gain from Capital
• Marginal cost of Capital

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Investment

• How much GDP does a firm buy?
• What determines desired level of Capital?
• Time to build forward looking
• Trade off
• Marginal gain from Capital
• Marginal cost of Capital

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Investment
Value of MPK/MC
rd
K
K
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Investment
Value of MPK/MC
rd
K
K
NEGATIVE function of the interest rate
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Investment Partial Equilibrium
r
r
Y
Quantity Invested
Quantity Consumed
Y
Quantity Produced
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Government

• Y C I G
• G amount of GDP that government buys
• Why does Government buy GDP?
• Sometimes useful
• We assume useless waste
• How does Government pay?
• Taxes or Borrowing
• We consider taxes

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Government

• How does government decide how much to spend?

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Government

• How does government decide how much to spend?
• We dont ask that like money supply exogenous
  decision (for analysis)
• Why?

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Government

• What does government spending do?

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Government

• What does government spending do?
• Increases demand
• Reduces Disposable income (higher taxes)
• Changes relative prices (Monday),if not a lump
  sum tax

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General Equilibrium
P
r
P
r
Qi
Qc
Ms
Y
M
Y
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Steps of Analysis

• Whats the point of Xaviers method?

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Steps of Analysis

• Whats the point of Xaviers method?
• Easy to confuse two things
• Changes in behavior vs Responses to Equilibrium
  changes

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Steps of Analysis

• Whats the point of Xaviers method?
• Easy to confuse two things
• Changes in behavior vs Responses to Equilibrium
  changesAKA

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Steps of Analysis

• Whats the point of Xaviers method?
• Easy to confuse two things
• Changes in behavior vs Responses to Equilibrium
  changesAKA
• Shifts OF curves vs Shifts ALONG curves

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Steps of Analysis

• Whats the point of Xaviers method?
• Easy to confuse two things
• So we ask FIRST how do the new functions look
  (if they change) for EVERY interest rate/price
• THEN what is the new equilibrium
• THEN what are the new quantities implied

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function
• On investment function
• On labor supply function
• Equilibrium Quantities and Interest Rate
• Effect on Money Market
• Equilibrium Price

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function
• On investment function
• On labor supply function
• Equilibrium Quantities and Interest Rate
• Effect on Money Market
• Equilibrium Price

KNOW THIS
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Example (from PS10)

• Using the Classical Model
• (c) Imagine that the government announces today
  (period 1) that they will reduce spending in
  period 2 (and will reduce taxes in period 2).
  Spending and taxes in period 1 will not change,
  and spending and taxes in periods 3, 4, and all
  future periods will remain the same. What will be
  the effects on output, consumption, investment,
  labor supply, the interest rate and the price
  level TODAY?

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Example (from PS10)

• Use the Keynesian model to answer Question 1. Are
  your answers different? Why?

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Example (from PS10)

• Direct Effects

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Example (from PS10)

• Direct Effects None

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function

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General Equilibrium
P
r
P
r
Qi
Qc
Ms
Y
M
Y
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General Equilibrium
P
r
P
r
Qi
Qc
Ms
Y
M
Y
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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function
• On investment function

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function
• On investment function
• None

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function
• On investment function
• On labor supply function
• Total lifetime income higher.
• Can work less and consume more

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Labour/Leisure choice

• Optimal decision

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Labour/Leisure choice

• Optimal decision

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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function
• On investment function
• On labor supply function
• Total lifetime income higher.
• Can work less and consume more
• PDV(Y) down, Ys up (small amounts)

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General Equilibrium
P
r
P
r
Qi
Qc
Ms
Y
M
Y
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General Equilibrium
P
r
P
r
Qi
Qc
Ms
Y
M
Y
100
General Equilibrium
P
r
P
r
Qi
Qc
Ms
Y
M
Y
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Steps of Analysis

• Direct Effects
• Indirect Effects
• On consumption function
• On investment function
• On labor supply function
• Equilibrium Quantities and Interest Rate
• Eqm Interest rate higher, Y indeterminate