ECO 317 Intermediate Macroeconomics

ECO 317

Intermediate Macroeconomics

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

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!

Required Textbook

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”

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

Hot Issues

• National Debt• Income gap: 1% vs. 99%• Globalization • 2007-2009 Recession

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?

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?

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

Summary

• Output does not grow if input and technology remain constant

• Wage is determined by the marginal product.

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?

Cobb-Douglas Production Function

• Constant return to scale• Constant factor share in income• Marginal product is proportional to average

product

Calculus

• Multivariate function • Partial derivatives

, Example: ,

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

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

Aggregate Demand

• Consumption: , which is fixed• Investment: which varies as the real interest

rate changes• Government expenditure: , which is fixed

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

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

Application

1. Why was interest rate high in early 1980?

2. Why was interest rate high in early 1990?

Crowding Out

• Chapter 3 implies that expanding government expenditure will completely crowd out investment

• Fiscal policy is ineffective• How about monetary policy?

MVPY

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?

Hyper-Inflation (to get Seigniorage)

Quantitative Easing (as a Policy Tool)

• http://www.youtube.com/watch?v=PTUY16CkS-k

• http://en.wikipedia.org/wiki/Quantitative_easing

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

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)

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

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

A Short Run Theory

• Consider the equilibrium in money market• Money supply = , a vertical line• Money (liquidity) demand = , a downward

sloping line• At equilibrium

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.

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

Review

• Nominal vs RealY: Real GDP PY: Nominal GDP

W/P: Real Wage W: Nominal Wage

r: Real Interest Rate i: Nominal Interest Rate

Classical Dichotomy

• Money does not affect real variables• Real variables are determined in Chapter 3• Price is determined in Chapter 4

Review

• Long Run vs Short RunLong Run: Short Run: