Econ 320

What is expected. R = i - E π

Actuals. R= i-π

i = R + Eπ. If the real interest rate is constant then the nominal interest rate (i) moves one-for-one with changes in expected inflation (Eπ).

• Difference between the Rate of return (r) and the return of holding money (- Eπ).
• Opportunity cost = R + Eπ

• Y= income
• C= consumption
• I= investment
• w/p= mpl (marginal productivity of labor)
• r/p = mpk (marginal productivity of capital)

separation between real and nominal variables

• p= price level
• w= wages
• π = inflation

Under the classical dichotomy changes in money supply (M) are neutral i.e. cannot effect real variables in the long run.

MPK = R/P (rent / price level) . MPK is the change in output for a unit change in capital input.

• wages = w/p
• rent = r/p

• Y= MPL * L + MPK * K + Economic Profit
• (economic profit is zero under perfect competition and constant return to scale)

Marginal Propensity to Consume (MPC) How much consumption changes by for a unit of increase in disposable income (Y_D ). Y-axis is consumption, x-axis is Yd slope is MPC [C= c(Y-D)] which is positive slope.

Earn more you consume more.

MPC

C= c(y-d)

• Both firms and households invest.
• Firms invest by changing capital stock and inventories
• Households invest by buying a new house.

R = i - π ( real interest rate = nominal interest rate - inflation)

Low interest rate mean that people are willing to invest. Investments is inversely (negatively) the real interest rate.

• Spend by purchasing goods and services.
• Government makes welfare payments, unemployment payments, and other payments.

• Taxes and Government spending is in Balance Budget.
• Taxes in greater than Government spending Government Surplus.
• Taxes in less tan government spending, government deficit.

S = Y-C-G

• Private savings + Public Savings = National savings
• (y-c-t) + (t-g)

• M1 (monetary aggregate) = highly liquid= C+DD+ travelers check+ and other deposits
• M2 = less liquid= M1+ savings+ small time deposits + shares in money market funds

MV=PY

• (M/P)^D =kY
• The demand for real money balances is proportional (k) to income (Y).
• As income increases real money balances increases.

If money supply increases, income also increases. Typically in the short run.

When money supply increase, price level increase. Typically happens in the long run.

Note: increasing the money supply and increasing the price level will result in inflation.

Number of people losing jobs = number of people finding jobs

• U/L= s/(f+s). Unemployment rate depends on the rate of jobs separation and job finding.
• If unemployment rate is decreased the we can see a decrease in job separation and increase in job finding.
• (increasing the number of people findings jobs and decreasing the number of people losing jobs)

• People have different job preferences
• imperfect job information
• geographical preferences

frictional unemployment: time taking to find a new job

• reduce frictional unemployment by employing as many people by:
• posing job information about position available
• unemployment benefits- unemployed are paid a fraction of their wages.

Wage rigidity= wages are not flexible and do not adjust to market conditions.

Classical approach minimum wages is flexible while in the kaizen it is slow to adjust.

• y-axis = w/p
• x=axis = L
• slope (negative) = D^L
• kept constant= Lbar (x-axis) line S^L you get a (w/p)* = wages are in equilibrium.
• Minimum wage (w/p)^min is found above the wage equilibrium.
• A binding minimum wage W^min is imposed so the real wage is above (w/p)*
• Supply of labor (w/p)^min is Lbar, and L^min workers are hired.

• Structural unemployment= Lbar- L^min

6%

• instantaneous
• structural unemployment
• frictional unemployment

• unemployment is a waste of resources
• difficult to reduce structure and frictional unemployment
• public policy sometimes increases unemployment rate for example unemployment insurance.