Econ2102 Lecture1 Handout(1)

7/31/2019 Econ2102 Lecture1 Handout(1)

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Econ2102

ProfessorJamesMorley

Lecture1

Whatexplainsthedifferencesinstandardsof

livingacrosscountriesandacrossBme?

CHAPTER1IntroducBonto

Macroeconomics

ClassOutline

SomeadministraBvemaers igpictureissuesinMacroeconomics TheasicNeoclassicalModelofAggregateProducBon

Readings:JonesChapters1-4 NextBme:JonesChapter5

Econ2102

Lecturer-in-charge:ProfessorJamesMorley Office:AS434 PhoneNo:93853366 Email:[email protected] ConsultaBonTimesWednesdays1:00-3:30 Coursewebsiteonlackboard


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TutorDetails

PaulVamvouklisEmail:[email protected]

Yiyuan(Edward)XieEmail:[email protected]

XiaoChunXu(tutor-in-charge)Email:[email protected]

LearningandAssessment

TextbookMacroeconomics2ndEdiBon,CharlesI.Jones,Norton

Press

LecturesComplement,notsubsBtutefortextbook

TutorialsProblemsetsapplyconceptsfromtextbookand

lectures

AssignmentsandFinalExamAssignmentsdueon13/8and24/9

WhatisMacroeconomics?

Macroeconomicsisthestudyofaggregateeconomicphenomena:

Long-RunEconomicGrowthInflaBonTheusinessCycle

Howdomacroeconomistsexplain

thesephenomena?

Measurement(seeChapter2):RealGDPCPITheUnemploymentRate

ObservaBonandTheory ModelsandPredicBon InMacro2,wefocusonmodels


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Whyfocusonmodels?

ModelsmaketheassumpBonsandpredicBonsoftheoriesprecise

AllowsforbeerevaluaBonofcompeBngtheories

eerunderstandingofthepotenBalandlimitaBonsofdifferentpoliciestoachieve

desirableoutcomesformacrophenomena

IntermediateMacro

WewillstudytwokeymodelsthatmacroeconomistsactuallyuseSolow-SwanModeloflong-runeconomicgrowthNewKeynesianModelofbusinesscycles

Wewillexplorewhythemodelsaresowidelyapplied,butalsoconsidertheirlimitaBons

Wewillconsiderhowmacroeconomistsdevelopandextendtheirmodels

WewillalsoconsideradvancedtheoriesofLong-RunInflaBon,ConsumpBon,Investment,andExchangeRateDeterminaBon

TheStructureofModels TheKeyDisBncBon

ThedisBncBonbetweenexogenousandendogenousvariablesiskeytounderstandingmodels

Avoidconfusionbyspecifyingwhichiswhich Exogenousvariablesarenotbeingexplainedbythemodel,whileendogenousvariablesare

Amodelprovidesthemechanismbywhichtheendogenousvariablesaredeterminedby

theexogenousvariables


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Topic1:Long-RunGrowth

MeasuredasanincreaseinRealGDPPerCapita Despiteflaws,RealGDPPerCapitasBllcapturesbulkofvariaBoninstandardsoflivingacrosscountriesandacrossBme

TheNeoclassicalAggregateProducBonFuncBonisthebasisforasimplemodelofthelevelofRealGDPPerCapitaacrosscountries

TheSolow-SwanModelextendsthebasicNeoclassicalmodelofaggregateproducBontoexplaineconomicgrowthoverBme

Chapter4AModelofProducBon

Inthischapter,welearn:howtosetupandsolveamacroeconomicmodel.howaproducBonfuncBoncanhelpusunderstand

differencesinpercapitaGDPacrosscountries.

therelaBveimportanceofcapitalperpersonversustotalfactorproducBvityinaccounBngforthesedifferences.

therelevanceofreturnstoscaleanddiminishingmarginalproducts.

howtolookateconomicdatathroughthelensofamacroeconomicmodel.


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TheasicNeoclassicalModelofAggregate

ProducBon

Considerasingle,closedeconomy,withonlyoneconsumpBongood.

Setting Up the Model

AcertainnumberofinputsareusedintheproducBonofthegood

InputsLabor(L)Capital(K)

ProducBonfuncBonShowshowmuchoutput(Y)canbeproduced

givenanynumberofinputs

Othersvariableswithabarareparameters. ProducBonfuncBon:

ProductivityparameterOutput Inputs

TheCobb-DouglasproducBonfuncBonistheparBcularproducBonfuncBonthattakesthe

formof

Assumed to be 1/3.Explained later.

AproducBonfuncBonexhibitsconstantreturnstoscaleifdoublingeachinputexactly

doublesoutput.


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Returns to Scale Comparison

Find the sum of exponentson the inputs

sum to 1

sum to more than 1

sum to less than 1

Result

the function has constantreturns to scale

the function hasincreasing returns toscale

the function hasdecreasing returns toscale

StandardreplicaBonargumentAfirmcanbuildanidenBcalfactory,hireidenBcal

workers,doubleproducBonstocks,andcanexactlydoubleproducBon.

Impliesconstantreturnstoscale.

Allocating Resources

TherentalrateandwageratearetakenasgivenunderperfectcompeBBon.

Forsimplicity,thepriceoftheoutputisnormalizedtoone.

Firm chooses inputsto maximize profit

Rental rateof capital

Wage rate

Themarginalproductoflabor(MPL)TheaddiBonaloutputthatisproducedwhenone

unitoflaborisadded,holdingallotherinputs

constant.

Themarginalproductofcapital(MPK)TheaddiBonaloutputthatisproducedwhenone

unitofcapitalisadded,holdingallotherinputs

constant.


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ThesoluBonistousethefollowinghiringrules:

HirecapitalunBltheMPK=rHirelaborunBlMPL=w

IftheproducBonfuncBonhasconstantreturnstoscaleincapitalandlabor,itwill

exhibitdecreasingreturnstoscaleincapital

alone.

Solving the Model:General Equilibrium

Themodelhasfiveendogenousvariables:Output(Y)theamountofcapital(K)theamountoflabor(L)thewage(w)therentalpriceofcapital(r)


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ThemodelhasfiveequaBons:TheproducBonfuncBonTheruleforhiringcapitalTheruleforhiringlaborSupplyequalsthedemandforcapitalSupplyequalsthedemandforlabor

Theparametersinthemodel:TheproducBvityparameterTheexogenoussuppliesofcapitalandlabor

AsoluBontothemodelAnewsetofequaBonsthatexpressthefive

unknownsintermsoftheparametersandexogenousvariables

Calledanequilibrium Generalequilibrium

SoluBontothemodelwhenmorethanasinglemarketclears


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InthismodelThesoluBonimpliesfirmsemployallthesupplied

capitalandlaborintheeconomy.

TheproducBonfuncBonisevaluatedwiththegivensupplyofinputs.

ThewagerateistheMPLevaluatedattheequilibriumvaluesofY,K,andL.

TherentalrateistheMPKevaluatedattheequilibriumvaluesofY,K,andL.

Interpreting the Solution

Ifaneconomyisendowedwithmoremachinesorpeople,itwillproducemore.

TheequilibriumwageisproporBonaltooutputperworker.

Outputperworker=(Y/L) TheequilibriumrentalrateisproporBonaltooutputpercapital.

Outputpercapital=(Y/K)

Inmanycountries,empiricalevidenceshows:Two-thirdsofproducBonispaidtolabor.One-thirdofproducBonispaidtocapital.Thefactorsharesofthepaymentsareequalto

theexponentsontheinputsintheCobb-DouglasfuncBon.


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Inthemodel,allincomeispaidtocapitalorlabor.

ResultsinzeroprofitintheeconomyThisverifiestheassumpBonofperfect

compeBBon.

AlsoverifiesthatproducBonequalsspendingequalsincome.

AnalyzingtheProducBonModel

Percapita=perperson Perworker=permemberofthelaborforce.

Inthismodel,thetwoareequal. Wecanperformachangeofvariablestodefineoutputpercapita(y)andcapitalper

person(k).

OutputperpersonequalstheproducBvityparameterBmescapitalperpersonraisedtothe

one-thirdpower.

Output per person

Capital per personProductivityparameter

Whatmakesacountryrichorpoor? OutputperpersonishigheriftheproducBvityparameterishigheroriftheamountofcapitalperpersonishigher.

WhatcanyouinferaboutthevalueoftheproducBvityparameterortheamountofcapitalinpoorcountries?


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Comparing Models with Data

ThemodelisasimplificaBonofreality,sowemustverifywhetheritfitsthedatawell.

CHAPTER4AModelofProducBon

The Empirical Fit of the Production Model

DevelopmentaccounBng:Theuseofamodeltoexplaindifferencesin

incomesacrosscountries.

Set productivityparameter = 1

Diminishingreturnstocapitalimpliesthat:CountrieswithlowKwillhaveahighMPKCountrieswithalotofKwillhavealowMPK,and

cannotraiseGDPpercapitabymuchthrough

morecapitalaccumulaBon

IftheproducBvityparameteris1,themodeloverpredictsGDPpercapita.


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Productivity Differences: Improvingthe Fit of the Model

TheproducBvityparametermeasureshowefficientlycountriesareusingtheirfactor

inputs.

OencalledtotalfactorproducBvity(TFP) IfTFPisnolongerequalto1,wecanobtainabeerfitofthemodel.

However,dataonTFPisnotcollected. Itcanbecalculatedbecausewehavedataonoutput

andcapitalperperson.

TFPisreferredtoastheresidual. AlowerlevelofTFP

Impliesthatworkersproducelessoutputforanygivenlevelofcapitalperperson


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Outputdifferencesbetweentherichestandpoorestcountries?

Differencesincapitalperpersonexplainaboutone-thirdofthedifference.

TFPexplainstheremainingtwo-thirds. Thus,richcountriesarerichbecause:

Theyhavemorecapitalperperson.Moreimportantly,theyuselaborandcapital

moreefficiently.


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Understanding TFP Differences

Whyaresomecountriesmoreefficientatusingcapitalandlabor?


Human Capital

Humancapitalisthestockofskillsthatindividualsaccumulatetomakethemmore

producBve(forexample,educaBon).

ReturnstoeducaBonarethevalueoftheincreaseinwagesfromaddiBonalschooling.

DifferencesinHumancapitalhelpspredictsomeofthelargedifferencesinTFP.


Technology

Richercountriesmayusemoremodernandthusmoreefficienttechnologiesthanpoor

countries.


Institutions

Evenifhumancapitalandtechnologiesarebeerinrichcountries,whydotheyhavetheseadvantages?

InsBtuBonsrefertopropertyrights,theruleoflaw,governmentsystems,andcontractenforcement,amongmanyotheritems.

Well-definedinsBtuBonsandlawscreateaclimateforeconomicgrowththatismuchbeerthananenvironmentwithcorruptanduncertain

insBtuBons.



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Evaluating the Production Model

PercapitaGDPishigherifcapitalperpersonishigherandiffactorsareusedmoreefficiently.

ConstantreturnstoscaleimplythatoutputperpersoncanbewrienasafuncBonofcapitalperperson.

Capitalperpersonissubjecttodiminishingreturnsandthediminishingreturnsareverystrongbecausetheexponentismuchlessthanone.

CHAPTER4AModelofProducBon CHAPTER4AModelofProducBon

IntheabsenceofvaryingTFP,theproducBonmodelincorrectlypredictsdifferencesin

income.

AddiBonally,themodeldoesnotprovideananswerastowhycountrieshavedifferentTFP

levels.

I.e.,ithasalimitedabilitytopredictoutofsample

Policy Implications?

ShouldpolicymakersfocusoncapitalaccumulaBonasawaytoclosethegap

betweenrichandpoorcountries?

OrshouldtheyfocusonHumancapitaland/orinsBtuBons?


Summary

ThebasicneoclassicalmodelofaggregateproducBonsuggeststhelevelofeconomicdevelopmentdependsontheendowmentofcapital

However,variaBonincapitalacrosscountriesonlyexplainsabout1/3ofthethevariaBonineconomicdevelopment

TFPexplainstherestofthevariaBon EconomicresearchsuggeststhatTFPcanberelatedtothelevelofHumanCapitalandtoInsBtuBons

NextBme:capitalaccumulaBonandeconomicgrowth(theSolow-SwanModel)


Econ2102 Lecture1 Handout(1)

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