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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 = ≈ + 1, − (, ) • 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 • • • • = , = 1− , (0 < < 1) Constant return to scale Constant factor share in income Marginal product is proportional to average product Calculus • ′ = −1 • Multivariate function = (, ) • Partial derivatives , Example: = , = −1 = −1 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: = < 0, 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=PTUY16Ck S-k • http://en.wikipedia.org/wiki/Quantitative_eas ing 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 Equation Application 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: 1+ 1+ = 1+ Fisher equation follows assuming = 0 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 = (, ) Discuss Dear 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 Real Y: 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 Run Long Run: = Short Run: = (, )