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c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
O
W
h a n g e Vi
e
PD
XC
er
O
W
F-
h a n g e Vi
e
PD
XC
er
F-
c u -tr a c k
.c
Macro
1 / 18
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
Macro
2 / 18
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
The major dierence between the two system arises from the
description of the labour market.
Macro
3 / 18
h a n g e Vi
e
PD
XC
N
y
to
k
lic
.c
.d o
c u -tr a c k
Supply Equation:
.d o
lic
to
bu
bu
O
W
F-
er
XC
er
PD
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
(1)
Demand Equation:
Y = C (Y ) + I (r ) + G ; 0 < C 0 (Y ) < 1; I 0 (r ) < 0
(2)
(3)
W = PFN (N, K )
(4)
M=M
(5)
Demand Equation:
Macro
(6)
July 24, 2014
4 / 18
!
y
c u -tr a c k
.d o
.c
Solution
consists of
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
Macro
5 / 18
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
(1)
W = Pg (N ); g 0 (N ) > 0
(3)
W = PFN (N, K )
(4)
Macro
6 / 18
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
We then club the SS & DD equations in the Money Market and the
DD equation in the Goods Market together:
Y = C (Y ) + I (r ) + G ; 0 < C 0 (Y ) < 1; I 0 (r ) < 0
(2)
M=M
(5)
(6)
Macro
7 / 18
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
Macro
8 / 18
h a n g e Vi
e
h a n g e Vi
e
XC
w
c
.d o
k.
Plot . c(3) and (4) in the N-W plane (assuming some arbitrarily
cgiven
u -tr a c
value of P):
.d o
lic
to
bu
bu
to
k
lic
C
O
W
PD
F-
O
W
er
XC
er
PD
F-
c u -tr a c k
Macro
9 / 18
h a n g e Vi
e
h a n g e Vi
e
O
W
c u -tr a c k
.d o
.c
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
c u -tr a c k
.c
Macro
10 / 18
h a n g e Vi
e
h a n g e Vi
e
O
W
Macro
.d o
.c
Correspondingly,
the output supplied remains xed at Y :
c u -tr a c k
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
c u -tr a c k
.c
11 / 18
h a n g e Vi
e
h a n g e Vi
e
O
W
c u -tr a c k
.d o
.c
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
c u -tr a c k
.c
Macro
12 / 18
h a n g e Vi
e
h a n g e Vi
e
O
W
c u -tr a c k
.d o
.c
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
c u -tr a c k
.c
(7)
(2)
Macro
13 / 18
h a n g e Vi
e
h a n g e Vi
e
O
W
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
.c
.d o
c u -tr a c k
Plot . cthe IS and the LM curve in the Y -r plane (assuming some
arbitrarily given value of P):
c u -tr a c k
Macro
14 / 18
h a n g e Vi
e
h a n g e Vi
e
O
W
lic
to
bu
PD
.c
.d o
c u -tr a c k
Now. c increase P to a higher level, say P 0 :
The LM curve shifts out proportionally - diverging away from the
earlier curve for higher values of Y (Why?)
c u -tr a c k
Macro
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
15 / 18
h a n g e Vi
e
h a n g e Vi
e
O
W
c u -tr a c k
.d o
.c
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
c u -tr a c k
.c
Macro
16 / 18
h a n g e Vi
e
h a n g e Vi
e
XC
w
.c
.c
.d o
In other
words, the AD Schedule under the Classical System
c u - t r is
ack
Downward Sloping:
.d o
lic
to
bu
bu
to
k
lic
C
O
W
PD
F-
O
W
er
XC
er
PD
F-
c u -tr a c k
Macro
17 / 18
bu
to
o
c
lic
C
w
.d o
O
W
PD
bu
to
k
lic
C
h a n g e Vi
e
XC
er
O
W
F-
PD
XC
er
F-
h a n g e Vi
e
.
k.
Equilibrium
price and quantity in the Goods Market - P and . dYo c u - t r-a c are
determined simultaneously by the intersection of the AS and the AD
schedule:
c u -tr a c k
Macro
18 / 18
y
o
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
O
W
h a n g e Vi
e
PD
XC
er
O
W
F-
h a n g e Vi
e
PD
XC
er
F-
c u -tr a c k
.c
Macro
1 / 15
bu
to
lic
C
w
.d o
O
W
PD
bu
to
k
lic
C
h a n g e Vi
e
XC
er
O
W
F-
PD
XC
er
F-
h a n g e Vi
e
c
.c
k.
Equilibrium
price and quantity in the Goods Market - P and . dYo c u - t r-a c are
determined simultaneously by the intersection of the AS and the AD
schedule:
c u -tr a c k
Macro
2 / 15
h a n g e Vi
e
O
W
c u -tr a c k
.d o
.c
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
h a n g e Vi
e
c u -tr a c k
.c
(M)
Macro
3 / 15
XC
h a n g e Vi
e
.c
The . cstandard Fiscal and Monetary Policies (which aect onlyw . d othe
c u -tr a c k
demand side of the economy) are completely ineective in raising
the equilibrium output and employment under the classical system:
.d o
lic
to
bu
bu
to
k
lic
C
O
W
PD
F-
O
W
er
XC
er
PD
F-
h a n g e Vi
e
Macro
4 / 15
XC
h a n g e Vi
e
y
lic
to
bu
y
bu
to
k
lic
C
.d o
So far
we had not introduced taxes in our model. Let us noww .
.c
.c
do
c u -tr a c k
introduce a proportional income tax (t).
w
O
W
F-
O
W
er
XC
er
PD
F-
PD
h a n g e Vi
e
c u -tr a c k
tY ) = C (Y d ); 0 < C 0 (Y d ) < 1
Macro
5 / 15
h a n g e Vi
e
h a n g e Vi
e
y
bu
.c
Macro
to
k
.d o
c u -tr a c k
lic
w
.d o
lic
to
O
W
PD
XC
O
W
F-
er
XC
er
PD
F-
c u -tr a c k
.c
6 / 15
h a n g e Vi
e
h a n g e Vi
e
O
W
.d o
c u -tr a c k
lic
to
bu
PD
.d o
lic
to
bu
N
m
XC
er
O
W
F-
PD
XC
er
F-
c u -tr a c k
.c
Macro
7 / 15
h a n g e Vi
e
h a n g e Vi
e
Macro
.d o
lic
to
bu
y
bu
to
k
lic
C
Suppose
tax rate decreases from t to t 0 :
.c
c u -tr a c k
.d o
O
W
PD
XC
O
W
F-
er
XC
er
PD
F-
c u -tr a c k
.c
8 / 15
h a n g e Vi
e
h a n g e Vi
e
XC
y
to
bu
y
bu
to
Macro
lic
k
lic
C
.d o
O
W
PD
F-
O
W
er
XC
er
PD
F-
9 / 15
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
Macro
10 / 15
h a n g e Vi
e
PD
XC
N
y
to
k
lic
.c
.d o
c u -tr a c k
Supply Equation:
.d o
lic
to
bu
bu
O
W
F-
er
XC
er
PD
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
(1)
Demand Equation:
Y = C (Y ) + I (r ) + G ; 0 < C 0 (Y ) < 1; I 0 (r ) < 0
(2)
W =W
(3)
W = PFN (N, K )
(4)
M=M
(5)
Demand Equation:
Macro
(6)
July 25, 2014
11 / 15
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
The only equation that diers between the two systems is the labour
supply equation.
The Keyenesian Sytem assumes that labour supply is perfectly elastic
.
at a given wage rate W
The Labour Market:
Supply Equation:
W =W
(7)
W = PFN (N, K )
(8)
Demand Equation:
Macro
12 / 15
!
O
W
PD
h a n g e Vi
e
y
bu
to
k
Macro
.d o
.c
lic
c u -tr a c k
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
h a n g e Vi
e
c u -tr a c k
.c
13 / 15
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
bu
to
k
lic
C
O
W
PD
h a n g e Vi
e
XC
er
O
W
F-
PD
XC
er
F-
h a n g e Vi
e
ack
.c
u -tr
So the AS schedule is upward sloping under the Keynesian system.
Question: What does this tell you about the eectiveness of the
standard monetary and scal policies?
Das (Lecture Notes, DSE)
Macro
14 / 15
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
goes up?
What happens when W
Macro
15 / 15
y
o
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
O
W
h a n g e Vi
e
PD
XC
er
O
W
F-
h a n g e Vi
e
PD
XC
er
F-
c u -tr a c k
.c
Macro
1 / 11
h a n g e Vi
e
y
bu
y
bu
.c
Macro
to
k
.d o
c u -tr a c k
lic
w
.d o
lic
to
goes up?
What happens when W
w
O
W
XC
O
W
F-
er
XC
er
PD
F-
PD
h a n g e Vi
e
c u -tr a c k
.c
2 / 11
h a n g e Vi
e
h a n g e Vi
e
XC
y
bu
y
bu
to
lic
lic
to
O
W
PD
F-
O
W
er
XC
er
PD
F-
Question: What about the real wage rate? Would the real wage
rate be higher/lower or remain the same in the new equilibrium?
Das (Lecture Notes, DSE)
Macro
3 / 11
h a n g e Vi
e
h a n g e Vi
e
O
W
c u -tr a c k
.d o
.c
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
c u -tr a c k
.c
Macro
4 / 11
h a n g e Vi
e
h a n g e Vi
e
O
W
.c
lic
to
bu
PD
.d o
lic
to
bu
XC
er
O
W
F-
PD
XC
er
F-
.c
do
c u -tr a c k
An extension of the general Keynesian structure was later proposed,
which was able to address this issue, while retaining the other basic
Keynesian features. This is the Neo-Keynesian extension, proposed by
Barro-Grossman and Malinvaud in the 1970s.
This extension assumes that not only that nominal wage is rigid, but
so is the nominal price level. (This school is also known as the
Disequilibrium Macroeconomicsor the Macroeconomics of Quantity
Rationing)
Sticky prices mean that the aggregate supply curve is horizontal at
some P = P.
Notice that a horizontal supply AS schedule means that this system is
completely demand-determined. At P whatever output demanded is
always supplied. (Thus this set up is diametrically opposite to the
supply-determined Classical System discussed earlier).
c u -tr a c k
Macro
5 / 11
XC
h a n g e Vi
e
y
lic
to
bu
y
bu
to
k
lic
C
.d o
Notice
that if output is demand-determined then the producers
may. c
w
.c
.d o
ck
not have the choice of picking the level of employment that c u - t r a
maximises their prot:
w
O
W
F-
O
W
er
XC
er
PD
F-
PD
h a n g e Vi
e
c u -tr a c k
is Y (P ).
, the prot maximizing
On the other, suppose at P = P and W = W
rms would like to employ N amount of labour such that output
W
) = F (N , K ), where PF
N (N , K ) = W
.
supplied is Y (P,
). In
If the demand constarint is binding then Y (P ) < Y (P, W
other words, at the prot maximising level of employment, there is
excess supply in the Goods Market.
Since prices are sticky, adjustments have to be made in terms of
quantities. This implies that the quantity produced cannot be
W
); it can at max. be Y .
Y (P,
This quantity adjustment will have implications for the labour demand
function as well.
Das (Lecture Notes, DSE)
Macro
6 / 11
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
Macro
7 / 11
XC
h a n g e Vi
e
y
bu
y
bu
to
lic
lic
to
Now lets see what happens when the nominal wage rate when W
w
. c up:
.c
. d o goes
.d o
c u -tr a c k
c u -tr a c k
w
O
W
F-
O
W
er
XC
er
PD
F-
PD
h a n g e Vi
e
Macro
8 / 11
!
y
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
h a n g e Vi
e
N
m
XC
er
O
W
F-
PD
XC
er
F-
O
W
h a n g e Vi
e
c u -tr a c k
.c
Macro
9 / 11
XC
h a n g e Vi
e
N
y
bu
y
bu
to
lic
u -tr
lic
to
PD
F-
O
W
er
XC
er
PD
F-
O
W
h a n g e Vi
e
u -tr a c
k.
Macro
10 / 11
h a n g e Vi
e
O
W
h a n g e Vi
e
y
o
c u -tr a c k
.c
.d o
.d o
lic
to
bu
y
bu
to
k
lic
C
PD
XC
O
W
F-
PD
XC
er
F-
er
c u -tr a c k
.c
Macro
11 / 11