Intermediate
Macroeconomics
Lecture 3
Topics
? Finish the assignment from last class
? Clarification for 4 questions from last class
? Demand for goods and services
? Equilibrium and the interest rate
Assignment
? Cobb-Douglas production function
1,What is MPL?
2,What is the relationship between labor
income and total income?
1(,)Y F K L A K L?? ???
Assignment
What is the shape for MPL?
1(,)Y F K L A K L?? ???
( 1 )YYM P L A K L
LL
??? ???? ? ? ?
??
1( 1 ) ( )M PL A K L
L
???? ??? ? ? ?
?
Assignment
? Labor income share
Labor income,
M P L L?
( 1 )A K L L??? ?? ? ?
1
( 1 ) 1M P L L A K L L
Y A K L
??
??
? ??
?
? ? ?? ? ?
Inventories
? In 2002,firm A produced 1000 pc,
800 sold at $1000 each,200 become
inventories,
1) What happened to GDP in 2002?
2) If the 200 inventories were sold at
$1500 each in 2003,what happened
to GDP in 2003?
CPI v.s.GDP deflator
? CPI may overstate inflation
(sorry! not always ?)
When it really overstates inflation,
comparing to the GDP deflator,we
should look for reasons from where it
differs from the GDP deflator,right?
CPI v.s.GDP deflator
CPI v.s,GDP Deflator (China)
0.00E+00
5.00E-01
1.00E+00
1.50E+00
2.00E+00
2.50E+00
3.00E+00
3.50E+00
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Year
CPI
GDP deflator
CPI v.s,GDP deflator (U.S.)
0.00E+00
5.00E-01
1.00E+00
1.50E+00
2.00E+00
2.50E+00
3.00E+00
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
YEAR
%
CPI
GDP deflator
CPI v.s.GDP deflator
? Inflation
or
10
0
C P I C P I
C P I
? 10
0
..
.
G D G D
GD
?
Inflation (China)
1988
1994
-5
0
5
10
15
20
25
30
1
9
7
8
1
9
8
1
1
9
8
4
1
9
8
7
1
9
9
0
1
9
9
3
1
9
9
6
1
9
9
9
year
%
consumer prices
GDP deflator
Inflation (U.S.)
0.00E+00
2.00E+00
4.00E+00
6.00E+00
8.00E+00
1.00E+01
1.20E+01
1.40E+01
1.60E+01
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
year
%
consumer prices
GDP deflator
CPI v.s.GDP deflator
? 3 differences between CPI & GDP deflator
Therefore,it might be
1,Basket has more expensive goods
2,Goods included in the basket have higher weights
than in the real world
(due to technological improvement)
3,Imports have sky rocketing price
☆ ☆ Statistics bureaus change basket (types of
goods and their weights) now and then
Production Function
--- many types/shapes
Depends on …?
L or K
Q
Production Function
? Constant Returns to Scale (CRS)
e.g,Y = L + K
Intuition,
1 person 1 spade
2 people 2 spades
……
L or K
Q Y
MPL or MPK
L or K
Q
Production Function
? Decreasing Returns to Scale (DRS)
e.g,
Intuition,
1 office 1 worker
1 office 2 workers
……
2 offices 1 worker
3 offices 1 worker
……
Y L K??
L or K
Q Y
L or K
Q
MPL or MPK
Production Function
? Increasing Returns to Scale (IRS)
e.g,
Intuition,
knowledge capital
1 firm 1 knowledge
2 firms 1 knowledge
……
L or K
Q
22Y L K?? Y
L or K
Q MPL or MPK
Production Function
? In real world,production function
function looks usual like
L or K
Q
Y
L or K
Q
MPL or MPK
Economic profits v.s,
accounting profits
? For competitive firms,
+ accounting profits; 0 economic profits
e.g,Competitive firm A hires 10 workers,$100/worker;
uses $100,000 capital; it produces 20,000 DVD
players with p=$100,
What is the accounting profit?
What is the economic profit?
What is the intuition for their difference?
Thanks for your
patience!
? Please come to me or email me your
questions whenever you feel necessary
? My office hours are Monday 10:30-12:00,
Door is open to everyone! ?
? Let’s get better in Macroeconomics together!
D for Goods & Services
? Y = C + I + G + NX
Closed economy → NX = 0
C,consumption
I,investment
G,government purchasing
NX,net export
D for Goods & Services
? 国民核算 (亿元 )
国内生产总值 95933
支出法国内生产总值 98618
居民消费 45923
政府消费 13029
固定资本形成 36813
(存货增加 648)
Demand for G & S (China,2001)
居民消费
政府消费
投资
D for Goods & Services
1,Consumption
Disposable income,Y – T
How to spend disposable income? (C&S)
Consumption function,C = C (Y - T)
Consumption depends directly on the
level of disposable income,The
higher disposable income is,the
greater consumption is,
D for Goods & Services
? The relationship between disposable income and consumption
? Marginal propensity to consume (MPC),the amount of
consumption changes when disposable income increases by
one dollar
Y-T
C
U.S,
Japan
D for Goods & Services
2,Investment and interest rate
The investment function,I =I (r)
r,real interest rate
r is 1) the cost of borrowing
2) the opportunity cost of using one’s
own funds
So,r↑→ I ↓
D for Goods & Services
? Government Purchasing (G)
T – G
Budget surplus,T – G > 0
Budget deficit,T – G < 0
Budget is balanced,T – G = 0
D for Goods & Services
Here,we assume
1) No transfer payments
2) Total tax is fixed
3) Total government spending is fixed
So,government purchasing is also fixed
Equilibrium
? Aggregate supply,
? Aggregate demand,
? Equilibrium,
? Which variable plays the key role to
ensure the demand for G & S equals
the supply?
Yes! Real interest rate!?
(,)Y F K L? ? ??
( ) ( )C Y T I r G? ? ? ?? ? ?
( ) ( )Y C Y T I r G? ? ? ? ?? ? ? ?
Equilibrium
? Loanable funds market
Demand?
--- investment
Supply?
--- national savings
Private savings:Y – T – C
Government savings:T – G
National savings:(Y–T–C) + (T–G) = Y – C – G
→ I ( r ) = Y – C – G
Equilibrium
I ( r )
()S Y C Y T G? ? ? ? ? ?? ? ? ?
r
S,I
Eq’m r
Eq’m level of I
Equilibrium
? Things that shift the savings curve
1) public saving
--- fiscal policy,changes in G or T
2) private saving
--- preferences
--- tax laws that affect saving
Equilibrium
1) Military spending ↑
2) Buy apartment instead of getting it free
3) Income tax rate ↑
r
S,I
S
I
Equilibrium
? Things that shift the investment curve
1) technological innovations
--- to take advantage of the
innovation,firms must buy new
investment goods
2) tax laws that affect investment
e.g,investment tax credit
Equilibrium
r
S,I
S
I
Equilibrium
? In real world,S depends on r as well,
r ↑ ? S↑
What if we relax the assumption that S is
fixed?
Equilibrium
? S is a also a function of r
I ( r )
S ( r ) r
S,I
Equilibrium
? In real world,when we look at
macroeconomic data,we usually fail to find
an obvious association between investment
and interest rates,
e.g,when interest rates are low,investment is
not always high,
Why?
Equilibrium
r
S,I
I ( r )
S ( r )
Chapter 3 Summary
Neoclassic model of macroeconomics
(assumptions,graphs,intuitions)
1,The production (factors,production function,
supply)
2,Distribution of national income into factors
(factor prices,firm’s demand for factors,
income distribution to factors)
3,The demand for goods and services (C,I,G)
4,Equilibrium and the interest rate (S and D for
the economy’s output,loanable funds
market)
Macroeconomics
Lecture 3
Topics
? Finish the assignment from last class
? Clarification for 4 questions from last class
? Demand for goods and services
? Equilibrium and the interest rate
Assignment
? Cobb-Douglas production function
1,What is MPL?
2,What is the relationship between labor
income and total income?
1(,)Y F K L A K L?? ???
Assignment
What is the shape for MPL?
1(,)Y F K L A K L?? ???
( 1 )YYM P L A K L
LL
??? ???? ? ? ?
??
1( 1 ) ( )M PL A K L
L
???? ??? ? ? ?
?
Assignment
? Labor income share
Labor income,
M P L L?
( 1 )A K L L??? ?? ? ?
1
( 1 ) 1M P L L A K L L
Y A K L
??
??
? ??
?
? ? ?? ? ?
Inventories
? In 2002,firm A produced 1000 pc,
800 sold at $1000 each,200 become
inventories,
1) What happened to GDP in 2002?
2) If the 200 inventories were sold at
$1500 each in 2003,what happened
to GDP in 2003?
CPI v.s.GDP deflator
? CPI may overstate inflation
(sorry! not always ?)
When it really overstates inflation,
comparing to the GDP deflator,we
should look for reasons from where it
differs from the GDP deflator,right?
CPI v.s.GDP deflator
CPI v.s,GDP Deflator (China)
0.00E+00
5.00E-01
1.00E+00
1.50E+00
2.00E+00
2.50E+00
3.00E+00
3.50E+00
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Year
CPI
GDP deflator
CPI v.s,GDP deflator (U.S.)
0.00E+00
5.00E-01
1.00E+00
1.50E+00
2.00E+00
2.50E+00
3.00E+00
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
YEAR
%
CPI
GDP deflator
CPI v.s.GDP deflator
? Inflation
or
10
0
C P I C P I
C P I
? 10
0
..
.
G D G D
GD
?
Inflation (China)
1988
1994
-5
0
5
10
15
20
25
30
1
9
7
8
1
9
8
1
1
9
8
4
1
9
8
7
1
9
9
0
1
9
9
3
1
9
9
6
1
9
9
9
year
%
consumer prices
GDP deflator
Inflation (U.S.)
0.00E+00
2.00E+00
4.00E+00
6.00E+00
8.00E+00
1.00E+01
1.20E+01
1.40E+01
1.60E+01
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
year
%
consumer prices
GDP deflator
CPI v.s.GDP deflator
? 3 differences between CPI & GDP deflator
Therefore,it might be
1,Basket has more expensive goods
2,Goods included in the basket have higher weights
than in the real world
(due to technological improvement)
3,Imports have sky rocketing price
☆ ☆ Statistics bureaus change basket (types of
goods and their weights) now and then
Production Function
--- many types/shapes
Depends on …?
L or K
Q
Production Function
? Constant Returns to Scale (CRS)
e.g,Y = L + K
Intuition,
1 person 1 spade
2 people 2 spades
……
L or K
Q Y
MPL or MPK
L or K
Q
Production Function
? Decreasing Returns to Scale (DRS)
e.g,
Intuition,
1 office 1 worker
1 office 2 workers
……
2 offices 1 worker
3 offices 1 worker
……
Y L K??
L or K
Q Y
L or K
Q
MPL or MPK
Production Function
? Increasing Returns to Scale (IRS)
e.g,
Intuition,
knowledge capital
1 firm 1 knowledge
2 firms 1 knowledge
……
L or K
Q
22Y L K?? Y
L or K
Q MPL or MPK
Production Function
? In real world,production function
function looks usual like
L or K
Q
Y
L or K
Q
MPL or MPK
Economic profits v.s,
accounting profits
? For competitive firms,
+ accounting profits; 0 economic profits
e.g,Competitive firm A hires 10 workers,$100/worker;
uses $100,000 capital; it produces 20,000 DVD
players with p=$100,
What is the accounting profit?
What is the economic profit?
What is the intuition for their difference?
Thanks for your
patience!
? Please come to me or email me your
questions whenever you feel necessary
? My office hours are Monday 10:30-12:00,
Door is open to everyone! ?
? Let’s get better in Macroeconomics together!
D for Goods & Services
? Y = C + I + G + NX
Closed economy → NX = 0
C,consumption
I,investment
G,government purchasing
NX,net export
D for Goods & Services
? 国民核算 (亿元 )
国内生产总值 95933
支出法国内生产总值 98618
居民消费 45923
政府消费 13029
固定资本形成 36813
(存货增加 648)
Demand for G & S (China,2001)
居民消费
政府消费
投资
D for Goods & Services
1,Consumption
Disposable income,Y – T
How to spend disposable income? (C&S)
Consumption function,C = C (Y - T)
Consumption depends directly on the
level of disposable income,The
higher disposable income is,the
greater consumption is,
D for Goods & Services
? The relationship between disposable income and consumption
? Marginal propensity to consume (MPC),the amount of
consumption changes when disposable income increases by
one dollar
Y-T
C
U.S,
Japan
D for Goods & Services
2,Investment and interest rate
The investment function,I =I (r)
r,real interest rate
r is 1) the cost of borrowing
2) the opportunity cost of using one’s
own funds
So,r↑→ I ↓
D for Goods & Services
? Government Purchasing (G)
T – G
Budget surplus,T – G > 0
Budget deficit,T – G < 0
Budget is balanced,T – G = 0
D for Goods & Services
Here,we assume
1) No transfer payments
2) Total tax is fixed
3) Total government spending is fixed
So,government purchasing is also fixed
Equilibrium
? Aggregate supply,
? Aggregate demand,
? Equilibrium,
? Which variable plays the key role to
ensure the demand for G & S equals
the supply?
Yes! Real interest rate!?
(,)Y F K L? ? ??
( ) ( )C Y T I r G? ? ? ?? ? ?
( ) ( )Y C Y T I r G? ? ? ? ?? ? ? ?
Equilibrium
? Loanable funds market
Demand?
--- investment
Supply?
--- national savings
Private savings:Y – T – C
Government savings:T – G
National savings:(Y–T–C) + (T–G) = Y – C – G
→ I ( r ) = Y – C – G
Equilibrium
I ( r )
()S Y C Y T G? ? ? ? ? ?? ? ? ?
r
S,I
Eq’m r
Eq’m level of I
Equilibrium
? Things that shift the savings curve
1) public saving
--- fiscal policy,changes in G or T
2) private saving
--- preferences
--- tax laws that affect saving
Equilibrium
1) Military spending ↑
2) Buy apartment instead of getting it free
3) Income tax rate ↑
r
S,I
S
I
Equilibrium
? Things that shift the investment curve
1) technological innovations
--- to take advantage of the
innovation,firms must buy new
investment goods
2) tax laws that affect investment
e.g,investment tax credit
Equilibrium
r
S,I
S
I
Equilibrium
? In real world,S depends on r as well,
r ↑ ? S↑
What if we relax the assumption that S is
fixed?
Equilibrium
? S is a also a function of r
I ( r )
S ( r ) r
S,I
Equilibrium
? In real world,when we look at
macroeconomic data,we usually fail to find
an obvious association between investment
and interest rates,
e.g,when interest rates are low,investment is
not always high,
Why?
Equilibrium
r
S,I
I ( r )
S ( r )
Chapter 3 Summary
Neoclassic model of macroeconomics
(assumptions,graphs,intuitions)
1,The production (factors,production function,
supply)
2,Distribution of national income into factors
(factor prices,firm’s demand for factors,
income distribution to factors)
3,The demand for goods and services (C,I,G)
4,Equilibrium and the interest rate (S and D for
the economy’s output,loanable funds
market)
