Equilibrium Y* Lecture 11 Dr. Jennifer P. Wissink ©2017 Jennifer P. Wissink, all rights reserved. March 6, 2017 1

Announcements: MACRO Spring 2017 ALL Prelim 1 TESTING LOCATIONS Early Time people on Tuesday (3/7) report to GSH-G64 (Kaufman Aud) by 5:00pm. Extended Time people on Tuesday (3/7) report to Uris 262 by 5:00pm. Regular Time people on Tuesday (3/7) report no later than 7:15pm to Uris Aud… right here! Makeup People on Wednesday (3/8) report to RCK 230 no later than 3:00pm. Extended Time people on Wednesday (3/8) report to Uris 260 by 1:30pm For Wissink’s OH before the prelim see the Blackboard Announcement. NO LECTURE ON WEDNESDAY MORNING. Sleep in! Wednesday Sections will still meet.

Interesting(entertaining, even) Listens/Reads The Audacity of Hopelessness http://www.cc.com/video-clips/rxdrv8/the-colbert-report-the-word---the-audacity-of-hopelessness What's Behind The Rise Of College Tuition? http://www.npr.org/2012/02/19/147115868/whats-behind-the-rise-of-college-tuition UC Students Propose Alternative To Tuition Increases http://www.npr.org/2012/02/07/146479925/uc-students-propose-alternative-to-tuition-increases “Under our proposal, students would pay 5 percent of their income for 20 years" following graduation, Locacio says. The 40 Most Unusual Economic Indicators http://www.businessinsider.com/40-most-unusual-economic-indicators-2013-2#the-first-date-indicator-1 Action chart; For whom the jobs toll; The new way of post-recession unemployment in America (very cool set of charts) http://www.economist.com/node/21620337

i>clicker questions Consider the fictional economy of Vinopolis that uses the Vinopolis $dollar as its currency. Vinopolis’ only final output is wine. In 2009 farmers in Vinopolis sold all their grapes, $5,000 worth, to local vineyards. The local vineyards used all these grapes and a variety of other inputs to make wine which sold to all the local retail wine stores for a total of $25,000. The local wine stores shelved and sold all the wine made in 2009 in 2009. Total wine sales to final consumers equaled $50,000. Of this $50,000, half the wine was sold to people who are ordinary citizens of Vinopolis and half of the wine was sold to foreign tourists visiting Vinopolis. Suppose citizens in Vinopolis consume imported cheese. Suppose in 2005 a pound of imported cheese sold for $5/pound. In 2009 imported cheese is selling for $10/pound. How does this change the value of 2009 GDP? Who knows? GDP stays the same. GDP will fall. GDP will rise. Vinopolis GDP in 2009 is $25,000 $50,000 $5,000 $75,000 Suppose the bureaucrats of Vinopolis report that real 2009 GDP for Vinopolis is $40,000 (the base year is 2005 for Vinopolis). What is the implicit GDP deflator index for Vinopolis for 2009? 100 25 125 1.25 80 This would be Real GDP Current GDP

i>clicker question HeavenLand is a country that is so nice that nearly all of its working citizenry stay in the country and work in HeavenLand’s economy. In addition, since HeavenLand is so nice there are a huge number of foreign citizens working in HeavenLand. Which one of the following statements is most likely to be TRUE? Heavenland's GNP will be greater than its GDP. Heavenland's GDP will be greater than its GNP. Heavenland's GNP and GDP will be equal. Heavenland's GDP will tend to be equal to its disposal national income. Heavenland's trade balance will be equal to zero. Which one of the following individuals is considered unemployed according to the way the U.S. calculates their official unemployment statistics? John, who works without pay for 30 hours per week in the family owned tax accounting business. Jill, who works 2 hours a week at Walmart as a greeter. Rose, who is currently a full time student at Cornell and working 60 hours a week on her studies to please her mom. Leyton, a former NFL football player just released from his contract who is now actively searching for some other job while taking a night class at TC3 (the local community college). His resume states, “Put me in coach, I’m ready to play!” A female with a Ph.D. in physics who decides to stay home and take care of her children after graduation.

END OF MATERIAL FOR PRELIM 1 WHEW!! HINTS: DON’T pull an “all-nighter”. READ questions carefully. Highlight or underline each important piece of information. For the multiple choice: Cover up all the answers and “do” the problem based on the narrative first, then your work will lead you to the correct answer. For “work” problem: Draw graphs big enough and carefully enough to make it so they can “show” you the way. Always label BOTH axes right away, it helps remind you of what goes where and what you are doing. Label any items you put into the graph (like D for demand and S for supply). Use a contrasting color to help see things. TRY each problem – at least do something so there is some chance that you might get partial credit for what you did. Don’t spin your wheels too long on any one problem. Give it your best shot, then move on, then go back to it if there is time.

Starting a Macro Model So, how can we analyze the determination of the various macro economic aggregates (that we now know how to calculate)? How big will GDP be? How fast will GDP be growing? Will GDP be big enough to create an acceptable amount of employment? And not too much inflation? How does the economy adjust to changes in the economic environment? Can fiscal, monetary or supply side policy matter? How? Why? 7

The Core of Macroeconomic Theory 8

A Super Simple Model to Get Us Started Only House Holds and Firms and a “Goods & Services” market for now. No Government yet. No Exports and Imports yet. No Money Market yet. No Inflation yet. The “Frugal” Economy Model 9

A Super Simple Model to Get Us Started SIMPLE SHORT RUN BUSINESS CYCLE MODEL ala KEYNES Traditional core model. Follows Keynes’ ideas. Will introduce the role of the government soon enough. Stress is on “Aggregate Desired Expenditures”. Focus for now on: An economy that produces a whole bunch of stuff in a given period. Income is generated by producing all this stuff. HHs consume stuff and save. Businesses make stuff and engage in buying stuff as investment stuff. 10

Pay-Day! Aggregate output (income) (Y) is a combined term used to remind you of the exact equality between aggregate output and aggregate income. Aggregate income is the total income received by all factors of production in a given period. Aggregate output is the total quantity of goods and services produced in an economy in a given period. 11

The Frugal Economy: Determining Aggregate Desired Expenditures=AEd What HHs spend out of Y = Consumption (C) How much Firms desire for investment = desired Investment (Id) AEd = C + Id Note: AEd depends on Y! In equilibrium, what we “desire to do” has to be equal to what we actually do. Otherwise, there is unplanned investment (via unplanned changes in inventory) and so the economy will adjust until the amount produced (Y) equals Aggregate Desired Expenditures (AEd). 13

HHs: Consumption (and Saving) out of Y Assume (for now): A household can do two, and only two, things with its income: Consume (C) (a.k.a. consumption) Save (S) (a.k.a. saving and not savings) NOTE the following identities (for now):

HHs:The Consumption Function Determinants of aggregate desired consumption include: Household income Household wealth Interest rates Households’ expectations about the future Other stuff, too. In The General Theory, Keynes argued that household consumption is directly related to its income. (Lots of other work by others, too.) So...C = f(Y), where Y = Aggregate Output (income) holding constant... Other stuff, too, liked lagged Y, etc.

HHs: Consumption Function Concepts the subsistence level of consumption dis-saving and saving the breakeven point the marginal propensity to consume (MPC) the average propensity to consume (APC) 17

HHs: Saving Function From consumption to saving Recall: C + S = Y, so… S = Y - C Like a see-saw the marginal propensity to save (MPS) the average propensity to save (APS) Note it will always be the case that: MPC + MPS=1 APC + APS=1

A LINEAR Aggregate Consumption Function Derived from the Equation C = 100 + .75Y AGGREGATE INCOME, Y (BILLIONS OF DOLLARS) AGGREGATE CONSUMPTION, C (BILLIONS OF DOLLARS) 100 80 160 175 200 250 400 600 550 800 700 1,000 850

Deriving a Saving Function from a Consumption Function Y - C = S AGGREGATE INCOME (Billions of Dollars) AGGREGATE CONSUMPTION (Billions of Dollars) AGGREGATE SAVING (Billions of Dollars) 100 -100 80 160 -80 175 -75 200 250 -50 400 600 550 50 800 700 1,000 850 150