Economic fluctuations Flashcards
In previous weeks what have we said about economic growth?
we stated that developed economies tend to grow for a constant rate in long run of about 2%
When we plot the log of GDP what shape do we tend to get and show whterre there is a peak or a trough?
What is the trend and what is the cycle?
The trend is the line and the swiggly line is the cycle.
What is a cycle, boom and recession?
Cycle = fluctuations around the trend
Boom = persistent positive deviations from trend
Recession = persistent negative deviations from trend
What are some charaterstics of the business cycle?
The fluctuations are quite choppy.
- There is no regularity in the amplitude of fluctuations
- There is no regularity in the frequency of fluctuations
Which one is the positive correclation and which is the negative
the first one is positive the second is negative.
As you are looking at GDP, and we are looking at the way a macroeconomic variable moves with gdp, what are the 3 types of behaviour, a macroeconomic variable can move with GDP?
Procyclial
Countercyclial
acyclical.
What does Procyclial mean?
If the deviations from trend in a macroeconomic variable are positively correlated with the deviations from trend in real GDP,then the variable is procyclical. ( variable moving in the same direction as GDP, so when GDP is above trend that variable will above trend and same for below)
What does countercyclial mean?
If the deviations from trend in a macroeconomic variable are negatively correlated with the deviations from trend in real GDP, then that variable is countercyclical ( variable moving the opposite direction to GDP, so when real gdp is above trend the variable tends to be below trend and vice versa)
What does Acyclial mean?
If a macroeconomic variable is neither procyclial nor countercyclial it is acyclial.
What are imports and GDP?
When GDP is below trend so is imports and when GDP is above trend so is imports, so imports are a procyclical variable.
What is a leading variable and what is a lagging variable and what is a concident variable?
A leading variable is one where the variable is following the cycle of real GDP but moves just before the GDP
A lagging variable is one where the variable is following the cycle of real GDP but moves after the real GDP.
A concident variable is where the variable is neither lagging nor leading.
What is the leading diagram and what is the lagging variable?
The first is the leading, the second is the lagging.
The answer is D
What are the symbol business cycle facts we need to know?
For our intertemporal model what are the 2 the full ingredients?
- Current and future periods.
- Representative Consumer – consumption/savings decision, present and future labour supply
- Representative Firm – hires labour and invests in current period, hires labour in future
- Government – spends and taxes in present and future, and borrows on the credit market.
With the representative consumer what are his 2 types of decisions?
Labour supply decisions ( how many hours of netflix will i spend watching in the current and future period)
Consumption decisions ( how many donughuts will i consume in the current and future period)
What is the representative consumers current period budget constraint?
This means that the decisions to consume or save ( s^p being aggregrate savings in the private sector, is funded by income from working plus profits from firms he owns minus taxes.
What is the representative consumer future budget constraint?
In the next period, there is no point of saving, you will only consume, is income from work, plus profit minus taxes plus savings from the the past period, with a reward of r.
With the representative consumer,using some calculations we did in previous weeks, how can we calculate the lifetime consumer budget constraint?
This tells us my lifetime wealth will depend on my labour income in both perids,divdiends coming from firms i won in both periods and taxes i have to pay to theh government.
What is the optimal choice for consumer in the current period, future period and intertemporal choice, we will not represent this on a diagram as it is quite difficult?
In our model what can consumers do and what is it called?
Consumers can subistute current consumption for future lesiure, which is called the intertemporal subsitution of lesiure.
When a representative consumer subsistutes current lesiure for future consumption, what is the tradeoff and what is the trade of of future lesiure?
The price of lesiure is w ( if this is wage per hour, if i wwatch an additional hour of netflix, i have to give away 1 hour of work, so one how left)
What is the price of future lesiure? w’/1+r ( the price of future lesiure in terms of current goods (* this is present value of an adiidtional hour of lesiure)
Looking at the trade off between subistuting current leisure for future lesiure, what happens when the real interest rate goes up?
Future leisure is cheaper w/1+r ( r increases so the whole fraction goes up) , hence the consumer wants to reduce current leisure (work more today) and increase future leisure (work less tomorrow)
• This INTERTEMPORAL SUBSTITUTION EFFECT on leisure (assuming it is dominant) implies current labour supply increases with
If the subsitution effect is dominant over the income effect, draw our labour supply curve of representative consumer current labour supply?
What happens when there is an increase in real interest rate?
When there is an increase in interest rate, future lesiure is cheaper, therefore the subsitutuion effect says we want more of this, this the way to fund this, is to work more today. so for the same wage we work more hours.
What happens when their is an increase in profits or decrease in taxes?
you experience a pure income effect, you will work less hours given the same wage, if there is an increase in current and future profits or deecrease in current or future taxes, so labour supply shifts to the left.
We are now going to focus on consumption now, plot a curve showing current ocnsumption and current income ( the diagram should show consumption demand as a function of real interest rate) ?
Why is the marginal propensity to consume( the additional amount of current consumption that i get with an increase in current aggregrate income) have a slope less than 1?
This is because if there is an increase in current income for out consumers, they wont spend it all, they will save a part of this increase in income and spread it over the 2 periods and increase both current and future consumption. So an increase in current income leads to a less than proportonal increase in the consumption demand.
What happens when there is an increase in the real interest rate to current and future consumption?
we will subisitute current consumprion for future consumption( so reduce current consumpiton and increase future consumption), you want to save more.
What happens if there is an increase in profits or decrease in taxes ( current of future for both)?
Notice the value of the interest rate doesnt change.
For the representative firm how is output produced in the current and future period and what is capital in the first period?
Capital is fixed in the first period.
What are firms future and current proifts?
First period = consumption goods i produce or output minus the wages i pay out to workers minus consumption goods i want to transformr into new plants
Second period = output produced - wages needed to be paid + you dont need to invest in the second period, so you will have (1-d)K’ left, we can transform into consumption goods and sell in the market for profits.
As shareholders of firms care about profits, today and and are greed, they want to know the present value of their profit, so what is the maxmising present value of profit?
How does a firm’s labour demand look like and what is it important to remember?
The marginal product of labour for a given wage will tell us how many workets, the firm hires.
What happens when there is an increasei n Z or K?
For the same wage you would hire more workers, each worker is more productive, in mixing capital and labour or has more capital on average, so each can product additional output, if we add an additional unit of labour, so MpN is higher.
So we know about everything about the firm, but how optimally should the firmbe investing, how many new capital goods should be creating? What is the marginal cost and benefit?
Marginal cost of investment = marginal benefit of investment
Marginal cost = 1, i can transform a donughut into investment goods one on one. To make kan additional plant, i give away one donughut, so thats the cost 1
The marginal benefit tells us what is the additional present value of profits i wil get, if i have an additional unit of investment ( the benefit comes in the second period as tou are able to produce more in second period).
( the MB in this formulal is ( the marginal product of capital in the next period which is higher + the investment goods i have which i can convert into consumption and sell for profits, calculated in terms of current consumption goods, so present value)
We know the optimal decision is where the marginal cost of investment = marginal benefit of investment, rearrange equation to get an answer?
What does this say?
This is the net marginal product of capital( net means minus depreciation) = real interest rate
What does the firms investment demand look like?
When interest is low, i invest more, but when interest rate is high i invest less
the marginal product of capital is decreasing function, the more capital i have the less the addition to the total increases.
What happens when there is an increase in z’?
if there is an increase in total factor productiviity in the future this means that marginal product of capital for every level of investment will be higher, this means firms will be willing to invest more because any additional unit of investment will be converted to capital tommorow, which is more productive than it used to be, meaning higher profits.
What happens when there is a decrease in capital?
to illustrate this i will use an example, if i have less capital today e.g. one less coffee machine, for every level of investment i do today, i will have less capital than tommorow, however, as you have less capital, the marginal product of capital is higher, meaning that an increase in investment, with less capital means, you can produce more, as the marginal product of capital is higher with less capital.So for the same interest rate, you will invest more,.
Now we want to build a compeitive equilbiirum, in the market with 2 diagrams, but first lets look at the governemnt budget constraint, what is it?
Government spending can be financed via taxes, or they can use bonds in the credit market. the credit markets works fine, everyone repaus their debts, the govt now can change govt spending.
Now we are going to derive the output supply curve from labour demand and production function. if there is an increase in real interest rate what would happen?
This means for the same interest rate workers want to move more, because future lesiure is cheaper w’/1+r. leading to an outward shift in labour supply to the right ( notice interest changes). The new equibrium will have a lower amount of real wage and more workers, due to the intertmeporal subsitiution of lesiure)
This translates to the production function as higher output and more workers working.
What happens when there is an increase in government spending now or in the future?
An increase in G or G’ means that takes are higher meaning, meaning that your lifetime wealth goes down, so for the same wage and interest rate, you want to work more.
Labour supply shifts to the right and the new equibirum involves a lower wage and more workers,
this translates on the production function as a higher output higher N.
this leads to an increase in output supply from y1 to y2, for the sam level of the interest rate.
If TFP goes up then the production function will go up, for every level of labour, we will be able to produce more. This means that the marginal product of labour for every level of hours worked is higher, so labour demand shifts to the right, and firmsm want to higher more workers. This means for the output supply for the same level of the interest rate i am able to produce more.
We have looked at output supply, now lets look at output demand remind we again the diagram of output demand as a function of current income for a given level of the interest rate?
So we know AD has components lets start with Investment then Government spending, does this vary with current income and show this on a diagram, whats the new slope of this curve?
Investment doesnt really vary with current income, so it is just a constant, so consumption as a function of the given real interest rate will shift upwards, as Investment acts like a constant same with government spending.
The slope is still the same as before, as these components added are kind of a constant
How can we find the demand for the consumption goods, investment goods and government spending, can be find?
That would be with the interesection of the curve with the 45’ line. thus AD equals y1.
How do i translate this to the output demand curve, where on the y axis i have real interest rate and on the x axis i have output?
I have to start changing interest rate, so y1 refers to y1 on the real interest as a function of output diagram, when i change the real interest rate ( increase it), this reduces consumption, investment, so that curve thill shit down leading to a lower output
What happens when there is an increase in govt spending?
The output demand will shift to the right equal to the amount g increases, for the same level of the interest rate you will have a higher output demand equal to y2.
now we have come to the end, how does the full intertemporal model look like now?
What are the 3 things that shift output supply the right?
What things shift output demand to the right?
Mr Burns Ltd is operating in Springfield for two periods. Which of these events will imply they want to hire more workers in the first period?
Select one or more:
a. The trade union imposes an increase in the current period real wage
b. Each employee receives an additional monitor for their computer in the first period.
c. The first period is tornado season in Springfield, and workers have some difficulty in reaching the plant, hence sometimes they arrive late to work. Moreover, some computers just stop working because of blackouts, and the North Side of the plant is at times inaccessible as it gets flooded.
d. The new operating system update in the first period makes the computers much faster.
b and d
with c total factor productiviity reduces
Mr Burns Ltd is operating in Springfield for two periods. Which of these events will imply they want to invest more in the first period?
Select one or more:
a. The government announces that there are hotspots of zombies outside of Springfield and they expect the zombies to take over the city in the second period.
b. An earthquake destroys part of the plant.
c. The rain has corrupted the structure of the plant which needs more maintanance
d. The Mayor has donated a new set of computers for the plant in the first period.
