What does the consumption over time graph look like
Plots c’ (vertical) against c (horizontal)
What is lifetime wealth?
y - t + (y’ - ‘t / 1+r)
Where is the consumers’ optimal point?
Where MRS = 1+r when deciding c and c’
Where MRS = w when deciding c and l
What is the formula for consumption
If c = c’ = we (1+r) / (2+r)
How does changing the interest rate affect the c c’ graph
E remains unchanged, increase in r makes the curve steeper
How does changing we affect the c, c’ graph
Increase in we shifts it out but you have to show whether this is due to y or y’
What is riccardian equivalence
If the change in current tax is the same as the PV of the change in future tax, there is no change in consumption behaviour
Assumes perfect markets, binding borrowing constraints can change this
What shifts the labour supply curve
Changes is we (- as higher we shifts left)
Changes in r (+ as higher r shifts right)
What does an increase in tax do to the consumer’s choice
- wealth effect
lower c, lower l, higher N (also shifts Ys)
What does an increase in rates do to the consumer’s choice
+ savings effect
higher s, lower c, higher N (no change in Ys)
What do firms aim to maximise?
The present value of their firm = p / (p’ / 1+r)
What is the formula for profit?
p = Y - wN - I (p gross = Y - wn) p' = Y - wN + (1-d)*K'
How do firms make their labour decision?
Same as in 1 prediod model - maximise gross profit
Where MPK = w
What shifts Labor Demand?
Increases in current z (+ higher z shifts Nd right)
Increases in K (+ as higher k shifts Nd right)
How do firms make their investment decision?
MB = MC = 1
Since (MB = MPK’ + 1 - d) / 1+r invest at MPK’ = r + d
What does the investment graph look like?
Plots r against I curve is equal to MPK’ - d
What increases I?
Lower in r (- as move down I curve) Higher d (+) shift Higher z' (+) shift Lower K (+) shift
What are the 3 graphs in the 2 Period Model?
1) Labour Market (w against N)
2) Goods Market (r against Y)
3) Credit Market (r against credit), don’t need to draw
What underpins the Labour Market Graph in 2PM
Nd comes from firm decision
Ns comes from household decision
What underpins the goods market?
Yd + C+I+G
Ys is based on labour decision and firm production
What shifts Ys?
Shifts when Ns shifts due to we or G
Shifts when Nd shifts due to z or K
What shifts Yd right?
Higher G (+) Lower taxes (-) Increase in y' (+) Decrease in k (-) Increase in z (+)
What is the result of lower K?
MPN becomes lower so ND shifts left, as does Ys
R increases so Ns shifts right and I decreases
What are the 3 RBC Graphs?
1) Labour Market (w against N)
2) Goods Market (r against Y)
3) Money Market (P against M)
What drives fluctuations in output in the RBC model
TFP
What drives fluctuations in output in the NK model
Demand
What is the formula for money demand?
Md = PY - P(1+q)x
What shifts Md right
Higher Y (+) or lower r (-)
Which model is money neutral in?
RBC, Money is not neutral in NK
Which model has flexible prices?
RBC, prices are sticky in NK
Which model is not perfectly competitive?
NK
What are the 4 markets in NK?
1) Firm production (plots Y against N and only has curved line where Y = zF(K,N)
2) Labour Market (only has upward sloping Ns curve)
3) Goods Market (plots r against Y, includes Ys and Yd but only Yd matters)
4) Money market (plots P against M, bank changes Ms to keep prices unchanged)
How do you analyse changes in NK?
1) see if there is a shift in Firm curve
2) determine affect on YD and shift, the new Y is based only on the Yd curve at the same interest rate
3) See how Md shifts and then shift Ms to keep inflation at 0
4) see how Firms have the change N in order to meet this level of production
5) see how much they need to pay to get this level of N
What are the 4 channels?
1) Y
2) Profit and Taxes
3) r
4) w
[5) M only in RBC]
How can the CB increase MS?
Gov issues new bonds which the bank buys
Printing money
