Lecture 12 Flashcards
(15 cards)
Max Profits Equation for Firms
{K,L}= F(K,L) - (w/p)L - rK
Max profits= Real output- Real Wage Cost- Real Capital Cost
Optimal Hiring: Capital Maximization
Cost of each worker is R; The benefit each unit brings to the firm is MPK
R=MPK
Capital Maximization: Labor Maximization
Marginal Cost of Labor = Marginal Benefit of Labor
W/P = MPL
Crowding Out Effect
Actions of government borrowing crowds out the funds to private sectors; Government commits more budget deficit, government savings fall, SS curve shifts left
Is there a right time/place for budget deficit?
When investment demand is inelastic; When economy is in a recession phase;
Government borrowing does not crowd out private investment as much as when investment is elastic. If businesses are sensitive to the change in interest rate the government should not undertake a budget deficit.
Fiscal Multiplier
Change in GDP/change in G
Fiscal multiplier measures the effect on GDP from a dollar spent by the government
Should the government undertake large budget deficit in times of higher or lower interest rates?
When interest rate is high, large budget deficit would crowd out investment even more
LRAS
“Classic Supply Curve”; Long-Run Aggregate Supply is jointly determined by the equilibrium in the labor market, production technology, and capital stock. Through the production
function, we get the GDP (output) corresponding to L*, K, and A.
What could shift LRAS to the left?
Extended and prolonged deficit (K* falls); Potential GDP is decreasing
What could shift LRAS to the right?
Permanent increase in productivity (both ID and LD shift right);
More K* and L*; More workforce; Potential GDP is increasing
What is the Natural Rate of Unemployment?
4%; considered the steady level of unemployment rate
When the economy is operating at RGDP below the potential GDP…
Unemployment rate is high as workers are not hired
When the economy is operating at RGDP above the potential GDP…
Unemployment rate is low as workers are hired
SRAS
Short-run aggregate supply curve; Relationship between GDP growth rate and inflation is upward sloping
Do wages and prices adjust quickly?
No because of sticky wage and sticky price. It allows firms to hire more workers temporarily when there is an inflation as workers are relatively cheaper when real wage falls.
