Static Model #1 Flashcards
Week 4
What is Business Cycle theory? Why can using it become complicated?
- SR business cycles are costly, due to instability (“Lost Generation”)
- The question becomes how are SR cycles determined by positive ansalysis
- The method becomes tough to use, as models can be static/dynamic, variables can be real/monetary and economies can be closed/open
What is the Question, Method and Technique used for the static model?
- QUESTION: Extensive Vs Intensive Margin (To work, how much to work)
- METHOD: NC model (1970s), static (no lag/lead) and micro-founded
- TECHNIQUE: Optimisation and substitution into simultaneous equations
What is the Volatility and Comovement of the extensive/intensive margin?
- Volatility: Extensive margin > Intensive margin
- Comovement: Extensive PROcyclical, Intensive Acyclical
How is labour supply defined in macroeconomics?
- Differs from microeconomics, as ‘aggregation’ is involved
- This means that a representative agent is found, who is the sum of all agents and represents GDP/Cap. and utility
What is microfoundation? Why is it used (Lucas Critique)?
- Microfoundations state that macroeconomic behaviour can be found within microeconomic principles
- For example, representative consumer maximises utility, subject to budget and time constraints
- This is immune to the Lucas Critique because all parameters are structural, not statistical
What are some criticism of the representative agent model?
- Assumes rationality, not necessarily true
- The law of large numbers
- Inequality
- Homogenous Vs Heterogenous consumers
- Fallacy of composition
- Fallacy of division
How can Consumption and Leisure be modelled within the static model?
- Optimisation problem of representative agent needs their own objective and their own constraint
- IMPLICIT [U(C,l)] Vs. EXPLICIT [C^α * l^1-α]
- As C and l are two independent variables, a 3D graph can illustrate this point (looks like an I.C)
What are the two constraints for Labour Supply? Which variables are endogenous/exogenous?
- BUDGET: Income = Expenditure
- Therefore, wNs + π - T = C
- TIME: Time endowment = work/leisure
- Therefore, h = l + Ns
- ENDO: Ns, C, l [agents can change]
- EXO: h, π, w, T
How can the optimisation problem be represented graphically?
- By substituting the time constraint into the budget constraint, you can find that;
wh - wl + π - T = C - This means that the intercept is h + (π-T) / w and the slope is - w
What is the relationship between π and T (examine the budget constraint)
- If π<T, the y-intercept is above h
- If π>T, the y-intercept is below h [impossible, making the budget constraint kinked]
Describe the graphical depiction of the extensive margin
- Looks like a regular diagram, with a downwards-sloping utility line and a budget constraint
- There is a kink at h, where the budget constraint becomes vertical
- (l * , C * ) is the optimal point where the two curves meet
Describe the graphical depiction of the intensive margin and the relevant effects
- As the individual decides to take on more work, the budget constraint moves higher
- There is then a substitution effect around the curve, and therefore an income effect from the jump between the same curve
How do you calculate the amount of labour supply / demand using the substitution method?
- Substitute the constraint into the objective function, leaving only one endogenous variable
- Differentiate w.r.t l (via chain rule) and set to 0 to maximise
- Find the F.O.C for optimal l based on whatever variable
What is the intratemporal condition for labour supply? How can this be derived?
- Partial differentiation using the chain rule (multi-variable) = [δU (C,l) / δC] * [δC / δl] + [δU (C,l) /δl]
- This gives MUc * -w + MUl = 0
- Therefore, w = MUl / MUc OR w = MRS (l,c) [MB=MC]
What does it mean if l>h?
- You are unemployed
- This becomes a corner solution
