Static Model #2 Flashcards
Week 5
What positive and normative analysis can be done using the intratemporal conditions?
- Positive: Correct/equilibrium w? Drives fluctuations of w?
- Normative: Can we do anything to reduce cycles?
What is the competitive equilibrium? Give some examples of these points (ONLY LABOUR AND OUTPUT)
- Supply = Demand
- Everyone is happy where they are
- All agents optimise and all markets clear and intratemporal conditions hold
- LABOUR: Ns = Nd = N
- OUTPUT: Y = C + I + G + NX
What is Walrus’ Law?
- If there are N markets, you only require N - 1 markets to clear
Why does denomination of variables become tough?
- Some variables (w, π, T) are exogenous to an individual, but endogenous to the system
How can all the equations be combined into a simpler equation (PPF)?
- There are 7 equations and 7 unknowns
- By using PPF curve, we can get the equation zF(K,h-l) - G = C
- wN cancels, π = Y - wN, T=G, Y = zF(K,N) and N = h - l
What does the PPF illustrate with respect to the static model?
- All constraints of all parties are on the PPF
- The Marginal Rate of Transformation = Slope of the PPF
- Competitive Equilibrium => MRT = MRS = MP(N) = w
What are the two theories of welfare economics?
- FFTWE: Under certain conditions, competitive equilibria is efficient [inivisible hand, pareto efficiency]
- SFTWE: Under certain conditions, any efficient outcome can be achieved by competitive equilibrium via lump sum taxes [fairer, visible hand]
- However, “certain conditions” don’t always hold
How can you calculate the optimal size of the government intervention?
- Assuming that it is costly for the government to turn a public good private, we can say that G = qT, where q is a coefficient that <1
- Y = C + T = C + G/q (budget constraint)
- G* is an optimal point
How does z drive business cycles? What evidence is there to support this?
- Says Law: SS fluctuations drive business cycles, therefore increasing TFP will shift the PPF curve outwards
- Termed as “Real Business Cycle theory”
- As z rises, Y and w also rise (procyclical), whilst N~ (acyclical)
- Historically, booms and busts are closely linked to Solow Residual (TFP)- largely driven by oil prices
How does G drive business cycles? What evidence is there to support this?
- In Keynesian tradition, business cycles are driven by demand-side fluctuations (G&T)
- As G or T increases, PPF shifts down, slope on the curve2 is flatter than the curve1 due to DMP(N)
- N increases (procyclical), Y increases and w falls (countercyclical)
- During WWII, G increased and Y increased- however there was a slight drop in C [‘Crowded Out’]
How does t drive business cycles? What evidence is there to support this?
- Lump-sum or proportional tax
- If tax is proportional to the wage rate, then C = w(1-t)(h-l) + π
- Increases in t disincentivise work
- Tax receipts = t * base [Mechanical Vs. Behavioural]
- Laffer curve shows the relationship between t and tax receipts
How does rigidity drive business cycles? What evidence is there to support this?
- Normal Vs. real rigidity exacerbates the magnitude/persistence of a boom/bust
- During 1929-1933 recession, unemployment peaked at 25%
- Wages were rigid downwards, which exacerbated the recession (z fell, wages are acyclical)
What do different schools of thought think about stabilisation fiscal policy?
- Classical: Fluctuations stem from TFP and SS, hence we cannot do anything
- Keynesian: Fluctuations are from G and DS, hence G can be manipulated in the SR to minimise shocks
- In reality, we know that the visible hand is required, it is just how large it should be
What is the effect on the following variables as a result of lower z:
U, V, Y, j, Q?
- U increases
- V decreases
- Q does not change
- Y falls
- j falls
What is the effect on the following variables as a result of lower e:
U, V, Y, j, Q?
- U increases
- V decreases
- Q does not change (potential decrease)
- Y falls
- j falls
