ECO209 - Macroeconomic Theory and Policy

The Representative Consumer Considers the behaviour of a single consumer who represents the whole economy. Preferences - Consumption Good and Leisure. Utility Function where is utility function, is quantity of consumption, and is quantity of leisure, as a particular consumption bundle. then bundle 1 is strictly preferred. then consumer is indifferent. Three Assumptions More is preferred to less. The consumer likes diversity in the consumption bundle. Consumption and leisure are normal g

Closed Economy – A model of a country that has no interaction with other countries. Model builds economic intuition useful for the open one. 3 Actors Representative Customer Representative Firm The Government. Government Behaviour – It wants to purchase a given quantity of consumption goods, and finances purchases with taxing the consumers. Public Goods – Everyone utilizes these goods and they are provided by the government through taxes. Spending simply involves taking goods from the private s

Preface Labour Market - Frictions complicate the workings of the macroeconomy. Goals - Examine behaviour of unemployment rate, participation rate, and employment/population ratio. Two Models One-sided Search Model - Behaviour of an unemployed person considering job offers Two-Sided Search Model - Incorporating the behaviour of firms The Behaviour of the Unemployment Rate, the Participation Rate, and the Employment/Population Ratio in Canada Important Values N – Working age population Q – Labour

Preface Thomas Malthus An economist whose theory states that improvements in technology for producing goods leads to increased population growth, so in the LR there is no possible improvement for standard of living. Predictions were wrong – the pessimistic predictions were disproved due to the Industrial Revolution, which fostered growth in stock of capital and not limited to fixed factors of production. Solow Model Widely used model of economic growth that predicts the effects of savings rates

Income Disparity Preface Endogenous Growth Model - Shows the importance of skills and education towards economic growth and how economic policy may affect the resources towards their development. Convergence Slow growth model predicts that poor countries will eventually catch up to rich countries to the same level of capital and output per worker. Graphically Rich and Poor Countries and the Steady State – Identical countries have different initial capital stocks per worker and converge to the

Two Period Model Preface Notes Intertemporal decisions - And implications for how government deficits affect macroeconomic activity. Ricardian Equivalence Theorem – Conditions under which the size of the government’s debt is irrelevant as it doesn’t affect important variables nor economic welfare. Real Interest rate – The interest rate at which consumers and the government can borrow and lend. Consumption Smoothing – Natural forces cause consumers to want smooth consumption rather than choppy.

Credit Imperfections Credit Market Frictions Asymmetric Information - Some market participant knows more about their own characteristics than other market participants. Credit Market - Borrower knows more about their own creditworthiness than potential lenders. Friction causes difference between lending interest rates and borrowing lending rates. Loan reflects a default premium → compensates lenders for the fact that some borrowers default on loans due to limited info. Interest Rate Spreads (g

Intertemporal Model Investment is determined by the real interest rate, representing opportunity cost of investment. This model has a representative consumer, representative firm, and a government, simplified with level of supply and demand curves. Consumer → Supplies labour in the labour market and purchases consumption goods in the goods market. Firm → Demands labour in the labour market, supplies goods in the goods market and demands investment goods in the current goods market. Government

International Trade Questions of International Macroeconomics International Trade and the gains from opening up to trade. Sovereign debt and recurrent defaults Flexible vs. fixed exchange rates and capital controls The transmission of macroeconomic shocks among countries. Small Open Economy model is used to analyze current account surplus. Economic agents are price takers. Intertemporal consumption-savings model is used A Two-Period Small Open Economy Economy lasts for 2 periods → current and f

Inflation and banking Friedman Rule Money supply grows at a rate that makes the rate of return on money identical to the rate of return on alternative assets and drives the nominal interest rate to zero. Financial Intermediary Any financial institution that falls under these conditions. It borrows from one group of economic agents and lends to another. The group of economic agents it borrows from is large, and so is the group it lends to. It transforms assets. It processes information. i.e. I