Chapter 5. A Closed- Economy One-Period Macroeconomic. Model. Copyright 2014 Pearson Education, Inc.

Transcription

1 Chapter 5 A Closed- Economy One-Period Macroeconomic Model Copyright

2 Chapter 5 Topics Introduce the government. Construct closed-economy one-period macroeconomic model, which has: (i) representative consumer; (ii) representative firm; (iii) government. Economic efficiency and Pareto optimality. Experiments: Increases in government spending and total factor productivity. Consider a distorting tax on wage income and study the Laffer curve. Public goods: How large should the government be? 1-2

3 Closed-Economy One-Period Macro Model Representative Consumer Representative Firm Competitive Equilibrium Experiments: What does the model tell us are the effects of changes in government spending and in total factor productivity? 1-3

4 Figure 5.1 A Model Takes Exogenous Variables and Determines Endogenous Variables 1-4

5 Competitive Equilibrium Representative consumer optimizes given market prices. Representative firm optimizes given market prices. The labor market clears. The government budget constraint is satisfied, or G = T. 1-5

6 Income-Expenditure Identity In a competitive equilibrium, the income-expenditure identity is satisfied, so Y = C+ G v 1-6

7 The Production Function 1-7

8 Figure 5.2 The Production Function and the Production Possibilities Frontier 1-8

9 Figure 5.3 Competitive Equilibrium 1-9

10 Key Properties of a Competitive Equilibrium 1-10

11 Figure 5.4 Pareto Optimality 1-11

12 Key Properties of a Pareto Optimum In this model, the competitive equilibrium and the Pareto optimum are identical. We know this as, at the Pareto optimum, MRS = l, C = MRTl, C MP N 1-12

13 First and Second Welfare Theorems These theorems apply to any macroeconomic model. First Welfare Theorem: Under certain conditions, a competitive equilibrium is Pareto optimal. Second Welfare Theorem: Under certain conditions, a Pareto optimum is a competitive equilibrium. 1-13

14 Figure 5.5 Using the Second Welfare Theorem to Determine a Competitive Equilibrium 1-14

15 Effects of an Increase in G Essentially a pure income effect C decreases, l decreases, Y increases, w falls 1-15

16 Figure 5.6 Equilibrium Effects of an Increase in Government Spending 1-16

17 World War II Increase in G Very large increase in G. Y increases, C decreases by a small amount. 1-17

18 Figure 5.7 GDP, Consumption, and Government Expenditures 1-18

19 Effects of an Increase in z (or an increase in K) PPF shifts out, and becomes steeper income and substitution effects are involved. C increases, l may increase or decrease, Y increases, w increases. 1-19

20 Figure 5.8 Increase in Total Factor Productivity 1-20

21 Figure 5.9 Competitive Equilibrium Effects of an Increase in Total Factor Productivity 1-21

22 Figure 5.10 Income and Substitution Effects of an Increase in Total Factor Productivity 1-22

23 Figure 5.11 Deviations from Trend in GDP and the Solow Residual 1-23

24 Figure 5.12 The Relative Price of Energy 1-24

25 Figure 5.13 Government Expenditures as a Percentage of GDP 1-25

26 Figure 5.14 Total Government Outlays as a Percentage of GDP 1-26

27 A Simplifed Model with a Proportional Income Tax Use the model to study the incentive effects of the income tax, and to derive the Laffer curve. 1-27

28 Production Function Without Capital Labor is the only input, but there is still constant returns to scale (linear production function). Y = zn 1-28

29 Production Possibilities Frontier C = z( h l) G 1-29

30 Consumer s Budget Constraint 1-30

31 Profits for the Firm 1-31

32 The Consumer s Budget Constraint in Equilibrium 1-32

33 Figure 5.15 The Production Possibilities Frontier in the Simplified Model 1-33

34 Revenue for the Government Given the Tax Rate t REV = tz[ h l( t)] 1-34

35 Figure 5.16 The Labor Demand Curve in the Simplified Model 1-35

36 Figure 5.17 Competitive Equilibrium in the Simplified Model with a Proportional Tax on Labor Income 1-36

37 Figure 5.18 A Laffer Curve 1-37

38 A Model of Public Goods: How Large Should the Government Be? To this point, we have assumed that government spending is to acquire goods that are thrown away. Economically, defense spending works like this defense may make us better off, but it diverts resources from other uses. What if we allow for public goods e.g. parks, public transportation, health services that provide direct benefits to the private sector. 1-38

39 A Model of Public Goods Representative consumer s budget constraint: C+ T = Y Production possibilities frontier: C G = Y q 1-39

40 The Optimal Choice of Government Spending The government chooses G to make the representative consumer as well off as possible. G chosen so that the marginal rate of substitution of private for public goods equals the marginal rate of transformation. 1-40

41 Figure 5.19 There Can Be Two Competitive Equilibria 1-41

42 Figure 5.20 The Optimal Choice of Government Spending 1-42

43 What Happens to the Optimal Choice of G when Y increases? This works like a pure income effect. Private consumption and government spending both increase. Wealthier countries choose to have larger governments but not clear whether G/Y increases or decreases. Is G a luxury good or an inferior good? 1-43

44 Figure 5.21 The Effects of an Increase in GDP 1-44

45 Figure 5.22 The Effects of an Increase in Government Efficiency 1-45

46 What Happens if the Government Becomes More Efficient? q increases can produce more G for a given input of private goods. Income and substitution effects. G increases, but private consumption may increase or decrease. 1-46