EPPE6024: Macroeconomics Lecture 2: Aggregate Demand (AD), Aggregate Supply (AS), and Business Cycle

Transcription

1 EE6024: Macroeconomcs Lecture 2: Aggregate Demand (AD), Aggregate Suppl (AS), and Busness Ccle The Goods Market: the IS curve IS curve shows the combnaton of the nterest rates and output level at whch there s equlbrum n the goods market. For goods market equlbrum, the AD for goods & servces must equal the suppl. Assumptons: Wages (W) and prces () are fxed; the suppl of output wll adjust to an change n AD. AD refers to the planned real expendture on goods and servces. In equlbrum, planned D real expendture must equal to real output, as: D (Goods market equlbrum) AD s made up of planned expendture on consumpton c, nvestment b prvate sector and planned government spendng g., D t, wealth Ir A g c,, (AD) c c 0 c t (Consumpton functon) t t Y, where, 0 c (tax functon) Thus, the consumpton functon s: c c c t 0 Investment s assumed to response negatvel on the real rate of nterest r, and postvel on the expected future proftablt A. Thus, the nvestment functon; I I r, A

2 2 To derve the IS curve, we use the planned expendture equaton as; g ar A t c c D 0 (lanned expendture) B rearrangng the fact that D, and replacng c b the MS, s, the locus equlbrum of combnatons of the nterest rates and output s: g ar A c t c r t c a t c g A c 0 0 g ar A c t c s 0 Fgure 2. : Dervng the IS curve

3 Multpler rocess To calculate the total change n ncome, we sum up the geometrc seres as shown below; I c I c 2 I c c c c... I I c I... I = multpler X I s Fgure 2.2: Adjustment to goods market equlbrum 3

4 4 The Mone Market: the LM curve LM curve represents the combnatons of the nterest rate and output at whch the mone market s n equlbrum. It s assumed that the central bank controls the mone suppl. L M D,, where 0, 0 L L The demand for mone In lnear functon, the demand fo mone s; v l l L M T D,, l l s asset demand or asset motve for holdng mone, and v T s transactons demand (transacton motve for holdng mone). Mone market equlbrum: M M S D Mone demand = mone suppl B assumng S M s to be fxed b the Central Bank; the mone market equlbrum s: M L S, Dervng LM Equaton M v l l S T l M l l t S LM Equaton

5 Fgure 2.3: Dervng the LM curve What do the fgures explan? The transactons demand for mone and the role of t The asset (or speculatve) demand for mone and the role of l The role of S M set b the central bank The equlbrum condton n the mone market: L, M S Four was n whch the poston and the slope of the LM curve can be affected A change n the transactons veloct of crculaton A change n the nterest rates senstvt of the asset demand for mone A change n the mone suppl A change n prce level 5

6 Fgure 2.4: Adjustment to mone market equlbrum 6

7 The IS-LM Model Fgure 2.5 : Comparatve Statc n the IS-LM model: sluggsh adjustment n the goods market, and rapd adjustment n the mone market Fscal polc : rse n G Monetar polc : rse n mone suppl 7

8 Fgure 2.6 : The lqudt trap 8

9 Aggregate Suppl In the compettve labour market, wth fxed captal stock (short and medum run), output s a postve functon of the level of emploment as; f E Fgure 2.7: Equlbrum n the compettve labour market 9

10 Suppl Sde n the mperfect competton model () Wage settng (WS) W. b( E) Wage equaton B assumng the actual and expected prce levels are equal, the wage equaton n terms of real wages s; w WS b(e) The excess of w on the WS curve above that on the labour suppl at an level of emploment s the mark-up per worker (n real terms) assocated wth labour market mperfectons. Two common nterpretatons of ths mark-up are: Wage settng b unons Effcenc wage settng b frms Fgure 2.8: The wage settng real wage curve: WS curve and the labour suppl curve 0

11 (2) rce settng (S) Under perfect competton, frms take the market prce (), and set t equal to ther margnal cost (MC) as; MC W ML W ML In contrast, under mperfect competton, frms set prce to maxmze proft. The mark up on margnal cost wll defend on the elastct of demand; Ex: Monopol case roft s maxmzed when margnal revenue (MR) s equal to margnal cost (MC). If elastct of demand s constant, then there s a constant mark-up greater than one of. Thus we have the standard monopol prcng as: W ML And the prce settng real wage s; W ML

12 Fgure 2.9: Relatonshp between the ML, the prce elastct of demand, and the S curve Three addtonal assumptons: If ML s constant (equal to the average product), and the mark-up s constant, the S real wage = to a constant fracton of labour productvt. If the ML declnes but the mark-up s counter cclcal (.e: the mark-up shrnks as emploment rses), then S curve wll flatten. If frms set ther prces usng rule of thumb, basng ther prce on ther average costs over BC, the S would also flatten. The assumptons of Baselne Case: A Flat S curve A constant M and a constant mark-up Gven these assumptons, s frms set prces to delver a specfc proft margn, then the fxed amount of output per worker s splt nto two parts: profts per worker and wages per worker. Then, S can be summarzed as the markng up of labour costs b fxed percentage ( ˆ ) as: ˆ W (Mark-up prcng rule) Where, unt labour cost ˆ are the cost of labour per unt of output (W X E dvded b ). w/e s output per worker, and s labour productvt. 2

13 t If t W t, then the prcng equaton s: Dvdng both sde b and rearrangng; W p Output per head = real proft per head + real W per head Gven mark up, the level of productvt, and mone wage, the prce level set b frms mples a specfc value of the real wage. Thus, the prce settng real wage s: w S W Fgure 2.0: The prce-settng real wage : S curve 3

14 Fgure 2.: Equlbrum emploment and unemploment Equlbrum n the labour market under mperfect competton The labour market s n equlbrum where the curves cross as: WS w b w S E 4

15 Fgure 2.2: Concept of unemploment 5

16 Aggregate demand (AD) and aggregate suppl (AS) AD: from the IS/LM dagram to the AD curve Fgure 2.3: Dervng the AD curve 6

17 AS: from labour market dagram to the AS curve Fgure 2.4: The AD and AS curve 7

18 Real Busness Ccle model: suppl shocks Fgure 2.5: The Real Busness Ccle (RBC) model: equlbrum fluctuatons due to the technolog shocks 8

19 The Dervaton of IS/LM Model 9