Economics 122a Fall Agenda for this week: 1. The classical macro model (Chap 3) 2. How economists measure output/income (Chap 2)

Transcription

1 Economics 122a Fall 2011 Agenda for this week: 1. The classical macro model (Chap 3) 2. How economists measure output/income (Chap 2) 1 The great chasm of macroeconomics This is our topic for today: classical approach Classical macro: - perfect markets -rational individuals - flexible wages and prices - full employment Keynesian macro: -imperfect competition -bounded rationality - sticky wages and prices - unemployment 2 1

2 Basics of Static Classical Model: Production Theory 3 Classical production model. The basic model is simplest representation of the classical approach. When dynamized, it becomes the neoclassical growth model. Factor markets: capital and labor inputs (K and L) One sector for output (Y). Aggregate production function (for real GDP, Y) What is a production function? Recipe for combining inputs into outputs for given technology. (1) Y = F( K, L) Standard assumptions: positive marginal product (PMP), diminishing returns (DR), constant returns to scale (CRTS): CRTS: my = F( mk, ml) PMP: Y/ K>0; Y/ L>0 DR: 2 Y/ K 2 <0; 2 Y/ L 2 <0 Basics of Static Classical Model: Production Theory Classical production model. The basic model is simplest representation of the classical approach. When dynamized, it becomes the neoclassical growth model. Factor markets: capital and labor inputs (K and L) One sector for output (Y). Aggregate production function (for real GDP, Y) (1) Y = F( K, L) Standard assumptions: positive marginal product (PMP), diminishing returns (DR), constant returns to scale (CRTS): CRTS: my = F( mk, ml) PMP: Y/ K>0; Y/ L>0 DR: 2 Y/ K 2 <0; 2 Y/ L 2 <0 4 2

3 Production function for popovers Courtesy of Florence Kling Harding, Twentieth Century Cookbook, Potential Output Potential output. With exogenous labor force (LF), inherited capital (K), unemployment at the NAIRU (u*), this gives potential output (Y p ): (2) Y p = F[K, (1-u*)LF] Potential output critical for unemployment theory and growth theory and for medium and long-run forecasts. u* = Mankiw natural rate of unemployment = non-accelerating inflation rate of unemployment (NAIRU) = unemployment rate at which inflation neither rises or falls = lowest sustainable rate of unemployment = around 5-6 percent today 6 3

4 Real GDP over the cycle 15,000 14,500 Potential (full employment) real GDP Actual real GDP 14,000 Large GDP gap 13,500 13,000 12,500 12, Example: Cobb-Douglas production function Very important production function: Cobb-Douglas (log linear) F( K, L) = AK α L 1-α Properties: = [AK α L 1-α α ]/ L=(1-α)AK α L 1-α α /L = (1-α)Y/L = (1-α) x APL (and similarly for MPK) 8 F( K, L) = 1.5 L L Y (discrete) (continuous/ derivative) na Y, Y Labor inputs (L) 4

5 Factor Markets Factor markets: capital and labor inputs (K and L): - Capital inherited from past investments - Labor inputs exogenous (from biology, health, customs, pharma) Real wage rate: = W/P = = Y/ L = [F( K, L)]/ L (see Fig. 1) Real rental rate on capital (like apartment rental as $ per month): = R/P = MPK = Y/ K = [F( K, L)]/ K National income = labor income + capital income = WL + RK Exhaustion of product theorem: With CRTS and competitive pricing, paying factors their marginal product leads income = output. 9 Distribution with the Cobb-Douglas production function National income Y = x L + MPK x K = L[(1-α)Y/L] +K[αY/K ] = Y (exhaustion of product theorem) Shares of capital and labor: share of K = RK/Y = (αy/k ) x (K/Y) = constant = α Why do economists like Cobb-Douglas? See next slide. 10 5

6 Near-constancy of labor s share of national income Applications of static neoclassical model Impact of immigration (today) Impact of foreign investment : Assume that foreign firms build a factory in US. What is effect in simple neoclassical model? Answer: Same as immigration, but reverse the factors. Impact of government debt (later in course): What is the effect of a growing government debt? Slightly more complicated, but might crowd out capital stock. This then reduces output. Note effects on wages and rentals. 12 6

7 What are the macroeconomic effects of immigration? Alfred Stieglitz 13 W/P Real wages and : graphics (W/P)* 14 L* L 7

8 W/P L* Output = sum of the slices of from 0 to L* 15 L* L Calculus of marginal and total product Total product = sum of marginal products up to input level. L* L* Y = F( K, L*) = ( L) dl = [ F( K, L)/ L] dl

9 W/P Neoclassical distribution of output/income (W/P)* Capital income* *More generally, all non-labor income Can reverse axes and get analogous results for capital. Total wages 17 L* L W/P Effect of immigration Assume immigrants are perfect substitutes for L Results: 1. Wage rate falls. 2. Output and national (W/P) 1 E 1 income rise. 3. Capital income rises. 4. More generally, income of substitutes fall and complements rise. 5. Empirical studies suggest that low-skilled and Hispanic workers are hurt (W/P) 2 E 2 by Mexican immigration. i i 18 L* L 9

10 National Academy of Sciences study (The New Americans) Immigration over the 1980s increased the labor supply of all workers by about 4 percent. On the basis of evidence from the literature on labor demand, this increase could have reduced the wages of all competing native-born workers by about 1 or 2 percent. Meanwhile, noncompeting native-born workers would have seen their wages increase Based on previous estimates of responses of wages to changes in supply, the supply increase due to immigration lowered the wages of high school dropouts by about 5 percent 19 Just what is this Y? Just how do we measure GDP and real GDP? 20 10

11 A puzzler Assume there are two goods (computers and shoes) Period 1 P Shoes = P computers = $1 Q shoes = Q computers = 1 Period 2 P shoes = 1; P computers = $0.01 Q shoes = 1; Q computers = 100 What is the growth of GDP from period 1 to period 2? 21 11