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ECON 304 MT#1
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Gravity
Key Concepts:
Terms in this set (28)
(Two Period Consumption Model)
Saver vs Borrower
Saver : (Y>C)
-cares most about FV of present resources
Borrower: (C>Y)
-cares most about PV of future resources
(Two Period Consumption Model)
Perfectly Smoothing Formula
C* = [(1+r)(y+a)+yf+af] / (2+r)
(Two Period Consumption Model)
NL/NB
(y+a, yf+af)
(Two Period Consumption Model)
Slope
-(1 + r)
(Two Period Consumption Model)
FV vs PV
FV: (1+r)(y+a)
PV: (yf+af)/(1+r)
(Two Period Consumption Model)
Pcc
Price of Current Consumption
(1+r)/1
(Two Period Consumption Model)
When drawing savings function... S=?
S = Y-C
(Two Period Consumption Model)
Formula for preference to consumer twice as much today relative to next period
C* = Cf = [(1+r)(y+a)+yf+af] / (3+2r)
and C = 2Cf
(Two Period Consumption Model)
When r RISES....vs FALLS
r rises - SAVER is better off
r falls - BORROWER is better off
(r*) fisher equation
i = r + π
i = neutral federal funds rate
r = natural REAL rate of interest
π = inflation target (always 2%)
(r*) Why has neutural rates gone DOWN?
1) an increase in Savings due to baby boomers aging close to retirement
2) a fall in productivity growth has lowered the investment opportunities in the US
Then, compare the r* and show how it's gone down.
(UC, MPK) UC equation
[(r+d) (1-ITC) x Pk] / (1-tao)
(UC, MPK) UC has..
same units as Pk
(UC, MPK) Profit-max condition
UC = MPk
(UC, MPK) Intuition to why changed behavior?
1) holding K constant at ___, UC ≠ MPK
2-1) UC < MPK, so BUY n units(of K), and MPK goes down by (slope x n) to reach the equilibrium
2-2) UC > MPK, so SELL n units, and MPK goes up by (slope x n) to reach the equilibrium
(UC, MPK) In the graph, the line is...
MPK [A, AS] and MPK [A', AS']
(UC, MPK) Given the shocks, what would they have to do to the real rate of interest (r) to achieve their objective?
1) Use K from previous part that it asks for
2) Get MPK, and set UC equation equal to that MPK
3) solve for r
(UC, MPK) draw a desired investment diagram
X axis - I / Y axis - r
(r*) Why is the fall of neutral real rate of interest such a big deal?
1) The Fed LOWERED the federal funds rate by an average of 5.97 % to fight the most previous 3 recessions
2) if the neutral funds rate stays at 3%, the fed will not have enough ammunition (bullets = 3%) to fight the next recession, this is a BIG DEAL!
(r*) 'Two percent is not enough' refers to...
the inflation target of two percent not being enough.
(UC, MPK) if K goes up.... I
goes up too
(Labor Market) Two diagram's axis
PF - X: N / Y: Y (PF [A= , K= ])
Labor Market - X:N / Y: W (Supply (Ns(a)) and Demand(Nd[A= , K= ])
(S=I) Solve for desired savings funtion
S = Y-C-G
(S=I) Solve for goods market clearing interest rate
1) Set savings function (S) equal to desired investment (I)
S=I
2) Solve for r, and then S or I
(S=I) Explain the movement to new equilibrium
1) @ originial r, compare new S and new I
2) compare Y and C+I+C (absorption)
3) if Y > absorption -> r must FALL to increase C and I to get back to equilibrium
4) if r goes from 0.05 to 0.02 -> when r falls by 0.03, C rises by 18 (-600 x -0.03 = 18), and I rises by 12 (-400 x -0.03) back to equilibrium where Y=C+I+G or S=I
(S=I) Are your results consistent with the conditions in the US economy since President Trump's election in November of 2016? Why or why not?
Trump -
1) Consumption : Shock to Consumption is POSITIVE - higher Wealth and CC
2) Investment: Shock to Investment is POSITIVE - lower tao and higher AS.
COMPARE FUNCTIONS when deciding + or -
(S=I) Name reasons why Investment function would go DOWN
1) tao 2) ITC ↓ 3) Pk ↑ 4) A↓ 5) AS ↓
(S=I) Name reasons why Consumption function would go UP
1) a ↑ 2) af ↑ 3) CC ↑ 4) yf ↑
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