1 / 9

Competitive Equilibrium in Two Period Model

Competitive Equilibrium in Two Period Model. Model with Exogenous Income. Exogenous Income. Assume { y 1 ,y 2 } given and no government. A competitive equilibrium is { c 1 *,c 2 * } and interest rate r* satisfying: (i) Utility Maximization (given r ):

liz
Download Presentation

Competitive Equilibrium in Two Period Model

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Competitive Equilibrium in Two Period Model Model with Exogenous Income

  2. Exogenous Income • Assume {y1,y2} given and no government. • A competitive equilibrium is {c1*,c2*} and interest rate r* satisfying: (i) Utility Maximization (given r): (ii) Market Clearing: y1 = c1 and y2 = c2  s = 0

  3. Indifference Map Diagram (i) Draw the indifference curve and locate market-clearing allocation where y1 = c1 and y2 = c2. (ii) Draw the lifetime (BC) tangent to indifference curve. The slope of the (BC) will represent the market clearing interest rate (1+r*)

  4. Goods Market Diagram: (i) Plots y and r (ii) Consumption demand curve * Downward sloping (substitution effect of r) * Income effects shifts curve. (iii) Output supply curve – vertical since y is exogenous.

  5. Effect of Income Shocks (1) Increase in current income (y1)  decreases equilibrium r*  dr*/d y1 < 0 (2) Increase in future income (y2)  increases equilibrium r*  dr*/d y2 > 0 (3) Temporary increase  identical to (1) (4) Permanent increase  combination of (1) and (2)  dr*/d y 0.

  6. Remark: Because the market always clears so c = y in each period, there is no consumption smoothing at the aggregate level. Does the CE conflict with the consumption facts??

  7. A competitive equilibrium (with exogenous income) in a multi (T) period model is (i) a sequence solving the household’s FOC: and lifetime BC: given

  8. (ii) Equilibrium values for rt* solving the market clearing condition st = 0 or: yt = ct

  9. Extensions to the model: (i) Government sector which can finance spending by taxes or borrowing (deficit). (ii) Endogenous leisure-labor tradeoff and output produced by profit maximizing firms. (iii) Productive capital  business cycles. (iv) Money  prices, inflation, monetary policy.

More Related