ECO 317 Intermediate Macroeconomics

1. ECO 317Intermediate Macroeconomics

2. Instructor • Jing Li (sounds like Lee) • 7-year experience of teaching at US colleges • Second year at MU • Married with two kids • Teaching eco 311 as well

3. Expectation • Hard-working is expected • Cramming for exam does not work • Memorizing does not work • Understanding is the key • If you need A or B, earn it!

4. Required Textbook

5. Webpage • http://www.fsb.muohio.edu/lij14/ • I use Nihhka only when I need to send group email and post grade • Google “jing li miami university”

6. Grades • Six homeworks, 10 points • Term paper, 10 points • Three midterm exams, 60 points • Final exam, 20 points • (bonus) Attendance, worth 3 points • None of the exam is accumulative

7. Hot Issues • National Debt • Income gap: 1% vs. 99% • Globalization • 2007-2009 Recession

8. Review • Labor (input) L is used to produce output Y • Production is captured by production function • Marginal product of labor (MPL) is the extraoutput that can be produced by using one more unit of labor • Q: What is the sign of MPL? • Q: What happens to MPL as L rises?

9. Two Properties of MPL • >0, so total product rises when input rises • <0 (decreasing or diminishing marginal product). The extra labor becomes less and less productive. • Graphically, the production function (total product curve) is upward sloping, and becomes flatter and flatter. • Q: how does the marginal product curve looks like?

10. Profit Maximizing • Profit = revenue – cost = . We assume competitive market. • Profit rises when marginal revenue is greater than marginal cost, and decreases otherwise • Profit is maximized when marginal revenue = marginal cost • Mathematically, the first order condition is

12. Summary • Output does not grow if input and technology remain constant • Wage is determined by the marginal product.

13. Discuss • What is the long run prospect of Japanese economy, where both population and technology stagnate? • Why does a doctor earn much more than a plumber?

15. Cobb-Douglas Production Function • Constant return to scale • Constant factor share in income • Marginal product is proportional to average product

16. Calculus • Multivariate function • Partial derivatives , Example: ,

17. Why Cobb-Douglas Function? • It can explain the following two facts • The shares of capital and labor incomes are constant • Real wage grows at the same rate as average product

19. The Demand Side • The supply side is captured by production function • We need to specify the demand side in order to find equilibrium • Demand = consumption + government expenditure + investment

20. Aggregate Demand • Consumption: , which is fixed • Investment: which varies as the real interest rate changes • Government expenditure: , which is fixed

21. Equilibrium • Equilibrium: supply = demand • Mathematically • We can solve this equation for , and obtain the equilibrium real interest rate • In short, real interest rate adjusts to equilibrate the market

22. Another Perspective • Alternatively, we can study the equilibrium for loanable funds market • At equilibrium, the supply and demand of funds are equal: Note the supply of fund is fixed

24. Application • Why was interest rate high in early 1980? • Why was interest rate high in early 1990?

27. Crowding Out • Chapter 3 implies that expanding government expenditure will completely crowd out investment • Fiscal policy is ineffective • How about monetary policy?

28. MVPY

29. Monetarism • In long run, price is mainly affected by money supply • Inflation rate equals growth rate of money supply if assuming fixed income and constant velocity • What if those two assumptions fails?

31. Hyper-Inflation (to get Seigniorage)

32. Quantitative Easing (as a Policy Tool) • http://www.youtube.com/watch?v=PTUY16CkS-k • http://en.wikipedia.org/wiki/Quantitative_easing

33. Classical Dichotomy • According to the long run classical theory, money is neutral (monetary neutrality): the money supply does not affect real variables • The theoretical separation of real and nominal variables is called classical dichotomy • Real variables are studied in Chapter 3 • Price is determined in Chapter 4 • They jointly determine nominal variables

34. Fisher EquationApplication of Classical Dichotomy So nominal interest rate is the sum of real interest rate and inflation rate . is determined in chapter 3, (Figure 3-8) is determined in chapter 4, (MV=PY)

35. Proof • You have two options: saving a good and earns real interest; or saving money and earn nominal interest. • There is no arbitrage at equilibrium: Fisher equation follows assuming

37. How to Forecast Nominal Interest Rate in Long Run? • First determine the real interest rate • Then determine the inflation rate • Finally use Fisher Equation: • Nominal interest rate matters because it is a key variable in Financial and Housing markets

38. A Short Run Theory • Consider the equilibrium in money market • Money supply = , a vertical line • Money (liquidity) demand = , a downward sloping line • At equilibrium

39. Discuss Dear Professor Li, I am in your 317 class and had a question regarding interest rates. Prior to class today I was reading an article that stated that a main reason why our economy has not felt the same effects of having a 70% debt to GDP ratio is that we have lower interest rates compared to European countries who have similar debt-GDP ratios(but these countries have higher interest rates). If our economies are similar in terms of this ratio, how come we have such a lower interest rate in comparison to a country such as Spain?  Also, thanks for an enjoyable class today. Stephen H.

40. Answer • US real interest rate is low because high (foreign) supply of loanable fund. Spain is opposite • US nominal interest rate is low because of quantitative easing

41. Review • Nominal vs Real

42. Classical Dichotomy • Money does not affect real variables • Real variables are determined in Chapter 3 • Price is determined in Chapter 4

43. Review • Long Run vs Short Run