ECO 306 Home Page

1. ECO 306 Home Page http:/www.depaul.edu/~jberdell Select Eco306 ID: macro PW: theory

2. Review W2 topics • 1) production function, diminishing marginal productivity and exponents. • 2) Okun’s Law recap • Level vs growth rate form • Our regression results • Estimates of alpha and beta, confidence intervals • 3) Labor Statistics and the social impact of unemployment. (skipped last time).

3. Production and Distribution

4. Marginal Products MPL Real Wage in Terms of the product MPL, K and A given N equilibrium N The production function together with K and A will yeild total employment and the real wage. Same can be done for capital. Methods we will not investigate can solve for K and N simultaneously.

5. Shares Y

6. Income Shares

7. Natural Logs and Elasticities

8. Income Shares and Elasticities This is a Cobb-Douglas production function. Douglas was a U of C Econ Prof and Senator. Formulated in 1920’s It is Constant Returns to Scale and homothetic. CRS: if N and K double their %change is 100 % change Y= alpha*100+(1-alpha)*100=100

9. Okun’s law How does unemployment vary with output. (level form) How does unemployment vary in response to the Growth rate of output? (growth form) What is the potential growth rate of the economy?

10. Arthur Okun’s Level Law At a moment in time, for every percentage point that the unemployment rate exceeds (is below) the natural rate, real GDP will be 2 percentage Points below (above) the full-employment level of GDP. The level version as an equation: 100( Y - Y)/ Y = 2(u - un), where u is measured in percentage points, i.e., u = 5.5%, not .055. F http://www.amherst.edu/~econ53/Okun.PDF

11. Text on Okun’s Level Law 2.5% GDP gap corresponds to 1% more Ue text forgot the 100

12. Okun’s Growth Rate Law II. The basic idea underlying the growth rate version is that when output grows more slowly than full employment output, unemployment will rise (i.e., the utilization of productive factors will be falling). This version of Okun’s Law is particularly useful for forecasting: For every 2 percentage points that the rate of growth of real GDP exceeds the rate of growth of full-employment GDP over the course of a year, the unemployment rate will fall by one percentage point. The growth rate version as an equation: D%Y = 3 - 2Du http://www.amherst.edu/~econ53/Okun.PDF

13. From Level to Growth Form of Okun’s law (an approximation)

14. Figure 3.16 Okun’s law in the United States: 1954-1998

15. Okun’s law US Data 1974-1995 1974-95: alpha (2.39, 2.86, 3.34) beta (-1.28, -1.84, -1.4) From BEA data

16. Okun’s Law US Data 1980-90 In 1980-90 alpha (2.4, 2.87, 3.32) beta (-2.57, -2.11, -1.7)

17. DeLong on Okun’s Law J. Bradford DeLong, 2000 Macroeconomics.

18. Economagic Okun’s Law 11 data points: to 2001

19. Economagic on Okun’s Law Y = Annual Change in real GDP, Percentage PointsX = Annual Change in Unemployment Rate, Percentage PointsY = 2.8702 - 1.8368*X, (-1.8368 is “Beta”)Std Err = 0.48889 (The most standard method fort value = -3.7572 judging the “significance” of beta is to ask if ‌ beta ‌ > 2*standard error)r = -0.78145R2 = 0.61067Standard deviation of errors = 0.94494Number of observations = 11

20. Krugman: How Fast? Paul Krugman, ‘How Fast Can The US Economy Grow? HBR July/Aug 1997 2.4% Potential Growth Rate

21. Figure 3.15 Change in employment status in a typical month Figure 3.15 Change in employment status in a typical month

23. Social Costs of Ue 1

24. Social Costs of Ue 2

25. US Poverty Rate with Recessions

26. Dismal on Participation Present Cycle Was 2001 on. http://www.economy.com/dismal/pro/article.asp?aid=2715

27. W3A Outline 1 Savings and Investment 1.1) Keynesian vs Classical Approaches 1.2) Classical Consumption: Savings and r 1.3) Investment: MPK and r 2 Recent Issues Wealth Effects and uncertainty effects on consumption

28. ~ For Next Week (W4) Read CH6, A. Smith, Sachs and Warner (It is long skim where needed.), Rodrik and Schleifer

29. W3A part 1 1 Savings and Investment 1.1) Keynesian vs Classical Approaches 1.2) Ch 4 (Classical) Consumption: Savings and r 1.3) Ch4 (Classical) Investment: MPK and r

30. Keynesian S=I via Y adjustment 45o line is Y AE Y AE here just C+Id Y S=Y-C Id Y

31. Classical S=I via r adjustment r S Classical: Y is constant as r adjusts to get S=I S’ Id S, Id

32. Ch4 and Keynesians vs Classical Keynesian: variations in spending (C or I) cause output changes Less spending is more savings: paradox of thrift Savings and investment (in a closed economy) become equal via output changes. Classical: the interest rate changes to set saving equal to Investment (in a closed economy) so output need not change. Output is determined by willingness to work, the capital stock and productivity. Not by spending. Chapter 4 is almost wholly Classical in orientation.

33. Consumption What is the role of: Habit and social positioning? Duesenberry on the short run MPC vs Long Run MPC Inter-temporal Substitution Does the interest rate strongly influence C vs S? Forward looking behavior: Rational vs Irrational Expectations (Key to “Ricardian Equivalence”: households offset government borrowing because they “know” that that borrowing means higher future taxes for them.

34. Figure 4.01b Total consumption expenditures and consumption expenditures on durable goods, first quarter 1987 to fourth quarter 1994 Figure 4.01b Total consumption expenditures

35. Figure 4.01a The index of consumer sentiment, January 1987-December 1994 Figure 4.01a The index of consumer sentiment, January 1987-December 1994

36. From FRED II (SIX MONTH LAG!!! ) http://research.stlouisfed.org/fred2/series/UMCSENT

37. 30 Aug. 2011 Consumer Confidence Indexplummeted in August. The Index now stands at 44.5 (1985=100), down from 59.2 in July. The Present Situation Index decreased to 33.3 from 35.7. The Expectations Index decreased to 51.9 from 74.9 last month. http://tradersnarrative.wordpress.com/2011/02/25/sentiment-overview-week-of-february-25-2011/

38. Consumer Confidence and Consumer Spending Sydney C. Ludvigson The Journal of Economic PerspectivesVol. 18, No. 2 (Spring, 2004), pp. 29-50 Published by: American Economic Association Article Stable URL: http://www.jstor.org/stable/3216889 Modest explanatory power of the sentiment idicies For next quarter’s income and stock market value when added to info on past income, interest rates and stock market value. Only detectable in first month of each quarter, which will become part of the next quarter’s income as announced in Advance or first round NIPA.

39. Figure 4.A.5 Life-cycle consumption, income, and saving

40. Figure 4.A.1 The budget line Figure 4.A.1 The budget line E is the Endowment saving borrowing

41. Optimal Cons Figure 4.A.3 The optimal consumption combination

42. Wealth up, r constant Figure 4.A.4 An increase in income or wealth, r constant More wealth increases consumption and lowers savings

43. Figure 4.A.6 The effect of an increase in the real interest rate on the budget line Figure 4.A.6 The effect of an increase in the real interest rate on the budget line

44. Figure 4.A.7 The substitution effect of an increase in the real interest rate Figure 4.A.7 The substitution effect of an increase in the real interest rate When consumption Is at the endowment We only have a Substitution effect: SAVE MORE!

45. Households are net lenders The household sector has historically been a net lender to firms and the public sector. So the household sector is typically benefited by a Higher real interest rate (lenders gain, borrowers loose). When the real interest rate rises there is a positive income effect as well as a substitution effect for households.

46. Figure 4.A.8 An increase in the real interest rate with both an income effect and a substitution effect Figure 4.A.8 An increase in the real interest rate with both an income effect and a substitution effect If the income effect is too large, Q will be to the right of D and savings falls as r rises.

47. Ambiguity of r on S and C Because the interest rate has both income and substitution effects, the savings line may not have much slope. It could even slope backwards. Since (neo) Classicals look to changes in S in response to r to Equilibrate the economy this is controversial. This chapter always gives it lots of positive slope.

48. Figure 4.06 Goods market equilibrium Figure 4.06 Goods market equilibrium

49. Figure 4.02 Determination of the desired capital stock Figure 4.02 Determination of the desired capital stock

50. Figure 4.03 A decline in the real interest rate raises the desired capital stock Figure 4.03 A decline in the real interest rate raises the desired capital stock