EC:250 Intermediate Macroeconomics!

1. EC:250Intermediate Macroeconomics! By: David Cade and Luke Sinclair

2. Today’s Schedule • Cover each chapter in detail • We will have examples after each concept so don’t worry if you don’t get it right away • Questions • Go over some more in-depth, comprehensive questions • Exam study tips • Additional resources

3. [Chapter 6: Unemployment]

4. [Definitions and Ratio’s] • Definitions: • Employed: Paid full time or part time employment • Unemployed: Available to work and has actively looked for work in the last 4 weeks • Not in the Labour Force: Not employed and under 15 years of age or has not looked for work in the past 4 weeks • Ratios • Employment = [E] • Unemployment = [U] • Labour Force = [L] = ([E] + [U]) • Unemployment Rate = [U] / [L] • Labour Force Participation Rate = [L] / population above 15

5. [Trends and Natural U] • Employment Trends • Women entering the workforce • 1950’s-1990’s steady increase in employment • 2000-2005 unemployment back to lower levels • Natural Unemployment: [u*] is the average level of unemployment over a given time (usually 20+ years) • s fraction of employed [E] people who become unemployed in a given month • ffraction of unemployed [U] people who become employed in a given month • Formula: [u*] = s / (s+f)

6. Example • Determine the Natural U if: • 0.3% of employed individuals become fired each month • 5% of unemployed people find work every month 0.003 = 0.0566 or 5.7% 0.003+0.05

7. [Frictional Unemployment] • Frictional Unemployment: Unemployment caused by the time it takes workers to find a job • Comes from • Sector shifts • Technology change • Business failures • Individual factors • Fired / Quit • Geographic Mobility • Why it lasts • Imperfect job information (job searching takes time) • Geographic immobility (most workers cannot just pack up and move) • Policies that affect frictional unemployment • Employment Insurance raises the rate of frictional unemployment • Employment agencies can aid unemployed • Retraining programs encourage companies to retrain rather than lay off “In between jobs”

8. [Structural Unemployment] • Structural Unemployment: Unemployment due to a mismatch between demand and supply of labour • This is caused by real wage rigidity and job rationing • Real wage rigidity: Failure of wages to adjust so that labour demand = labour supply • If wages are too high compared to demand Job rationing Real Wage Labour Supply Rigid Real Wage Structural Unemployment Employment Equilibrium Wage Labour Demand

9. [Reasons for Wage Rigidity] • Minimum wage laws • Raise the real wage above the market equilibrium • Refundable tax credits: Better way to increase incomes for the poor (as this does not affect labour costs) • Unions • Raises wages above equilibrium through collective bargaining • Raises wages at non-unionized firms • Efficiency Wages • Higher wages = more productive workers Real Wage Labour Supply Minimum Wage Unemployment Minimum wages raise the real wage above equilibrium and create unemployment Employment Equilibrium Wage Labour Demand

10. [Employment Explained] • Incidence of unemployment: The chance that a worker will become unemployed (increase in unemployment is 1/3 a result of an increase in incidence)** • Duration of unemployment: Average spell of unemployment (increase in unemployment is 2/3 a result of an increase in duration) • Upward shift in unemployment from 1950’s-1990’s: • Changing Composition: More young workers / women • Faster Sectoral Shifts: Increased pace of technological change • Skill Based Technical Change: Led to lower employment rather than lower wages

11. Chapter 7: Economic Growth

12. The Growth of GDP • In chapter 3 K and L are fixed and thus determined the level of real GDP  Y = F(K,L) • In reality: • K increases with capital accumulation • L grows due to population growth • If there are constant returns to scale (z), calculating Growth is simply  zY = F(zK,zL) • If both K and L grow by 5%, Y will grow by 5% • What if they grow by different percentages though?

13. The Growth Accounting Eq’n • The Growth Accounting Equation • α is the elasticity of Y with respect to an increase in K • 1-α is the elasticity of Y with respect to an increase in L • This equation makes no sense. Explain! • The growth rate of output can’t be more than the growth rate of either K or L as it is a function of the two • Its growth needs to be a balance of the two L K

14. Growth Accounting: Example • Let’s take Canada: • We have lots of really old people leaving the workforce • Growth rate of labour is low: 0.5% • Elasticity in Canada is low: 1/3 • On the other hand we have a lot of capital accumulation • Growth rate of capital is strong: 6% • What is the growth rate of output (Y)? • %∆Y = (1/3)*0.06 + (2/3)*0.005 • = 0.02 + 0.0033 • = 2.33%

15. Useful Metrics • Growth Per Capita (y) • Determined (intuitively) by dividing output (Y) by the number of units of labour (L) • y = Y/L • Increases when your output is growing faster than your labour force • It means your labour is getting more efficient, not just more numerous • ∆y = ∆Y/Y - ∆L/L • Capital Per Worker (k) • Same deal: k = K/L • Technological Progress (A) • An index of the productivity of capital and labour represented by A • Growth rate of A or ∆A/A is the rate of technological progress • So Growth accounting equation becomes: • ∆Y/Y = ∆A/A + α*∆K/K + (1- α)*∆L/L • Single most important source of Canadian growth in Y and y

16. Solow Growth Model • This model shows how the long-run equilibrium growth is determined by three factors: • The rate of savings • The rate of population growth • The rate of technological progress • Start Simple: No population growth or technology • We assume constant returns to scale • zY = F(zK, zL) • Because of this output per worker is a function of only capital per worker • Why…? We can now substitute z for 1/L to find y • Y/L = F(K/L,L/L)  y = F(k, 1)  y = f(k) • This is called the per capita production function • y = f(k)

17. Solow: No pop. Or tech. • y=f(k) • It has a positive slope but diminishing returns • If you invest more capital into better equipment you are going to get a better return but this is not constant • The slope = marginal product of capital (MPK) y (output per worker) k (capital investment per worker) f(k): per capita production function MPK

18. Solow: No pop. Or tech. • Investment per worker (i) • Need investment in order to get capital accumulation • Determined solely by the savings (s) per worker • i = sy i = sf(k) • Once again, diminishing returns y f(k) k ∂k sf(k) • Depreciation (∂) wears machinery down  ∂k

19. Solow: No pop. Or tech. • Steady-State (k*) • As worker investment growth increases, output per capita increases • However, depreciation also increases because there is more depreciable capital • This lowers capital per worker • So: ∆k = sf(k) - ∂k • When worker investment is equal to the rate of depreciation (∆k=0) this is called the “steady-state” level of capital stock per worker • It is denoted by k*

20. Solow: No pop. Or tech. • The actual level of capital per worker will always increase or decrease to equal to the steady state in the long run • If the rate of investment is greater than the depreciation then k will continue to increase but by diminishing returns • This increase in k will result in an increase to the amount that is depreciated until sf(k)=∂k and k = k* y k* f(k) ∂k k sf(k)

21. Example 1 • We start with a basic economy at steady-state equilibrium y s1f(k) k1 f(k) ∂k k

22. Example 1 • Suppose savings rate increases from s1 to s2 • s2f(k1) > ∂k1 y s1f(k) k1 f(k) ∂k k s2f(k)

23. Example 1 cont. • Suppose savings rate increases from s1 to s2 • s2f(k1) > ∂k1 • The rate of investment is greater than the rate of depreciation so capital stock is increasing faster than it is depreciating. • k increases • As k increases, more is being depreciated • Eventually k increases to the point where the rate of depreciation and the rate of savings are equal (k2) y s1f(k) k1 k2 f(k) ∂k k s2f(k)

24. The Golden Rule • Based on the previous example, we see that for every level of savings there is a steady state that will result over time • Is there a steady state that is better than the others? • There is and it is called the Golden Rule level of capital • Denoted by k*gold Pictured: Wrong Golden Rule

25. The Golden Rule • The Golden Rule level of capital is not determined by output or capital, we care about buying more stuff! • So we look at maximizing consumption per capita (c): • Consumption per capita at the steady state (c*) is equal to the the vertical distance between the per capita production function and the depreciation line • In other words, c* = f(k*) - ∂k* y f(k) k ∂k c* sf(k)

26. The Golden Rule • We want to maximize c* • c* is greatest where the slope of the per capita production (MPK) function equals the slope of the depreciation line • In order to increase consumption per capita, the economy should increase or decrease the savings rate y slope f(k) k ∂k c*gold k*gold

27. Example • We want to maximize c* • c* is greatest where the slope of the per capita production (MPK) function equals the slope of the depreciation line • We are not at the Golden Rule level of k*. What do we do? y f(k) k ∂k k*

28. The Golden Rule • Increase the level of savings! • The economy increases the savings rate • This will result in less per capita consumption (y) in the short term • But greater per capita consumption in the long term y f(k) k ∂k k* k*gold

29. Solow: Adding Population • We now assume that population and labour force grow at a constant annual rate (n) • Now, if k is to increase it needs to outpace both the depreciation, and also the growth in the number of workers • Need to equip more workers • So we add the growth rate to the depreciation line y f(k) (∂ + n)k k As before, the steady state is where the change in k is 0. So, where: (∂ + n)k – sf(k) = 0 sf(k)

30. Example • Start off in steady state of an economy with population growth • Suppose the rate of population growth decreases • So n↓ changing the slope • No longer in steady state • Rate of saving is greater than depreciation and population growth rates y y y1 k*1 f(k) f(k) (∂ + n1)k (∂ + n1)k k k (∂ + n2)k sf(k) sf(k) y2 y1 k*1

31. Example • k* increases in the longterm • Output per worker (y) increases as well y y (∂ + n2)k k*1 k*2 f(k) f(k) (∂ + n1)k (∂ + n1)k k k (∂ + n2)k sf(k) sf(k) y2 y1 k*1 k*2

32. Chapter 8: Econ. Growth II

33. Solow: Adding Technology • The result: • Labour input is improved by increases to the efficiency of workers • So we now measure Labour in terms of “effective workers” • Equal to the number of workers (L) multiplied by worker efficiency (E) • Y = F(K, L*E) • E grows at a constant annual rate (g) • If we include the rate that the population increases (n) then we can say that the effective number of workers (L*E) is growing at a rate of n+g We have the technology!

34. Solow: Adding Technology • Now when we look at per capita production, we are looking at production per effective worker • y = Y/L*E and k = K/L*E • Steady State with technological progress • ∆k = sf(k) – (∂+n+g)k = 0 • So NOW we need enough savings to meet: • The depreciation in capital • The cost of equipping new workers • AND the cost of equipping the new effectiveness of workers that is being created by technological progress

35. Solow: Adding Technology • Here is what the graph looks like now y f(k) (∂ + n + g)k k sf(k)

36. Empirical Growth Studies • Prediction of balanced growth • Solow predicts that total output will grow at the same rate as the total capital stock and output per actual worker • Prediction of convergence • Similar economies that start at different levels of capital accumulation will converge in the long run. Dissimilar economies will exhibit conditional convergence where they converge on their own steady states.

37. Policies to Promote Growth • Increase the Canadian Saving Rate • Run a budget surplus • Raise private savings • Reduce investment taxes • Emphasize sales tax instead of income tax • Tax-free savings initiatives • Promoting Investment • Eg. Investment tax credits, R&D credits • Policies on allocating investment • Government can invest in forms of capital with positive externalities (social return) • Eg. Infrastructure, human capital etc. • Policies to encourage technological progress

38. [Chapter 9: Intro to Economic Fluctuations] Cycle of economic stock fluctuations

39. [Intro to Short Run and Long Run] • Short Run • Prices and/or wages are sticky • Business Cycle significant part of short run economics • The business cycle is unpredictable (expansion followed by recession) • Long Run • Prices are fully flexible • Assume full employment of labour and capital

40. [Long Run AD-AS Model] • Aggregate Demand Curve [AD Curve] • The AD curve shows how [Y] (quantity of output) varies with [P] (price level) for given values of [M] (money supply) and [V] (velocity) P Aggregate Demand Curve Y

41. [Complete Long Run AD-AS Model] LR Impact of a Increase in M P LRAS P1 Y P0

42. [Short Run AD-AS Model] • Aggregate Supply Curve [AS Curve] • The AS Curve shows how [y] (supply of output) varies with [P] (price level) in the short run P Aggregate Supply Curve Y SRAS

43. [Complete AD-AS Model] SR Impact of a Increase in M P SRAS Y y0 y1

44. [Summary of a Demand Shock] • M or V • SR • Y P • LR • Y P • M or V • SR • Y P • LR • Y P IN THE LR MONEY OR VELOCITY HAVE NO IMPACT

45. [Chapter 10 Aggregate Demand I: Building the IS-LM Model]

46. [Planned Expenditure Curve] • Assumptions based on Keynesian-Cross Model: • E = C + I + G • C = MPC(Y-T) • I = I G = G T= T E E0 Y C0 Planned Expenditure Curve y0 What is the slope of the PE Curve???

47. [Equilibrium of the Economy] • Output adjusts so that Y = E • If E-Y < 0 Output will decrease • If E-Y > 0 Output will increase E EE Y 45◦ yE

48. [Equilibrium Example] • A decrease in G • Unplanned inventory buildup • Firms produce less E E0 Y E1 45◦ Y1 Y0

49. [Government Purchases Multiplier] • Definition: The amount by which equilibrium Y changes following a one unit change in G: • Example: • MPC = 0.75 • Purchase Multiplier Thus a $1.00 decrease in government spending will reduce equilibrium Y by $4.00

50. [Tax Multiplier] • Definition: The amount by which equilibrium Y changes following a one unity change in T: • Example: • MPC = 0.75 • Purchase Multiplier Thus a $1.00 increase in taxes will reduce equilibrium Y by $3.00