ec4004 lecture18 markets and the macroeconomy

EC4004 Lecture 18Markets & The Macroeconomy

Dr Stephen Kinsella

Today

Recap

Households

Constructing the BC

SULIS Test: Opens Friday 2pmCloses Friday 2pm


Exam: Friday 12 Dec 4pm

PE HALL/GYM


Exam: Friday 12 Dec 4pm

PE HALL/GYM

Extra Lecture Wk 13Thursday 12-1 Concert Hall

086 399 83 06

Labour: L (w)

Capital: K (r)Households

ProductsProfit=

PY-(wL+rK)

ProductsProfit=

PY-(wL+rK)

BondsiB

ProductsProfit=

PY-(wL+rK)

BondsiB

Labourw/P*Ls

ProductsProfit=

PY-(wL+rK)

BondsiB

Labourw/P*Ls

Capitalr/P - δ

Constructing the Budget Constraint


Quantities and prices determined on four markets will determine household income.



Total sources of funds must equal the total uses of funds.



Total sources of funds must equal the total uses of funds.

This equality is the household budget constraint.

Income

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Income

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IncomeProfits

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IncomeProfitsHouseholds earn profit—an excess of revenue over costs—from their business activities.

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•Y= A· F( Kd, Ld )

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•Y= A· F( Kd, Ld ) π = PY − (wLd+ RKd)

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•Y= A· F( Kd, Ld ) π = PY − (wLd+ RKd) π = P A· F( Kd, Ld ) − ( wLd+ RKd)

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Income

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IncomeWage income

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IncomeWage income If households supply the quantity of labour Ls to the labour market, they receive the nominal wage income of wLs per year.

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IncomeWage income If households supply the quantity of labour Ls to the labour market, they receive the nominal wage income of wLs per year. Quantity of labour supplied is the fixed amount L, so nominal wage income is wL.

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Income

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IncomeRental income

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IncomeRental income If households supply the quantity of capital Ks to the rental market they receive the nominal rental income of RKs per year.

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IncomeRental income If households supply the quantity of capital Ks to the rental market they receive the nominal rental income of RKs per year. Since households supply all of their available capital, K, to the rental market, so that Ks = K, the nominal rental income is RK.

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Income

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IncomeRental income

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IncomeRental incomeThe quantity δK of capital disappears each year.

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IncomeRental incomeThe quantity δK of capital disappears each year. The euro value of this lost capital is P· δK.

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• net nominal rental income= nominal rental income− value of depreciation

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• net nominal rental income= nominal rental income− value of depreciation• net nominal rental income = RK − δ P K

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• net nominal rental income= nominal rental income− value of depreciation• net nominal rental income = RK − δ P K• net nominal rental income = (R/ P)·P K − δ P K

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• net nominal rental income= nominal rental income− value of depreciation• net nominal rental income = RK − δ P K• net nominal rental income = (R/ P)·P K − δ P K• net nominal rental income= ( R/ P − δ) · P K

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Income

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IncomeRental income

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IncomeRental income

• rate of return on owning capital= R/ P − δ

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Income

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IncomeInterest Income

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IncomeInterest IncomeIf a household’s nominal bond holdings are B, the flow of nominal interest income received is iB per year.

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IncomeInterest IncomeIf a household’s nominal bond holdings are B, the flow of nominal interest income received is iB per year.Since B equals zero for the whole economy, we have that the total of interest income equals zero.

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• Total income

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• Total income –Household nominal income= nominal profit +

nominal wage income + nominal net rental income+ nominal interest income

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• Total income –Household nominal income= nominal profit +

nominal wage income + nominal net rental income+ nominal interest income–Household nominal income = π + wL + (R/P − δ) ·

PK + iB

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Consumption

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ConsumptionHouseholds consume goods in the quantity C per year at price= P

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ConsumptionHouseholds consume goods in the quantity C per year at price= P–Household nominal consumption= P C

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Assets

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AssetsHouseholds hold assets in three forms:

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AssetsHouseholds hold assets in three forms: money, M;

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AssetsHouseholds hold assets in three forms: money, M; bonds, B;

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AssetsHouseholds hold assets in three forms: money, M; bonds, B; ownership of capital, K.

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Assets

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AssetsAssume households hold a fixed amount of money in euro terms.

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AssetsAssume households hold a fixed amount of money in euro terms. We assume that the change over time of a household’s nominal money holdings is zero

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AssetsAssume households hold a fixed amount of money in euro terms. We assume that the change over time of a household’s nominal money holdings is zero

∆M=0

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Assets

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AssetsIn considering whether to hold assets as bonds or capital, households would compare the rate of return on bonds, the interest rate, I, with the rate of return on ownership of capital, R/P − δ.

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AssetsIn considering whether to hold assets as bonds or capital, households would compare the rate of return on bonds, the interest rate, I, with the rate of return on ownership of capital, R/P − δ.Rate of return on bonds= rate of return on ownership

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AssetsIn considering whether to hold assets as bonds or capital, households would compare the rate of return on bonds, the interest rate, I, with the rate of return on ownership of capital, R/P − δ.Rate of return on bonds= rate of return on ownershipi = R/ P − δ

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• Household nominal income=

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• Household nominal income= π + wL + i · ( B+ P K )

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Household Budget Constraint

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Household Budget Constraint–nominal value of assets= M+ B+ P K

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Household Budget Constraint–nominal value of assets= M+ B+ P K–nominal saving to be the change over time in the

nominal value of assets.

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nominal value of assets.–nominal saving= (∆nominal assets)

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nominal value of assets.–nominal saving= (∆nominal assets)

= ∆M + ∆B + P·∆K

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Household Budget Constraint

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Household Budget Constraint–nominal saving= nominal income− nominal

consumption

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consumption–nominal saving= π + wL + i · ( B+ P K ) − P C

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consumption–nominal saving= π + wL + i · ( B+ P K ) − P C

∆B + P ·∆K = π + wL + i·( B+ PK ) − P C

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Household Budget Constraint in Nominal Terms

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Household Budget Constraint in Nominal Terms–PC + ∆B + P·∆K = π + wL + i·( B+ P K )

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Household Budget Constraint in Nominal Terms–PC + ∆B + P·∆K = π + wL + i·( B+ P K )

nominal consumption + nominal saving = nominal income

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Household Budget Constraint real terms

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Household Budget Constraint real terms–C + ( 1/ P)·∆B+ ∆K = π/ P + ( w/P)·L + i·(B/P+K)

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Household Budget Constraint real terms–C + ( 1/ P)·∆B+ ∆K = π/ P + ( w/P)·L + i·(B/P+K)

consumption + real saving = real income

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Clearing of the Markets for Labour and Capital Services

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Profit Maximization


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Profit MaximizationReal Profit


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Profit MaximizationReal Profitπ/P = A·F(Kd,Ld) − (w/P) · Ld − (R/P) · Kd


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• real profit= output


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• real profit= output −real wage payments−real rental payments


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The Labour Market

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The Labour MarketDemand for labour

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The Labour MarketDemand for labour∆(π/P) = ∆[ A·F( Kd, Ld) ] − w/ P

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The Labour MarketDemand for labour∆(π/P) = ∆[ A·F( Kd, Ld) ] − w/ P = MPL − w/P

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The Labour MarketDemand for labour∆(π/P) = ∆[ A·F( Kd, Ld) ] − w/ P = MPL − w/P

• change in real profit= marginal product of labour− real wage rate

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Supply of labour

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Supply of labourWe are assuming that each household supplies a fixed quantity of labour to the labour market.

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Supply of labourWe are assuming that each household supplies a fixed quantity of labour to the labour market. Therefore, the aggregate or market supply of labour, Ls, is the given amount L.

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Clearing of the labour market

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Clearing of the labour market–w/P is determined to equate the aggregate quantity of

labour demanded, Ld, to the aggregate quantity supplied, L.

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Clearing of the labour market–w/P is determined to equate the aggregate quantity of

labour demanded, Ld, to the aggregate quantity supplied, L.

( w/ P)* = MPL ( evaluated at L)

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The Market for Capital Services

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The Market for Capital ServicesDemand for capital services

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The Market for Capital ServicesDemand for capital services∆(π/P) = ∆[ A·F(Kd, Ld) ] − R/P

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The Market for Capital ServicesDemand for capital services∆(π/P) = ∆[ A·F(Kd, Ld) ] − R/P = MPK − R/P

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• change in real profit=

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• change in real profit= marginal product of capital− real rental price

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The Market for Capital ServicesSupply of capital services

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The Market for Capital ServicesSupply of capital services For the economy as a whole, the aggregate quantity of capital, K, is given from past flows of investment.

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The Market for Capital ServicesSupply of capital services For the economy as a whole, the aggregate quantity of capital, K, is given from past flows of investment. In the short run, the aggregate or market quantity of capital services supplied, Ks, equals K.

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The Market for Capital ServicesClearing of the market for capital services

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•R/P will be determined to clear the market—that is, so that the aggregate quantity of capital services supplied, K, equals the aggregate quantity demanded, Kd

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•R/P will be determined to clear the market—that is, so that the aggregate quantity of capital services supplied, K, equals the aggregate quantity demanded, Kd

(R/P)* = MPK( evaluated at K)

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The Market for Capital ServicesThe interest rate

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• i = R/P − δ

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• i = R/P − δ• rate of return on bonds=

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rate of return on ownership of capital

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rate of return on ownership of capital

• i = MPK ( evaluated at K) − δ

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Profit in Equilibrium

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Profit in Equilibriumπ/P = A· F(K,L) − (w/P)·L − ( R/P)· K

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•w/P = MPL

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•w/P = MPL•R/P = MPK

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•w/P = MPL•R/P = MPK

π/P = A· F(K, L) − MPL· L − MPK· K

Next Time: Business Cycles

Read Barro, Cht 8

EC4004 Lecture 18Markets & The Macroeconomy

Dr Stephen Kinsella

ec4004 lecture18 markets and the macroeconomy

Education

household income

nominal rental income

household budget constraint

nominal wage income

budget constraintquantities

rental market

lost capital

quantity of capital