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Foundations of Modern Macroeconomics Third Edition: Chapter 1: Review of The AD-AS Model
Foundations of Modern Macroeconomics Third Edition: Chapter 1: Review of The AD-AS Model
Building blocks
Schools of thought
Ben J. Heijdra
13 December 2016
Outline
1 Introduction
Getting started
Technology
Production function:
Y = F (N, K̄)
Profit maximization
Short-run profit:
Π ≡ PY − WN
max Π ≡ P Y − W N
{N }
= P F (N, K̄) − W N
Profit maximization
dΠ
= 0: P FN (N, K̄) − W = 0
dN
where FN ≡ ∂F ∂N (N,K̄)
is the marginal product of labour, i.e.
the partial derivative of F (N, K̄) with respect to N
See Figure 1.1 for the graphical derivation
A
!
C!
N
A
panel (b)
A
!
A(N)
B
C! !
N
N D = N D (W/P , K̄ )
− +
D
with NW/P D ≡ −F
≡ 1/FNN < 0 and NK̄ NK /FNN > 0
(“cooperative factors”)
See Figure 1.2 for the effect of an increase in K̄
W/P
-
ND(W/P, K1)
-
ND(W/P, K0)
Preferences
U ≡ U (C, 1 − N S )
C is household consumption
N S is household supply of labour (1 is the time endowment so
1 − N S is leisure)
U is (an index of) household utility
Properties:
UC > 0, U1−N > 0
UCC < 0, U1−N,1−N < 0
2
UCC U1−N,1−N − UC,1−N >0
E1
C1 !
S
C0 !
EN
CC ! U1
E0
C0 !
U0
! ! ! ! !
0 1!NCS 1!N1S 1!N0S 1 1!N S
W/Pe NS(W/Pe)
NS(W/Pe,U0)
E1
(W/Pe)1 ! !
EN
(W/Pe)0 !
E0
! !
0 N0S N1S NCS 1 N
Equivalently:
W Pe
= g(N S )
P P
W=P2 g(NS) B
P2 ! !
W2 ! B E2 E2
!
W=P2 FN
N2 N1 N Y2 Y1 Y
Y Y
A
E0 ! !A
Y* ! !
E0
B
! !B
-
Y=F(ND, K)
N* N Y
N2 N* NS2 N Y2 Y
Y Y
E0,B
Y* ! ! E ,B
0
A! !
A
-
Y=F(ND, K)
N* N Y
****
Theory of money
Speculative motive:
D
M
mD
S ≡ = l(R), lR < 0
P S
l(Y,R)
RMIN
l(Y,R)
mD ≡ mD D
S + mT = k(Y ) + l(R) [≡ L(Y, R)]
mS = M/P
mD = mS
M is the exogenous nominal money supply (under control of
the monetary authority)
m is real money (nominal money in terms of price level)
Real demand equals real supply of money
The LM curve summarizes money market equilibrium – see
Figure 1.8 for the graphical derivation
As we shall see, the slope of the LM curve is an important
source of disagreement among the different schools of thought
in macroeconomics
Foundations of Modern Macroeconomics - Third Edition Chapter 1 28 / 48
Introduction Block 1: Labour demand
Building blocks Block 2: Labour supply
Schools of thought Block 3: Demand for money
R lR = 0 R !kY/lR 6 4 LM
A2
RMAX ! ! A1
!4 < lR < 0 !kY/lR > 0
C2 ! !
lR 6 !4 !kY/lR = 0 C1
RMIN B2
! !
D2
!
D1
!
B1
l(R)
A3 l(R) Y
! !A
k(Y) C3 k(Y) 4
! ! C4
B3
! !B
4
D3
! ! D4
l(R) + k(Y) = (M/P)0
l(R) Y
Y =C +I +G
C = C(Y − T ), < CY −T < 1
I = I(R), IR < 0
T = T (Y ), 0 < TY < 1
M/P = l(Y, R), lY > 0, lR ≤ 0
Slope of LM curve:
M/P = l(Y, R) ⇒
d(M/P ) = lY dY + lR dR ⇒
d(M/P ) − lY dY
dR = (S2)
lR
Foundations of Modern Macroeconomics - Third Edition Chapter 1 31 / 48
Introduction Block 1: Labour demand
Building blocks Block 2: Labour supply
Schools of thought Block 3: Demand for money
IR d(M/Pl)−l Y dY
+ dG
dY = R
1 − CY −T (1 − TY )
d(M/P ) − lY dY
[1 − CY −T (1 − TY )] dY = IR + dG
lR
I R lY IR
1 − CY −T (1 − TY ) + dY = d(M/P ) + dG
lR lR
****
Classical economists
Keynesians
Neo-classical synthesis (a.k.a. neo-Keynesian synthesis)
Monetarists
New-Classical economists
Supply-siders
New-Keynesians
Distinguishing features
Classical Economists
M = kP Y
with k constant.
LM curve vertical (lR = 0 in our notation)
AD curve independent of government consumption G
investment. R1 !
“real” things.
IS(G0)
• Classical dichotomy: money is a
veil which determines nominal prices P
AS
but does not affect real quantities
and relative prices. Monetary P1 !
neutrality.
AD(M1)
• Conclusion: no need for P0 !
Keynes?
nothing. IS(G1)
IS(G0)
• Pigou: Even in the liquidity trap
the real balance effect in P
AD(G0) AD(G1) AS
Neoclassical synthesizers
Neoclassical synthesizers
IS(G0)
Y
P AS(Pe=P2)
AS(Pe=P0)
P2 !
P1 !
P0 ! !
AD(G0,M1)
AD(G1,M0)
AD(G0,M0)
Y* Y
Monetarists
Supply siders
T
A
!
!
B
! C
! !
0 1 tL