Intermediate Macroeconomics

22ECB001

Revision Lecture

Allyson King
Dawid Trzeciakiewicz

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 January exam

• January exam (20%) will take place during the normal

examination period for Semester 1.
• The January exam lasts 1 hour.
• The exam will test your knowledge of the following two topics:
Consumption and Investment.
• In the exam you are asked to answer two questions out of three.
• Each question can consist of few sub-questions which can
comprise calculation and/or discussion of the concepts
introduced in the two topics.
• This is a closed book in-person exam (no extra notes).

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 Other Exam Information
• Any general exam questions after the revision session
can be done via:
• The Discussion Board on Learn
• Email
• During consultation/feedback hours
• You will not be able to ask questions during the exam
(unless there is an issue whereby you can speak to the
invigilator).
• No calculator to be taken in the exam (you will not
need it).

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 Sample question:
a) Discuss how can we test the permanent income hypothesis and what it implies for the
marginal propensity to consume. (20 marks)

b) In a two-period economy illustrate the impact of a drop in an income tax rate in the first-
period if the consumer does and does not face a binding borrowing constraint. Discuss your
results and its implications in the context of the potency of fiscal policy.
(20 marks)

c) Some economists have predicted that as members of the baby-boom generation (a large
segment of the population) age, we will have a smaller demand for housing. Use the model
of residential investment to illustrate graphically the impact of this prediction on housing
prices and residential investment. (10 marks)

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 Consumption
• John Maynard Keynes: consumption and current income
• Irving Fisher: intertemporal choice
• Franco Modigliani: the Life-Cycle Hypothesis
• Milton Friedman: the Permanent Income Hypothesis
• Robert Hall: the Random-Walk Hypothesis
• Borrowing constraints
• Precautionary savings
• David Laibson: the pull of instant gratification

Keynes => C=f(Current Income)

More recent evidence => C=f(Current Income, Expected Future

Income, Wealth, Interest Rates, Self-Control Mechanisms)
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 Investment
• How individual firms make investment decisions?
• Net Present Value

• Theoretical models of business investment

• Neoclassical model of investment:

• Tobin’s q:

• Residential investment

• Inventory investment
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 The IS-LM Model
• Goods market –IS curve
• Three ways of expressing equilibrium in Keynesian cross
• Used second form () to construct product market equilibrium
• Factors affecting IS slope:
• Slope of Investment schedule
• Slope of Savings function
• Factors that shift IS slope:
• Changes in G, T and autonomous I

• Money market – LM curve

• Need to understand the relationship between quantity of money and r
• Motives for demanding money (and relationship with Y and r) to help construct money
market equilibrium
• Traditional LM – upward sloping
• Modern LM – Horizontal
• Policy Applications

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 AS and Short-run Tradeoff between
Inflation and Unemployment

• Two Models of AS
• Sticky-price
• Imperfect-information

(1) SRAS equation

• Phillips Curve reflects SRAS curve:
as policy makers move economy
along SRAS, inflation and
unemployment move in opposite
directions.
• Sacrifice ratio: the percentage of a
year’s real GDP that must be
forgone to reduce inflation by 1
percentage point.

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 Dynamic AD AS model

1.Develop a theoretical
model
2.Find long-run equilibrium
(steady-state)
3.Calibrate parameters
4.Generate impulse-
responses
• Demand shock
• Supply shock

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 The Open Economy
• The Mundell-Fleming model extends our analysis of AD to include international trade and finance.
• The model is closely related to the IS-LM model:
• Key difference: IS-LM is closed and Mundell-Fleming assumes an open economy.
• One lesson from Mundell-Fleming model: behaviour of open economy depends on its exchange rate
system.

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