Honors - Economic Analysis III
Lecture 0: Introduction
Simon Mongey
Winter, 2021
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This course
• Questions
• How does the economy grow?
• How does it respond to changes?
• What determines output, consumption, investment?
• How are assets (stocks, government bonds) valued?
• How do individuals in the economy bear risk?
• How do these answers change under different government policies?
• Answers
- Build on general equilibrium neo-classical model from micro
1. Consumers: Consume, save, supply labor
2. Firms: Produce, invest, demand labor
3. Markets: For goods, bonds, stocks, labor
2
Structure of the macroeconomy
Labor: N , Capital: K
Wages: WN , Rental: RK
Profits:
Households Firms
U(C,N) F(K,N)
Revenue: PY
Goods: Y
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Structure of the macroeconomy
Labor: N , Capital: K
Income
Y = WN+RK+ Wages: WN , Rental: RK
Profits:
Households Firms
U(C,N) F(K,N)
Expenditure
Y = C+I
Revenue: PY
Capital tomorrow
K’= K+I
Goods: Y
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Structure of the macroeconomy
Labor: N , Capital: K
Income
Y = WN+RK+ Wages: WN , Rental: RK
Profits:
Households Firms
U(C,N) F(K,N)
Expenditure
Y = C+I
Revenue: PY
Capital tomorrow
K’= K+I
Goods: Y
• Government: Taxes on payments to fund government spending: G
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• Output Y , Consumption C, Investment I, Government G:
Y =C +I +G
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• Shares: C/Y , I/Y , G/I
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• Long run growth: log Yt − log Y1950
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• Short run changes: log Yt − log Yt−1
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Housekeeping
• Lectures
- 2 × 80 minutes, Online, Tue/Thu: 2:40-4:00pm
- Please try to skim through lecture slides before coming to class
- Main resource for study are lecture slides and problem set solutions
• Discussion
- 1 × 50 minutes, Online, TBD
- Go through solutions to problem sets
- There will be additional, examinable material covered!
- If you want to focus on a particular area, please email Santiago by
the end of Monday
10
Office hours
• Simon
- After class on Tuesday until 5:00pm
- Office: Zoom (same link as class)
• Santiago
- TBD
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Assessment
• Problem sets
- 7 problem sets. 20% of grade.
- Online by end of Tuesday. Due in TA session of following week
- Weeks 1, 2, 3∗ , 6, 7, 8, 9 ∗
: two weeks to complete
- Go to Santiago’s office hours
• Mid-term exam
- 80 minutes. 35% of grade.
- In class, Thursday February 11, Week 5
• Final exam
- 120 minutes. 45% of grade (70% if do better than mid-term)
- TBA, Thursday March 18
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Programs
• MATLAB
- Download and install using the University student license
- Will be used for problem set solutions and examples in class
- Excel will also come in handy
• Writing
- I recommend using Lyx which is a LATEXtype-setting software
- New programs for collaboration: OverLeaf (?)
• Canvas
- All class announcements will be through Canvas
- Email me or message questions on Canvas, if the question / answer
is relevant to everyone I will post it out as an announcement
- I will assume that you have read all announcements on Canvas ...
make sure emails of the alerts go through to your primary inbox!
• St. Louis Fed’s - FRED
- Use for data related tasks
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Textbooks
- Due to the advanced nature of the course and the wide range of
subjects covered, there is no required textbook for this class.
- The class will be self-contained, and slides / problem set solutions
will be the most useful reference. The following books are
recommended for different purposes:
- R.J. Barro,Macroeconomics, 5th ed. MIT Press, 1997.
- Standard undergraduate text, useful for intuition but below the
level of this course
- M. Doepke, A. Lehnert, and A.W. Sellgren, Macroeconomics, 1998
- A PDF document that supplements Barro, designed for Chicago
second year undergraduate course. More rigorous than Barro, but
still below the level of this course
- M. Wickens, Macroeconomics, 2nd ed
- Comprehensive reference for advanced undergraduates and masters
- Ljunqvist and Sargent, Recursive Macroeconomic Theory, 4th ed
- Graduate textbook, simplified versions of chapters and exercises in
this text will be the core of this course.
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Outline
Week Lecture 1 Lecture 2 Problem set
1 Terminology Solow model 1. Solow model / GDP
2 Neo-classical model - Centralized NCM - Dynamics 2. NCM
3 NCM - Decentralized NCM - Fiscal policy 3. NCM + taxes
4 NCM - Fiscal policy / dynamics Dynamic programming I —
5 Dynamic programming II Mid-term
6 Dynamic programming III Labor supply 4. Dyn. programming
8 Real business cycle model RBC - Results 5. Labor supply
9 Asset pricing I Asset pricing II 6. Asset pricing
10 Complete mkts - Centralized Complete mkts - Decentralized 7. Complete markets
11 Risk - Incomplete mkts No class
- Welfare properties
- Centralized (planner) → Decentralized (competitive equilibrium)
- Risk
- None (Solow, Neo-classical), Agg. (RBC, Assets), Individual
(Comp/Incomp. markets)
- Dynamics
- Trends (Solow), Transitions (NCM), Fluctuations (RBC, Assets)
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Terminology
• Course will focus on macroeconomic dynamics
• Consider a function F : R+ → R+ ... this is our ‘model’
Xt+1 = F Xt
• We will be interested in the properties of the time-series {Xt }∞
t=0
• We will call X0 the initial condition
• We will say that the steady-state value of Xt is X that satisfies
X=F X
• We will refer to Xt as an endogenous variable
• Suppose F (Xt ) = AX e tα , we will refer to α as a parameter
... we will refer to A
e as an exogenous variable
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Terminology
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Terminology
18
Terminology
19
Terminology
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Questions
• Steady state
- What are the properties of the steady-state of the economy?
- e.g. If people saved more would average consumption be higher or lower?
• Transition dynamics
- Given an initial condition X0 , does Xt converge to X?
- How quickly does it converge?
- e.g. One country has half the K0 as another, which grows faster?
• Dynamics following shocks
- Suppose we are initially in steady-state: X0 = X
- Suppose A
e jumps up to A e0 > Ae forever, what happens to {Xt }∞ ?
t=0
- e.g. The government doubles income taxes, what happens in short/long run?
- e.g. Productivity falls, but only temporarily, what happens?
• Comparative statics
- How do the answers to the above depend on α?
- e.g. If people are more tolerant of risk, do stocks have lower or higher returns?
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Terminology
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Terminology
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Terminology
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Terminology
25
Terminology
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Tool
• We will often use linearization to help answer these questions
∂F (X)
F (Xt ) ≈ F (Xt−1 ) + (Xt − Xt−1 )
∂X
X=Xt−1
• This gives
∂F (X)
Xt+1 ≈ Xt + (Xt − Xt−1 )
∂X
X=Xt−1
• Manipulating
Xt+1 − Xt ∂F (Xt−1 ) Xt−1 Xt − Xt−1
≈
Xt ∂Xt−1 F (Xt−1 ) Xt−1
∆ log Xt+1 ≈ εF,X ∆ log Xt
• Intuition - Economic quantities don’t really have units!
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Tool
• We will often use linearization to help answer these questions
∂F (X)
F (Xt ) ≈ F (Xt−1 ) + (Xt − Xt−1 )
∂X
X=Xt−1
• This gives
∂F (X)
Xt+1 ≈ Xt + (Xt − Xt−1 )
∂X
X=Xt−1
• Manipulating
Xt+1 − Xt ∂F (Xt−1 ) Xt−1 Xt − Xt−1
≈
Xt ∂Xt−1 F (Xt−1 ) Xt−1
∆ log Xt+1 ≈ εF,X ∆ log Xt
• Intuition - Economic quantities don’t really have units!
∗ On the board - (i) Function of two variables, (ii) log and %∆
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Example - Macro Back-of-envelope 101
• Approximately, what is the effect of a 1 percent increase in Ct on Yt ?
Yt = Ct + It + Gt , Yt = F (Ct , It , Gt )
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Example - Macro Back-of-envelope 101
• Approximately, what is the effect of a 1 percent increase in Ct on Yt ?
Yt = Ct + It + Gt , Yt = F (Ct , It , Gt )
• Take an approximation around average values: X := E [Xt ]
F (Ct , It , Gt ) ≈ F C, I, G + 1 Ct − C + 1 It − I + 1 Gt − G
• Manipulating
Yt − Y C Ct − C I It − I G Gt − G
≈ + +
Y Y C Y I Y G
• Answer given by average consumption C divided by average GDP Y
• In the U.S. economy the share of consumption is? (Problem set 1)
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Example - Macro Back-of-envelope 102
• Approximately, what is the effect of a 1 percent increase in Nt on Yt ?
Yt = ANtα Kt1−α , Yt = F (Nt , Kt )
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Example - Macro Back-of-envelope 102
• Approximately, what is the effect of a 1 percent increase in Nt on Yt ?
Yt = ANtα Kt1−α , Yt = F (Nt , Kt )
• Take an approximation around Nt , Kt
Yt+1 ≈ Yt + αNtα−1 Kt1−α (Nt+1 − Nt )
• Manipulating
Yt+1 − Yt αNtα Kt1−α Nt+1 − Nt Nt+1 − Nt
≈ = α
Yt Yt Nt Nt
• Answer given by the parameter α
• How can we come up with an estimate of α? (Problem set 1)
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Example - Macro Back-of-envelope 102
• Suppose this is the output of a profit maximizing firm
Πt = max Pt F (Nt , Kt ) − Rt Kt − Wt Nt
Kt ,Nt
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Example - Macro Back-of-envelope 102
• Suppose this is the output of a profit maximizing firm
Πt = max Pt F (Nt , Kt ) − Rt Kt − Wt Nt
Kt ,Nt
• First order condition for Nt
0 = Pt × αANtα−1 Kt1−α − Wt
Nt :
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Example - Macro Back-of-envelope 102
• Suppose this is the output of a profit maximizing firm
Πt = max Pt F (Nt , Kt ) − Rt Kt − Wt Nt
Kt ,Nt
• First order condition for Nt
0 = Pt × αANtα−1 Kt1−α − Wt
Nt :
• Result - Under constant returns to scale, competitive pricing of inputs
implies that factor shares equal output elasticities
W t Nt
=α
Pt Yt
• In the U.S., labor share of revenue α ≈ 0.60
• Let Kt = K0 , Nt+1 = (1 + γN )Nt with γN = 0.02, then Yt grows at 1.2%
• 10% percent decline in employment over 2020, ≈ 6% decline in GDP
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Example - Macro Back-of-envelope 102
A. Output B. Employment
19.5 160
Civilian employment (millions)
155
19
Real GDP ($ trillions)
150
18.5
145
18
140
17.5
135
Jan 2018 Jan 2019 Jan 2020 Jan 2021 Jan 2018 Jan 2019 Jan 2020 Jan 2021
• Output - Yt - Around 19 trillion
• Employment - Nt - Around 150 million workers ≈ 50% of pop.
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Example - Macro Back-of-envelope 102
Change in GDP and Employment
0.00 GDP
Pct. change (vs. Jan 2019)
Employment
−0.05
−0.10
−0.15
−0.20
Jan 2020 Apr 2020 Jul 2020 Oct 2020 Jan 2021
Wt Nt
∆ log Yt ≈ α ∆ log Nt , α= ≈ 0.60
Pt Yt
| {z } | {z }
Black dashed line Data
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Covered
• Terminology
- Exogenous variable, Endogenous variable, parameter
- Steady state, transition dynamics, shock
- Comparative statics
• Linearization
- Functions of one variable, two variables
- Elasticity
• Profit maximization
- Firm problem, First order conditions
• Next
- TA - Constant returns to scale production function
- TA - Approaches to GDP: Income, Expenditure, Value added
- Lecture - Growth facts, Solow model
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