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Macro Lecture Notes

Macro Lecture Notes

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Published by: Shahrul Ameen on Nov 29, 2011
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  • Money and Prices
  • 1.1 Definitions
  • 1.1.1 Prices
  • 1.1.2 Money
  • 1.2 The History of Money
  • 1.3 The Demand for Money
  • 1.3.1 The Baumol-Tobin Model of Money Demand
  • 1.4 Money in Dynamic General Equilibrium
  • 1.4.1 Discrete Time
  • 1.4.2 Continuous Time
  • 1.4.3 Solving the Model
  • 1.5 The optimum quantity of money
  • 1.5.1 The Quantity Theory of Money
  • 1.6 Seigniorage, Hyperinflation and the Cost of Inflation
  • 1.7 Problems
  • Nominal Rigidities and Economic Fluctuations
  • 2.1 Old Keynesian Economics: The Neoclassical Synthesis
  • 2.1.1 Open Economy
  • 2.1.2 Aggregate Supply
  • 2.2 Disequilibrium Economics
  • 2.2.1 Setup
  • 2.2.2 The Walrasian Benchmark Case
  • 2.2.3 Exogenously Fixed Price
  • 2.2.4 Exogenously Fixed Nominal Wage
  • 2.2.5 Both prices and wages inflexible
  • 2.2.6 Analysis of this model
  • 2.3 Imperfect Information Models
  • 2.4 New Keynesian Models
  • 2.4.1 Contracting Models
  • 2.4.2 Predetermined Wages
  • 2.4.3 Fixed Wages
  • 2.5 Imperfect Competition and New Keynesian Economics
  • 2.5.1 Macroeconomic Effects of Imperfect Competition
  • 2.5.2 Imperfect competition and costs of changing prices
  • 2.5.3 Dynamic Models
  • 2.6 Evidence and New Directions
  • 2.7 Problems
  • Macroeconomic Policy
  • 3.1 Rules v. Discretion
  • 3.1.1 The Traditional Case For Rules
  • 3.2 The Modern Case For Rules: Time Consis- tency
  • 3.2.1 Fischer’s Model of the Benevolent, Dissembling Gov- ernment
  • 3.2.2 Monetary Policy and Time Inconsistency
  • 3.2.3 Reputation
  • 3.3 The Lucas Critique
  • 3.4 Monetarist Arithmetic: Links Between Mon- etary and Fiscal Policy
  • 3.5 Problems
  • Investment
  • 4.1 The Classical Approach
  • 4.2 Adjustment Costs and Investment: q The- ory
  • 4.2.1 The Housing Market: After Mankiw and Weil and Poterba
  • 4.3 Credit Rationing
  • 4.4 Investment and Financial Markets
  • 4.4.1 The Effects of Changing Cashflow
  • 4.4.2 The Modigliani-Miller Theorem
  • 4.5 Banking Issues: Bank Runs, Deposit Insur- ance and Moral Hazard
  • 4.6 Investment Under Uncertainty and Irreversible Investment
  • 4.6.1 Investment Under Uncertainty
  • 4.7 Problems:
  • Unemployment and Coordination Failure
  • 5.1 Efficiency wages, or why the real wage is too high
  • 5.1.1 Solow model
  • 5.1.2 The Shapiro-Stiglitz shirking model
  • 5.1.3 Other models of wage rigidity
  • 5.2 Search
  • 5.2.1 Setup
  • 5.2.2 Steady State Equilibrium
  • 5.3 Coordination Failure and Aggregate Demand Externalities
  • 5.3.1 Model set-up
  • 5.3.2 Assumptions
  • 5.3.3 Definitions
  • 5.3.4 Propositions
  • 5.4 Problems
  • Continuous-Time Dynamic Optimization

1. Consider the following model of the labor market (Diamond, 1982):
Let L denote the number of workers, of whom at any given moment E are
employed and U are unemployed. There are K jobs, of which F are filled
and V are vacant. At any given point in time, a fraction b of employed
workers lose their jobs. Output is y, the wage is w and the real interest
rate is r.


(a) Write down the relationship between the unemployment rate u = U


the vacancy rate v = V

K, and the job-to-worker ration, k = K


Let WE and WU denote the value to the worker of being employed and
unemployed, respectively. Let WF and WV denote the value to the firm
of having job filled and having a vacancy, respectively.

(c) Assuming workers and firms split the joint surplus equally, what is
the relationship between WE, WU, WF and WV ?
(d) Write asset-pricing relationships for WE, WU, WF and WV .
(e) Solve for the fraction of output paid out as wages. How does this
quantity depend on the unemployment rate and the vacancy rate?

2. Consider the following model of the labor market. Suppose the economy
has two types of workers, skilled (S) and unskilled (U). The production
function is Y = Sα


. Let WS denote the nominal wage paid to skilled
workers,WU the wage paid to unskilled workers and P the price level.
Let ¯S denote the number of skilled workers and ¯U denote the number of
unskilled workers, and assume that each workersupplies one unit of labor
inelastically. The price level is perfectly flexible.

(a) Solve for the wage, employment, and rate of unemployment (if any)
for both types of workers under competitive equilibrium.
(b) Now suppose that a minimum wage ¯W is imposed for the unskilled
workers. Solve for the wage, employment, and rate of unemployment
(if any) for both types of workers.
(c) What level of minimum wage for the unskilled workers, if any, would
a social planner who cared about the utility of a representative un-
skilled worker choose? A social planner who cared about the utility of
a representative skilled worker? One who cared about some weighted
average of the two?

Now supposed the unskilled workers are unionized. Assume that the union
gets to choose the level of the wage, after which the representative firm
gets to choose how many workers to hire. Assume that the union’s utility
function is defined

à ˆU

! (WU

P )1−θ
1−θ +

Ã1− ˆU



where ˆU is the number of unskilled workers employed and UI is the (ex-
ogenous) level of unemployment insurance.



(e) Provide some justification for this objective function.
(f) Conditional on the wage, solve for the firm’s maximization problem
for how many people to hire.
(g) Knowing how the firm will solve its maximization problem, solve for
the level of the wage the union will choose. Then solve for the rate
of unemployment in the unskilled sector.

3. Let’s consider the following model of unemployment through job creation
and matching, due to Christopher Pissarides. We will break the problem
into two parts, first focusing on the workers, and then focusing on the
Suppose there are L workers. At a given time, a worker may be employed
or unemployed. If a worker is employed, he or she receives a wage w, but
there is a constant probability λ that his or her job may be eliminated. If
unemployed, the worker receives unemployment insurance z. With proba-
bility θq(θ), the worker finds and accepts job. θ = v

u, where v is the ratio

of job vacancies to the labor force and u is the unemployment rate.

(a) Write down the equation for how the unemployment rate evolves over

(b) Solve for the equilibrium unemployment rate
(c) Assuming the discount rate is r, and letting E denote the value to
the worker of being employed and U the value of being unemployed,
write down the Bellman equations for the worker.

Now consider the firm’s problem. If the firm has a job which is filled, the
firm produces y units of output and pays wage w. There is a constant
probability λ (the same as above) that the job will be eliminated. If the
job is eliminated, the firm does not automatically create a job by posting
a vacancy. If the firm does decide to create a job by posting a vacancy, it
pays a flow cost c to post the vacancy. With probability q(θ) it fills the

(e) Letting J denote the value to the firm of having a filled job, and V
the value of having a vacancy, write down the Bellman equations for
the firm.
(f) In equilibrium, V = 0. Why?

(N.B. You can go on to solve for the equilibrium job vacancy rate, but we
won’t do that in this problem).


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