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    Mec 102 2007369817

    Uploaded by

    Sarpanch Kainthari

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    © All Rights Reserved
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    i a C Iignou THE PEOPLE’S UNIVERSITY Name: Piyush Sharma Enrolment number: 2.007 369817 Regional Centre Code: 24. DELHI2CRAI GHAT) Study Centre Code: 7640Shyam [al ollge) Programme Code: HEC % MASTER OF ARDS (ECONOMICS) Course Code(s) of attached assignments: M&c 002 Mobile number: 40742744 84 Email ID: pipusbeshormergp Ogunaike com | | i a freefrarers Of =. ity __!ndira Gandhi National Open Univers! seer Maidan GarhiNew Delhi. 110068. ONOU- Soden enty cart Enrolment Number: 2007368817 RC Code: 29: DELHI 2 (RAJGHAT) a Programme. MEC: MASTER OF ARTS (ECONOMICS) Name : PIYUSH SHARMA) Father's Name: NEERAJ KANT SHARMA Kaintharl Bhawan, Salpau road briana DholpurDHOLPUR RAJASTHAN Pin Code: 328001 {Tos atte pose onomant ta Teta woe sani ars iteoeses ee seedp sear press Dowes aT Thera crscen onsets none teenie SECTION-A ae Qt Denive the conditions ton steady state growth in the Solow wnodel. What ane its implicatLons? Lnwhat respects 46 the golden mule difpentnt trom the steady state? Ans. The Steady State: Acconding te Solow model, an Acomeny Ls in equilibrium when investment pen unit of Lggective Laboun & qual te savings pen Unit of effective Laboun, Lesy Whene I is investment, sis MPS and Y is income, Slee Y i a function of capital, we can say that Tes¢h Whene, k is entsting capital stock of an LEON HrY, Tt Lmplica that ke sy) Whene k ls change ink Le entating capital stock of the sconeny This Lquilibnium conditLen Ls true fon an zeonenny whens, (a) Deprectatlon 16 ZLne; ©) PepulatLen La constant; © TechneLegy Ls given and constant. 200726981 F Now Let us ae what rappers when we nolan tear Oo” UMnealtstic assumptions, The cnowth of Capital and Steady State: Ln Solow model, - P 4 AE Ls assumed that capital depreciates at a fined nate. Let us denote it by Thenepone, tveny yean k amount of Capital is depreciated. Lavestment and depreciatlen act Ln opposite dinectLons and the growth in capital atock is met of the two qpantities, kHei Oko) Since Le sf ke ®) kOe sg kO-£O From tay. OD, we can conclude that (a) Capital stock incneases when $ (ke Dk ©) Captial stock falls when ¢ k OEkO © And capital stock nemains constant when (ke &) Bk &) Pepulatlen Growth and Steady State: In this section we shall elaborate onthe changes im population and Labeun fonce at a constant nate m When thene is a grouth of Labour force, we need to imnease capital; te maintain 2007 0817 Adame Level of k Tt is easential that the economy has Adequate investment to take cane of Aepreclatien () and population growth (nd I¢ we introduce min the equation GW above, it will be zqnal te kOesg kb-un ko Tg wet wamt to maintain steady growth nate we need te coven depreciation which is equal te WO and to providewonkens with capital 2qpal te (Md. In this case, break wen Lrvestment will become tapal to eM k Thesconomy will attain steady gnouth rate at a point whene Lavestment cane Lnbensects (40 k cane, Tt is shown withthe help of following dlagnam. 4f (nt BK ny) otle) ' ' kyeek 1 —_ 4 Ay bteady growth in two count non Ty Mea this means investment is greaten than break ven Lavestment and Lt will cause capital and output te nLdL. 200FABLF Tf k2¥ le thon k will decline until it becomes 2qual bo km Population growth gives us an tmplanailon fon steady teonomic growth nate Tt is heweven, assumed that utput pen effective Laboun remains constant, It 1a alao seen that at steady qnouth nate k and y nemain constant, But capitalsteck © and output ) keep increasing at the nate OE M6 arte keep k andy constant. This ¢eatune zoplains thecnoss-countny dispanities Ln income, Lf country one is enpeniencing population grouth@ mn and countny two iaenpeniencing population growth at mZ auch that mL>n2 and if¢ the saving nates ane same in both the countnizs then 62 k with a slope greaten than nh) k has been drawn, A country with bighen nate of population growth nake wh Mas Lowen atthe steady Level of capital) and hence Loweny Le output pen e¢gective Labour. And the countny with Loewen nate of population mt has a highen ke the steady Level ofcapital) and hence Mrighten y Le. output pen pfecive Labour Technological Progress and Strady State: By intreducing technological progheass, we can explain growth meutput pon 2pfective Labour in Solow model. It 1s assumed that technological growth 1s Labour augmenting Le, LELMChLASLA productivity pen L¢ficiency of Labour, Thenefone, with the technological progress thene will be an incneasein the quantity of 2¢pective Laboun (ALL Tf we 2007F2O1LF ge- assume that the nate of technological Lmprovement is 4 then the changein k oven time canbe waithen as: ROS af UM -Heg Oko Actually eqn Vili) La the key equatlon of the SeLow model We have snplained this tqnation with the help 6 4 diagnam Tt is clean fromthe tquation ULL) that the analysis of steady state remains unagpected with the inclusion of technological progress but the mew break-even Lyvestment becomes tapral to nt g #8) k ©, Out of total investment, k will be used fon necoveny of Aeprectatlon and mk ameunt of capital will be nequined te maintain capital pen effective Laboun at a comatant nate. But with the nesulte¢ the technological. Lnprovement 4 increases at the nate of q Individually m, and ¢ maybe positive on negative but their sum total i assume te be positive inthe model, Total output will givow at the nate of nrg) Thenepone, we can conclude that intneductlon of technological progness Leads to an Increase in output pen wonken, Solow model claims that persistent alae in standand at Living always owe to technological progneas. THE GOLDEN RULE InthLs section we shall considen the eppect of change in saving nate on steady state. Let us assume that saving nate increases while the nq and remain to be same. As 2007369817 sf W4 know that i af), thene will be highen Laveatinent which will Lead te capital acunulatlen and output growth and the economy will finally reach te a mew steady state with Mighen capital and output. When nate of savings increase prom al te a2 then the Lavestiment CUnve alec increases prom sb {UO te a2. Thenepone the Aconemy reaches at new steady state b2 through the process of capital accumulation and output growth. From the above smplanatlon, one wea Gump to a bunnied conclusion that a higher saving is always Aeainable as Aighen savings will Lead te Aighen capital acumubatLen and theneby increased output in the zconony You may alas misintenpret that the 100A saving nate will Lead te highsst possible capital accumulation and output in the zconemy but it Ls mot true. At dif¢¢enent Levela of 4, thene ant difpentnt Levels of capital accumulation but thene is one optimum Level of capital accumLation which is called golden mule Level of capital, At the golden mule Level of capital the Level of saving La such that consumption pen eppective Labour Ls martian at the steady state. The reason is that individuals ane comcenmed with the ameunt of sutput they consume T= fon them capital. stock on total output of the zcomomy is mot of much significance. Theneponse, that Level of saving nate which maniumiges the consumptlon pen effective 2007369817 Laboun is the moat Atsinable and the optimus It is known aa Golden mule Level of saving nate’. we can say that in a twe secton tconemy matLonal income La the sum total of consumption and investment assuming that saving and Lavestment ane tqnal te each othen Thenepone, steady state consumption can be found by deducting Lavestment trem Licome, ae gue | and we know y is a functlon of capital and i is a function | of mg and, thenefpone we can newnlte above Lapatlen as Os § Ud) - nt g 4d x Tt is inteneating to see that this increase in steady state capital has a comtnasting effect on steady state comsumptlenLycnease in steady state capital Leads to were eutput which means increase Ln comaumptien and alse a highen breakeeninestment equal to (a+ gtd kx Lt is shown with the help of gollowing dlagnam Ln the dLagnam steady state consumption La the difference betweenthe steady state output and steady state break vin Lyvestmnent. Tt La mani at kogold Level of capital pen effective Labour. It hasbeen explained in the beginning of this chapten that the slope of the preductLon fumctLon Ls the 200FE9BIF Manginalpneduct of capital iz. MPK It is alee clean from the ALagnam that cagold Level of consumption Ls the golden mule Levelo¢ consumptlon and at this Level of Consumption the slope of production function equals the slope of break-eveninvestment, LeManginal productivity of Capital, WK = (n+ g 43 MK -¢ (ae g) mw) This golden rule Level of steady state is mot achieved automatically Tt nequines a panticlan nate of saving subscript in onden to attain golden rule steady state of capital Jeaubscnipt, a saving nate of subscript is nequined in such a way that manimig-es cesubscnipt. Ly 4 subscnipt then thene is dynamic ineppiciency in the Aconemy Ty we decrease & bo subscript it will Lead te increase in consumptlon, If s¢sgold then a rise n saving will decrease consumptlon inthe shont nun but Lead te a Arighen comaumptLon in the Lemg-nun in the tconemy Q. 2 What ane the implications of IS and LM cunves? What ane the tactons om which the position andthe slepe of IS and LM cunves depend? Ans an tconemy Ls in equilibrium when aggregate demand L& gust tqual te aggregate supply In 4 twe-section zcanemy AD compnises of consumptlen and Lyv.eatment, While aggntgate supply compnlses of consumption and savings. Thenepone, at Lapilibnium Level of output, savings is equal investment. If fon simplicity sake, we take 200720217 . _ Ge Muestment as autonemeus and thenttone, a honigzontal Line panallel te income ania, then zconanny L& Ln tqpilibrivm at point E as shown in the dlagnam On the night side of point E, unplanned investment will be positive and onthe Lest hand side, unplanned investment 18 megativelLyvestment is an Lnvense functLon of nate of intenest and Saving 1s a positive functlon of income. Beth savings and investment can be Integnated to get Aqpilibnium Level of inceme and intenest nate. The IS cue shows the equilibainm inthe neal secton of the Acomomy Let us see bow IS cunve is derived Tn siden te undenstand Wow IS cue La derived Let us finat undenstand what ane we taking on yanis and me Anis. In finst quadrant, wt have taken nate of inteneat ANT AMLs and income On M-anLs. In second qpadnamt, We Arave taken nate of intenest on yanis and investment on mn-anss. In thind quadnant, we have taken saving on y- amis and Lvestment on manis. Ln fourth quadrant, we have taken savings On yams and Income On m~amLs. Second quadrant is showlng that thene La an inverse nelatLonahip between Lnvestment and rate of intencat. Mone ia the nate of inteneat; Less La the Level of investment and vicevensa, othen things being constant. Ln the thind quadrant, we have shown a US Line to emhibit that on this Line at all Levels saving 1s equal to investment. Ln the fourth quadrant peaitive rnelatien 2007369814 between savings and investment as been shown, Lt is showing the difgenent Levels of savings at diggenent Levels of income Hence, by Lmplication that saving Ls Alnectly nelated te income and investment La Lyvendely ntlated te nate of intencat and saving La equal to tavestment at equilibria Level, it is clean that thene is an lyvense nelatlen between nate of intenest and Lncome Tt is shown by IS cane inl quadnant which is the Locus At Lay Uibatum Levels of Income Ln othen wends, eveny point on IS cane represents equilibrium Level of income and intenest nates. When thene is change inthe Level of investment, thene will be a chain of reactions. Change im imestment nequined Level of savings will change Equilibnimm Level of income will change It is Lmplied in IS cunve that neal secten can be in Lqpilibnium in any combination of Lowen nate of inteneat and hightn income on highen nate of inteneat and Lowen INCOme Equilibrinm Ln Menetany Secon -LM Cums is based on the concept of thamsactLon demand fon money and speculative demand fon money Accondingte Keynes, transactLen demand fon monty 1s a positive function of income ie, at higher Level of income the tnansactLondemand fon money is mone and victv.ensa. Speculative demand $on money Ls an Lnvense function of nate of inteneatAt 2007264817 Aighen nate of intenest, the speculative demand $oh money is Less and vicevensa because nate of intenest Ls theoppentunity cost of Molding money Ln the fonm of cash, The denivation og LM cue ts shown with the help of AlLagnam given below, In this Alagham in finat quadrant, wehave taken nate of interest on yanis and income on Wane. In second qpadnant, we have taken nate of intenest on yanis and Speculative demand fon money on wm amnis. Ln thind qpadnant, we have taken thansactLen demand fon money ony-anis and spraulative demand fon money on am-anis. In fourth quadnant, we have taken thamsactlon demand $on MOMLYON Yamls and income on WM amid, k on a ye rt Sot 1s yi Y* ¥ 1O-2M Monel In orden to eplain dow LM cunve Le denived Let us stant with second quadnant, Second quadrant is showing 200F 20981 F theimvense rtlatLenship between nate of inteneat nie Speculative demand fon money Thind quadrant 14 showing thatmoney manket is in 2ayailibnium when demand ton money which is sum total of transaction demand ton money andapeculative demand $on money) Lb tqpal to supply of money Since total demand fon money 14 tqpal to sum total oftnansactlon demand fon money and speculative demand fon money Lqpilibninm Ln money wmanket can be shown by astnaight Line which touches y ans at a point whene eney supply is tanal te tnansactlon demand fon money iespeculative demand fon money Ls zene. And it touches mania at a point whene Money supply is equal to speculativedemand ¢on money Le transaction demand ton money ia zene, transaction demand fon monty La a constant propentlen of income Thenepone, mone Lathe Level of income mone willbe the Level of thansactlon demand fon money and vice-~vensa. Tt Ls shown in the fourth quadrant of the dlagnam Onthe basis of second thind and fourth quadrant, LM came is shown inl quadrant whene LM awe is shown as anupwand sloping cust. Each peint on LM cunve pepressnta [Librium in meney manket. Money manket Ls in eqpilibriumoith Lowen income and Lowen nate of interest and ighen income with Aighen nate of interest. SECTION-B 2007364817 Gg BA What does the Phillips cums signify How de you neconcile the diggenence in the shape of thecunve in the alent nun and the Long muse Ans. Phillips Cunve: Ald, Philips gave this concept which Le known as Phillips cume aften iis name which describes the ntlatLenship between the nate of unemployment and the nate of inflation He tiled te establish a relationship between the Level of unemployment and changes in Wage nates. His tunpinical wonk phoved that the Lowen is the initial nate of unemployment; the greaten would be the nise in the money wage nate conntsponding to a given rise inthe nate at unemployment. He collected data fon a peniod of anound 100 weans URGI-LISA, This data got fitted inte a Aryperbola. This data provided proog to his hypothesis. He made an assumption that the natie between prices and nomial wage nates is constant inthe shent nun On this assumption the Phillips une showed the inverse relation between the nate of unemployment and the nate of Lnglation Le the existence of thade off between unemployment and inflatLon. He took a simple Lintan equation of the fallowlng fonm ce abu When lathe nate of wage increase, a andb ane constant and u isthe nate of unemployment. He found 2007209814 that thene eoista an inense nelatLonship peruse acd Ut. wage nate and nate of unemployment. Later, data was collected fon many othen courtnies and the relationship held tune pon almost all countnies. Thentpont, it represented a stable nelatlon between inglatlLon and unemployment svtn tle, which suggested Le economists that they will have te bean one problem in the Aconemy te get nid of othen and it La up te them which combination of these problems they would Like to chess. 14 we choose Low nate of LrgLatLon, unemployment nate would be high and vicevensa. Di¢genence betwen Shent Run and Leng-nun Phillips Cane: The Long-Run Phillips Cane: The Leng-nun Phillips cunve is avertical line at the natunal nate of unemployment, a6 inglation and unemployment ane unrelated in the Long nUM. Acconding to economists, thene can be no thade-oty between inglatlen and unemployment in the Long nun. Decreases in unemployment can Lead te increases in inglatLon, but only in the ahont nun Ln the Long nun, inglation and unemployment ane unrelated Graphically this means the Phillips cue La vertical at the natural nate of unemployment, on the dypothetical unemployment nate if aggregate production is in the Leng-nun Level. Attempts te change unemployment nates only serve te move the economy up and down this vertical Line 2007269817 oe Assume the economy stants at point A and has an initial nate of unemployment and inglatlon nate. I¢ the qevtnmment decides te punsue ecpansionany Lconemic policies inglation will increase as aggregate. demand shi¢ts to the nlght. This is shown as a movement along the ahont-nun Phillips cone, te point B which Ls an unstable 2qpilibninim As aggnegate demand LMcnLaaes, mone Wwenkens will be bined by pinms in onden te produce mone eutput te meet rlaing demand and unemployment will decrease, Howevin, dure te the Aighen inflation, wenkens’ Anmpectations of future inglatLon changes, which ahigta the shent-nun Phillips cune te the night, trom unstable Lqpilibnium point Bie the stable equilibrium peint C At point C the nate of unemployment has incneased back te its matunal nate, but inflation remains highen than its initial Level. 2009369817 NATRU and Phillips Cunve: Although the economy stants with an Initially Low Level of inflation at point A attempts te decrease the unemployment nate ane futlle and only increase inglation to point C The Unemployment nate cannot fall below the matunal nate of untinpLewment, on NATRU, witheut increasing inflatlen Ln the Long TUM, The reason the shent-nun Phillips ume shifts is due to the changes in inglation tmpectations. Wonkens, whe ane assumed te be completely natlenal and informed, will ntcognize thein nominal wages have not kept pace with inglation increases the movement trom A to B) ao thein neal wages have been decreased As such in the future, they will renegotiate thein mominal wages to neglect the Aighen Amped inglatlen nate, in onden te keep thein neal wages the same As nominal Wages Lncneane, preductLon coats fon the supplicn increase, which diminishes profits, As profits decline, suppliens will decrease output and employ fewen wonkena (the movement from B te 0. Consequently an attempt to decnease unemployment at the coat of Aighen inflation in the sherk nun Ledte highen inglation and ne ¢ 2 Ln unemployment Ln the Long nun The shent-nun Phillips ame depicts the Lvense trade~ off between inflation and unemployment, The Phillips cue depicts the relationship between inflation and 2007269817 untmpleyment nates. The Leng-nun Phillips cane Ls vertical Line that illustrates that thene is ne permanent thade-oft between inflation and unemployment Ln the Long nun. However, the short-run Phillips cunve La roughly L-shaped to neglect the initial inense nelatLonahip between the two variables. As unemployment nates Lncnease, inflation decreases: as unemployment nates decnease, inflation increases. Shent-Run Phillis Came: The shont-nun Phillins cunve shows that inthe shent-tenm thene is a thade- At fretwiwn inflation and unemployment. Contnast it with the Lemg-nun Phillips cane in ned, which shows that ven the Leng tenm, unemployment nate stays mone oh Less steady nigandless of inflatLon nate. Comsiden the eocample shown in When the unemployment nate 1a 24 the connesponding inflation nate is 10% As untmployment decreases to 1% the inflation nate Lncneases to 15%. On the sthen hand when winempLoyment Lncneases to 6%, the inglatien nate Anops to 2%, Q. 4 From Lucas’ point of view, what ane the Limitations og the Keyneslan model? What Linprovementedete he angg-eatt Ans The Lucas’ CabtLque Of Ecomemetnic PeLicy Evaluation: Keynes Genenal Theeny gave birth te a mew branch of zconomics and theneponse, Keynes is also known as fathen af macroeconomics. But the teaching At MAChoLOMOMICs 2007 2648LF 44 4 discipline was based on many mathematical tonmalizations which wene penceived to be contaLning to the 2ssence of Keynes’ economic doctrine. IS-LM model, ASAD model which ane the bare of mache-Lconemic theonies and models and which wene used in many Countnies te predict the eppect of alternative policies on MAChO LOMO MLC vanlables Keynes meven hecomumended using these modela fon policy formulation but still they were used in vanying degrees in most developed countnies. Begone we proceed funthen, it Ls betten to undenstand some basic terme: (a) Structune of the Medel: The whole complen of featunea which ane assumed te remain constant, ane called economic structune on structune of the model Structunal Panametenas Thene ane some mumenical constants that chanactenize the atructune of the model, they ane known as structural panametens. © Endogenous Vaniable: Those vantables that ane Aetenmined within the model ane known as 2ndogenous vanlable. In othen wends, the value of thease variables Le detenmined within the system of tanatlens given by the model, 2007369817 (A Emogenous Variable: Those variables whose values ane assumed te be known and gin and the value of these vanables ane mot determined by the system of tquatlons given by the model ane called Lnogenous vanables. A slimple model of income determination is given below, C4+Iay Ceat+khL bY wy 12 When, Ca Aggnegate consumption Lmpenditune as Autonomous comsumptLon bs Pc Le Manginal. propensity of consumptLon Le Aggregate investment tmpenditune YeReal National Income FeRwenne from dinect tanea In this equation a and b ane structural panametena; C and ane endogenous vantables andl andt ane AMO hMOUS vanLables. (et) ¥ La personal disposable income It is an enample of deterministic model in which the endogenous variables cand y ane sentinely determined given the values of 20ogeneus variables T and £. From Lam. Q) we get yet+b fla th 2007364817 Cefad Hise ad ty Thene ant some Limitations of deterministic models. The most Umpentant one is that a dckenminLatic model is genenally used to isolate the moat Lumpent art Aetenmining factions fon the variables of interest, Like y inthe above Laasnple. ©) Second these models ane used to represent the nelatLonships between the variable in the model in a slnple and clean mannen These modele ane oven Almplified venslons of reality and do ignone many factons that can appect the variables of inteneat. Hence, we cannot empect that these models will amactly descnibe the nelatLonship between the Andegenous Variables and snegensus variables asthe fonmen ane being determined ina sLmpligied vensien that is tee away from the reality while the Latten is being determined by the actual data. New the question anises that how to solve thls probleme How to relate detenmintatic economic models te actual data? The usual stnategy is te intneduce mew vaniablea in Aiggentntdetenministic equations of the model The mew vanlables) conntaponding to tach Lqpation is tmpected te compensate fon the effects of all othen factions that can appect the relationship between enogencus and sndogencus variables inthe model. These newly Introduced variables ane nandem in matune and nepresent 200726481 F namdem Alstunances to the detenministic nelatiolhips between eaegencus and sndoqenous variables in the Wedel Se, in onden te intneduce nandem varlable we can modify the ean. W) as $olLows: Cearb Ot) ua Whene, u is representing an additive disturbance term which will help te judge the emact relationship between AMOZLNOUS and endogenous vaniables inthe model When we intreduce additive dlstumbance Lenm in deterministic equation it is called stechaatic Lqpnatlen as stochastic tenmu Ls introduced ene. The above tqnations ane an eaample of a simple macro-economic model But the neal Life economic models which are used fon policy fonmulatlen, ane certainly wuch Langen and complicated as these models include many mone variables and equations. Fen ecampl.e, a classic macne-ecomomic model was developed by LR KLLen and AS. Goldbengen Ln 1455 which contained twenty atechaatic eqpatLons, twenty endogenous vaniables and eighteen LM GLMIHUS vanLables. Eon trample, in eqn @) above, tisa policy vani.abl If we ssume that the stochastic vantable u 14 distributed with cenpactes value 0, then prom taps (D and tan D wt

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