- Macro goalso Stable prices Inflation- Monetary system may break down (may stop being accepted by others)- High transaction cost (like shoe-leather costs)- we want to spend our money now to avoid the lowering of the value of our money if there is inflation, and that comes with a transaction cost (it takes effort and timeto figure out how to spend your money). Deflation- “Debt-deflation”o E.g. you buy a house and take out a mortgage from the bank. Deflation may cause the value of the house to fall, but you still owe the same amount of money to the bank (thus you lose money).- You may also earn less money, so debt is even harder to pay- There is lowered consumption and demand for products when people have less money, which only causes more deflation and lower prices- This happened during the Great Depression You want neither inflation nor deflation; you want stable prices to avoid these downsides. Generally prices fall during a recession because of lowered demand- A model for long run economic growtho Using the labor market and the aggregate production function The labor market is an input market Aggregate production function: Y = f(K, L, tech.)= f(capital, labor, technology) Slope of the ray from the origin through A = (Y1/L1) = output/labor = labor productivityo Diminishing marginal returns to labor More and more units of labor are hired for a fixed level of capital and technology. Output will increase but it will eventually increase at a diminishing rate.SL (consumers)Wage ratesDL (firms)Real GDP, or YL1Q of laborAggregate production function (K and tech are constant)AY1L1Q of laborYAggregate production functionQ of L ΔY/ΔL = MPL = Marginal product of labor (diminishes as quantity rises)o MPK = marginal product of capitalo Modeling economic growth Model #1:- The economy grows through the increase of labor/the increase of employment Model #2:YAggregate production function (L and tech. are constant)Q of KReal GDP, or YBY2Aggregate production function (K and tech are constant)AY1L2L1Q of laborReal GDP, or YAggregate production function 2 (K and tech are constant)Y3CAggregate production function 1 (K and tech are constant)AY1L1Q of labor- K increases from K1 to K2- The economy grows through an upward shift in the aggregate production function (capital increases)- Model #1: economic growth due to increased employmento To increase labor, you can shift either demand or supply to the righto Right shift in the labor supply curveWage rateDSL1Q of LSLWage ratesDLL2L1Q of laborReal GDP, or YBY2Aggregate production function (K and tech are constant)AY1L2L1Q of labor As we move from A to B, labor productivity (the slope ofthe ray through a point on the graph) decreases The labor productivity at A = Y1/L1, the labor productivity at B = Y2/L2 E.g. with a fixed amount of machinery, there will be more people per machine and therefore labor productivity will fall- Alternatively, we can use model #2- The slope of the ray through a point on the aggregate production function measures capital productivity- Capital productivity at A = Y1/K1, at B = Y3/K1- Capital productivity increases as labor increases- E.g. the amount of use you get out of a machine increases with an increase in labor (because you have more people per machine)Real GDP, or YAggregate production function 2 (K and tech are constant)Y3CAggregate production function 1 (K and tech are constant)AY1K1Q of
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