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Economics

ECON 2HH3

Rashid Khan

Spring

Description

Job loss, job finding and the natural rate of unemployment
Therefore, U/L = s/(f+s)
The steady-state rate of unemployment depends on f and s.
If f increases, unemployment rate goes down.
If s increases, unemployment rate goes up.
Any policy at lowering the natural rate must either increase the rate of job finding or
reduce the rate of job separation.
There are two underlying reasons for unemployment:
Job search: frictional unemployment
Wage rigidity: unemployment resulting from wage rigidity and job rationing is
called wait unemployment.
Three causes of wage rigidity:
Minimum-wage Laws
Union and collective bargaining: inside-outside theory
Efficiency wage hypothesis
(1-t)(1-a)w = b
b = (1-u)w(1-t) + u(cw)
u = a(1-t)/(1-c-t)
Higher income tax rate leads to lower return from workers. To counter the above, the
firms raise wage, leading to more unemployment. The implication is: lower tax rate will
reduce unemployment.
Try some numerical examples with t, c and a.
The production function, MP aKd returns to scale
Should know how to find MP K
Therefore, the steady-state equilibrium condition (when there is no population growth
and no technological progress) is:
(s/) = (k/y)
If we can solve steady-state k , we can solve y, c and per-labour saving.
Find the effects of an increase in marginal propensity to save (mps) on k , y, c, and per-
labour saving.
Find the effects of an increase in on the above.
When consumption (c) is maximized, it is called the Golden Rule.
Use the following equation and take the first derivative with respect to k and set it equal
to zero.
c = f(y) - k
dc/dk = MP -k= 0
The condition for Golden Rule k is:
MP =k
Consider population growth and (no t*chnological progress).
The condition for the steady-state k is:
sy = ( + n)k. That means,
[s/( + n)] = k/y Consider population growth and technological progress.
The condition for the Golden Rule of k is:
MP =k+ n
The condition for the steady-state k is:
sy = (+ n+g)k. That means,
[s/(( + n+g)] = k/y
The condition for Golden Rule k is:
MP =k + n + g
From the above, we can solve y, c and mps under the Golden Rule.
If the current mps is less than Golden Rule mps, implement policies to increase mps.
As a result, there will be an initial fall in c, but in later years, c will increase until the
Golden Rule c is achieved.
If the current mps is greater than the Golden Rule mps, then, implement policies to
reduce mps. As a result, there will be an initial increase in c, and c will continue to
increase until the Golden Rule c is achieved.
The growth accounting:
% change in Y = % change in A + % change in K + % change in L
(1- )
Y=AK L
The Solow Residual:
( A/A) = Y/Y – ( K/K) – (1- )( L/L)
Total factor productivity
Growth of labour productivity
Rationalize why IS-LM-r curves intersect when we draw the above graphs in r-Y plane.
If you know the components that make up the horizontal Y-intercepts of both IS and LM
curves, it will help you to rationalize the shifts of these above curves.
* *
Understand the derivation of IS and LM curves when we draw exchange rate (e) on
vertical line and Y on the horizontal line.
Make sure you know what causes the shifts of IS curve and LM curve.
Consider Flexible Exchange Rate system and show the effects of the Fiscal Policy (either
an increase in G or cut in taxes) on Y, C, I and net exports.
Show the effects of the Monetary Policy on Y, C, I and net exports under flexible
exchange rate system.
Show the effects of the Fiscal Policy (either an increase in G or cut in taxes) on Y, C, I
and net exports under fixed exchange rate system.
Consider the Fixed exchange rate system and show the effects of the Monetary Policy on
Y, C, I and net exports.
Consider also the policy-combinations under both fixed and flexible exchange rate
system.
Show the effects of devaluation policy.
Show the effects of an increase in the world interest rate (r ) on Y, C, I and net exports.
Show the effects of an increase in the risks in a given economy.
Make sure you know the insulation property under flexible exchange rate system. Consider the CPI effects and re-evaluate the previous policy-impacts and insulation-
property.
See the graphs and rationale behind self-adjustment mechanism with changing Price level.
Aggregate Supply (AS) function is:
Y = Y + (P – P ), where P = EP e
Derive the Phillips curve from the AS equation of Y = Y + (P – P ) e
n
Use Okun’s Law of (1/)(Y – ) = - Yu-u ) and derive the expectation-based Phillips
curve: equation:
e n
= - (u-u ) + v
The slope of the Phillips curve is: -.
Steeper the aggregate supply curve, steeper the Phillips curve
Understand the causes behind the shift of the Phillips curve.
Distinguish the short run Phillips curve from the long run Phillips curve.
Demand-pull and cost-push inflation
n
Estimate sacrifice ratio: assuming actual u exceeds u by 0.01, then GDP falls by 0

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