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Ch_5_One_Period_Model.pdf

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Department
Economics
Course
Economics 2152A/B
Professor
Jennifer Mori
Semester
Summer

Description
INTRODUCTIONSo far we have accomplished two things 1 We have modeled the behavior of the representative consumer and the representative firm and 2 We have built a labour marketWe now want to put together a model that uses what we have so far but that also has a government This will be a closed economy no foreign sector and it will be a one period economy This second fact is very important because it means that borrowing and lending can not happen in this economy since the economy only lasts for one periodLets imagine what ONE PERIOD really means It means that no market exists where economic agents can exchange consumption over time Now that is really confusing Or is itWhat do you do when you borrow What you are really doing is consuming something today and then paying for it in the futureExample You buy furniture today and dont pay for it today but in one years time you pay for the furniture Now the store will usually charge you a fee to postpone this paymentan interest rate Even Leons and the Brick calculate the interest in the no pay until 20XX events by charging higher prices than they would otherwise So in effect you have borrowed from the store the store has lent you real consumption in the form of furniture and you pay in one year You have really purchased two things one is the furniture and the other is timeWell not really time as time can not be purchased but the postponement of payment is measured in time The cost of the borrowing and the return on lending is the interest rateNow getting back to our economythese types of transactions over two periods can not take place Our model for the moment only lasts for one period All agents operate within this one period Later we will relax this assumption and allow for borrowing and lending but not quite yetADDIND GOVERNMENT TO THE MODEL Remember everything in the model is measured denominated in terms of the consumption good So when we want to add government we must allow the government to have some of the production of the consumption good to carry out their functions This we will call government expenditure and it is the usually G in our modelThe way that the government finances this expenditure is by taking away some of the consumption available to the consumer This is a tax T in our modelNow lets be sure we recognize that this tax is a lump sum taxThis simply means that the government in this simple one period model decides how much of the consumption good it wants G and takes this from the production Y of the economy Notice this alumpsum The consumer is affected by this BUT the actual amount of T is simply decided by the governmentit is what is called exogenous An exogenous variable AFFECTS the agents in the model but is NOT DETERMINED by the agents in the modelNormally this is stated as follows exogenous variables are determined OUTSIDE the model endogenous variables are determined BY the modelFor our purposes one way of discerning whether a variable is endogenous or not is to look at the variable on the axes of our diagramsIf the variable appears on the x or y axis then it is endogenous If the variable you are considering does not appear one of the axes then it is exogenous This makes intuitive sense since any point in the xy space is a function of the two variablesendogenous Now given that there is only one period and that taxes are lump sum the equation that represents the government sector is very simple indeedG TThis is formally called the governments budget constraint It means that fiscal policy is now in the modelfiscal policy is the expenditure G and tax revenue T of the governmentBecause the government can not borrow in the model and expenditure must be covered by taxation during the period Thus the budget of the government will always be balancedno deficit or surplus is possible This is true because a deficit means you spend more in one period than you have and then presumably pay for it laterWE ONLY HAVE ONE PERIOD A surplus means you have more revenue in the current period than you need and you can spend it lateragain we only have ONE periodCOMPETITIVE EQUILIBRIUMIn this economy all agents are price takers This means that no one agent is large enough to affect market prices
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