macro

Very Long Run

30-100 years, economic growth: slope of trend RGDP; g_Y=g_E+n

Long Run

In the long run, since the economy is at Y_P the income distribution is

1. Output at potential or trend; Y=Y_P when K and L employed at LR equilibrium levels. A, K, and L are not growing.

2. All prices are flexible

3. All markets in LR equilibrium all resources are “fully employed” L-Market: L^d=L^s=L —> u-rate is between 4 and 6% K-Marktet: K^d=K^s=K; —> capacity utilization rate is about 80% Financial market: S=I; all financial resources fully employed Goods Market: Supply = Demand; production =spending; Y_P=Y=C+I+G+NX = aggregate spending

Short Run

1-3 years, RGDP fluctuates around trend: recessions and expansions

US Real GDP, Y, and Potential RGDP, Y_^P

92% of time Y is within +-2% of Y_P, Y_P=Y when K and L employed at LR equilibrium levels, Y=C+I+G+NX = aggregate expenditure

Neo-classical Model of Income Distribution

Each factor of production (like labor or capital) is paid based on its marginal contribution to output. A firm will hire an input up to point where the real price of the factor equals its marginal product. W/P=MPL and R/P=MPK. Assumes rationality, perfect competition and that the total product is exactly exhausted by factor payments.

Why is MPL = W/P a profit maximizing condition?

A firm should hire labor up to the point where the cost of the last worker (W) equals the value of the workers output, which is the marginal revenue product (PxMPL). If the value of the output from an additional worker (PxMPL) is greater than the wage, W, hiring more workers will increase profits. A firm will continue hiring until this point is reached, where hiring one more worker would not increase profit, leading to the condition PxMPL=W, which rearranges to MPL=W/P

Why is MPK = R/P a profit maximizing condition?

A firm should continue to use capital until the marginal revenue from an additional unit of capital equals the marginal cost of that unit. This condition means that the firm hires capital until the value of the marginal product of capital (PxMPK) is equal to the real rental price of capital (R/P).

What happens in the LR when there is a one-time increase in capital?

More capital raises labor productivity (MPL), benefiting workers with higher wages and employment, but it reduces the return to capital (lower rental rate).

How did the Bubonic Plague affect the labor and capital markets in the long run?

The Bubonic Plague caused the death of 30-60% of Europes population so labor scarcity increased wages and workers bargaining power, while capital became less productive and landowners returns fell. The huge fall in labor supply increased MPL which increased real wages and decreased employment. Although capital was unchanged, it was in excess relative to labor. This meant the MPK decreased since it was less productive and the real rental rate of capital decreased.

Marxian Model of Income Distribution

Wages are fixed at subsistences level (just enough to survive) and the surplus value goes to capitalists as profit. Income distribution is determined by class power and exploitation

What is the difference in how Marxian and Neoclassical models view labor and capital?

Marx sees income distribution as a result of class conflict while Neoclassical theory sees it as the natural outcome of productivity in competitive markets.

What happens in the labor market in the long run after a one-time increase in immigration?

Immigration increases labor supply, lowering wages but increasing total employment. MPL decreases, so real wage decreases, employment (L) increases (more workers hired but at a lower wage).

What happens in the capital market in the long run when immigration increases?

Immigration raises MPK and rental rates in the short run, encouraging capital accumulation. Initially, there is more labor with the same capital so the MPK increases. The capital becomes more productive and scarce relative to labor so the rental rate of capital increases and capital demand increases. Over time, capital accumulates to restore MPK to normal.

What are the benefits and costs from one-time increase in immigration?

Owners of capital benefit since R/P increases, other things equal. Domestic workers are worse off since W/P decreases ote. Immigrant workers are better off (which is why they move).

Immigrants often bring substantial capital with them.

Immigrants bring human capital

Immigrants are more entrepreneurial than domestic residents; A increases

Which model better explains our world from 1800s to today?

According to McCloskey, today real wages are 8 times higher than in Marx’s day due to tech change that dramatically increased productivity. Thus, Marx was wrong about the development of capitalism.

What are the main reasons for the recent fall in the US labor share of GDP?

Measurment issuesL W is understated (more income counted as capital) and P is overstated using CPI instead of PCE so real wages look lower.

Structural shifts: rise in capital income (e.g. pensions, 401k returns, housing gains) and more income classified as capital rather than labor.

Power and mobility: lower labor mobility has caused weaker wage growth and an increased political and market power of top 1% and capital owners

Immigration: expanding labor supply and causing downward pressure on wages

According to the Neoclassical model, who gains and who loses from a one time increase in immigration?

Capital owners benefit as the rental rate of capital increases. Domestic workers are worse off as the real wage decreases. Immigrant workers are better off than in origin country. Real GDP increases because L increases. Immigration raises output and benefits capital owners, but lowers native wages in the basic model.

Why did David Card find smaller or no negative wage effects from immigration?

Because “other things are not equal”. Immigrants bring additional inputs that shift production, so wages don’t fall.

What key mechanisms did David Card identify that make immigration beneficial for both workers and capital owners?

Immigrants bring physical capital (K): K increases, MPK decreases, rental rate decreases. K increases, MPL increases so wages rise. 

Immigrants bring human capital (H): H increases so MPK and MPL increases and r and W/P stay the same. Everyone is better off.

Immigrants increase innovation and entrepreneurship (A increases): A increases so MPK and MPL rise —> rental rate stays the same and wages increase. This raises productivity economy-wide.

When immigrants bring capital, skills, and entreprenuership, both wages and returns to capital can rise —making everyone better off.

What are the long run consequnces of persistent government budget deficits?

Higher national debt and rising interest payments. Crowding out: less private investment because government borrowing increases real interest rates. Slower long-run economic growth (less capital accumulation). Reduced fiscal flexibility during recessions or crises. Higher future taxes and/or lower future government services. Potential default/inflation risks if debt becomes unsustainable.

what is the “crowding out” effect of long run deficits?

Government borrows more so the demand for loanable funds increases, the real interest rate increases, private investment decreases and there is a smaller future capital stock. Lower future GDP and wages. Long run deficits reduce private investment and future growth.

What was the Mariel Boatlift and why is important for studying immigration?

In 1980, Fidel Castro allowed 125,000 Cubans to leave for Miami. Increased Miamis Labor force by 7% almost instantly. This was a large one time immigration event that provides real world evidence on labor market impacts.

What did economists find about te wage and employment effects of the Mariel Boatlift?

Borjas found a 10-30 % wage drop for Miamis low-skilled workers. David Card found little to no change in wages or unemployment for lowskilled workers compared to similar US cities. Why? Immigration increased capital inflows and economic dynamism, offsetting wage pressure. Big immigration shocks have small or zero overall effects on wages and employment, though small short-run negative effects may occur for specific low skill groups.

what is consumption in GDP?

Household spending on goods and services and makes up about 70% of US GDP.

What is the basic consumption function?

C = a +b(Y-T)

Y-T = disposable income

a = autonomous consumption (does not depend on current income and is driven by expectations of future income and basic necessities)

b.= MPC (marginal propensity to consume) (fraction of extra income spent)

What is national saving?

S = Y - C - G

it is the part of national income not used for consumption or government spending

How do we express national saving using the consumption function C = a +b(Y-T)?

S = Y - a - b(Y-T) - G

S = (1-b)Y-a+bT-G

Does natonal saving depend on interest rate?

No because C does not depend on r in this model. Saving only depends on Y, T, G, and a.

What is investment (I)?

Spending on new factories, machines, inventories, and homes. It is the demand for loanable funds.

What is the investment function and what do its components mean?

I = f - hr

r = real interest rate (real cost of borrowing)

h = sensitivity of investment to r

f = autonomous investment

how does the real interest rate effect investment?

r rises —> borrowing costs increase and investment decreases. r decreases —> borrowing costs decreate and investment increases.

What is autonomous investment (f)?

The part of investment independent of interest rates. It is driven by expectations of future after tax profits. Keynes called it “animal spirits” — optimism/pessimism of firms (bull and bears).

what is h in the investment function?

measures how sensitive investment is to interest rate changes. Larger h —> investment reacts strongly to r.

What does Keynes mean by “animal spirits” in the context of investment?

“Animal spirits” refers to business confidence and emotion-driven expectations about future profits. It is the autonomous part of investment (f) not explained by interest rates. Optimism (bullish) —> firms invest more; pessimism (bearish) —> invest less

Animal spirits capture how psychology , confidence, and sentiment influence investment decisions.