ECO102 Lecture 09

ECO102 - Week 08.pdf part 2

Trade Policy
- Analyse how tariffs will affect the US economy.
- Tariff reduces MPI, creates an Inflationary Gap
- $A S = 3 p + 10 - w$
- $w_{0} = 10$
- $C + 12 + 0.8 (Y - 10 - 0.2 Y)$
- $I = 8$
- $G = 15$
- $N X_{0} = 3 - 0.35 Y - 1.5 P$
- $N X_{1} = 3 - 0.1 Y - 1.5 P$
- $M P I_{0} = 0.35$
- Tariffs make imported goods more expensive, so it drops the MPI to $0.1$
- $A E = C + I + G + N X$
- $A S = 3 p$
- $A E = 30$
- $A E = 12 + 0.8 (Y - 10 - 0.25 Y) + 8 + 15 + (3 - 0.35 Y - 1.5 P)$
- $A E = - 1.5 P + 0.25 Y + 30.0$
- $Y = A E$
- $Y = - 1.5 P + 0.25 Y + 30.0$
- $Y = 40.0 - 2.0 P$
  - $A D$
- Tariffs make the demand curve steeper
- $A E = 12 + 0.8 (Y - 10 - 0.25 Y) + 8 + 15 + (3 - 0.1 Y - 1.5 P)$
- $A E = - 1.5 P + 0.5 Y + 30.0$
- $Y = - 1.5 P + 0.5 Y + 30.0$
- $Y = 60.0 - 3.0 P$
  - $A D$
- $A S = 3 p$
- $L R A S$ is vertical at initial equilibrium output
- Only thing that happens after tariffs is that prices and wages rise.
- $N X_{0} = 3 - 0.35 Y - 1.5 P$
- $N X_{1} = 3 - 0.1 Y - 1.5 P$
- When we go from $B \to C$ then $P ↑$ causing $N X_{1}$ to shift downwards.
- Going from $C \to D$ then $P ↑$ again, giving us the same point as $A$
- So the NX diagram shows:
  - $N X_{0} ↑ N X_{1} ↓ N X_{2} ↓ N X^{*} = N X_{0}$
  - NX is unchanged.
- So tariffs just raise wages and prices, but don't change output or NX.
- #tk
  - Savings function
  - Budget balance
  - What are the changes through eq a,b,c,d?
6 LRAS Shock
- LRAS Shifts Right
- When LRAS shifts right, we have a recessionary gap.
- $y_{0} < y^{*}$
- They're closed by falling wages and prices.
  - #tk flashcards
- No bundle C in this case.
- $y^{*} = y_{0}$
- $A S_{0} = 2 p + 80 - 2 w$
- $w_{0} = 40$
- $A S_{0} = 2 p + 80 - 80 = 2 p$
- $C = 36 + 0.8 (Y - 20 - 0.25 Y)$
- $I = 10$
- $G = 30$
- $N X = 40 - p - 0.1 Y$
- Shock by $y^{*} = 120$
- $A E = C + I + G + N X$
- $A E = 36 + 0.8 (Y - 20 - 0.25 Y) + 10 + 30 + (40 - p - 0.1 Y)$
- $A E = 0.5 Y - p + 100.0$
- $Y = 0.5 Y - p + 100.0$
- $A D$
  - $Y = 200.0 - 2.0 p$
- $A D = A S_{0}$
- $200 - 2 p = 2 p$
- $p = 50 ⟹ Y = 100$
- At bundle B, $Y = 100, p = 50$ but $y^{*} = 120$
- $A D = 200 - 2 p$
- $120 = 200 - 2 p$
- $p = 40$
- $120 = (2) (40) + 80 - 2 w$
- $w = 20$
- $A S = (2) (40) + 80 - (2) (20)$
- $A S = 120$
- What causes the Long-Run Aggregate Supply to shift?
  - Something permanent
  - Changes in $w$ will shift short run.
  - War
    - If people are unable to go to work.
    - Society isn't functioning.
    - Then prices rise
8 Monetary Policy
- $C = 14 + 0.9 (y - 10 - 0.1 Y)$
- $I = 15 - r$
- $r_{0} = 5$
- $r_{1} = 2$
- $G = 4$
  $N X = 11 - 0.01 Y - 0.5 p$
- $A S = 5 p + 20 - w$
- $w_{0} = 20$
- Two ways the govt can manipulate exchange rate:
  - Direct
    - Overnight rates
    - Interest rates charged to banks by the central bank
    - These rates are passed onto consumers.
  - OMO
    - Open Market Operations
    - Buying and selling government bonds to influence the money supply.
    - If central bank sells bonds, price goes down. (supply increase, value down)
      - Price goes down, so yield goes up.
        
        Yield is difference between par (face value) and price you paid.
        
        You have a bond worth 100, but you bought it for 80, so you get 20 back. Yield is 20.
      - $Yield = \frac{Worth - Par}{Worth} = \frac{100 - 80}{100} = 0.2$
- With this example, the yield makes the $I$ negative. It's the opportunity cost for investments.
- $r_{0} = 5$ , then $I = 10$
- $r_{0} = 2$ , then $I = 13$
- $C = 5 + 0.9 (y - 10 - 0.1 Y)$
- $A E = 5 + 0.9 (Y - 10 - 0.1 Y) + 10 + 4 + 11 - 0.01 Y - 0.5 P$
- $A E = - 0.5 P + 0.8 Y + 21.0$
- $Y = A E = A D$
  - $Y = - 0.5 P + 0.8 Y + 21$
  - $Y = 105.0 - 2.5 P$
- #tk he got:
  - $A E_{0} = 30 + 0.8 Y - 0.5 P$
  - $A D_{0} = 150 - 2.5 P$
  - $A E_{1} = 33 + \dots$
  - $A D_{1} = 165 + \dots$
- A:
  - $p_{0} = 20$
  - $y_{0} = 100$
- B:
  - $p_{1} = 20$
  - $y_{1} = 115$
  - $S M = \frac{15}{3} = 5$
- C:
  - $p_{2} = 22$
  - $y_{2} = 110$
  - $S M = \frac{10}{3} = 3. \overset{―}{33}$
- $A S = 5 p - 30$
- Fiscal Policy:
  - Affects $G, T, t$
  - Takes a lot of time to affect govt spend and tax changes.
- Monetary Policy:
  - Affects $r$
  - Implemented in a day.
  - Easy to drop and bump.
  - However this affects a lot of the canadian economy.
  - Higher interest rates affect business borrowing, net present value, return on investment, etc.
  - Argument:
    - Manipulating economy by $r$ will destabilize the economy, so it's not a good idea to do it too much.
    - People who are in charge of monetary policy, need to have independence from politicians.
    - Is this why Federal Reserve is independent from the US government?
  - #tk flashcards on differences between fiscal and monetary.
We've been studying keynesian macro.
- We can't wait for the long run to happen?
- Classical says keep hands off the economy. No govt policy.
- Hayek says no policy.
- Keynes says we need to intervene in the economy to get out of recessionary gaps and inflationary gaps.
7 Balance the budget
- $A S = 2 p + 100 - w$
  $w_{0} = 100$
- $C = 20 + 0.8 (Y - 0.25 Y)$
- $T_{0} = 0$
- $I = 10$
- $G = 40$
- $N X = 10 - 0.8 P$
- Indirect taxes are initially $0$
- Find $\hat{T}$
- $A S_{0} = 2 p$
- $M P I_{0} = 0$
- $A E = 20 + 0.8 (Y - 0.25 Y) + 10 + 40 + (1 - 0.8 P)$
- $A E = - 0.8 P + 0.6 Y + 71$
- $Y = - 0.8 P + 0.6 Y + 71$
- $Y = 177.5 - 2.0 P$
- #tk he got $A E = 80 + 0.6 Y - 0.8 P$
- $A D = 200 - 2 p$
- $A S_{0} = 2 p$
- $A D = A S_{0}$
  - $p_{0} = 50$
  - $y_{0} = 100$
  - $b_{0} = 0 + 0.25 (100) - 40$
  - $b_{0} = - 15.0$
- Find $\hat{T}$ so $b_{2} = 0$
  - $b = \hat{T} + 0.25 Y - 40$
  - $\hat{T} = - 0.25 Y + b + 40$
  - $\hat{T} = - 0.25 Y + 40$
- $A E = 20 + 0.8 (Y - (40 - 0.25 Y) - 0.25 Y) + 10 + 40 + 10 - 0.8 P$
- $A E = - 0.8 P + 0.8 Y + 48.0$
- $A E = Y$
- $Y_{2} = 80$
- Adding taxes will make GDP go from 100 to 80, but it will balance the budget.
- $\hat{T} = 40 - 0.25 (80 = 20)$
- $A E = 64 + 0.6 Y - 0.8 P$
- $A D = 160 - 2 p$
- $100 = 2 \cdot 30 + 100 - w$
- $w = 60$
- $b_{0} = - 15$ needs $\hat{T} = 20$ to balance the budget.
- We need to tax more than budget deficit because multipliers.
- Since $t = 0.25$
- Contractionary fiscal policy reduced GDP by $20 $$ . So direct tax revenues fell by $5$ dollars. So we need to increase $T ↑ 15$ and then $T ↑ 5$ to make up for loss in direct tax revenue.
- In long run, policy is too strong.
  - We got rid of deficit but now we have a surplus of $b = 5$
  - It's a common outcome.
  - It's a short-run overreaction.
- Find $\hat{T}$ so $b^{*} = 0$
- $\hat{T} = 15$ at $b_{0} = - 15$ if $t y = 0.25 (100)$ , GDP stays at original level.
- 3 questions each worth 5 marks.