代写ECON0016: Macroeconomic Theory and Policy Term 1, Problem set 2代写数据结构语言程序
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Term 1, Problem set 2
1. Perfect and imperfect competition on the supply side
Draw a single diagram showing the Classical model and the wage setting / price setting model.
· The distance between the WS curve and the LS curve shows the extent to which competition in the labour market is imperfect, due to workers’ market power, efficiency wages, or both
· The distance between the PS curve and the LD curve shows the degree of firms’ market power
· Remember that the PS is horizontal because we have assumed the MPL is constant.
What are the differences between the two models in terms of:
(a) Assumptions
· Perfect vs imperfect competition. In the “classical” model firms and workers are price takers with perfect information and the ability to write complete contracts. In the WS / PS model firms have market power so can set prices; workers have market power so have wage-setting power and incomplete contracts mean firms are unable to write contracts for effort so need to pay higher wages to persuade workers to exert effort.
(b) Methodology
· Micro-foundations. The Classical model is “micro-founded” in the sense that it is derived from the microeconomic problems facing firms and households
· The PS curve is micro-founded in the sense that it can be understood as the optimal behaviour of a firm with market power
· The WS curve is “ad hoc”. We haven’t derived micro-foundations for it, though one could in principle do so.
(c) Implications
· They imply different “equilibrium” levels of output, compare potential output y* with equilibrium output ye in the diagram above. At potential output all unemployment is voluntary; at equilibrium output there is both voluntary and involuntary unemployment.
· Whereas potential output is first-best, given the LS and LD curves; equilibrium output will be less than optimal so policy could improve welfare by shifting the WS and PS curves closer to the LS and LD.
· WS and PS depend on a whole range of factors such as the structure of the goods market and the degree of union power which can potentially change equilibrium output and employment
2. Using the IS – MR – PC model
Starting from the medium-run equilibrium, consider a temporary shock which shifts the IS curve rightwards for one period only.
(a) Show the response of the economy to this shock using the 3 equation model and explain carefully the path of output, inflation and interest rates. Your answer should include of careful explanation of the behaviour of price setters and wage setters using the diagram of the labour market.
Period 1
The shock hits, the IS curve shifts rightwards.
1. Interest rates are r=rs so demand increases to y1. Firms increase output to y1 to bring the goods market into equilibrium
2. Output is above equilibrium, so unemployment is lower, and workers have more bargaining power. They increase their nominal wages by more than expected inflation to reflect this, a total of π1 >πT. The gap π1 – πT is a measure of the extra bargaining power workers have as a result of lower unemployment/
3. Firms immediately set prices as a markup over wages so prices increase by π1
4. The economy moves to the red point, with y=y1, π= π1, r=rs.
5. The central bank is now off its MR curve. Interest rates are assumed only to affect the economy with a one-period lag, so the CB needs to forecast where the PC will be in the next period. Actual inflation today is π1 so the CB knows expected inflation in the next period will be π1 so forecasts that the PC will be move to PC1.
6. The CB wants output on the intersection of this forecast PC with the MR curve (the blue point) in the next period. Should the CB choose the appropriate interest rate from IS0 or IS1? Since the interest rate change takes one period to have an effect, it could be argued that either of these is relevant.
Period 2
1. The IS curve shifts back to IS0
2. The increase in interest rates in period 1 decreases the interest sensitive components of demand so moves the economy along the IS0 curve. Aggregate demand and output change to y2
3. Inflation last period was π1 so expectations are updated to reflect this.
4. Output is below equilibrium, so unemployment is higher and workers have less bargaining power. They increase their nominal wages by less than expected inflation to reflect this, by π2 < π1. The gap π2 – π1 is a measure of the lower bargaining power workers have as a result of higher unemployment.
5. Firms immediately set prices as a markup over wages so prices increase by π2 = π1-x1 and the actual real wage is again w0.
6. The economy moves to the blue point, with y=y2, π= π2, r=r1.
7. The central bank knows that expected inflation in the next period will equal actual inflation in the current period so forecasts that the PC will shift to PC2.
8. To get to the intersection of this forecast PC with the MR curve (the green point) in the next period the CB sets interest rates in this period to r2.
From then on the CB guides the economy back down the MR curve to the medium run equilibrium with the PC shifting in each period as expectations are updated.
Analysis in the model
Time paths of variables
(c) How would the path of the variables change if the shock was permanent?
· The labour market and the path of inflation and output would be the same. However the central bank would need to choose higher interest rates on IS1.
(d) How would the response of the central bank be different if it was unsure whether the shock was temporary or permanent?
· A prudent approach would be to make the interest rate response a weighted average of the two possibilities, the weight depending on how likely the central bank thinks each possibility is. This would mean the economy is off the MR curve