DOCSLIB.ORG

Problem Set 3 – Some Answers FE405

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Problem Set 3 – Some Answers FE405 Problem Set 3 – Some Answers FE405 1. Use the Discrete Time Ramsey equation and the Ramsey consumption function and explain what happens to the growth of consumption and to current consumption under the following circumstances: (a) a rise in the rate of interest (b) the individual becomes more impatient (c) the individual unexpectedly inherits a house ANSWER: a) A rise in the rate of interest (holding the discount rate constant and assuming for simplicity an initial situation of r = ρ) implies positive growth of consumption. In turn, this means a reduction in current consumption (the present value of wealth falls). b) If the individual’s discount rate goes up, consumption growth is negative. The individual wants to consume a larger share of their life-time income now so current consumption goes up. c) This will not affect the growth of consumption . i.e. the consumption path remains unchanged. However, it raises life-time wealth and hence consumption is higher now and in each subsequent period as compared with the situation before the unexpected windfall. The unexpected event increases permanent income and therefore consumption, there is going to be a jump up in consumption, to the new level consistent with the higher permanent income, when the event occurs. 2. What is precautionary saving? What assumptions are needed for precautionary savings to arise? Does precautionary saving resolve some empirical puzzles in consumption behavior? ANSWER: Precautionary savings are savings that are accumulated for a rainy day, a form of insurance against uncertainty. It requires the introduction of uncertainty (e.g. in health or labor income) and technically the third derivative of the utility function has to be positive so that the marginal utility of consumption is convex. It explains why individuals seem to consume ‘too little’ early in life, and why then consumption rises with current income, and why people save ‘too much’ at retirement. 3. What is meant by the expression “excess sensitivity” of consumption? How do the assumptions of the simple PIH have to be amended to account for this finding? ANSWER: By excess sensitivity is meant that consumption reacts too much to variations in current income that are predictable. PIH has to be amended with imperfect credit markets or simply by referring to precautionary savings. 4. Explain what is meant by the “excess smoothness” of consumption and why it may characterize behavior. Problem Set 3 – Some Answers FE405 ANSWER: By excess smoothness is meant that consumption reacts too little (sluggishly) to news about permanent income. Instead of jumping immediately to the new level of consumption predicted by the PIH, consumption adjusts slowly. Again, liquidity constraints may be an explanation for this. 5. This question relates to the consumption function presented in Section 1.10. Suggest why the real interest rate may have a negative effect on consumption. Use an IS diagram to represent the consumption function and discuss how consumption and hence the IS curve responds (ceteris paribus) to, (a) a higher proportion of creditors in the economy (b) an easing of liquidity constraints (e.g. because of more competition in the credit sector) (c) more uncertainty about future income growth (d) lower overall wealth (e.g. due to the bursting of a housing price bubble.) ANSWER: A higher real interest rate would under optimizing behaviour suggest delaying consumption in order to profit from the higher return/consumption in the next period. a) Consumption will rise by relatively less in response to lower interest rates: a steeper IS curve (see Fig. 7.3). b) An easing of liquidity constraints will allow a number of households to borrow against future income. This will raise the MPC and make the IS curve flatter (pivots on the r axis - see Fig. 2.16). c) Precautionary savings will go up. This would reduce the MPC and the size of the multiplier. IS curve becomes steeper (pivots on the r axis - see Fig. 2.16). d) This would reduce consumption, lowering permanent income. IS curve shifts left. The above answers can be related to the estimates presented in Section 1.10. 6. Compare the investment function of Chapter 2 (I = A – b*r) with the investment function in section 2.5 (I = A – b0*r + b1*y). Why is the additional output term in the equation? How would the following affect the IS curve (ceteris paribus): (a) increased sales (b) a change in competition law that will allow firms to exploit more economies of scale opportunities in the future. (c) a fall in corporation tax (d) a fall in the interest rate (e) higher interest-sensitivity of investment (f) higher output-sensitivity of investment ANSWER: Given borrowing constraints, investment is a function of current revenues/profits of a firm and this is why y is included in the second version of the IS curve Problem Set 3 – Some Answers FE405 a) Might affect A or only y therefore it depends how we model it, shift of IS curve to the right in the former; incorporated in the multiplier effect in the second case. b) changes A, profitability of investment. c) Since profits are increasing in y, a rise in corporation tax reduces the multiplier making the IS curve steeper. d) Movement south-east along the IS curve. e) IS curve flatter. f) .This is equivalent to a higher MPC in the consumption function. It has the same effect, i.e. increases the size of the multiplier, making the IS curve flatter. 7. Imagine you are running a safe house in the early 19th century. Assume there are 2000 gold coins deposited with you and that you have issued these people with deposit notes. You have lent 1800 gold coins. (a) Apart from lending money, what is the essential service that you provide? (b) What determines how much money you lend? (c) Why will people rarely withdraw their gold? (d) What is your implicit reserve-asset ratio? (e) If an additional 200 gold coins are deposited, how many additional deposits will you create? (f) Why may the calculation you made in (e) not be entirely accurate? (g) In a neighboring village, a banker was unable to meet calls on his funds and he went bankrupt. You decide to increase your reserve asset ratio to 20%. Why is it a bad idea to call in loans you have already made in order to meet the higher ratio? (h) An additional 1000 coins are deposited by people from the neighboring village. How many gold coins will you hold in cash and how many loans will you want to make if you decide to adjust to the more cautious reserve asset ratio? ANSWER: (a) The main function of a safe house was initially to provide a safe place to keep gold. (b) I want to lend as much as I can because I earn interest but I must take account of the fact that I must have liquid assets should people choose to withdraw their gold coins. (c) People will use deposit notes to exchange goods and to compare prices. Gold will in general not be used for day-to-day transactions. (d) 10%. (e) I will create an additional 2000 gold coins’ worth (200*(1/10)), which means I lend 3600 gold coins in total. (f) Cash drain and low uptake on loans. Problem Set 3 – Some Answers FE405 (g) Calling back loans will signal that I am in trouble and will mean that less people will deposit with me and, more seriously, people may decide to withdraw their deposits so I risk going bankrupt myself. (h) I now have 1400 in cash which means I lend 5600 gold coins worth in total. 8. What is the ‘money multiplier’? What determines its size? What leverage does this give the central bank over the money supply? ANSWER: The money multiplier is the amount by which an increase in high-powered money is converted to a change in the money supply. Its size depends on the cash to deposit ratio and the reserve to deposit ratio as shown in the formula: κ = (1+cd)/(cd+rd). The central bank can first and foremost determine the money supply by creating high- powered money while keeping the banking multiplier in mind. Second, it can affect the banking multiplier: an increase in rd lowers κ and vice versa. 9. Why might the cash/deposit ratio and the reserve asset ratio be decreasing functions of the rate of interest? How does an interest sensitive money supply affect the LM curve? Illustrate using an example, comparing the new LM with the standard LM. ANSWER: The cash/deposit ratio may be a decreasing function of the interest rate if higher interest rates 1) encourage people to borrow from non-bank financial intermediaries and 2) increase their deposits (this effect is reinforced if the deposit accounts pay interest). The reserve asset ratio may be a decreasing function of interest rates if banks hold excess reserves so that they are encouraged to lend more with higher interest rates. If κ increases with the interest rate for these reasons, this will make the LM curve more sensitive to the interest rate: it will be flatter. Fig. 2.3 can be modified to show this. 10. In Japan, the price of real estate dropped dramatically in the late 1980s. Many Japanese firms have long-term relationships with a so-called main bank. How would you expect a deterioration of the balance sheets of Japanese firms and of their main banks to affect investment? Would you expect smaller or larger firms to be most affected? ANSWER: The fall in the price of real estate generated a loss of wealth for firms as well as households.
Load more

Recommended publications
  • Macroeconomic Overview of India
    Macroeconomic Overview of India Since India gained independence from the British in 1947, they have made steady progress in economic growth and poverty reduction. There has been political unrest and tension with Pakistan. However, there have not been substantial shocks to the economy. The most recent crisis was in 1991, but was not a major crisis when compared to Asia or Mexico. GDP did not decline in 1991 or 1992. Despite the political tensions, India has shown substantial growth in the very long run. India is one of the fastest growing economies in the world.1 Output has increased incrementally, poverty rates have been reduced, and there has been ongoing improvement in measures of human capital. Substantial challenges, such as ameliorating the persistence of poverty and insuring growth continues, still exists. Currently, India’s GDP is around $3-$4 trillion, per capita GDP around $3000. The GDP in India is growing at a rate of 8%. 2 By looking at the Solow Growth Model and some other key macroeconomics theories, some improvement can be done to improve these figures. Economic Policy Changes Government controls on foreign exports and investment have been reduced which provides an opportunity for continued growth. In 1991, the government implemented a number of reforms to liberalize the economy and integrate into the global market. These included currency devaluations and making currency partially convertible, reduced quantitative restrictions on imports, reduced import duties on capital goods, decreases in subsidies, liberalized interest rates, and tax reforms.3 The policy changes have resulted in a $200 million increase in Foreign Direct Investment (FDI) from 1991 to 1992.
    [Show full text]
  • Chapter 4 the Overlapping Generations (OG) Model
    Chapter 4 The overlapping generations (OG) model 4.1 The model Now we will briefly discuss a macroeconomic model which has most of the important features of the RA model, but one - people die. This small con- cession to reality will have a big impact on implications. Recall that the RA model had a few special characteristics: 1. An unique equilibrium exists. 2. The economy follows a deterministic path. 3. The equilibrium is Pareto efficient. The overlapping generations model will not always have these characteristics. So my presentation of this model will have two basic goals: to outline a model that appears frequency in the literature, and to use the model to illustrate some features that appear in other models and that some macroeconomists think are important to understanding business cycles. 1 2 CHAPTER 4. THE OVERLAPPING GENERATIONS (OG) MODEL 4.1.1 The model Time, information, and demography Discrete, indexed by t. In each period, one worker is born. The worker lives two periods, so there is always one young worker and one old worker. We’re going to assume for the time being that workers have perfect foresight, so we’ll dispense with the Et’s. Workers Each worker is identified with the period of her birth - we’ll call the worker born in period t “worker t”. Let c1,t be worker t’s consumption when young, and let c2,t+1 be her consumption when old. She only cares about her own consumption. Her utility is: Ut = u(c1,t) + βu(c2,t+1) (4.1) The worker is born with no capital or bond holdings.
    [Show full text]
  • Arxiv:1907.02155V1 [Econ.GN] 3 Jul 2019
    EMERGENT INEQUALITY AND ENDOGENOUS DYNAMICS IN A SIMPLE BEHAVIORAL MACROECONOMIC MODEL Yuki M. Asanoa,b,c, Jakob J. Kolbb,d, Jobst Heitzigb and J. Doyne Farmere,f,g,1 aDept. of Engineering Science, University of Oxford, OX1 3PJ, UK bFutureLab on Game Theory and Networks of Interacting Agents, Potsdam Institute for Climate Impact Research (PIK), PO Box 60 12 03, D-14412 Potsdam cFernUniversität in Hagen, Universitätsstraße 47, D-58097 Hagen dHumboldt-Universität zu Berlin, Unter den Linden 6, D-10099 Berlin eInstitute for New Economic Thinking at the Oxford Martin School, University of Oxford, OX1 3UQ, UK fMathematical Institute, University of Oxford, OX2 6GG, UK gSanta Fe Institute, Santa Fe, 87501 NM, USA 1Corresponding author: [email protected] July 5, 2019 ABSTRACT Standard macroeconomic models assume that households are rational in the sense that they are per- fect utility maximizers, and explain economic dynamics in terms of shocks that drive the economy away from the stead-state. Here we build on a standard macroeconomic model in which a single rational representative household makes a savings decision of how much to consume or invest. In our model households are myopic boundedly rational heterogeneous agents embedded in a social network. From time to time each household updates its savings rate by copying the savings rate of its neighbor with the highest consumption. If the updating time is short, the economy is stuck in a poverty trap, but for longer updating times economic output approaches its optimal value, and we observe a critical transition to an economy with irregular endogenous oscillations in economic out- put, resembling a business cycle.
    [Show full text]
  • Dynamic Efficiency in the Two-Sector Overlapping Generations Model
    ARTICLE IN PRESS Journal of Economic Dynamics & Control 30 (2006) 1915–1936 www.elsevier.com/locate/jedc Dynamic efficiency in the two-sector overlapping generations model Emily T. Cremersà Department of Economics, National University of Singapore, Singapore 117570, Singapore Received 29 April 2004; accepted 31 May 2005 Available online 8 September 2005 Abstract This paper examines dynamic efficiency in the context of a two-sector overlapping generations model. First, conditions for dynamic efficiency in a centrally planned economy are derived. Then, in a competitive environment, the implications of dynamic (in)efficiency for the steady state relative price and steady state welfare are demonstrated. For the special case of a log-linear world, the golden rule savings rate is identified along with restrictions on parameters that yield dynamically efficient steady states. The results are further demonstrated via a welfare analysis of a simple tax/subsidy scheme. r 2005 Elsevier B.V. All rights reserved. JEL classification: O41; E13; D9 Keywords: Dynamic efficiency; Two-sector; Overlapping generations 1. Introduction It has been known since Diamond (1965) that a competitive equilibrium in the one-sector overlapping generations (OG) model with productive capital may be dynamically inefficient,1 and by now it is equally well-known that the welfare effects ÃTel.: +65 6874 6832; fax: +65 6775 2646. E-mail address: [email protected]. 1In the one-sector neoclassical growth model, a steady state is said to be dynamically inefficient when a Pareto improvement is made possible via a reduction in capital accumulation. Galor and Ryder (1991) 0165-1889/$ - see front matter r 2005 Elsevier B.V.
    [Show full text]
  • How Discounting and Growth Can Be Good for the Environment
    How Discounting and Growth can be Good for the Environment Sjak Smulders* University of Calgary and Tilburg University This version: May 2007 Abstract It is often argued that discounting future utility imposes a threat on the conservation of the environment for future generations. The same holds for productivity growth. Discounting puts a lower weight on the future and reduces optimal investment levels, both investment in productive man-made capital and in environmental assets. Productivity growth might bias investment towards investment in man-made capital, thereby crowding out environmental investment. We will show that implicit in these arguments are assumptions about whether the environment is mainly a source of productive inputs (i.e., a productive asset) or a (direct) source of utility. It is shown that, in contrast to conventional arguments, if society cares enough about the environment (thus acting as a durable consumption good), higher discount rates may increase optimal levels of environmental quality. If society cares relative less about environmental amenities, growth stimulates investment in environmental quality if the rate of intertemporal substitution is high. This paper derives optimal investment rules in a neoclassical growth model with both man-made and environmental capital. We find that maximizing discounted utility may result in a level of environmental quality that exceeds the level that would be chosen when altruistically maximizing future generations' utility levels. SSRN areas: environmental economics, macroeconomics. Keywords: investment, growth, environment, discounting. JEL codes: O41, Q20. I would like to thank Lucas Bretschger, Reyer Gerlagh, Christian Groth, Cees Withagen and seminar participants at Copenhagen University for useful comments on an earlier version.
    [Show full text]
  • ECNS 502 Macroeconomic Theory Montana State University – Depart
    ECNS 502 Macroeconomic Theory Montana State University – Depart. of Ag. Econ. & Econ. Course Number 30020 Spring 2017 Course Packet Dr. Gilpin Course Schedule Term Paper Homework Week Date Topic Due Dates Due Dates 1 Jan 12 Syllabus & Lecture 1 2 17 Lecture 2 2 19 Lecture 3 & Lit. review guidelines 3 24 Lecture 3 con. Topic 3 26 SAS Module 1: Importing/exporting data 4 31 Lecture 3 con. 4 Feb 2 Lecture 3 con. 5 7 Lecture 4 Step 2 (references) 5 9 SAS Module 2: Cleaning data 6 14 Lecture 5 6 16 Lecture 5 con. 7 21 Lecture 5 con. 7 23 Lecture 5 con. 8 28 SAS Module 3: Merging data 8 Mar 2 Exam I: Lectures 1- 5 (LINH 306 – during class time) 9 7 Lecture 6 Step 3 (summaries) 9 9 Lecture 6 con. 10 14 Spring Break (no class) 10 16 Spring Break (no class) 11 21 Lecture 7 Step 4 (paper outline) 11 23 Lecture 7 con. 12 28 Lecture 8 12 30 Lecture 8 con. 13 Apr 4 Lecture 8 con. 13 6 Lecture 8 con. 1st draft of research paper 14 11 Lecture 9 14 13 Lecture 9 con. 15 18 Lecture 9 con. 15 20 Student Presentations Present research 16 25 Student Presentations Present research 16 27 Review for exam 17 May 1 Final Exam: Lectures 6 – 9 (LINH 406 2-3:50 pm) Final draft This page is intentionally left blank ECNS 502: Macroeconomic Theory Dr. Gilpin Table of Contents ______________________________________________________________________________ Syllabus ............................................................................................................................................ i Lecture 1: Introduction to Macroeconomics` ..................................................................................1
    [Show full text]
  • Alan Deardorffks Contributions on Trade and Growth!
    Alan Deardor¤’sContributions on Trade and Growth Gene M. Grossman Princeton University September 2009 To be presented at Comparative Advantage, Economic Growth, and the Gains from Trade and Globalization: A Festschrift in Honor of Alan V. Deardor¤, sponsored by the Department of Economics and the Ford School of Public Policy at the University of Michigan. The festschrift will be held at the University of Michigan on October 2-3, 2009. 1 1 Introduction It has been a pleasure to re-read some of Alan Deardor¤’spapers on trade and growth, and to read others for the …rst time. These papers are typical of Alan’s work; they artfully tease new insights on important issues from simple, familiar models. It is …tting to begin my review with “A Geometry of Growth and Trade.”Alan loves diagrams and given his skill in developing them, it is easy to see why. His diagrammatic analyses are as incisive as any algebraic treatment and more pleasing to the eye. Deardor¤ (1974) provides a simple geometric tool for analyzing trade and growth in a small open Solovian economy. Consider a small economy that produces a single consumer good and a single investment good from two factors of production, capital and labor. For simplicity, take the labor force as …xed.1 Suppose that households save a constant fraction s of income and that capital depreciates at constant rate . In Figure 1, R (p; K) represents the revenue or national-product function for an economy facing world relative price p of the consumer good and having a stock of capital K.
    [Show full text]
  • LECTURE 4 Douglas Hanley, University of Pittsburgh ECONOMIC GROWTH in THIS LECTURE
    INTERMEDIATE MACROECONOMICS LECTURE 4 Douglas Hanley, University of Pittsburgh ECONOMIC GROWTH IN THIS LECTURE Why do countries grow economically? Why do some countries grow faster than others? Why has growth progressed at different rates over time? What is the best way to measure growth? OVERVIEW OF THE FACTS Growth in living standards was stagnant until about 1800 During this time, cross-country differences in living standards were small Since the industrial revolution, a subset of countries has experienced sustained per capita output growth of about 2% Because some countries did not experience this, cross- country differences in per capita output have increased GROWTH IN THE VERY LONG RUN POST INDUSTRIAL REVOLUTION "THE GREAT DIVERGENCE" TWO MODELS OF GROWTH Malthusian Model Plausible and accurate for pre-1800 experience Features population growth and fixed supply of land Solow Model Applicable to post-1800 industry led growth Features growth in population, technology, and capital MALTHUSIAN MODEL THOMAS MALTHUS (1766-1834) CONCEPTUAL MOTIVATION We want to make a model of an agrarian society Low level of technological advancement No substantial capital investment No way to control birth or death rates Expect a pretty grim outcome THEORETICAL COMPONENTS Output is produced from land and labor C = Y = z ⋅ F(L, N) Population growth is a function of birth and death rates N ′ = N(1 + b − d) Assume this varies systematically with per capita income N ′ C = 1 + b − d = g N ( N ) CONTEMPORARY EVIDENCE Life expectancy rises strongly with output
    [Show full text]
  • An Overlapping Generational Model with Capital Accumulation in a Small Open Economy Walter Enders Iowa State University
    Economic Staff aP per Series Economics 1981 An Overlapping Generational Model With Capital Accumulation in a Small Open Economy Walter Enders Iowa State University Harvey E. Lapan Iowa State University Follow this and additional works at: http://lib.dr.iastate.edu/econ_las_staffpapers Part of the Behavioral Economics Commons, Entrepreneurial and Small Business Operations Commons, and the Macroeconomics Commons Recommended Citation Enders, Walter and Lapan, Harvey E., "An Overlapping Generational Model With Capital Accumulation in a Small Open Economy" (1981). Economic Staff aP per Series. 69. http://lib.dr.iastate.edu/econ_las_staffpapers/69 This Report is brought to you for free and open access by the Economics at Iowa State University Digital Repository. It has been accepted for inclusion in Economic Staff aP per Series by an authorized administrator of Iowa State University Digital Repository. For more information, please contact [email protected]. An Overlapping Generational Model With Capital Accumulation in a Small Open Economy Abstract In this paper we develop a portfolio balance model which can be used to make an equitable comparison of alternative exchange rate regimes. Our point of departure from standard portfolio models is that we derive all asset demand functions from microeconomic behavior. As Helpman and Razin (1979) and Lapan and Enders (1980) have observed, all asset demand and expenditure functions used in a comparison of exchange rate systems must be consistent with individual optimizing behavior. This seemingly innocuous observation implies that many of the macroeconomic comparisons of fixed and flexible exchange rates are not legitimate. Inherent in any portfolio balance model is the implication that asset demand functions depend upon the joint distribution of asset yields.
    [Show full text]
  • Is the EU Structural Fund Creating Economic Growth? a Policy Analysis of the European Regional Development Fund - ERDF
    Is the EU Structural Fund Creating Economic Growth? A Policy Analysis of the European Regional Development Fund - ERDF Jonas Hallström Bachelor Thesis in Economics, 15 credits Economics C100:2 Spring term 2019 ABSTRACT The European Union uses a considered amount of the member states´ resources in the structural and cohesion funds to equalise income differences in the union and to induce growth to get economic cohesion between regions. An interesting and disputed question is if the funds are used in an effective way and if they reach their goals of economic growth. This is studied in the paper by a literature review and a following policy analysis which compare EU cohesion policy and academic knowledge. This question is addressed by performing a literature review of 16 articles about economic growth and its determinants in the European Union, and by comparing results from these studies with priorities of the main structural and cohesion fund’s policy, the investment priorities of European Regional Development Fund (ERDF). The paper concludes that seven out of 11 investment priorities correspond or fairly well correspond, to results from academic research of European growth. The study highlights the importance of the 11th investment priority, which is regional governments´ quality and its impact on the structural and cohesion funds´ growth efficiency. The paper also concludes that a well-adopted policy change would be to increase the status and importance of the 11th investment priority of the ERDF and the overall EU cohesion policy. Keywords: Structural and cohesion funds, EU regional growth policy, European economic growth, literature review, European regional development fund, policy analysis, growth efficiency, efficient allocation of EU funds, ERDF investment priorities.
    [Show full text]
  • ECON 581. the Solow Growth Model
    ECON 581. The Solow Growth Model Instructor: Dmytro Hryshko 1 / 59 General info e-mail: [email protected] office: HM Tory Building, 9-19 office hours: Friday 2{3 PM, or by appointment Teaching material available online web-page: http://www.artsrn.ualberta. ca/econweb/hryshko/ 2 / 59 General info Recommended text: Daron Acemoglu (2009). Introduction to Modern Economic Growth. Princeton University Press. But there're many other. Grading: an in-class midterm (35%) and final (45%) exams, and two problem sets (20%). 3 / 59 Scope of the course Growth (Solow model and models of endogenous growth) Consumption and savings Asset pricing Policy issues etc. 4 / 59 Outline for today Measures for standard of living The importance of economic growth Main long-run growth facts and their implications A basic model of long-run growth (the Solow model) Readings: Acemoglu, Chapters 1{3. 5 / 59 What is Economic Growth? Standard economists' answer: Growth in GDP per capita (or per worker), Y=L Does growth in per capita GDP reflect anything important about the improvement of living standards? {No consideration, for example, of the distribution of income within the economy (inequality) 6 / 59 Key Questions in Economic Growth Why are there countries so rich and others so poor? Why do growth rates vary across countries and over time? What are the policies that can change growth in the short and long run? Why do some countries \take off" while others fall behind 7 / 59 Measures of Living Standards Normally, the focus on two statistics of the average person's well-being: income and GDP per worker (productivity measure), and income and GDP per capita (welfare measure).
    [Show full text]
  • Observing the Evolution in Macroeconomic Theory
    Munich Personal RePEc Archive Observing the Evolution in Macroeconomic Theory Podshivalov, Georgii The Victor Popov Academy 30 November 2019 Online at https://mpra.ub.uni-muenchen.de/97657/ MPRA Paper No. 97657, posted 18 Dec 2019 12:28 UTC Observing the Evolution in Macroeconomic Theory Georgii G. Podshivalov Abstract: The principal purpose of the given work is to summarize certain observations on the evolution of thought in macroeconomic theory with the original (rather than conventional) notation where appropriate. The observations are organized by topic and supplied with respective references. JEL Classification Numbers: B20, E12, E19, E21, E24, E31, E43, E49, E52 Keywords: Economic Though, Economic History, Macroeconomic Models, Models Derivation, Notation, Expectations, Growth, Consumption, Unemployment, Inflation, Random Walk Hypothesis, Money, Natural Rate Electronic copy available at: https://ssrn.com/abstract=3495882 2 1. Expectations Rational behavior suggests that economic agents intent to choose actions that maximize their benefits (minimize costs) in prolonged periods of time. To be able to evaluate the optimality of decisions affecting their future in present, agents need information about relevant conditions and trajectory of change in such conditions in future. Expectations are beliefs used by agents as substitutes to factual information about said conditions. Accounting for expectations leads to more detailed and correct reflection of agents’ behavior in economic models. Consider, for example, the CBOE Volatility index (VIX) futures fair value model FV=f(Pt,vart[FT])=100sqrt((365-30)(Pt-vart[FT]) where FV is the fair value of the futures contract on VIX, Pt – forward price of de- annualized variance in the 30 days after the futures expiration, and vart[FT] - concavity adjustment (“Additional Features of VIX Futures”).
    [Show full text]