Transcript Slide 2

Slide 2
After Exam 1
Distribution of Exam 1 Score
18
17.5
17
17
16
15.5
15.5
15.5
15.5
15.5
15
14
13.5
13.5
13
12.5
12.5
12
11.5
11
10.5
10
10
10
7
A Lecture From Mr. Romney
• http://www.youtube.com/watch?v=eur8rYBot
xg
US Trade Balance
(Deficit if Negative)
US Trade Balance (Million Dollars)
100,000
0
1960
1970
1980
1990
2000
2010
-100,000
-200,000
-300,000
Series1
-400,000
-500,000
-600,000
-700,000
-800,000
Facts
• Data from http://www.census.gov/foreigntrade/statistics/historical/#
• US had no trade deficit before 1980
• China joined world trade organization in
December 2001
• Hot issue: is Chinese currency the main reason
for US trade deficit?
Hint 1
• Before 2000, US had trade deficit mainly with
Japan and Germany
• Both countries use floating exchange rates
Hint 2
Hint 3
• In eco 201 you learn that it is demand and
supply that determine the price, not vice versa
• Mr Romney just looks at the demand curve,
and he forgets supply curve
Three Questions
• How to explain the rising trade deficit in early
1980?
• How to explain the rising trade deficit in early
1990?
• How to explain the falling trade deficit in late
2000?
Review
• We apply classical dichotomy to open
economy
• We first find net export, then real exchange
rate, and finally nominal exchange rate
Long Run Model for
Exchange Rate
• Arbitrage will not stop until
𝑃∗
𝑃 = (Law of One Price)
𝑒
𝑃
𝜀 ≡ ∗ = 1 (Absolute PPP)
𝑃 /𝑒
∗
𝑃
𝑒=
𝑃
𝑒% = 𝜋 ∗ − 𝜋 (Relative PPP)
Discuss
• What may cause law of one price or
purchasing power parity to fail?
• If inflation in England was higher than
Germany in 1992, then British Pound was
expected to ______________ against German
Mark
Short Run Model
• The nominal exchange rate is the price for
currency
• Suppose home is China, and foreign country is
US
• The exchange rate for Chinese currency yuan
is denoted by $/¥. Yuan appreciates when the
exchange rate goes_______
Warm Up
• As yuan appreciates, the Chinese good
becomes (more expensive or cheaper), and
this will (increase or decrease) the demand for
Chinese good
Demand and Supply
• The demand for yuan comes from China’s
export
• The demand curve is downward sloping since
China’s export falls as yuan appreciates.
• The supply for yuan comes from China’s
import
• The supply curve is ______ sloping since
China’s import ________ as yuan appreciates
Application
• How to explain that there are more and more
Chinese students coming to US when yuan
appreciates?
Graph Time
• The demand-and-supply diagram for yuan is
Critical Thinking
• Draw the demand and supply curve for Yuan,
but now the exchange rate is ¥/$
Story Time
• In order to help China’s export, the Chinese
government want to keep the value of yuan
(low or high)
• That means, thanks to Chinese government’s
intervention on the FX market, there will be
(shortage or surplus) of yuan, and China will
have trade (deficit or surplus)
How To Intervene
• Chinse government needs to constantly sell
yuan and buy dollars on the FX market
• That means supply curve of yuan shifts to
(right or left), and Chinese dollar reserve (rises
or fall)
US Foreign Debt
There is no free lunch
• Undervalued Yuan helps Chinese export
• Undervalued Yuan may lead to inflation in
China (How?)
Application: Quantitative Easing
• China exports good, and US exports inflation
(to a country whose currency is pegged to US
dollar)
China can control exchange rate, but
only the nominal one, and only in
short run
• In long run, price level in China will rise, and
this will cause yuan to appreciate in real term,
even though the nominal rate is fixed (how?)
In long run, the winner is
Currency Crisis
• George Soros vs Bank of England
• Before September 1992, Pound was pegged to Mark
• Soros thought Pound is ________ because inflation in
England was higher than Germany
• To keep Pound from depreciating, Bank of England had
to ____ Pound and _____ Mark
• The foreign reserve of England went ______
• Crisis happened when __________
• Soros tried again, in 1997, at HongKong, but this
time….
Do not mess with Texas
• Because they are big!
Why do economists hate
budget deficit?
• Rising government expenditure crowds out
investment and export
• Investment is crucial for growth
Production Function
•
•
•
•
𝑌 = 𝐹(𝐾, 𝐿)
Static Model, limited but still insightful
Why is Japanese economy stagnant?
Why is China’s growth faster than US?
Solow Model
•
•
•
•
Dynamic Model
Proposed by Robert Solow, a Nobel winner
It shows how the income grows over time
The key concept is steady state (dynamic
equilibrium)
Per Worker Terms
• 𝑌 = 𝐹(𝐾, 𝐿)
𝑌
,𝑘
𝐿
𝐾
𝐿
• Let 𝑦 =
= denote the per-worker term.
Constant return to scale implies that
𝑦 = 𝑓(𝑘)
Assuming constant saving rate
𝑖 = 𝑠𝑓(𝑘)
where 𝑖 is per-worker saving and 𝑠 is the saving rate.
Fundamental Equation
• Change of capital equals investment minus
deprecation.
∆𝑘 = 𝑠𝑓 𝑘 − 𝛿𝑘
• ∆𝑘 > 0 when investment exceeds deprecation
• ∆𝑘 < 0 otherwise
• ∆𝑘 = 0 at steady state 𝑘 ∗ . In other words, 𝑘 ∗
solves the equation
𝑠𝑓 𝑘 ∗ − 𝛿𝑘 ∗ = 0
Exercise
• Fundamental Equation:
∆𝑘 = 𝑠𝑓 𝑘 − 𝛿𝑘
• Find 𝑘 ∗ when 𝑠 = 0.3, 𝛿 = 0.1, 𝑓
• Find ∆𝑘 when 𝑘 = 4
• Find ∆𝑘 when 𝑘 = 16
=
Critical Thinking
What if Increasing Marginal Product
• Fundamental Equation:
∆𝑘 = 𝑠𝑓 𝑘 − 𝛿𝑘
• Find 𝑘 ∗ when 𝑠 = 0.3, 𝛿 = 0.1, 𝑓
• Find ∆𝑘 when 𝑘 = 4
• Is the steady state stable?
= ( )2
Discuss
• What is the effect of rising saving rate on
growth?
Steady State
• Dynamic equilibrium
• No change over time
• Fundamental equation
∆𝑘 = 𝑠𝑓 𝑘 − 𝛿𝑘
• At steady state, ∆𝑘 = 0, i.e., 𝑘 ∗ satisfies
𝑠𝑓 𝑘 ∗ = 𝛿𝑘 ∗
Solow Model
Without Population Growth
(1) At steady state 𝑘 = 𝑘 ∗ is constant
(2) At steady state 𝑦 = 𝑓(𝑘 ∗ ) is constant
(3) At steady state K = 𝑘 ∗ 𝐿 is constant
since L = 𝐿 (no population growth)
(4) At steady state Y = 𝐹(𝐾, 𝐿)is constant
• (4) is inconsistent with reality of persistent
growth in GDP
Dynamics
• Suppose at beginning 𝑘 < 𝑘 ∗
• Then 𝑘 will rise (∆𝑘 > 0) because investment
exceeds deprecation
∆𝑘
𝑘
• But the growth rate
falls as 𝑘 approaches
𝑘∗
• Just like a person, who grows fast when he is
baby, and stop growing eventually.
A Dilemma
• Figure 7-5 shows that higher saving can
increase 𝑘 ∗ , so is good in long run
• But higher saving cuts current consumption,
so is bad in short run
• Is there an optimal saving rate?
Golden Rule
• The goal is to find a saving rate so that the
corresponding 𝑘 ∗ maximizes consumption
• At steady state
𝑐 ∗ = 𝑦 ∗ − 𝑖 ∗ = 𝑓 𝑘 ∗ − 𝛿𝑘 ∗ (7)
𝑐 ∗ is maximized when first derivative equals 0:
𝑓 ′ 𝑘 ∗ = 𝛿 𝑜𝑟 𝑀𝑃𝐾 = 𝛿 (8)
We denote the steady-state 𝑘 ∗ that satisfies (8)
∗
as 𝑘𝑔𝑜𝑙𝑑
, called golden rule.
Optimal Saving Rate
∗
• After finding 𝑘𝑔𝑜𝑙𝑑
, the optimal saving rate is
(from the fundamental equation)
𝑠𝑔𝑜𝑙𝑑 =
∗
𝛿𝑘𝑔𝑜𝑙𝑑
∗
𝑓 𝑘𝑔𝑜𝑙𝑑
∗
• Exercise: Find 𝑘𝑔𝑜𝑙𝑑
and 𝑠𝑔𝑜𝑙𝑑 when 𝛿 =
0.1, 𝑓
=
Policy Implication
• If the current saving rate is less than 𝑠𝑔𝑜𝑙𝑑 , the
government may consider policy that
encourages more saving, such as higher tax
break to 401K account
Solow Model
with Population Growth
• Assuming the population growth rate is
∆𝐿 𝐿
𝑛≡
≈
𝐿
𝐿
where 𝐿 =
𝑑𝐿
𝑑𝑡
denotes the instantaneous change
Fundamental Equation
• Now the fundamental equation becomes
∆𝑘 = 𝑠𝑓 𝑘 − (𝛿 + 𝑛)𝑘
so 𝑘 can fall because either capital depreciates
or population grows
Proof (Optional)
∆𝐾 ≈ 𝐾 = 𝑠𝐹 𝐾, 𝐿 − 𝛿𝐾
𝐾
= 𝑠𝑓 𝑘 − 𝛿𝑘
𝐿
𝐾
𝐾𝐿 − 𝐾 𝐿 𝐾
∆𝑘 ≈
=
= − 𝑘𝑛
2
𝐿
𝐿
𝐿
= 𝑠𝑓 𝑘 − 𝛿𝑘 − 𝑛𝑘 = 𝑠𝑓 𝑘 − (𝛿 + 𝑛)𝑘
Application
• How does the one-child policy of China affect
its long run living standard?
Solow Model
with Population Growth
(1) At steady state 𝑘 = 𝑘 ∗ is constant
(2) At steady state 𝑦 = 𝑓(𝑘 ∗ ) is constant
(3) At steady state K = 𝑘 ∗ 𝐿 grows
(4) At steady state Y = 𝐹(𝐾, 𝐿) grows
• (4) is consistent with persistent growth in GDP
• (2) is inconsistent with persistent growth in
living standard.
Exercise
• At steady state K grows at rate ___?___
• (Optional) At steady state Y grows at rate _?_
assuming 𝐹 is Cobb-Douglas
Summarize
• Saving can increase future living standard
• Population growth can increase GDP
• Population growth can reduce future living
standard
• How about technology? Read chapter 8
(optional)