Eleni Iliopulos
Spring 2012
Static model with three goods, a nal good, labor and money, three types
of agents, producers, consumers and a government, and perfect competition,
i.e. all agents are price-takers and prices are exible.
1.1
Production Sector
1.2
, N =
Consumers
N) =
C
b=(b + d)
1
M=P
d=(b + d)
Ne
e
(1)
with C the consumption, M=P the money demand (in real terms), H the
time endowment, > 0, e 1, b; d 2 [0; 1], and b + d 1.
The representative household maximizes his utility function facing the
budget constraint:
P C + M = M0 +
(2)
T + WN
with M0 > 0 the stock of money and T 0 lump-sum taxes. Taking as given
the real income I = M0 =P + (
T )=P + (W=P )N , we obtain:
C=
b
M
d
I and
=
I
b+d
P
b+d
N e =e
One obtains:
W
=
N e 1I 1
P
b+d
(3)
b d
(4)
1=(e 1)
When b + d = 1, W=P = N e 1 , N = 1 W
, i.e. 1=(e
P
the elasticity of labor supply with respect to the real wage.
1.3
1) represents
Government
1.4
b)I.
Equilibrium
M0
+Y
P
(5)
b+d
Ne
M0
+Y
P
1 b d
(6)
G=
b
b+d
M0
+Y
P
G
(7)
b M0
,P =
dY G
Equilibrium on money market is ensured by Walras law.
1.5
Case b + d = 1
a
1=(e a)
a=(e a)
N pc =
Y
pc
W
P
; P
pc
pc
e 1
a
= ae
M0
1 a
e a
(8)
1 b Y pc G
Money and public spending are neutral.
M0 > 0 and G > 0 only
pc
pc
pc
imply P > 0, without eect on Y , N , and on the relative prices.
1.6
Case b + d < 1
a(b + d)
e a
b+d a
(N
b
1 b d
=1
(9)
>0
(10)
2 (0; 1)
(11)
G)
Dierentiating, we obtain:
dN
= a
dG
N [e
(1 b d)N
a(b + d)] G(e
a)
Using Y = N a ,
dY
(1 b d)aY
= a
dG
N [e a(b + d)] G(e
a)
The economic mechanism is based on an income eect that aects the labor
supply when b + d < 1. G ") T ") income # ) labor supply increases for
all level of W=P . Therefore, at equilibrium, W=P decreases.
Since I = b+d
(Y G), we get dI=dG < 0, i.e. an increase of G reduces
b
C and M=P .
Using (7) and (9), one may also conclude that monetary policy is neutral.
One attempt to have keynesian results in macroeconomic models with
micro-foundations is based on price rigidities: the xed-price approach.
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1=(1 a)
N = (aP=W )
b
Y =
; N =
M0
+G; Ys =
b P
1W
P
P
a
W
1=(e 1)
(12)
a=(1 a)
(13)
2.1
M0
+G<
b P
a=(1 a)
P
a
W
(Y ).
W
,
<a
P
b
1
M0
+G
b P
(1 a)=a
(14)
b
1
M0
b M0
+ G , P > P pc
+G<
b P
1 b P pc
4
(15)
2.2
The producer does not perceive any quantity rationing, i.e. F 0 (N ) = W=P .
This requires Y d > Y s , i.e.
W
>a
P
b
1
M0
+G
b P
(1 a)=a
(16)
W
>
P
W
P
pc
(17)
2.3
W
<
P
W
P
pc
(18)
2.4
M0
b M0
+G>
+ G , P < P pc
b P
1 b P pc
(19)
Concluding Remarks
One obtains a classication with clear-cut policy recommendations.
However, such type of models have a crucial weakness: the absence of
a satisfactory theory of price and wage formation.
Therefore, another attempt to have economic models with market failures and (perhaps!) keynesian features: macroeconomic models with
imperfect competition ! explicit price and wage formation.
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