●●● Lecture13 Neoclassical model
0 Lecture 13 Neoclassical Model
Economic Models o Real economy is too complicated to understand o Built your own, simple economy o Ingredients ● People e Goods and technologies Institutions
1 Economic Models Real economy is too complicated to understand Built your own, simple economy Ingredients ⚫ People ⚫ Goods and technologies ⚫ Institutions
●● Microfoundations o Use models that explicitly incorporate household and firm decision problems o Allows to capture how decisions adjust when economic environment of policies change
Microfoundations Use models that explicitly incorporate household and firm decision problems Allows to capture how decisions adjust when economic environment of policies change 2
● Using models o Tools to predict outcomes ● Optimization Market Clearing o Check whether model matches data o Yes: Likely that model world captures key features of the real world ●No: Build new model
Using Models Tools to predict outcomes: ⚫ Optimization ⚫ Market Clearing Check whether model matches data: ⚫ Yes: Likely that model world captures key features of the real world ⚫ No: Build new model 3
° A Simple Market Economy o One consumer. one firm o Consumer and firm trade in markets o Markets for consumption C and labor N
A Simple Market Economy One consumer, one firm Consumer and firm trade in markets Markets for consumption C and labor N 4
● Market Prices o Prices o Price of consumption normalized to one o Price for n is real wage W
Market Prices Prices: ⚫ Price of consumption normalized to one ⚫ Price for N is real wage w 5
The household's problem in ●●● the Market Economy o Utility function U(C, D) o C: Consumption(coconuts) ∶: Leisure o Budget constraint o Consumption expenditure equals income from capital and labor .C=wN+P-T o p is given, capital income o n is given by time constraint: n=h
The Household’s Problem in the Market Economy Utility function U(C,l) ⚫ C: Consumption (coconuts) ⚫ l: Leisure Budget constraint ⚫ Consumption expenditure equals income from capital and labor ⚫ ⚫ p is given, capital income ⚫ N is given by time constraint: N=h-l 6 s C wN p T = + −
●● The Consumers Preferences o Utility function U(C, D) o Assumptions o More is better than less U>0,u>0 o Diversity is good: Falling MRS o Consumption and leisure are normal goods
The Consumer’s Preferences Utility function U(C,l) Assumptions: ⚫ More is better than less: , ⚫ Diversity is good: Falling MRS ⚫ Consumption and leisure are normal goods 7 0 UC 0 Ul
● Indifference curves D Leisure, I
Indifference Curves 8
Properties of Indifference ●●● Curves o Downward sloping: Follows from positive marginal utilities o Convex: Follows from falling marginal rate of substitution
Properties of Indifference Curves Downward sloping: Follows from positive marginal utilities Convex: Follows from falling marginal rate of substitution 9