Vorlesung by tonze.danzel


									 Business Cycle and Employment
                Lecture # 8
       Static Macroeconomic Models:
        The Lucas Supply Function

                    KoBe I / Lecture #8        1

• Review of last time
• Main conclusions of "first pass" at competitive
  model with aggregate supply
• Role of expectations
• Imperfect information and rational expectations
  (Lucas' Island Model)
• Implications for macroeconomic theory and
                    KoBe I / Lecture #8        2
           1. Review of Last Time
• Critique #1 of both classical and Keynesian models:
  primitive aggregate supply
• Foundations of aggregate supply: Why nominal
  wages and prices are not constant
• First pass: Classical model with flexible prices and
  perfect information, with firms as price takers
• Possible also to think of firms as price setters using
  models of monopolistic competition (we will return
  to this later)
                       KoBe I / Lecture #8         3

            1. Review of last time

 • We began with perfect information about p and m
   and perfectly competitive submarkets
 • Result: aggregate supply results from a decision
   concerning a relative price (output price relative
   to the known price level)
 • Result: money is neutral
 • If p and m not observable, agents will form
   expectations of these variables
                       KoBe I / Lecture #8         4
           2. Role of expectations
 • Key aspect of Lucas' "island model" is that agents
   do not have perfect information and therefore
   must form an expectation of the aggregate price p
 • How they form this expectation (pe) is crucial
 • Adaptive expectations alone could generate model
   dynamics: Example: pet = λpet-1+(1-λ)pt-1
 • Lucas (as Sargent and others) criticized this
   assumption and insisted on rational expectations
                         KoBe I / Lecture #8            5

           2. Role of expectations
• The rational expectations hypothesis: expectations
  should reflect rational behavior otherwise presumed
  in agents
  – Strong form: agents know model, form mathematical
    expectation of relevant variables: pet=E[pt]
  – Intermediate form: agents form conditional expectations,
    given a subset of the relevant information pet=E[pt|It-1]
  – Weak form: agents do not make systematic mistakes
• We'll use the intermediate form, and thus need to
  learn a few facts about expectations
                         KoBe I / Lecture #8            6
     3. Second Pass: Imperfect
 information, rational expectations
• Lucas (1972, 1973) "Island Model"
• Assumption: labor supply is based on pet
           lt = (γ−1) −1(pit - pet )= (γ−1)−1E[sit|Iit]
• Assumption: Iit is given by pit
• What is E[sit|pit]?
• Signal extraction problem
• Model solution
                         KoBe I / Lecture #8              7

                         KoBe I / Lecture #8              8
                      AS: σ2m>> σ2x

KoBe I / Lecture #8                    9

KoBe I / Lecture #8                   10
                                             AS: σ2m<< σ2x

                       KoBe I / Lecture #8               11

• One story about aggregate supply studies how
  agents behave when they have to make supply
  decisions with incomplete information
• Dynamics come into the model via expectations
• How to get dynamics into the model:
  – Adaptive expectations
  – Capital stock
• …but neither works well with rational expectations

                       KoBe I / Lecture #8               12
• The Lucas-Supply Function shows how agents can
  have an incentive to use observable data to extract
• The solution to the signal extraction problem leads
  to the appearance of price rigidity…
• …even though prices are in fact perfectly flexible
• The slope of the AS curve will depend on the
  (perceived) variances of aggregate demand and
  idiosyncratic (individual) shocks
                      KoBe I / Lecture #8       13

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