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My macro mid-term
Here is question number two, if you are bold try to sketch an answer in the comments.
Let us say you had a real business cycle model where production took a very long period(s) of time, rather than just a single (shorter) period. Might this help such a model explain the aggregate macroeconomic data? What might become easier and what might become harder?
Hint: One good approach is to break your answer down in the three categories of "comovement, persistence, and labor supply."
Posted by Tyler Cowen on October 27, 2005 at 07:07 AM in Economics | Permalink
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Comments
I've got part one, but part two is a bit trickier:
"Might this help such a model explain the aggregate macroeconomic data?"
Yes. It might.
Posted by: joshg at Oct 27, 2005 8:12:14 AM
It seems like RBC models never really pinpointed the exact source of the shock to the economy – it was always just an event. Extending the time periods used in the model allows for the persistence of the shock and helps explain the stages of production – I guess this goes along with the work of Kydland and Prescott. In terms of macroeconomic data, the model would more easily explain the cyclical nature of investment and consumption. I’m not sure if it would improve the interpretation of comovements among industries. Perhaps by extending the time period, the persistence of a production shock in the model increases, and this might help explain industry comovements. As for labor supply, an increase in the time period may explain frictional unemployment. Can’t think of what would become more difficult to explain…
Posted by: Jimmy at Oct 27, 2005 1:48:52 PM
Can we trade a good answer in the comments for one on the exam?
Posted by: ryan at Oct 27, 2005 6:05:36 PM
If our horizon is the short term and production took longer than our short-term horizon, then production is inelastic in our short-run.
Under this condition, any demand side shock will have no corresponding reaction from the supply side, in the short-run, and producers will react instantaneously to the demand shock by adjusting prices, a good example would be the last oil shock. From talking to the gas station owner where I buy my coffee every morning, he tells me that he never had any problem in the supply of gas, he was always able to get his daily quota during the hurricane(s). After the hurricanes, people anticipated a shortage in supply and that triggered a temporary demand shock, and producers (having an inelastic supply capacity in the short run, not because of the hurricanes) responded with higher prices.
As to co-movement, a slower production function allows for a more uniform distribution of demand among the slow producing suppliers. For example, if you use a drycleaner that can respond quickly to a demand side shock, you will not notice the demand shock the next time you walk into the drycleaner and will continue using the same drycleaner (no co-movement between your drycleaner and the one up the street). But if your drycleaner is slower in responding to a demand side shock, then the next time you walk into your drycleaner you will notice the long lines, and may decide to walk the extra steps to the next drycleaner, if long lines are at that next drycleaner too, then you will keep searching and may decide to use your own washing machine (increasing the demand for washing machines, etc). The result is a more uniform distribution of the demand shock, and if that continues a bit longer, prices will go up simultaneously (think of a group of balloons that are interconnected at 2/3rd there height, if you start pouring water into one balloon and the balloon is made out of very flexible rubber, then the one balloon will keep expanding with no overflowing to the next balloon, if the balloon is made out of more rigid rubber, then there is more chance that water –demand, will over follow to the next balloon, pushing the water-level –price, higher in all balloons.).
As to the labor market, the opposite could be true. An inelastic production function will cause labor demand by producers to be less reactive to demand shocks, here we have to assume a low marginal product of labor, other wise producers will attempt to increase production by increasing labor input, paying overtime, etc. Again, think of the gas station, the gas station owner cannot respond to a demand side shock by hiring more attendants.
Posted by: aly at Oct 28, 2005 9:17:25 AM
I guess this goes along with the work of Kydland and Prescott. In terms of macroeconomic data, the model would more easily explain the cyclical nature of investment and consumption. I’m not sure if it would improve the interpretation of comovements among industries.
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