1. EC4004 Lecture 18
Markets & The Macroeconomy
Dr Stephen Kinsella

2. Today
Households
Recap
Constructing the BC

6. SULIS Test:
Opens Friday 2pm
Closes Friday 2pm

7. SULIS Test:
Opens Friday 2pm
Closes Friday 2pm
Exam:
Friday 12 Dec 4pm
PE HALL/GYM

8. SULIS Test:
Opens Friday 2pm
Closes Friday 2pm
Exam:
Friday 12 Dec 4pm
PE HALL/GYM
Extra Lecture Wk 13
Thursday 12-1
Concert Hall

11. 086 399 83 06

14. Labour: L (w)
Households
Capital: K (r)

18. Products
Profit=
PY-(wL+rK)

19. Products
Bonds
Profit=
iB
PY-(wL+rK)

20. Products
Bonds
Profit=
iB
PY-(wL+rK)
Labour
w/P*Ls

21. Products
Bonds
Profit=
iB
PY-(wL+rK)
Capital Labour
r/P - δ w/P*Ls

24. Constructing the Budget Constraint

25. Constructing the Budget Constraint
Quantities and prices determined on four
markets will determine household income.

26. Constructing the Budget Constraint
Quantities and prices determined on four
markets will determine household income.

27. Constructing the Budget Constraint
Quantities and prices determined on four
markets will determine household income.
Total sources of funds must equal the total uses
of funds.

28. Constructing the Budget Constraint
Quantities and prices determined on four
markets will determine household income.
Total sources of funds must equal the total uses
of funds.

29. Constructing the Budget Constraint
Quantities and prices determined on four
markets will determine household income.
Total sources of funds must equal the total uses
of funds.
This equality is the household budget
constraint.

30. Income

31. Constructing the Budget Constraint
12

32. Constructing the Budget Constraint
Income
12

33. Constructing the Budget Constraint
Income
Profits
12

34. Constructing the Budget Constraint
Income
Profits
Households earn profit—an excess of revenue over costs—
from their business activities.
12

35. Constructing the Budget Constraint
Income
Profits
Households earn profit—an excess of revenue over costs—
from their business activities.
• Y= A· F( Kd, Ld )
12

36. Constructing the Budget Constraint
Income
Profits
Households earn profit—an excess of revenue over costs—
from their business activities.
• Y= A· F( Kd, Ld )
π = PY − (wLd+ RKd)
12

37. Constructing the Budget Constraint
Income
Profits
Households earn profit—an excess of revenue over costs—
from their business activities.
• Y= A· F( Kd, Ld )
π = PY − (wLd+ RKd)
π = P A· F( Kd, Ld ) − ( wLd+ RKd)
12

38. Constructing the Budget Constraint
13

39. Constructing the Budget Constraint
Income
13

40. Constructing the Budget Constraint
Income
Wage income
13

41. Constructing the Budget Constraint
Income
Wage income
If households supply the quantity of labour Ls to the labour
market, they receive the nominal wage income of wLs per year.
13

42. Constructing the Budget Constraint
Income
Wage income
If households supply the quantity of labour Ls to the labour
market, they receive the nominal wage income of wLs per year.
Quantity of labour supplied is the fixed amount L, so nominal
wage income is wL.
13

43. Constructing the Budget Constraint
14

44. Constructing the Budget Constraint
Income
14

45. Constructing the Budget Constraint
Income
Rental income
14

46. Constructing the Budget Constraint
Income
Rental income
If households supply the quantity of capital Ks to the rental
market they receive the nominal rental income of RKs per year.
14

47. Constructing the Budget Constraint
Income
Rental income
If households supply the quantity of capital Ks to the rental
market they receive the nominal rental income of RKs per year.
Since households supply all of their available capital, K, to the
rental market, so that Ks = K, the nominal rental income is RK.
14

48. Constructing the Budget Constraint
15

49. Constructing the Budget Constraint
Income
15

50. Constructing the Budget Constraint
Income
Rental income
15

51. Constructing the Budget Constraint
Income
Rental income
The quantity δK of capital disappears each year.
15

52. Constructing the Budget Constraint
Income
Rental income
The quantity δK of capital disappears each year.
The euro value of this lost capital is P· δK.
15

53. Constructing the Budget Constraint
Income
Rental income
The quantity δK of capital disappears each year.
The euro value of this lost capital is P· δK.
• net nominal rental income= nominal rental income−
value of depreciation
15

54. Constructing the Budget Constraint
Income
Rental income
The quantity δK of capital disappears each year.
The euro value of this lost capital is P· δK.
• net nominal rental income= nominal rental income−
value of depreciation
• net nominal rental income = RK − δ P K
15

55. Constructing the Budget Constraint
Income
Rental income
The quantity δK of capital disappears each year.
The euro value of this lost capital is P· δK.
• net nominal rental income= nominal rental income−
value of depreciation
• net nominal rental income = RK − δ P K
• net nominal rental income = (R/ P)·P K − δ P K
15

56. Constructing the Budget Constraint
Income
Rental income
The quantity δK of capital disappears each year.
The euro value of this lost capital is P· δK.
• net nominal rental income= nominal rental income−
value of depreciation
• net nominal rental income = RK − δ P K
• net nominal rental income = (R/ P)·P K − δ P K
• net nominal rental income= ( R/ P − δ) · P K
15

57. Constructing the Budget Constraint
16

58. Constructing the Budget Constraint
Income
16

59. Constructing the Budget Constraint
Income
Rental income
16

60. Constructing the Budget Constraint
Income
Rental income
• rate of return on owning capital= R/ P − δ
16

61. Constructing the Budget Constraint
17

62. Constructing the Budget Constraint
Income
17

63. Constructing the Budget Constraint
Income
Interest Income
17

64. Constructing the Budget Constraint
Income
Interest Income
If a household’s nominal bond holdings are B, the flow of
nominal interest income received is iB per year.
17

65. Constructing the Budget Constraint
Income
Interest Income
If a household’s nominal bond holdings are B, the flow of
nominal interest income received is iB per year.
Since B equals zero for the whole economy, we have that the
total of interest income equals zero.
17

66. Constructing the Budget Constraint
18

67. Constructing the Budget Constraint
• Total income
18

68. Constructing the Budget Constraint
• Total income
–Household nominal income= nominal profit +
nominal wage income + nominal net rental income
+ nominal interest income
18

69. Constructing the Budget Constraint
• Total income
–Household nominal income= nominal profit +
nominal wage income + nominal net rental income
+ nominal interest income
–Household nominal income = π + wL + (R/P − δ) ·
PK + iB
18

70. Constructing the Budget Constraint
19

71. Constructing the Budget Constraint
Consumption
19

72. Constructing the Budget Constraint
Consumption
Households consume goods in the quantity C per year at
price= P
19

73. Constructing the Budget Constraint
Consumption
Households consume goods in the quantity C per year at
price= P
–Household nominal consumption= P C
19

74. Constructing the Budget Constraint
20

75. Constructing the Budget Constraint
Assets
20

76. Constructing the Budget Constraint
Assets
Households hold assets in three forms:
20

77. Constructing the Budget Constraint
Assets
Households hold assets in three forms:
money, M;
20

78. Constructing the Budget Constraint
Assets
Households hold assets in three forms:
money, M;
bonds, B;
20

79. Constructing the Budget Constraint
Assets
Households hold assets in three forms:
money, M;
bonds, B;
ownership of capital, K.
20

80. Constructing the Budget Constraint
21

81. Constructing the Budget Constraint
Assets
21

82. Constructing the Budget Constraint
Assets
Assume households hold a fixed amount of money in
euro terms.
21

83. Constructing the Budget Constraint
Assets
Assume households hold a fixed amount of money in
euro terms.
We assume that the change over time of a household’s
nominal money holdings is zero
21

84. Constructing the Budget Constraint
Assets
Assume households hold a fixed amount of money in
euro terms.
We assume that the change over time of a household’s
nominal money holdings is zero
∆M=0
21

85. Constructing the Budget Constraint
22

86. Constructing the Budget Constraint
Assets
22

87. Constructing the Budget Constraint
Assets
In considering whether to hold assets as bonds or
capital, households would compare the rate of return on
bonds, the interest rate, I, with the rate of return on
ownership of capital, R/P − δ.
22

88. Constructing the Budget Constraint
Assets
In considering whether to hold assets as bonds or
capital, households would compare the rate of return on
bonds, the interest rate, I, with the rate of return on
ownership of capital, R/P − δ.
Rate of return on bonds= rate of return on ownership
22

89. Constructing the Budget Constraint
Assets
In considering whether to hold assets as bonds or
capital, households would compare the rate of return on
bonds, the interest rate, I, with the rate of return on
ownership of capital, R/P − δ.
Rate of return on bonds= rate of return on ownership
i = R/ P − δ
22

90. Constructing the Budget Constraint
23

91. Constructing the Budget Constraint
• Household nominal income=
23

92. Constructing the Budget Constraint
• Household nominal income=
π + wL + i · ( B+ P K )
23

93. Constructing the Budget Constraint
24

94. Constructing the Budget Constraint
Household Budget Constraint
24

95. Constructing the Budget Constraint
Household Budget Constraint
–nominal value of assets= M+ B+ P K
24

96. Constructing the Budget Constraint
Household Budget Constraint
–nominal value of assets= M+ B+ P K
–nominal saving to be the change over time in the
nominal value of assets.
24

97. Constructing the Budget Constraint
Household Budget Constraint
–nominal value of assets= M+ B+ P K
–nominal saving to be the change over time in the
nominal value of assets.
– nominal saving= (∆nominal assets)
24

98. Constructing the Budget Constraint
Household Budget Constraint
–nominal value of assets= M+ B+ P K
–nominal saving to be the change over time in the
nominal value of assets.
– nominal saving= (∆nominal assets)
= ∆M + ∆B + P·∆K
24

99. Constructing the Budget Constraint
25

100. Constructing the Budget Constraint
Household Budget Constraint
25

101. Constructing the Budget Constraint
Household Budget Constraint
–nominal saving= nominal income− nominal
consumption
25

102. Constructing the Budget Constraint
Household Budget Constraint
–nominal saving= nominal income− nominal
consumption
– nominal saving= π + wL + i · ( B+ P K ) − P C
25

103. Constructing the Budget Constraint
Household Budget Constraint
–nominal saving= nominal income− nominal
consumption
– nominal saving= π + wL + i · ( B+ P K ) − P C
∆B + P ·∆K = π + wL + i·( B+ PK ) − P C
25

104. Constructing the Budget Constraint
26

105. Constructing the Budget Constraint
Household Budget Constraint in Nominal Terms
26

106. Constructing the Budget Constraint
Household Budget Constraint in Nominal Terms
– PC + ∆B + P·∆K = π + wL + i·( B+ P K )
26

107. Constructing the Budget Constraint
Household Budget Constraint in Nominal Terms
– PC + ∆B + P·∆K = π + wL + i·( B+ P K )
nominal consumption + nominal saving = nominal income
26

108. Constructing the Budget Constraint
27

109. Constructing the Budget Constraint
Household Budget Constraint real terms
27

110. Constructing the Budget Constraint
Household Budget Constraint real terms
– C + ( 1/ P)·∆B+ ∆K = π/ P + ( w/P)·L + i·(B/P+K)
27

111. Constructing the Budget Constraint
Household Budget Constraint real terms
– C + ( 1/ P)·∆B+ ∆K = π/ P + ( w/P)·L + i·(B/P+K)
consumption + real saving = real income
27

112. Constructing the Budget Constraint
28

113. Clearing of the Markets for Labour and
Capital Services
29

114. Clearing of the Markets for Labour and
Capital Services
Profit Maximization
29

115. Clearing of the Markets for Labour and
Capital Services
Profit Maximization
Real Profit
29

116. Clearing of the Markets for Labour and
Capital Services
Profit Maximization
Real Profit
π/P = A·F(Kd,Ld) − (w/P) · Ld − (R/P) · Kd
29

117. Clearing of the Markets for Labour and
Capital Services
Profit Maximization
Real Profit
π/P = A·F(Kd,Ld) − (w/P) · Ld − (R/P) · Kd
• real profit= output
29

118. Clearing of the Markets for Labour and
Capital Services
Profit Maximization
Real Profit
π/P = A·F(Kd,Ld) − (w/P) · Ld − (R/P) · Kd
• real profit= output
−real wage payments−real rental payments
29

119. Clearing of the Markets for Labour and
Capital Services
30

120. Clearing of the Markets for Labour and
Capital Services
31

121. Clearing of the Markets for Labour and
Capital Services
The Labour Market
31

122. Clearing of the Markets for Labour and
Capital Services
The Labour Market
Demand for labour
31

123. Clearing of the Markets for Labour and
Capital Services
The Labour Market
Demand for labour
∆(π/P) = ∆[ A·F( Kd, Ld) ] − w/ P
31

124. Clearing of the Markets for Labour and
Capital Services
The Labour Market
Demand for labour
∆(π/P) = ∆[ A·F( Kd, Ld) ] − w/ P
= MPL − w/P
31

125. Clearing of the Markets for Labour and
Capital Services
The Labour Market
Demand for labour
∆(π/P) = ∆[ A·F( Kd, Ld) ] − w/ P
= MPL − w/P
• change in real profit= marginal product of labour− real
wage rate
31

126. Clearing of the Markets for Labour and
Capital Services
32

127. Clearing of the Markets for Labour and
Capital Services
33

128. Clearing of the Markets for Labour and
Capital Services
Supply of labour
33

129. Clearing of the Markets for Labour and
Capital Services
Supply of labour
We are assuming that each household supplies a fixed
quantity of labour to the labour market.
33

130. Clearing of the Markets for Labour and
Capital Services
Supply of labour
We are assuming that each household supplies a fixed
quantity of labour to the labour market.
Therefore, the aggregate or market supply of labour, Ls,
is the given amount L.
33

131. Clearing of the Markets for Labour and
Capital Services
34

132. Clearing of the Markets for Labour and
Capital Services
Clearing of the labour market
34

133. Clearing of the Markets for Labour and
Capital Services
Clearing of the labour market
–w/P is determined to equate the aggregate quantity of
labour demanded, Ld, to the aggregate quantity
supplied, L.
34

134. Clearing of the Markets for Labour and
Capital Services
Clearing of the labour market
–w/P is determined to equate the aggregate quantity of
labour demanded, Ld, to the aggregate quantity
supplied, L.
34

135. Clearing of the Markets for Labour and
Capital Services
Clearing of the labour market
–w/P is determined to equate the aggregate quantity of
labour demanded, Ld, to the aggregate quantity
supplied, L.
( w/ P)* = MPL ( evaluated at L)
34

136. Clearing of the Markets for Labour and
Capital Services
35

137. Clearing of the Markets for Labour and
Capital Services
36

138. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
36

139. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Demand for capital services
36

140. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Demand for capital services
∆(π/P) = ∆[ A·F(Kd, Ld) ] − R/P
36

141. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Demand for capital services
∆(π/P) = ∆[ A·F(Kd, Ld) ] − R/P
= MPK − R/P
36

142. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Demand for capital services
∆(π/P) = ∆[ A·F(Kd, Ld) ] − R/P
= MPK − R/P
36

143. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Demand for capital services
∆(π/P) = ∆[ A·F(Kd, Ld) ] − R/P
= MPK − R/P
• change in real profit=
36

144. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Demand for capital services
∆(π/P) = ∆[ A·F(Kd, Ld) ] − R/P
= MPK − R/P
• change in real profit=
marginal product of capital− real rental price
36

145. Clearing of the Markets for Labour and
Capital Services
37

146. Clearing of the Markets for Labour and
Capital Services
38

147. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
38

148. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Supply of capital services
38

149. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Supply of capital services
For the economy as a whole, the aggregate quantity of capital, K,
is given from past flows of investment.
38

150. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Supply of capital services
For the economy as a whole, the aggregate quantity of capital, K,
is given from past flows of investment.
In the short run, the aggregate or market quantity of capital
services supplied, Ks, equals K.
38

151. Clearing of the Markets for Labour and
Capital Services
39

152. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
39

153. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Clearing of the market for capital services
39

154. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Clearing of the market for capital services
• R/P will be determined to clear the market—that is, so
that the aggregate quantity of capital services supplied, K,
equals the aggregate quantity demanded, Kd
39

155. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
Clearing of the market for capital services
• R/P will be determined to clear the market—that is, so
that the aggregate quantity of capital services supplied, K,
equals the aggregate quantity demanded, Kd
(R/P)* = MPK( evaluated at K)
39

156. Clearing of the Markets for Labour and
Capital Services
40

157. Clearing of the Markets for Labour and
Capital Services
41

158. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
41

159. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
The interest rate
41

160. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
The interest rate
• i = R/P − δ
41

161. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
The interest rate
• i = R/P − δ
• rate of return on bonds=
41

162. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
The interest rate
• i = R/P − δ
• rate of return on bonds=
rate of return on ownership of capital
41

163. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
The interest rate
• i = R/P − δ
• rate of return on bonds=
rate of return on ownership of capital
41

164. Clearing of the Markets for Labour and
Capital Services
The Market for Capital Services
The interest rate
• i = R/P − δ
• rate of return on bonds=
rate of return on ownership of capital
• i = MPK ( evaluated at K) − δ
41

165. Clearing of the Markets for Labour and
Capital Services
42

166. Clearing of the Markets for Labour and
Capital Services
Profit in Equilibrium
42

167. Clearing of the Markets for Labour and
Capital Services
Profit in Equilibrium
π/P = A· F(K,L) − (w/P)·L − ( R/P)· K
42

168. Clearing of the Markets for Labour and
Capital Services
Profit in Equilibrium
π/P = A· F(K,L) − (w/P)·L − ( R/P)· K
• w/P = MPL
42

169. Clearing of the Markets for Labour and
Capital Services
Profit in Equilibrium
π/P = A· F(K,L) − (w/P)·L − ( R/P)· K
• w/P = MPL
• R/P = MPK
42

170. Clearing of the Markets for Labour and
Capital Services
Profit in Equilibrium
π/P = A· F(K,L) − (w/P)·L − ( R/P)· K
• w/P = MPL
• R/P = MPK
π/P = A· F(K, L) − MPL· L − MPK· K
42

171. Next Time: Business
Cycles
Read Barro, Cht 8

172. EC4004 Lecture 18
Markets & The Macroeconomy
Dr Stephen Kinsella