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Intermediate Macroeconomics


5. General Equilibrium Model


Here we expand the intertemporal model of consumer and saving decisions (a previous section) to include consumers' decisions for work versus leisure and bring that together with the production side of the economy. Consumers' income is no longer predetermined, but rather determined by their choices for work versus leisure and equilibrium wages. We use consumers' utility maximization rule to derive a theory for labor supply, use producers' profit maximization rule to derive a theory for labor demand, and bring these together to describe equilibrium in the labor market. Supply in the market for final goods and services is determined by the production function and equilibrium in the labor market. On the demand side, we derive output demand by combining consumers' utility maximizing consumption decisions with producers' profit maximizing investment decisions (a previous section). The final Pencasts in this section use the entire general equilibrium model to describe and illustrate the equilibrium consequences deriving from a number of potential changes in the economy.


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Budget constraint

In our two-period intertemporal model, consumers face two budget constraints: one for the present period and one for the future period. There are consumption decisions for the present and the future and income depends on labor / leisure choices for the present and the future. We combine these two budget constraints to reveal a single lifetime budget constraint that has an intuitive economic implication. [Play Pencast]


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Consumption and Leisure Choices

Now we combine the budget constraint with indifference curves representing utility derived from consumption and leisure in the present and the future. We illustrate the optimal choices for these variables, and describe the optimal decision rule in terms of marginal utilities, wages, and interest rates. [Play Pencast]


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Labor Supply

We use the utility maximizing decision for leisure in the present period to derive a labor supply curve that is an upward sloping function of the wage. [Play Pencast]


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Impact of Interest Rates on Labor Supply

We use the utility maximizing decision for leisure in the present versus leisure in the future to predict the effect that an increase in interest rates has on leisure and labor supply choices. [Play Pencast]


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Output Supply

Here we combine the labor market equilibrium and the production function to derive a theory for output supply. We show that output supply depends positively on the interest rate. [Play Pencast]


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Government Spending Output Supply

An increase in government expenditures is often associated with an increase in output demand, and rightly so as government expenditures is one of the expenditure components of output demand. Often overlooked, though, is the potential for government tax or expenditure policy to influence the supply side of the model, through consumers' labor supply decision. Here, we combine the consumer utility maximizing model of consumption and leisure together with the model for equilibrium in the labor market and the output supply function. We show that an increase in government expenditures, resulting in an increase in tax liability (either in the present or the future), leads to an increase in labor supply. The increase in employment in the labor market leads to an increase in production and a rightward shift in the output supply. [Play Pencast]


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Consumption Demand

We use the consumption / saving utility maximizing framework to derive consumers' optimal demand for consumption. We show that consumption demand depends negatively on the real interest rate and illustrate this graphically. [Play Pencast]


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Output Demand

Here we combine theories for consumption demand, investment demand, and government spending behavior to derive the output demand curve. We show that output demand depends negatively on the real interest rate. [Play Pencast]


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General Equilibrium Framework

Here we show the a multi-graph framework for analyzing general equilibrium models. The framework includes the graph illustrating equilibrium the labor market, the production function, the equilibrium in the output market, and consumption and investment demand. Together, these models describe and illustrate the equilibrium outcomes for real wage, real interest rate, total employment, real GDP, consumption, and investment. [Play Pencast]


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Equilibrium Effects: Improvement in TFP

Here we look at all the general equilibrium effects from a temporary improvement in total factor productivity (TFP). An improvement in total factor productivity can result from anything that makes the production process more productive. A temporary improvement implies that the improvement is only manifested in the present period and not in the future period. Examples for this might include an improvement in weather or climate conditions or a change in regulatory policy that improves firms' productivity but may expire or change in the future. [Play Pencast]


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Equilibrium Effects: Decrease in Capital Stock

Here we look at all the general equilibrium effects from a decrease in capital stock. This could be the result of a large natural disaster, such as a massive earthquake, or destruction from a war. [Play Pencast]


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