Competitive Equilibrium in One Period Model: Optimality and Responses to Shocks - Prof. Ch, Study notes of Macroeconomics

Download Competitive Equilibrium in One Period Model: Optimality and Responses to Shocks - Prof. Ch and more Study notes Macroeconomics in PDF only on Docsity! 1 1 Outline of Chapter 5 A. Competitive Equilibrium (CE) in the One Period Model 1. Government 2. Optimality of the CE B. Responses of Firms and Consumers to ‘Shocks’ (exogenous variables) 2 • Government – Purchases Goods (G) which represent public goods. – In principle these good provide benefits to our representative consumer through the utility function. – The government pays for its goods with lump sum taxes (T). We can view this as taking real resources from the private sector – Govt Budget Constraint: G = T 3 • Competitive Equilibrium (CE) A CE is a set of quantities and prices such that: 1) Markets Clear (demand=supply) [labor market] 2) All participants in the model are optimizing [consumers] [firms] 3) All budget constraints are satisfied [consumer] [Firm] [government] 4 • Optimality – The production possibilities frontier (PPF) tell us the maximal quantities of each good that we can produce – We derive the economies’ PPF using the production function – Firm optimization implies that we will produce at the point where the slope of the PPF (or minus the slope of production function) is equal to the negative of the real wage (which also happens to be the slope of the consumer’s budget constraint) – This implies that in the CE the consumer’s marginal rate of substitution is being set equal to the economies marginal rate of transformation