Answer to Question #167135 in Macroeconomics for vineeth

Question

a. let β>0 be the discount factor, present and solve for both the competitive equilibrium and the steady state of the two-sector economy. With the use of phase diagram, identify the saddle path.

b. Fourth, explain how you can incorporate a government into your model in Part (c) to illustrate the crowding-out effect.

c. Finally, suppose now we allow the output price level in Part (b) to vary. Explain how we can introduce nominal rigidities and therefore price dynamics to this economy. You should explain both methods commonly used in the macroeconomic literature. 

Answer 1

a. Taking into account the discount rate of δ > 0, we obtain the following functional that determines

the welfare of the population:

$J = \intop c(t) e^{−δ⋅t}dt = \intop (1− p(t)) f2 (k2 (t)) e^{−δ⋅t}dt$

b. To reduce the deficit, the government again takes loans from the market. Since the government's fiscal policy affects the economy on a much larger scale, it affects the private sector of the market. Due to the increase in government borrowing, the demand for investment in the market is increasing. The price of funds increases automatically. This means that it increases the interest rate in the market. Consequently, an increase in market interest rates is again having an impact on the private sector. Private entrepreneurs cannot borrow much when the interest rate of borrowed funds increases. In this case, they can stop or rein in their growth or expansion plans.

Thus, the government absorbs money circulation in the market, thereby creating a crowding-out effect in the market. Interest rates and loans are inversely related. As soon as interest rates increase, borrowed funds decrease and vice versa. The government can create a displacement effect

c. There are different methods: direct price regulation; indirect price regulation. With direct methods of regulation, the state directly affects the price level by regulating their level, establishing standards of profitability or standards of the elements that make up the price, as well as other similar methods. Indirect methods include the regulation of the discount rate of interest, taxes, income, the level of the minimum wage, etc. These methods are manifested in the impact not on the prices themselves, but on the factors that affect pricing, which are of a macroeconomic nature.