September 21: Lecture: Equilibrium in the Flexible-Price Full-Employment Business-Cycle Model

September 21: Lecture: Equilibrium in the Flexible-Price Full-Employment Business-Cycle Model

Full-Employment Equilibrium

• Flexible prices and full employment
• Look at the flow of funds through financial markets to understand what's going on
  • Equilibrium prices: the real interest rate r and the exchange rate e
  • The circular flow principle: balance in the flow of funds through financial markets means balance in the sense of aggregate demand equals output
  • We could also look at the flow of purchasing power for output in the "goods market"--but that is less transparent
  • Savings = Investment
    • The real interest rate adjusts to make the flow of funds balance...
  • What things depend on the real interest rate?
    • Exports (indirectly through the exchange rate)
    • Investment

Using the Model: Examples

• Changes in saving
  • Household saving
  • Government saving (the deficit)
  • Foreign saving
• Changes in business demand for funds for investment
• More examples...