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Econ 208

Econ 208. Marek Kapicka Lecture 6 The Effects of Gov’t Spending. B2) The Effects of Government Spending Extension#2: Monopolistic Competition. Suppose that instead of competitive markets, there is monopolistic competition

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Econ 208

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  1. Econ 208 MarekKapicka Lecture 6 The Effects of Gov’t Spending

  2. B2) The Effects of Government Spending Extension#2: Monopolistic Competition • Suppose that instead of competitive markets, there is monopolistic competition • There is a final good producer that demands the intermediate goods • There are many small identical,monopolistic firms producing intermediate goods where is markup

  3. B2) The Effects of Government Spending Extension#2: Monopolistic Competition • Since is constant, the frictionless economy with monopolistic producers behaves similarly as the competitive economy • The fiscal multiplier is exactly the same • Note that the level of production is inefficiently low

  4. B2) The Effects of Government Spending Frictions • Larger increase in would be possible if rises more than • Introduces a ‘’labor wedge’’ into the equilibrium condition: • Before we had . • If then the fiscal multiplier is larger

  5. B1) The Effects of Government SpendingEquilibrium Conditions

  6. B2) The Effects of Government Spending Frictions • How to justify increasing ? Assume sticky prices: some producers cannot change their nominal price • How much the labor wedge changes depends on • How sticky prices are • What the monetary policy does

  7. B2) The Effects of Government Spending Frictions • Suppose that there is a nominal price of the final good . Each producer charges a nominal price for its product • Before we had and, in equilibrium, . • Suppose that a fraction cannot change the output price (fixed producers) • The remaining fraction can choose prices freely (flexible producers)

  8. B2) The Effects of Government Spending Frictions • Final good producer has a CES production function • Intermediate good producers:

  9. B2) The Effects of Government Spending Frictions • Suppose that before an increase in government spending there is • A fraction of firms has to keep • Think of monetary policy controlling directly • can be correlated with

  10. B2) The Effects of Government Spending Frictions • Final good producer • Intermediate good producers:

  11. B2) The Effects of Government Spending Frictions • Final good producer demands: • Fixed intermediate good producers: • Flexible intermediate good producers

  12. B2) The Effects of Government Spending Frictions • In equilibrium, obtain • Corresponds to • If an increase in triggers an increase in the price level then increases with • A response of monetary policy matters!

  13. Results from a world with frictions • If prices are sticky and the monetary policy reacts to increased government spending by producing some inflation, the fiscal multiplier is larger • If monetary policy maintains constant price level then the fiscal multiplier is the same as before

  14. Empirical Evidence • Main question: • How does consumption and wages respond to an increase in government spending? • Valerie Ramey (2008): • The effects of military expenditures • Largely unrelated to other economic factors

  15. Real Government Spending Per Capita

  16. The effects on GDP

  17. The Effects on Consumption and Wages

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