Monday, February 18, 2008

Homework 2

MODEL SIM



Question 1
1.1 The vertical columns must necessarily sum to zero, because the change in the amount of money held must always be equal to the difference between households’ receipts and payments, however these are determined. Similarly the change in the amount of money created must always, by the laws of logic, be equal to the difference between the government receipts and outlays. And, as they are assumed to hold no cash, producers’ receipts from sales must equal their outlays on wages.

1.2 Unlike the vertical columns, it may not be assumed in advance that the horizontal entries sum to zero. Thus, we have to specify the mechanisms by which these equalities come about. The most realistic mechanism is related to the existence of inventories. Firms hold a buffer of finished goods, which can be called upon whenever demand exceeds production. Sales are always equal to demand because it is assumed that inventories are always large enough to absorb any discrepancy between production and demand.
This approach generates the assumption that whatever is demanded (services, taxes and labour) is always supplied within the period i.e.
Cs = Cd
Gs = Gd
Ts = Td
Ns = Nd
These equalities thus give rise to a zero sum across the horizontal rows.

Question 2
Consumption
Households open each period with a stock of wealth rolled over from the previous period (H-1) and during the period they receive post tax income equal to YD. Households will consume either of these sources of funds. Consumption is therefore determined as some proportion, α1, of the flow of disposable income and some smaller portion, α2, of the opening stock of money.

Government Expenditure
This refers to the amount of money that the government spend on goods and services produced by the production sector.
Gd represents the purchases of government services. This denotes an outflow of funds and thus has a negative sign. On the otherhand Gs represents the sale of government services to the production sector. This results in an inflow of funds to the government which is illustrated by the positive sign.

Output
Total production, [Y], is not a transaction between two sectors and hence only appears once, in the production column 2. Total production is defined as the sum of all expenditures on goods and services or as the sum of all payments of factor income.
Y = C + G = WB

Factor income
This is the returns earned on labour, i.e. wages. W is the wage rate and N is the employment. Then, W*N is the ‘wage bill’. W*Ns is the total wage that earned by the households. This is a source of funds so it has a positive sign. On the other hand, W*Nd is the total wage that paid to employees by the production sector. This represents an outflow of funds so it has a negative sign.

Taxes
Taxes are the amount that households pay to the government. Td is the amount that the government receives in a period, hence the positive sign. Ts is the amount that the households pay in the same period, hence the negative sign.

Change in Money Stock
The change in the stock of money issued by the government in each period, ∆Hs, is given by the difference between government receipts (Td) and outlays in that period (Gd), i.e. ∆Hs = Hs - Hs-1 = Gd - Td. This also represents the budget constraint of the government.

The change in the accumulation of household’s wealth in each period, ∆Hh, is determined by their financial balance - the excess of disposable income over expenditure, i.e. ∆Hh = Hh – Hh-1 = YD-Cd. This also represents the budget constraint of the household.

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