How to convert daily returns to annual returns? I have a task: to download daily stock quotations, create a portfolio and draw a CML-line. Risk-free rate was given: 6.5% of annual.
I decided to convert daily returns to annual returns, using formula from here:
$$AnnualReturn = [(DailyReturn + 1)^{365} - 1]*100\%$$
I found out, that result numbers are just insane. For example, for one company price 2017/09/07 was 27.025 , price 2017/09/08 was 27.77. Then
$$ DailyReturn = \frac{27.77-27.025}{27.025} = 0.0276$$
$$AnnualReturn = [(1.0276)^{365} - 1]*100\%=2069063\%$$
I suppose I did something wrong. Could you help me, please?
And there is one more question: can I convert a daily return to annual return like this?
$$AnnualReturn = DailyReturn*365$$

So, let me start with your second question.  No you cannot multiply by 365.  You could approximate it by $$\log(\text{Annual Return})=365*\log(\text{Daily Return}),$$ but for what you are doing, it does not make sense to do so.

You are correct in your annualized rate of return.  It is 2069063%. It should be obvious as to why you would not want to do this.

There are two solutions.  The first is to convert annual rates, such as the bond rate, from an annual format to a daily format.  So make your risk-free rate: $$\text{Daily risk-free rate}=1.065^{\frac{1}{365}}-1=0.0001725485.$$  The second is to search through the dates of your returns and find returns that are 365 days apart, so return would be $$r=\frac{p_{366}}{p_1}.$$

By annualizing daily returns, you are insanely increasing the variability, but it is artificial so it isn't a true increase, it is an artifact of the method you are choosing.


How do countries create their own currencies (and give them meaningful value)? Regardless of why they'd do it, what do countries do to make their own currency, replacing the old one, and give their new one value?

I sorta get how it works, but this kind of economics is still super confusing to me; thus I thought I'd ask. You know, I get the ideas of supply and demand and what-not, but beyond that I'm at a general loss.

Example, if the Ryukyu islands had an uprising and separated from Japan to form their own nation, what could they do to make their own currency? To replace their Japanese Yen? Again, regardless of why they'd want to.

Money is something which has value because everyone believes it has value.

A good way to create a trustworthy currency is to create a representative currency. A representative currency is a currency which is backed by some rare commodity by always guaranteeing that it can be exchanged back into that commodity. For example, a state might decide to create a new currency, let's call it the TirousCoin, and back it with gold. They decide that one TirousCoin is worth one gram of gold. The state guarantees that when you give them 100 gram of gold, you get 100 TirousCoins from them. And when you give the state 100 TirousCoins, you get 100 gram of gold. That means the TirousCoin's value is bound to the world market price of gold. Giving someone 10 TirousCoins is as if you would give them 10 gram of gold which is as if you give them 442 USD.

But many countries go a step further and have currencies which are pure fiat money. Fiat money is money which is not backed by any commodity. It is simply printed by a central bank, lent to regular banks and from there lent to people. And people trust that central bank to not lend too much of it, because that would cause inflation.

But how do you get people to accept your TirousCoins as their tender for their every day business transactions instead of competing currencies issued by other states?

Declare it legal tender by law. This means that you decree by law that  the TirousCoin is valid payment for all debts. When someone thinks that someone owes them, they can ask the state to force their debtor to compensate them with money. They do that by bringing the case to the state's civil court system. But the court system will consider a debt settled if it is paid in TirousCoins. When a creditor rejects the debtor's TirousCoins and demand to be paid in some other currency, the state will consider the case closed and won't assist the creditor.
Have the state do all their financial business in TirousCoins. Pay government employees in TirousCoins, demand that taxes are paid in TirousCoins (including taxes on transactions in foreign currency), pay subsidiaries and welfare in TirousCoins and demand fines in TirousCoins. When people need to acquire TirousCoins to avoid going to prison for tax evasion, the coins gain real value.
Make sure TirousCoins are a stable currency. Many states in financial perils make the mistake of paying their bills in freshly printed fiat currency instead of playing fair and only spend what they receive in form of taxes. This leads to an inflation which destroy trust in the currency and leads people to do dealings in other currencies.

For further watching, I recommend the Extra History's series on the history of paper money.


Extraction of Inflation Expectation from bond yields In my introductory monetary economics course we have learned that inflation expectations can be calculated by comparing yields on index-linked and conventional bonds of equal maturity and assuming a risk neutral investor. One simple example given is:

A risk-neutral investor is indifferent between 1-year conventional and index-linked gilts (issued at par value, i.e. p = F) if expected returns until maturity equal:
$$ (1+i) F = (1+r) (1+\pi) F $$ so knowing $i$ and $r$ (from financial data), we can calculate $\pi$, the inflation expectation.

Now this I am completely fine with, but then the lecture goes on to the following example:

  Extracting inflation expectations from gilts (assuming risk
  neutrality) Use Tr 4.5pc ‘42: i = 1.71%, and IL 0.625pc ‘42: r =
  −1.66% [Tradeweb] $$(1 + 0.0171)^N = (1 − 0.0166)^N (1+\pi^e_N)^N$$
  giving $\pi_N^e \approx 3.43%$ break-even inflation for a horizon of N =
  23 Years

My question is: how can this calculation be valid when the coupon rates are different for the two gilts? What are the assumptions (eg issued at face value)?

My thinking is that to extract inflation expectations, we must equate the expected returns of the bonds until maturity, just as in the earlier simple example. The rate of return is however clearly tied to the coupon payments, which each need to be multiplied at the relevant accrued yield, leading to a much more complicated equation for the inflation expectation.

Yes, the number you give is an approximation. If you wanted to calculate the true economic breakeven, you would need to include the effect of the lag used in the indexation process (which includes known inflation information), coupon cash flows, seasonality of inflation, etc. If there is a maturity mismatch, then you would need to decide how to handle that as well.

However, the deviation between the economic breakeven and the approximation is normally small. In fact, the market convention is (or at least it was) to ignore compounding and just use the spread between quoted rates.

You would need a full fixed income pricing suite to calculate the true economic breakeven, so a course would stick to the approximation.


Cournot duopoly with differing costs There are two firms in a Cournot duopoly that face inverse demand $P = \alpha - Q$, but one firm has total costs $c_1*q_1$ and the other has total costs $c_2*q_2$ with $c_1 < c_2$. I want to show that firm 1 will have greater profits and produce a greater share of market output than firm 2 in equilibrium.

Intuitively that makes sense to me because if one firm is more cost efficient they should be able to produce more and capture more of the market, right? I'm just having trouble showing this mathematically. I've gotten to the point of writing down profits for each: $Profit_1 = (\alpha - Q)q_1 - c_1*q_1$ and $Profit_2 = (\alpha - Q)q_2 - c_2 * q_2$, but taking derivatives with respect to the q's doesn't get me anywhere. Would appreciate some help

I think the missing link for you is not realizing that $Q$ is actually equal to $q_1 + q_2$: in a duopoly, quantity demanded can only be derived for the two firms in question. With that in mind, we can rewrite the profit functions for both firms in terms of $q_1$ and $q_2$ and then optimize with respect to the $q$'s accordingly (since Cournot competition is competition over quantities). We are then going to be left with two best response functions, one that tells you the optimal level of $q_1$ as a function of $q_2$ and another that tells you the optimal level of $q_2$ as a function of $q_1$. Then it just becomes an algebra problem to find the Nash equilibrium and the relationship of quantities and profits between the firms will become clear.

Firm 1 maximizes profits
\begin{align*}
\Pi_1(q_1) = (\alpha - (q_1 + q_2))q_1 - c_1 q_1.
\end{align*}

The first-order condition is
\begin{gather*}
\frac{d \Pi_1(q_1)}{dq_1} = 0 \\
\implies \alpha - 2q_1 + q_2 = c_1 \\
\implies q_1(q_2) = \frac{\alpha - c_1}{2} + \frac{q_2}{2}.
\end{gather*}

Similarly, Firm 2 maximizes profits
\begin{align*}
\Pi_2(q_2) = (\alpha - (q_1 + q_2))q_2 - c_2 q_2.
\end{align*}

The first-order condition is
\begin{gather*}
\frac{d \Pi_2(q_2)}{dq_2} = 0 \\
\implies \alpha - 2q_2 + q_1 = c_2 \\
\implies q_2(q_1) = \frac{\alpha - c_2}{2} + \frac{q_1}{2}.
\end{gather*}

Solving the system of equations for $q_1$ and $q_2$ yields
\begin{align*}
q_1^* &= \frac{\alpha - 2c_1 + c_2}{3} \\
q_2^* &= \frac{\alpha - 2c_2 + c_1}{3},
\end{align*}

which implies that $\mathbf{q_1^* > q_2^*}$ since $c_1 < c_2$.

Note that both firms face the same price $P^* = \alpha - (q^*_1 + q^*_2)$. Therefore, we have that
\begin{align*}
(P^* - c_1)q_1^* &> (P^* - c_2)q_2^* \\
\implies \mathbf{\Pi^*_1} &> \mathbf{\Pi^*_2}.
\end{align*}


Can I use percentage change in CPI to calculate fare rate schedule? There was a recent rollback in the fare rate in our city from 9.50 pesos to 6.50 pesos because of the decrease in the price of gasoline. The fare rate here is pegged to the prevailing price of gasoline as stipulated in a city ordinance crafted in 2007. Due to the decrease in the fare rate, public transportation drivers held a strike arguing that 6.50 pesos was too low considering the prices of necessities and rent for their vehicles have not declined.

My question is will it be sufficient to use the percentage change in CPI between 2015 and 2007 multiplied by 2007 fare rate to arrive at a new fare rate for 2015? I'm thinking since CPI already takes oil and gasoline prices into account, we don't have to factor in percent change in gasoline prices.

I plan to pose this problem in my economics class as a practical application of what we learned about inflation and the CPI.

Thank you for taking the time to read this!

Without anything better than a CPI, a CPI would approximate it. That said, I don't think it would be accurate. A better gauge would be a measure of the cost of living for the effected people. Vehicle maintenance and the like would be much higher than a typical person.


Proxies for technological change in an economy? I am writing a paper on the application of Value-Added TFP to measurement of technological change. Just thinking of throwing in a few variables into my regression. I have ICT capital share (as seen in KLEMS dataset) as another proxy.

I would be grateful to hear your suggestions on other known proxies (if you know papers that relate to those proxies even better).

I would say these are some proxies

Number of patents
Number of published scientific papers
Human capital


Can a complement good be free or have a fixed cost? I was not around at this time but I know roads(existing for bikes) and gas(existing for tractors) were complements for cars.

I was looking at complements for computers and noticed the ARPANET could maybe be regarded as a complement because it appears it would increase a computers usefulness.  I'm trying to leave the history out of this but I figured an example would be helpful.

Can a complement good like the ARPANET have either a fixed cost or be free?

Air is a complement good for a lot of things. If you get no air at all then food, gold and iPhones give you no utility either. And air is free! Except in Spaceballs...


If a currency crashes, does that effect the value of rare or collector coins? I own lots of collectable coins from the 70's (mostly mint dollars and quarters.)  Some of my friends are telling me that the US economy is going to crash and the the dollar is going to lose its value.  This got me thinking.  In the unlikely event that this happens (hyper inflation, a drastic drop in value compared to other currencies or a complete loss of value), how would that effect the value on my coins?

This may not be the best place to ask this question.  Please help me get it to the right place.

Yes, their value would collapse.

But not for the reason you might think.

It's not because they're the same currency, per se.

But rather because a major collapse in the US dollar's value would be part of a much larger economic collapse. Which means that disposable wealth would be rare, and the demand for indulgences such as collectors' coins would dry up. At the same time, you'd have lots of owners of such coins trying to liquidate their assets. So, there'd probably be both a big increase in supply, and a big decrease in demand, leading to plummeting prices.

Promoters of any number of yieldless "investments" such as bitcoin, gold, or collectables, will tell you that their investment would be a safe-haven in times of crisis. But at times of major crises, the correlations (the betas) tend towards one. Hedges stop being hedges.


What is the resolution down to which the annual inflation value can be controlled? Judging by previous posts in the site, the inflation target is set annually to 2% by the Federal Reserve. Regardless of the reasons behind this choice, I am curious to understand how precisely can the Federal Reserve aim for a value (maybe understanding the means they use to control it will be enlightening for that purpose). Could it be set, for the sake of the example, to 1.9% instead? Or to 1.95%?

What is the resolution down to which the annual inflation value can be controlled?

They can target arbitrary number. For example, they can target $1.9999\%$ or $3.1415\%$.

Could it be set, for the sake of the example, to 1.9% instead? Or to 1.95%?

Yes, it could. However, the target inflation rate is more or less aspirational and it is the value Fed aims to hit on average over the business cycle rather than maintain it at all times (in fact the target is not just $2\%$ but $2\%$ over the long run (see official Fed explanation here). Fed has dual mandate of keeping price stability and full employment. Following both of these objectives requires that inflation is sometimes above $2\%$ and sometimes below. In fact recently Fed chairman announced that in the near term they want to target inflation moderately above $2\%$.
In addition, note that Fed is not expected to hit its target with surgical precision. Consequently, there is not much point in setting it to $1.95\%$. For example, if Fed would keep the $2\%$ but inflation over long-run would happen to average at $1.95\%$ they would likely consider it a success since it is close enough to their target. Even though Fed can control inflation, price level (change in which gives you inflation) depends also on random macroeconomic perturbances/shocks. Consequently, most economists would not consider it a failure if average inflation deviates from its long run target by just $0.5\%$.
Regarding the means Fed has to control inflation there are several ones. Following, Blanchard et al. Macroeconomics central banks can control inflation via:

It can do it via changes in the interest rates (this is one of the most common ways).
Direct changes to the money supply.
Changes to the reserve requirement (currently abolished in the US).

An important caveat is that Fed is also institutionally constrained in the use of the above. For example, helicopter money is one way how central bank could expand money supply from economic perspective, but it might not be legal in the US (it is highly questionable). Fed can still affect money supply in other ways such as open market operations but these constraints mean that sometimes Fed cannot go as far as it would want with expansion of money supply.
Some other instruments are constrained by economic reality. For example, Fed cannot set interest rates too low as there is effective lower bound on how low the Fed funds rate can go. Typically models show it is at zero interest rate (although practically it is possible to go bit below) because cash has implicit $0\%$ interest rate and thus if Fed would set its rate significantly below zero (which would make commercial banks to go below zero as well) people would just refuse to keep their money in their banks and just keep cash (the interest rate can go bit negative as there are storage costs for keeping large sums of cash at home).
However, going over every minutiae detail of how Fed is constrained by law or economics would be beyond the scope of SE answer, but you should keep in mind that there are asterisks to the above.


Why did US dollar appreciate during the Global Economic Crisis (2007-09) We know that the US dollar exchange rate increased during the global recession while usually when an economy performs weakly its currency should depreciate. How was there still a huge demand for USD in foreign markets even when subprime mortgage crisis was at its peak.

Because dollar is a major reserve currency. When a financial crisis occurs in other countries, like India, Brasil, Russia, etc, everyone sells stocks and liquiates assets to raise cash. But the cash they want to raise is usually dollars or euros. When a crisis hit the US, everyone started selling assets FOR dollars. I.e. they were buying dollas for stocks, trillions of dollars worth. This demand for cash appreciated dollar. There was a multitude of other factors involved, as discussed in this paper: Dollar Appreciation in 2008: Safe Haven, Carry Trades, Dollar Shortage and Overhedging http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1519814

After Fed's relatively successful monetary policy decisions, the US economy recovered faster than the economies of the EU and Japan, other reserve currency emitters. Then it was natural for dollar to continue strengthening.


How can a positive relationship between capital per effective worker and technological change be explained? I'll get to the point: so, in the context of theories of long-run economic growth, I understand at a basic level that, in the Solow model, there is a negative relationship between capital per effective worker (K/AL) and technological change () - higher amounts of technological change means it is harder for firms to keep with up new innovations in capital terms.

In contrast, there is, supposedly (speaking in very simplified terms) a Schumpeterian-type ('market for inventions') model, where there is a positive relationship between K/AL and technological change, because technological change is determined, in part, by K/AL, as this increases the supply of 'innovations'.

I do not understand how an increase in K/AL would increase the supply of innovations within this model - would someone please explain for me why this relationship might hold true?

Your question is not that clear. So let me elaborate an answer on what I have understood from your question.

Note that for the Solow model, when technological change increases, it is the "per capita" capital which decreases. This one is normal because you should give much more capital to your workers, as they are more productive (here the technical progress increases the productivity of workers.)

I don't understand in which context $\frac{K}{AL}$ increases supply of innovations. What spurs innovation in Schumpeterian type growth models is the labor allocation in R&D (or spendings in R&D). This increases the creative destruction rate in the economy. For example, in this case, a decrease in labor $L$ can be consiidered as an increase in labor allocation in R&D.

Or another possible interpretation that I can make is the following one. There exists a stock effect in Schumpeterian models. This means that if your knowledge stock $A$ is high enough, it would be difficult to make new innovations. (See Acemoglu 2009, chapter 14)

So, in this case a higher $\frac{K}{AL}$ implies more innovation.


Maximin utility function If someone has the attitude that they want to maximize their worst possible outcome (so they are maximally risk-averse), what does the utility function for that look like?  Can this attitude be expressed as a utility function?

Maybe as a function defined by a limit?

You can simply apply what you know about perfect complements. If we have $C_i$ for $i=1,2,...,n$, where $C_i$ is consumption in the $i$th state of the world, each state of the world occuring with some probability, the utility function $U=\min\{C_1,C_2,...,C_n\}$ will ensure that the consumer will choose to have equal consumption in every state of the world.


What kind of contractual problem is this? Oliver Hart, a Nobel Price winning economist, made the following case against privately founded prisons in an interview from 2017: “There are some things that are difficult to specify [in a contract between a government and a private prison]. One is the quality of the guards. A private company may have incentives to hire cheaper, less trained guards and yet still be within the contract.”

What is this type of contractual problem called? Why does it occur?

Hello everyone,

I'm struggling with the question above.
It is from and old exam in my lecture 'Organization and Management' (consisting mostly of contract theory).

I think the question is either aiming for:

'Incompleteness of contracts' since the "quality of guards is hard to specify". Probably because the quality is observable but not verifiable (or specifying the quality would be too costly) OR
'Adverse Selection' since the government does not know what kind of cost function a private company would have (for the quality of the guards) prior to signing the contract.

Now that I wrote that I feel like it must be the former just because it makes sense to me.

What do you think? May the contractual problem at hand also be something entirely different?

Thank you in advance,
Chris

This looks like a case of incomplete contracts, or what is sometimes known as non-contractibility.

In the principal/agent paradigm, adverse selection arises when an informed agent transacts with an uninformed principal and, in particular, the principal cannot distinguish between desirable and undesirable agent trading partners.

I don't think your example is a good fit for adverse selection: here the principal would be the government and the agent would be the prison company. But the quality uncertainty concerns the guards rather than the agent itself, and the government is not directly interacting with the guards here.

From the world of information asymmetries, this looks more like a situation of moral hazard where the agent is not incentivised to act in the prinipal's interests. Moral hazard is only really a problem when you Cann't write a contract stipulating thet the agent should behave in the principal's interests. This could be for various reasons

the agent's action can't be directly observed;
while the angel't action cab be observed, its badness can't be objectively verified (i.e., it can't be conclusively proven in court that the action was bad, so a court could never enforce the contract);
the number of contingencies is so large that it is impossible to write a contract specifying all of them
there is no relevant authority to enforce the contract (e.g., a drug dealer and his supplier can't write a meaningful contract because they can't exactly expect a court to enforce it)


Are taxes,subsidies and social money transfers(i.e. welfare) accounted in money velocity? As far as I know, money velocity is an average amount of times a typical, say, dollar, gets spent on goods during 1 year. So if it's spend N times to pay for goods, then money velocity equals N.
But I wonder if it's all the truth or only part/simplification of it. Suppose an average dollar is spent, on average, 1 time to pay for goods, 2 time to pay taxes, 4 times to pay subsidies, 8 times to pay pensions. What money velocity would be?

Velocity of money is according to the Fed definition:

The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time.

Hence paying taxes/transfers is not counted. In your example the velocity would be 1 assuming government does not spend the money from those taxes on goods and services, and assuming the money transferred through subsidies or pensions are not spent at all.
Also, as a side note velocity is rarely calculated directly due to the practical difficulties. Rather its often just inferred from other variables.  Furthermore, the example you give cannot occur in practice as 1 dollar cannot be simultaneously just spent once, taxed twice and transferred 12 times at the same time but I take it that the numbers are just randomly selected.


What are the 'Public Account Liabilities' of the Government of India? In the Quarterly Report on Public Debt Management for the Quarter Jul - Sep 2020 of the Government of India, an increase in 'Public Debt Liabilities' is declared.
What are they?

As per Factly:

Public Account liabilities
include liabilities on account of National Small Saving Fund (NSSF),
Provident Funds, Reserve Funds and Deposits, and Other Accounts.
Liabilities under ‘Other Accounts’ include, among others, special
bonds issued to oil marketing companies, fertilizer companies and
FCI.


Is there an economic interpretation of the production transformation function? The production set has a simple meaning: It is the set of all production vectors that are feasible to a firm.

The production function also has a simple meaning: It gives the output quantity for a given vector of input quantities (for a firm that produces only one output. )

But what is the production transformation function? It is defined as the function $F(y)$ such that the production set is $\{y: F(y)\leq 0 \}$. Essentially, it is a way to encode the production set.

But is there also a meaningful interpretation of this function itself, rather than merely as a mathematical device to define the production set in a way that's analytically tractable?

It is, as you say, a mathematical device to define the production set in a way that is analytically tractable

I have seen one description as thinking of it as a measure of the amount of technical progress now required to make the combination $y$ a feasible one, so

if $F(y)=0$ then that combination is just feasible with current technology,
if $F(y)\lt 0$ that combination is feasible with less than current technology,
if $F(y)\gt 0$ that combination requires more than current technology enables and so is currently not feasible

though this looks more like handwaving and rationalisation rather than something actually meaningful


What's the Difference Between Being Pro-business and Being Pro-market? In a recent interview I watched a economist say something along the lines of:

"There is a distinction between being pro-business and being pro-market. There should be rules in place so that businesses can compete in a way that is good for the economy and not just good for their shareholders."

Question: What is this distinction exactly? In other words, what is he probably referring to?

The only thing that comes to mind when I think about that statement is how many corporations are using large amounts of profits to buy back their shares as opposed to investing in capital. Am I on the right track, or is there more to it than that?

In a nutshell, pro-business policies help currently existing businesses and their shareholders. Pro-market economies are those that follow the tenets of the free market - competition, no barriers to entry and so on. Pro-business policies may not imply a pro-market environment.

This is discussed at length for the case of India in Rodrick, D. and Subramanian, A., 2004. From “Hindu growth” to productivity surge: the mystery of the Indian growth transition, NBER Working Paper Series, WP 10376.


Why is Keynes attacking the (neo)classical theory of interest rates on the grounds that it is indeterminate? I do understand that he argues that in order to draw the loanable funds supply curve, you have to already know the volume of income, i.e. production, and therefore the interest rate in advance.
But why couldn't you just test for coherence in the following way?
Assume a level of income. Draw the corresponding loanable funds supply curve. Calculate the interest rate at the intersection of the supply and the demand curve, i.e. the interest rate for which the capital market clears. Determine if the income level corresponding to this interest rate is indeed the income level we assumed in the first place. If it is, this interest rate is an/the equilibrium rate, if it's not, it's not.
Is there anything wrong with this argument?

You can use some some initial $Y_0$ to find an interest rate, but this is precisely the indeterminacy problem.  We would like to be able to derive the equilibrium interest rate without assuming some initial values.
Furthermore, note the indeterminacy problem is actually present even in canonical Keynesian models (See Hansen, 1951) and Neo-Keynesian models (see Beyer & Farmer 2004).
However, the Keynes critique is now a bit outdated. Keynes was writing in a past before macroeconomic was even given proper formal treatment (by modern standards), and at a time when macro had no micro-foundationds. Nowadays you can solve the indeterminancy problem in macroeconomic model of either variety by assuming central bank follows some interest rate setting rule, such as Taylor rule or making some specific assumptions about model's micro-fundamentals (see Romer's Advanced Macroeconomcis for discussion of this). Although as the Beyer & Farmer point out in their paper even central bank interest setting rules won't solve this issue always so the problem is somewhat open.


How exactly does removing labor market rigidities reduce structural unemployment and increase potential output in an economy? Here I want to focus primarily on the potential benefits of labor market reforms such as a reduction in job security and trade union power and not their controversies. I wish to learn a few thoroughly explored reasons for how labor market reforms may decrease structural unemployment and increase the productive potential of the economy through improvement in efficiency.

Potential benefits of labor market reforms such as a reduction in job security and trade union power:

To find the answer to a reduction in job security, just apply it to your personal life(assuming you are employed). If labor market reform comes in and puts my job at risk, I would become more competitive and work harder in order to keep my job. This reaction would apply to most people.

As for a reduction in union power, this is more macro scale oriented. What unions don't realize is that financially they are hurting themselves & their company, albeit ethically/morally/quality of life at work they are gaining. So to keep things short and not go too far into controversial topics regarding unions, if union power is reduced, then market efficiency would increase from a financial standpoint not only for the firm, but for the macro economy and thus the employees.

As for structural unemployment, if there are market reforms structural unemployment will almost always rise in the beginning, but usually fall back down and most times dip even lower than previous levels due to efficiency gains from adapting to the reforms.

Hope this helps, I know it's not as detailed as you probably want it to be, but for that level of detail one must get into the controversial topics and pick a bias.


Understanding the gradient of the social cost curve in a market failure/ negative externalities diagram Why does the social cost supply curve in a negative externalities diagram have a steeper gradient than the private cost to firms?

I assumed it should only be shifted upwards as the negative social costs are directly proportional to the production quantity?

Any explanation is greatly appreciated.

It simply depends on the shape of the marginal external damages. If the total damages are linear in output, then the marginal damages are constant, and the gradient of the marginal social cost is the same as that of the marginal private cost.

If the total damages are quadratic (or some other form with increasing marginal damages), the marginal social cost has a steeper slope than the marginal private cost.

In a simple example: if the marginal private costs are $MPC(Q)=70+2Q$, where $Q$ is quantity produced and total damages are $D(Q)=50Q$, then marginal external damages are $MED=50$ and the marginal social costs of production would be:

$MSC=MPC+MED=70+2Q+50=120+2Q$

If in contrast the damage function would be $D(Q)=50Q+2Q^2$, then marginal external damages would be $MED=50+4Q$ and the marginal social costs of production:

$MSC=MPC+MED=120+6Q$

As you can see the latter has a steeper slope than the original MPC, whereas the former does not.


Questions on supply curve I need advice on whether on my supply logic is correct.

Question 1: Any point on the supply curve indicates the minimum price that a producer must receive in order to supply a specific quantity of output. True or false?

I think, it is true because, if the price increases the quantity supplied would be differ.  Thus, it is indeed the minimum price.

Question2: An increase in price results in an increase in supply but not an increase in the quantity supplied.

I think, it is false because price causes a movement along the supply curve.  However, if the price of complementary good-in-production increase, the supply will increase, but this will also lead to an increase in quantity supplied, unless the demand decreases due to other factors.

Question 1 That's a reasonable way to think about it,but maybe missing out on a bit of nuance.  Realize that at any given price, the supply curve indicates how much WILL be supplied.  You are correct that if the price drops, the supplier will no longer be willing to supply that quantity of a good.  But likewise, if price increase, the supply will seek to supply a greater quantity.

Question 2 Yes, this is false. A change in price results in a movement along the supply curve and so increases/decreases the quantity supplied.  Supply itself is changed, meaning a shift of the whole supply curve, when faced with a shock, such a technological change.


Question regarding General Equilibrium under non-convexities I have the following question on my problem set:

It's clear to me, since consumer 2 does not care about good 2, that we should give all the economy's endowment of good 2 to consumer 1. In the other hand, both consumers care about good 1.

For item a), I think that in any optimal allocation we should have $x_{2,1} = 1$, since consumer 2 does not care about good 2.

Also, with this in mind, any allocation that has $x_{1,1} + x_{1,2} = 1$ is Pareto optimal, because we can only make one better hurting the other (assuming we have already exhausted good 2, giving all the economy's endowment to consumer 1). Question: is this reasoning right?

Another question: assuming I got it right, I have no idea how to find the vector price for each case.

For item b), the 1st Welfare Theorem needs to hold because there's local non-satiation for both consumers. On the other hand, lexicographic preferences are not convex. So, there's no reason for the 2nd theorem to hold. Is that sound?

Thanks a lot in advance!!

You are right. Set of Pareto efficient allocations consist of all feasible allocations $((x_{11}, x_{21}), (x_{12}, x_{22}))$ satisfying the property that individual 1 consumes all of good 2 i.e. $x_{21} = 1$ and $x_{22} = 0$.

Competitive (or Walrasian) equilibrium in such an economy does not exist. At all price vectors $(p_1, p_2)$ satisfying $p_1 > 0$ and $p_2 > 0$, both the consumers will only demand good 1. As a result we will always have excess demand for good 1 and excess supply of good 2. When we consider a price vector $(p_1, p_2)$ of the form $p_1 > 0$ and $p_2 = 0$, then consumer 1 will demand infinite amount of good 2 leading to excess demand for good 2. Therefore, there does not exist a price vector that clears both the markets.

First Welfare Theorem holds because preferences satisfy Local Non Satiation. Second Welfare Theorem does not hold because no matter how we distribute endowments, competitive equilibrium in such an economy does not exist, but efficient allocations exist.

Also, please note that the lexicographic preferences are convex.


Wealth effect from OMO In a paper by Eric Leeper he says:

  For example,
  a contractionary open-market sale of government bonds raises
  nominal interest rates, including yields on government bonds. If
  the higher debt service is permitted to flow in to more rapid growth
  in nominal debt with no prospect of eventually higher taxes –
  or primary surpluses, more generally – then bond holders will
  perceive that their wealth has increased and seek to convert that
  wealth in to purchases of goods. This higher aggregate demand will
  ultimately raise the price level.

On a theoretical level I seem to understand what he is saying but I do have some questions regarding the operation from practical perspective.

Say in period $t-1$ I own some government bonds. In period $t$ the central bank performs the contractionary OMO. So they lower the price of government bonds but raise its yield. This will increase the debt service cost for the government and if they decide to fund it by selling more bonds, I will experience a positive wealth effect.

I think I'm confused because I don't quite understand the specifics of bond trading. So the bonds that I own in period $t-1$, is their yield flexible? I.e, once the CB performs the OMO and raises yield, will the bonds I already own also receive this new, higher yield?

Also, in period $t-1$, when I bought the bonds, I paid a certain price. Then the CB starts selling bonds, thus lowering its price while raising yield. The higher debt service cost results in the government issuing more bonds, surely this lowers the bond prices further? So when I eventually sell the bond, I should have lost money?

What am I missing here?

I've changed order slightly, for ease of explanation.

  I think I'm confused because I don't quite understand the specifics of
  bond trading. So the bonds that I own in period t−1, is their yield
  flexible?

In the real world (and more complex models) certainly - otherwise bond trading would be rather boring.

During the day, bond traders exchange bonds at various prices, and the yield is essentially the implied internal rate of return (modulo quote convention effects) corresponding to those prices if the bond is held to maturity. That is, if you hold to maturity, you are guaranteed that internal rate of return (IRR)
 - absent default - although total return depends upon coupon reinvestment. Otherwise, your profit/loss depends upon what price you sell at (and coupon income during your holding period).

Dynamic economic models quite often diverge from this reality in two ways.

All bond trading during a period occurs at one price. Therefore, you cannot have gains/losses during a single accounting period.
In many models, "bonds" mature in the next period. ("Bills" would be a better label.) Since there are no intermediate time periods, you cannot suffer a capital loss on bonds in such a period. The only way to have capital gains/losses on bonds is to allow for multi-period maturity bonds (or perpetuals), which complicates the model mathematics.

  I.e, once the CB performs the OMO and raises yield, will the bonds I
  already own also receive this new, higher yield?

If you are investing in one period bills, your existing bill matured, and you would invest in a new bill at a higher yield.

If you hold multi-period bonds, their projected internal rate of return would rise. However, the effect on your wealth is mixed. The way that bond yield conventions work is that you would receive the running yield of the bond (+), but you would get a capital loss (-) which roughly equals the modified duration of the bond in the next period, times the yield change. For long maturity bonds, the capital losses are typically much larger than the running yield. In other words, you would likely experience a short term capital loss, but that is made up by higher projected returns. After all, if you hold to maturity, you get the initial yield as an IRR.

  Say in period t-1 I own some government bonds. In period t the
  central bank performs the contractionary OMO. So they lower the price
  of government bonds but raise its yield. This will increase the debt
  service cost for the government and if they decide to fund it by
  selling more bonds, I will experience a positive wealth effect.

Leeper's text is phrased in a somewhat confusing way. It refers to a model of a representative household, who effectively owns all government liabilities. In a world with multiple households, if you bought a long-term bond at t-1, you could easily have less wealth in period t; the increased interest could be received by other households who held 1-period bills that matured, and did not have a capital loss.

That is, he is really writing about the household sector, and not individual bond owners.

  Also, in period t−1, when I bought the bonds, I paid a certain
  price. Then the CB starts selling bonds, thus lowering its price while
  raising yield. The higher debt service cost results in the government
  issuing more bonds, surely this lowers the bond prices further [1]? So
  when I eventually sell the bond, I should have lost money [2]?

Sub-question [2] is covered by the above; your gain/loss depends upon the trade-off between the running yield and the capital loss.

As for [1], the effects of supply on bond yields is controversial. In a simplified model where there is no term premium, bond yields depend only upon the expected path of interest rates. If the increased interest payments do not cause the central bank to raise interest rates (over the lifetime of the bond), bond yields are unaffected.

In the real world, there presumably is a term premium, which might be affected by the amount of bond issuance. Even so, it is clear that the effect is not that large: we have had plenty of rate hike cycles, and bond yields did not enter a positive feedback loop of ever-rising yields.


Marx: Relative and equivalent-form. Difference? I don't understand the difference between the two. For example:

2 Shoes = 3 wood

Now Marx says that the first is the relative-form and the second is the equivalent-form. So the use-value expressed in the equivalent-form is represendet in the value of the relative-form. Why does the equivalent-form represent the use-value of the wood? Isn't it just a commodity with use-value and exchange-value? So why is the equivalent-form only the use-value of that thing?

Marx says in the simple-value form there is a contradiction because one is equating use-value and it's opposite, value.
But aren't they both commodities with use- and exchange-value? Because they already exist as commodities in the system.
Is it because the commodity is "new" in the market and exists only as use-value until I put it into the relationship with commodities in the market and therefore obtains value??

It has nothing to do with new products in the market, nor with confusion of use-value and exchange-value. To make it a bit simpler:

1) Commodities in capitalism have a two-fold character. The use-value (they are useful products for the buyer to consume) and the exchange-value (they can be exchanged to another products in a given way).

2) The exchange-value of the product depends on the embodied labor of the product, which is named as Value by Marx. So in a sense, exchange-value = Value.

3) Products can only be compared in relation to one another. You cannot understand anything by saying ex. 2 apples = 2 apples.

Thus, we reach to the Elementary Form: 20 yards of linen = 1 coat
In this equation, linen plays the active role or Relative form and coat plays the passive role, or Equivalent form. In other terms, you define the Value of linen comparing it to the Value of coat.

Now, here is the core of the analysis.  Marx claims that since there is a comparison (20 linen=1 coat), there must be a common element to compare. That common element is not the use-value (linen is not the same as coat). It is the exchange-value, or Value, or the human labor embodied in the two products. In other words, this equation states that labor needed to develop 20 yards of linen is equal to labor needed to develop 1 coat (given constant technological advancement, resources, etc.) Use-value, on the other hand, just acts as a carrier of Value.

The importance of this realization, is to understand the essence of exchange in capitalistic world and connect it to the money form (20 yards of linen = 1 coat = 100 Euros), and understand socio-economically how money was created and what does it really mean.

Karl Marx. Capital Volume One, Part I: Commodities and Money, Chapter One: Commodities


How do you read currency exchange rates in terms of domestic and foreign currency? I am having some issues understanding how to read exchange rates.
E is the exchange rate

I read online that if we have for example E\$/€, then the base currency in this case is the dollar and the quote currency is the euro . In this case , if E\$/€ = 1.50, this would mean that 1$ would buy 1.50€.

However, in my textbook i am having some miss understandings.
In my textbook , the domestic currency is the EURO and the foreign currency is the DOLLAR.

It states :
The exchange rate can be defined in two ways, the first one being

1) The price of the domestic currency (euro) in terms of the foreign currency (dollar). If 1€ =$1.50 , then E=\$/1€=1.50.

If i look at E=\$/1€=1.50  , i see E\$/€.

This implies how in this case, the base currency , orelse 1€, is written as a
the second currency , and E\$/€= 1.50 . With one euro you can buy 1.50 dollars.

2) The second way of writing the exchange rate is the price of the foreign currency in terms of the domestic currency . In this case E=€/\$= €0.65 .
In this case, the base currency is also written as the second currency , with 1 dollar being able to buy 0.65 euros.

Then my questions is that i'm not sure why there are different ways of writing the exxhange rate. On internet E\$/€=1.50 means that with one dollar you can buy 1.50 euros. In my textbook, E=\$/1€=1.50.  , which i assume is the same thing as E=\$/€= 1.50 means that with 1 euro you can buy 1.50 dollars.

What am i misenterpeting ?

The currency in the denominator is always the currency that is being priced. For example $\$/€=x$ means that the price of euros is $x$ dollars. That is, if you want $1$ euro, you have to pay $x$ dollars (Keep in mind that in practice the euro will have a bid and an ask price, but in both cases, the euro will be in the denominator). In fact, the notation $\$/€$ should be read "dollars per euro". In contrasts, $€/\$$ reads "euros per dollar", so the currency that is being priced now is the dollar (of course in terms of euros).

With this in mind, the statement online that says "E$\$/€ = 1.50$, [...] would mean that $1\$$ would buy $1.50€$". was either misunderstood or simply wrong. Such notation means that $1.50\$$ is equivalent to $1€$.

Finally, keep in mind that, in practice, countries decide to write their exchange rate in terms of the dollar according to convenience of the numbers. For example, the exchange rate for the Mexican peso is almost always written as peso/dollar. Technically speaking such notation is giving the price of dollars, but note that it is more convenient to say that E$(peso/dollar)=24$ pesos rather than saying E$(dollar/peso)=0.041666$ dollars. This creates no problem since both quotes are equivalent.


Name of robustness check where you exclude individuals? I have a panel dataset and to check the robustness of the results, I'm re-estimating the models with each panel unit excluded once. Does this robustness check habe a particular name?

Depending on the context this is sometimes called Jackknife resampling

  In statistics, the jackknife is a resampling technique especially
  useful for variance and bias estimation. The jackknife pre-dates other
  common resampling methods such as the bootstrap. The jackknife
  estimator of a parameter is found by systematically leaving out each
  observation from a dataset and calculating the estimate and then
  finding the average of these calculations. Given a sample of size n
  $n$, the jackknife estimate is found by aggregating the estimates of
  each $( n − 1 )$-sized sub-sample.

It may also be referred to as leave-one-out cross validation, which isn't exactly the same but very close.

  Leave-one-out cross validation is K-fold cross validation taken to its
  logical extreme, with K equal to N, the number of data points in the
  set. That means that N separate times, the function approximator is
  trained on all the data except for one point and a prediction is made
  for that point.

Well, that's the name for leaving out a single observation at a time. Strictly speaking, it isn't the name for leaving out each panel unit once. When you resample in way that accounts for the panel or time series structure, that is usually called Block Bootstrapping, in this case a kind of cluster bootstrapping.

Personally, I would call this block-jacknife or leave-one-block-out cross validation.


Restrictions proving quasiconcavity of utility function I have the utility function given as $u(x)=x_1+x_2^\gamma$. The answer says that for a utility function to exhibit strict quasi-concavity, $\gamma$ needs to be between 0 and 1; but I don't understand why this is true. I know strict quasi-concavity means that if $f(x) ≥ f(x')$, then $f((1−λ)x + λx') > f(x')$ but I don't know how this can be shown in this example...

Since $u$ is twice differentiable, it is quasi-concave if and only if its marginal rate of substitution declines as $x_1$ increases and $x_2$ falls. You can then compute
$$
MRS = \frac{\frac{\partial u}{\partial x_1}}{\frac{\partial u}{\partial x_2}} = \frac{1}{\gamma x_2^{\gamma - 1}} = \frac{x_2^{1 - \gamma}}{\gamma};
$$
which is increasing in $x_2$ (so quasi-concave) if and only if $\gamma < 1$. [We assume throughout that $\gamma > 0$ since $u$ is increasing.]


Negative interest rate on bond yield In Black-Scholes model $r$ is defined as risk-free interest rate. What I have understood is that risk-free comes from the yields on sale of government bonds. What does that mean if the interest rate(fed fund rate) are negative? Does the yield on government bonds then also go negative? I understand the price of the bond will go up, but is that yield correlated with the fed fund rate?

The yield on government bonds is not necessarily equal to fed fund rate. Fed fund rate is a rate at which other banks can borrow from Fed.

This being said the funds rate affects interest rates on all debts since if the banks can borrow more cheaply from Fed they can also offer better terms to their own creditors. Bonds compete on markets for loanable funds so if the interest rate on loans go down  the bond yield will also be lower.

If we are talking about risk free bond then it’s yield will be quite close to the funds rate but not necessarily equal. Also, yes the bond yield can be negative.


If Greece defaults, can it still stay with the euro? Should Greece default, a forced conversion from euros to drachmas will be a further catastrophe to Greek economy as the drachma will quickly collapse. However, if Greece leaves the Eurozone, but keeps the Euro as a national currency (at least for a year), its value will be kept stable because of the implicit trust in the euro.

There already are precedents of countries using the euro without being members of the Eurozone (Montenegro, Kosovo, Monaco, etc.). Is that possible for Greece?

The Greek banks will not be able to get any Euro to give out, if the IMF and the EU cuts of all the loans to Greece.   Therefore if Greeces remains in the Euro, there will be no banking system in Greece.


Why can't we use $R^2$ for different dependent variables? Imagine we have a linear regression model with dependent variable $y$. We find its $R^2_y$. Now, we do another regression, but this time on $\log(y)$, and similarly find its $R^2_{\log(y)}$. Why can't I compare both $R^2$ to see which model is better suited?

Intuitively I would say that the log will decrease the variability, hence any model will improve once we 'add' the log transformation.

Is there another reason? Also is there a way to formalise this intuition?

Any help would be appreciated.

$R^2$ measures the fit of the model to the data.  Notice the ordering of that sentence, "model to the data," and not "the data to the model."  You want to use $R^2$ as a criterion to select among two possible equations.  The fact that you are posting here also probably means either someone told you that you cannot do that or you read online that this will not work.  The fact is, it can work, but it does not function well.

Several aspects of how $R^2$ is calculated make it an inadequate criterion.  First, and this is the classical reason, all you have to do to increase $R^2$ is add variables.  If you were predicting the impact of milk substitutes on babies' performance on a physical test and you added in the price of flawless, color D, three carat diamonds as traded in Hong Kong your $R^2$ may go up, but it will not go down.  In addition, your total sum of the squares will change under the transformation you propose.  Because of this, it is not well suited to using an F-test to compare models.

This brings you to the AIC and the BIC.  Philosophically, the AIC and the BIC are algorithmic approximations of the Bayes factor to choose between the two models.  Because you know your data and we do not, you should read a book on model selection, such as this one.

However, given the limited information that you did provide, it would appear, at least on the surface, that either the AIC or the BIC would produce equivalent results.  That is because you have only two models and they have an equal number of parameters.

If you have not used a Bayesian method before, they reverse the direction of probability.  Instead of assuming a model is true and determining whether or not the data is as extreme or more extreme than some standard, it assumes the data is fixed and not random and that the models are uncertain, and so selects the best parameters and models based on the data.  There is no null hypothesis.  So the AIC or BIC are approximations of odds transformed into an algorithmic rule.

They differ in two ways.  First, the BIC gives each model equal prior probability of being "true," while the AIC gives probabilities in proportion to their number of parameters so that complex models are penalized for being complex.  Second, they approximate the likelihood function differently so that the AIC ends up penalizing complex models less than the BIC unless the sample size is large.

The reason to use either tool, rather than a full-blown Bayesian method, is that they are faster, they are good approximations in most circumstances to the Bayesian solution, and they are less complex than a Bayesian model selection process.

You cannot formalize the idea of the logarithm reducing volatility and creating nicer models because it may not do so.  Consider a model whose true form is $y=5x+7$ and you then transform those variables.  A log-linear model would be expected to be a worse model than the untransformed model.  Although using logs would reduce the scale of all variables, $R^2$ is based on the relative scale.  Dividing all variables by two would also reduce variability, but not improve $R^2$ or model selection.


What are production limiting programmes? Under WTO domestic support norms, blue box measures include:

  Direct payments under production limiting programmes (often referred to as “Blue Box” measures) are exempt from commitments if such payments are made on fixed areas and yield or a fixed number of livestock.

These are also referred to as production limiting subsidies? Why would governments want to limit production? And isn't subsidy usually aimed at increasing production?

Reference: https://www.wto.org/english/tratop_e/agric_e/ag_intro03_domestic_e.htm

Subsidies are often primarily aimed at increasing the income of the agricultural sector

When subsidies lead to increases in production, this can cause the market price to fall with negative effects on agricultural incomes, with much of the benefit flowing through to consumers rather than farmers.  This then leads to calls for further subsidies

To avoid a spiral of increasing subsidies, governments will often move to a stage which restricts production, and one possibility is to tie the subsidies to given levels of production (often based on previous levels of production or on fixed assumptions about areas and yields), either not paying subsidies on production above some stated level or, in more extreme cases, withdrawing subsidies if production exceeds a quota

The aim of such production-limiting subsidies is to maintain subsidies at a level which is sustainable both in terms of market prices and government expenditure.  It is in fact a double distortion of the domestic market, both through the subsidies and through the production-limiting elements, but was deemed to be less distorting of international trade than unlimited production-based subsidies


Estimation of the future growth of real GDP per capita of the world From 60's to 70's, the real GDP growth per capita of the world fluctuated about 3%. Since then, it fluctuated about 1.8% or somewhere around. (I mean, the average would be about 1.8% since 1970.) I  found this trend from the data provided by Google public data. Is there a consensus among economists that the real GDP growth per capita of the world will be stable or gradually decrease in the future?

I don't think there is a consensus about this. In 1980s and 1990s, growth theorists have tried to endogeneize the technological progress in growth models, that shows a "balanced growth path" (in which economy grows at a constant rate in long distance.) So, we can say that economists don't want a decrease in GDP.

But note that there are some people who support the idea of "degrowth". You can find a definition on Wikipedia.


Objective criteria and judgement of models How do professional economists 'judge' how valid or accurate a economic model is? What criteria do they use, and are these criteria objective?

Clearly, we don't know what the truth is. So a model can't be judged based on whether it predicts true things. So how is it judged?

This is a good question with a complex answer. Different models are created with different purposes in mind. As an example, there are qualitative and quantitative models. Qualitative models sacrifice some realism to demonstrate a particular phenomenon in the clearest way possible. Quantitative models sacrifice this clarity to create something more empirically relevant.
I once came across this sentence in a paper and I like the way they phrased it:
It's from "Optimal Environmental Taxation in the presence of other taxes: General-equilibrium analyses" by Bovenberg and Goulder:

  The use of a numerical model enables us to employ a realistic
  specification of taxes and adopt a fairly detailed representation of
  production and demand. Our paper thus combines the strength of
  analytical and numerical approaches: a stylized analytical model
  uncovers the major mechanisms at play, while a numerical model
  explores the empirical significance of these mechanisms in a more
  realistic setting. Despite considerable differences in the complexity
  of the analytical an numerical models, we find a strong coherence
  between the two model's results.

Also,
there are some models that are purely statistical.
There are also some models that are built solely for prediction. In short, there are many more types of models with different purposes. A model should be judged on its purpose.

Also, as for uncovering "the truth." You might consider reading more about causal inference. This is one of the most important parts of econometrics. For starters, read about the method of Instrumental Variables. There are several other questions and answers on this website that deal with this.


Why is the Bank of Japan buying all the government bonds? I've recently read that the Bank of Japan is continuously buying government bonds. Apparently, at the rate they are going, the BoC will own all the bonds by 2026, which means the government will essentially owe all its debt to itself.

What is the point of doing this? And once they buy all the bonds, does it mean that the debt of Japan will be nil?

Central banks usually buy back government bonds to combat deflation and facilitate economic growth. This policy is commonly called "quantitative easing" or QE. After the arguable success of QE during 2008-2009 recession in the United States, many other countries choose to adapt this monetary policy.

It is very unlikely that the Bank of Japan will keep this policy until 2026 because at some point inflation will pick up and they will have to stop buying bonds and perhaps even raise interest rates. In the US, UK, and EU the bond-buying quantitative easing programs haven't lasted longer than 5 years and they are usually closely monitored and can be stopped at any time.

When the central bank buys government bonds, they stay on its balance sheet until maturity. Normally, central banks are happy to keep them as a convenient monetary tool. They can sell the bonds back to reduce inflation. Whether the government debt on the central bank's balance sheet can "cancel out" depends on the countries laws.


Is the loan principal ever delivered in pieces over time? Not sure if this is the right place for this question but it's more of a theoretical finance question than a personal finance question.

So a loan has a principal amount that is given to the borrower in a lump sum, and the borrow then pays back that amount plus some interest. For example, let's say that George loans \$100 to Fred at 10% interest over 10 months. Fred then pays back at \$11 a month and is debt free at the end 10 months.

Is it ever the case that George lends the money in increments instead of a single lump sum? That is, George pays Fred \$20 a month for five months, while at the same time Fred pays back at \$11 a month for 10 months.

I ask because this would be less useful to Fred but less risky to George.

Handing out the principal amount of debt gradually, in increments, is standard practice in investment loans extended by a bank to a corporation.

The rationale is clear : the corporation wants to make an investment, say a new factory. The whole plan is laid out and the cash flows of the pre-operational, construction period are also detailed, based on forecasts or specific agreements with the suppliers (contractors etc) that will be involved. The bank checks and accepts all these, but it also wants to see the corporation deliver (both the corporation's part in the financing but also as regards the actual build up of the investment).

So specific milestones are agreed between the two parties, and to each milestone a round of financing is agreed (these milestones become contracutal obligations, legally binding). Milestones usually include specific technical phases of the build up to be accomplished (say, the building's foundations are complete, or the power infrastructure has been installed, etc).

In this way risk is reduced without hurting the necessary cash flow for the project. It also reduces the interest burden for the firm.


Tax imposed on customer affects demand or supply curve? I have a example of supply and demand. If there is a regulation that requires customers to pay additional tax when they purchase cigarettes, would supply or demand curve shift? I know that tax/subsidies is one of supply's non-price determinants, however, it is only applicable to producers. I doubt that this example is concerned with demand curve. Nevertheless, tax is not one of demand non-price determinants. Thanks!

In partial equilibrium, demand shifts down, with the (vertical) distance between the pre-tax and post-tax curve being exactly the height of the tax.

pre-tax curve: $q=f(p)$

post-tax curve: $q=f(p+t)$


What does "(Earnings Per Share) sen" mean in a shareholders' context? What does "SEN" / "sen" (possibly an abbreviation?) mean in a shareholders' context?

In particular, I am wondering how to interpret "sen" in the following context:

"Earnings Per Share (sen)"

This can be encountered a lot, as a simple google query "Earnings Per Share (sen)" shows.

Perhaps "sen" is no more than a 1/100 sub-unit of the (e.g.) currency Malaysian ringgit? Such a sub-unit is called "sen", and is etymologically related to the English word "cent".

It seems even more likely that "sen" in  "Earnings Per Share (sen)" refers to a 1/100 sub-unit of a currency, as the google query "Earnings Per Share (cents)" yields many similar results.

But even if that would be the case, I think there can be more elaborate answers than mine, which also explains a bit more about the meaning of the words "Earnings Per Share", in relation to numbers expressed in either "cents" or "sen".


GDP Identity:Why does $\text{C+S+T = C+I+G+(X-M)}$? $$\text{C+S+T = Y = C+I+G+(X-M)}$$
  where:
  $\text{Y}$ is GDP
  $\text{C}$ is Private consumption
  $\text{S}$ is Private savings
  $\text{T}$ is net taxes
  $\text{I}$ is investment
  $\text{G}$ is Government's expenditure on final goods.

How does $\text{C+S+T= C+I+G+(X-M)}$?
What do they form? Which one's aggregate demand and which one's distribution of income and why are the called so?

A concrete example makes it easier to think about:

Let's say during the week you receive \$1000 income. Only 3 things can happen to your $1000:

You could be taxed some/all of it (T: Tax)
You could spend some/all of it (C: Consumption)
You could save some/all of it (S: Savings)

In this example we've used your $1000 income. The distribution of income (Y = C + S + T) is exactly the same but not just one week of your income, but 52 weeks of everyone's income. So it's a measure of how much income was received across everyone in the economy for the whole year.

Now, all this income had to originate from somewhere, and there are only four possibilities:

someone's spending (C: Consumption) - this goes to businesses and is paid out as wages, as interest on business loans, or as share dividends or profits to owners
government spending (G: Government Spending) - payments to government workers and for anything government buys (e.g. materials to build roads, defence spending etc etc)
banks making loans (I: Investment) - loans made to businesses or individuals
sales to foreign economies less what is paid to foreign economies for their goods and services (X - M: exports minus imports)

Adding these components together gives aggregate demand: C + I + G + (X - M); it's the $ amount of all the goods and services purchased in an economy over one year.

GDP is not a perfect way to measure the size of an economy, but it's probably the most common way. So when we talk about GDP = Y = C + S + T = C + I + G + (X - M), what we know is that GDP can be measured in a few different ways, and that more spending will mean more income (and vice-versa).


How does government spending on imported goods affect GDP? How does government spending on imported goods affect GDP?

Is it first counted as government spending and then subtracted as imports?

For instance, if the US government buy a new accounting system from overseas, how would this affect the US GDP?

Recall the definition of GDP that it is the aggregate value of all goods and services produced within the domestic territory.

The concept of domestic territory is central here. Only those government expenditures that creates a domestic income is counted in GDP.

For instance, if US government gives economic aid to a poor African country it will not be a part of US GDP, although it is a government expenditure.

In the same way the government expenditure on imports does not create any domestic income hence the value of imports will be subtracted from the GDP without any complementary addition.


Unemployment Claims vs Monthly Jobs Report Lately weekly Unemployment claims have been around 700,000.  So Monthly unemployment claims are about 4 x 700,000 or 2,800,000.    YET Jobs Reports say:  The U.S. economy gained 638,000 jobs in October.  Are we really losing    2,800,000 -  638,000  or   2,162,000 jobs monthly?

On the last inference of the first graph, the unemployment rate is at 6.7%. This means that out of the 164.6 million Americans that the labor force is comprised, 11.2 million are unemployed as of November 2020 (data: Bureau of Labor Statistics2).
This graph and the graph to its right, both indicate that people are beginning to get employed at a dropping rate.
On the following (red) graph you may notice that as of August, fillings for unemployment have remained relatively constant (data: Department of Labor3).

So the answer I can quickly come up with goes like this; the US is not actually losing 2,000,000 jobs monthly, as the 2nd chart has shown. There might be other incentives at play that encourage people to file for unemployment - perhaps they need to do so in order to receive government handouts even if they didn't work and didn't need to file for unemployment prior to the crisis; meaning they weren't part of the active labor force.


What are some good books, explaining why the society and economy developed like it is through the history? It has always been fascinating to me why, out of so many other options, the society has developed in this way. So I was searching for resources which explain what chain of events-and why- from beginning of the civilization proceeded what we have today. Unfortunately, what I have found are either very specific or very technical. I hope you could help me.

I recommend Jared Diamond's Guns, Germs and Steel, for this topic. I don't know what you mean by "the society." Diamond makes it clear that there are many different societies around the world, progressing at different rates. To answer your question about why we have what we have today and why individual societies developed in the direction they did: some technologies are inevitable, such as farming, writing and mettalurgy. What differs is that a few societies developed these technologies much earlier than others. Diamond lays out the reasons why; differences in intelligence across races is not a reason but the geology and biogeography of people's habitats are ultimate causual factors. These ultimate factors lead to more proximate factors such as animal and plant domestication, leading to denser and more sedentary populations with more complex political organization. Technological development led to further economic development, with most technology arising from it being spread from other societies—and that transmission depends again on geography. Eurasia had the advantage of an east-west axis that made transfer of domestic food and animal species easier (along the same lines of latitude and hence similar climes), and thus the technology which accompanies more sedentary societies. More isolated societies such as Australia did not benefit from the spread of technology, and hence remained a hunting-gathering society until European conquest.

His book is entertaining and interesting to read. I've learnt facts and a perspective of the differences amongst races that I couldn't do without.


What's a « 1-Ratio» ? From a text on Capital's share of GDP In this article, the writer talks about the «capital share, as a percent of GDP — here just 1 – labor share percentage»

What's this 1-labour share percentage?

I'm pretty sure he means "1 minus the labour share percentage", i.e. he's estimating the capital share of GDP as the proportion of GDP not going to labour.  It's not typeset well, but he has used an em-dash (longer) after "GDP" and a minus sign (shorter) after "1".


GDP of domestic and foreign economic activities of a country Is there an indicator which shows how much GDP of a country is generated by domestic economic activities (e.g. business between food production in Germany and agriculture in Germany) and how much GDP is generated by economic activities of that country with foreign countries (e.g. business between food production in Germany and agriculture in Brazil)?

You can calculate domestic economic activity by calculating GDP and subtracting net exports. Any activity that requires dealings with foreign country will be recorded as either export or import. Once you subtract exports and imports from GDP you are left just with domestic activity.


Second-hand products in GDP I am aware that secondhand goods are not counted in GDP due to double counting issues, but I want to ask about a specific case of transaction of second-hand goods.

For instance, what if a student buys a book for 20$,

uses the book  for a bit, and then sells it to a college bookstore for

40$? And what if the college bookstore sells that used book to another

student for 50$?

I know that for the second case, the 10 $ (50 $ - 40 $) will be counted in

GDP because this represents the bookstore's services created for providing

books.

But what about the first scenario, where a student sold the book to the

bookstore for 40 $?

Would the 20 $ (40 $ - 20 $) be counted in GDP? Or would

this just count as the increase in the student's wealth?

Its because the student did not produce any value added in the production of the book. She used the book and then basically transferred it to the bookstore. On the other hand, the bookstore may repair the book and sell it for a \$10 profit.  (the bookstore may be advertising, displaying, and other services). The \$10 reflects this additional value added in the economy in the current year, and is thus added to the current GDP.


Lotteries and expected utility Suppose we have the following four lotteries:

$L_{1}=[(1,\$1)]$

$L_{2}=[(0.01,\$0),(0.89,\$1),(0.1,\$5)]$

$L_{3}=[(0.9,\$0),(0.1,\$5)]$

$L_{4}=[(0.89,\$0),(0.11,\$1)]$

If our agent says that he prefers $L_{1}$ to $L_{2}$ and prefers $L_{3}$ to $L_{4}$, then he is not following the expected utility assumption of independence (also known as substitutability).

Anyone know how to explain this?

Your example is the classic Allais paradox.

I think the best way to see how the preference pattern $L_1\succ L_2$ and $L_3\succ L_4$ violates independence is to visualize it geometrically. Consider the following figure:

Observe that
\begin{align}
L_2&=L_1+(0.01,-0.11,0.1)\\
L_3&=L_4+(0.01,-0.11,0.1).
\end{align}
Therefore, the indifference curves passing through $L_1$ and $L_4$ should be parallel. Since $L_1\succ L_2$, the latter lottery should lie below the IC through $L_1$. By implication of the parallelism of the ICs, $L_3$ should also lie below the IC through $L_4$. But we're given that $L_3\succ L_4$. This means that $L_4$ lies below the IC through $L_3$ (the blue dashed line). Since parallelism of ICs is a necessary condition of independence, the agent's preference is inconsistent with independence, because it can only be justified by a set of non-parallel ICs.

Alternatively, you can think of the inconsistency between the agent's preference and expected utility theory in the following way.
Suppose expected utility theory holds. Then $L_1\succ L_2$ is equivalent to the inequality
\begin{equation}
u(\$1)>0.01u(\$0)+0.89u(\$1)+0.1u(\$5).
\end{equation}
Adding $0.89u(\$0)-0.89u(\$1)$ on both sides, we get
\begin{equation}
0.89u(\$0)+0.11u(\$1)>0.9u(\$0)+0.1u(\$5).
\end{equation}
But this second inequality is simply saying $L_4\succ L_3$, which is contradictory to the agent's preference.


Reject worker after match In the DMP family of labor models, we typically have $V$ denoting a vacancy and $J$ denoting the value of a job. $V$ typically becomes 0 through free entry.

Say a firm get matched with a worker of value $J_i$ and could reject him, to search again. In order to do so, it would need to hold that $V > J_i$. But as (through free entry) $V = 0$, that would only be the case if the worker has zero value to the firm.

However, in the real world, we see firms rejecting applicants and searching for new applicants. How do DMP models achieve to generate this observation?

In the standard model, all workers have the same productivity. So if J < 0, your expected value of a vacancy would also be negative. That the reason why, once a match is made, the only variable to be set is the wage. In the real world, they have to deal with different expected productivities.

Pissarides 94 distinguished between two kinds of applicants (but in this case, the firm is passive in the decisions).


Mixed Strategy Bayesian Nash Equilibrium There was an exercise question regarding two players with two types each in a game theory class.
The two players were assigned to do a team project together.
The utility from doing the team project is 10 for both players. The cost of doing the project for player 1 (C1) can be either 5 or 15, and the cost of doing the project for player 2 can also be either 5 or 15.
and the probability that the cost will be 15 is 1/3 for both players.

Now the professor said there were three Bayesian Nash Equilibria. Among the three two were quite similar.
One equilibrium was
Player 1 with high cost type - not do project
Player 2 with high cost type - not do project
Player 1 with low cost type - not do project
Player 2 with low cost type - do project
and another Bayesian equilibrium is the same thing as above with the Player 1 with low cost type and Player 2 with low cost type swapped in terms of their action. And thankfully I understood how the two equilibria were derived using expected utility comparison.
The problem I have right now is with the third equilibrium. The teacher mentioned that there is a third equilibrium existing here using 'Mixed Strategy' but that's all he mentioned and he didn't go over it. How can we solve for the Mixed Strategy Bayesian Nash Equilibrium for this kind of question? I've done mixed strategy for perfect information, but I have no idea how to do it for incomplete information Bayesian Nash Equilibrium. I would appreciate some explanations on how to solve for the mixed strategy Bayesian nash equilibrium using this activity. Thanks.

The trick for finding a mixed strategy Nash Equilibrium is that given everyone else's strategies, all players will be indifferent between each of the options their randomizing over (ie. those options will yield the same payoff). So all you need to do is write an expression relating each player's expected payoffs for each strategy, and solve for the frequencies. Letting x represent the probability that player j does the project, low-cost player i's payoff for doing the project is 5, while their expected payoff for not doing the project is 10x. So you know in the Nash Equilibrium, 5=10x. The incomplete information makes the problem slightly more complicated: player i may expect j to complete the project half the time, the task is now finding j's probability of completing the project given that they are low-cost (not too difficult, since high cost players will never do the project). I'll leave the rest to you.


Public debt of European countries, by year Where can I find lists with public debt of European countries such as the UK, by year? (or by fiscal year)

If there are such lists on Eurostat but only for the last 10 year or so, I would like to have longer lists, for each country in part.

Later edit: If possible, having both the amount in Euros and in percentage of GDP, would be great. Like for example this list for Spain: http://www.datosmacro.com/deuda/espana

If you know lists for a single country, please mention them. For example if you are from Germany and you have links with such a list for Germany, from the National Institute of Statistics or another site, please let me know about it, I'll vote your answer.

Would you be satisfied with a graph of the last 20 years?
Is yes, you can use Google Data Explorer.
It seems to rely on Eurostat as well, so the data is probably available from them somewhere.


How to find the market equilibrium by surplus maximisation when there is a consumer subside? Let's assume a market with linear demand and supply functions, let's say $Q_d = 20 - 4p$ and $Q_s = -4 +8p$ respectively.

We can easily find the market equilibrium by either setting $Q_d = Q_s$ (or $P_d = P_d$ in the inverse demand and supply functions) or by maximising the total surplus, as done in the following screenshot:

We can now add a subside to the consumers, let's say 2 monetary unit/quantity unit, and the result is to shift up the demand curve, so that the new equilibrium can be easily obtained setting for example the prices equal in the new apparent demand curve $Q_dsub = 28-4p$ and the supply curve, and we find equilibrium quantity with subside $Q^{*sub} = 52/3$, eq. price with subside for the producers $P^{*sub}_{S} = 8/3$ and eq. price for the consumers with subsides $P^{*sub}_{D} = 2/3$

The problem is that if I try to obtain that results by maximisation of the total surplus as before, I obtain:

$$TotalSurplus = - \frac{3}{16}Q^2+\frac{9}{2}Q + P^{*sub}_{S} * Q^{*sub} - P^{*sub}_{D} * Q^{*sub}$$

When I account for $P^{*sub}_{S} = P^{*sub}_{D} + 2$, I obtain:

$$TotalSurplus = - \frac{3}{16}Q^2+\frac{9}{2}Q  + 2 * Q^{*sub}$$

And here I don't know how to continue, as the equilibrium point doesn't write off any more.

never work on weekends :-)

What you really do here is to find the total surplus in terms of $Q*$ and then maximise it setting the derivative to $Q*$ equal to zero.
So, you just maximise
$$TotalSurplus = - \frac{3}{16}Q^{*2}+\frac{9}{2}Q^{*}  + 2 * Q^{*}$$
for $Q*$ and you obtain the expected results.


Right definition of natural rate of unemployment? Earlier I studied macroeconomics from Blanchard. But now while reading Mankiw's Macroeconomics I found different definition for natural rate of unemployment. According to Blanchard,

"the rate of unemployment (and by implication the level of output) that prevails if the price level and the expected price level are equal." (pg. 135, sixth edition) and

"The natural rate of unemployment is the rate of unemployment required to keep the inflation rate constant." (pg. 170, sixth edition)

But according to Mankiw,

"The natural rate is the rate of unemployment toward which the economy gravitates in the long run, given all the labor-market imperfections that impede workers from instantly finding jobs."(pg. 177. eighth edition),i.e., where unemployment rate reaches steady-state, it neither increases or decreases, where rate of job finding is equal to rate of job separation.

What is the common ground between all these definitions? Are they different or essentially the same? If so, then how?

One definition of the natural rate of unemployment is the NAIRU: non-accelerating-inflation rate of unemployment. The classic story of the money illusion and unemployment works like this:

  Both Friedman and Phelps argued that the government could not
  permanently trade higher inflation for lower unemployment. Imagine
  that unemployment is at the natural rate. The real wage is constant:
  workers who expect a given rate of price inflation insist that their
  wages increase at the same rate to prevent the erosion of their
  purchasing power. Now, imagine that the government uses expansionary
  monetary or fiscal policy in an attempt to lower unemployment below
  its natural rate. The resulting increase in demand encourages firms to
  raise their prices faster than workers had anticipated. With higher
  revenues, firms are willing to employ more workers at the old wage
  rates and even to raise those rates somewhat. For a short time,
  workers suffer from what economists call money illusion: they see that
  their money wages have risen and willingly supply more labor. Thus,
  the unemployment rate falls. They do not realize right away that their
  purchasing power has fallen because prices have risen more rapidly
  than they expected. But, over time, as workers come to anticipate
  higher rates of price inflation, they supply less labor and insist on
  increases in wages that keep up with inflation. The real wage is
  restored to its old level, and the unemployment rate returns to the
  natural rate. But the price inflation and wage inflation brought on by
  expansionary policies continue at the new, higher rates.

The Concise Encyclopedia of Economic: Phillips Curve by Kevin D. Hoover, emphasis mine.

At first this seems like a Blanchard-type definition. But why it is that the NAIRU takes one value and not another? The answer typically given is like that provided by Mankiw:  labor-market imperfections impeding or incentivizing workers from instantly finding jobs. A decline in unemployment insurance, a reduction in the regulatory costs of firing workers, or a technological improvement in the ability of workers and employers to find each other all could reduce unemployment without altering inflation or inflation expectations.

In my eye, both definitions contribute something important to the idea of a natural rate of unemployment. If labor market frictions are moving around a great deal it is hard to speak of a natural rate of unemployment. If the fiscal or monetary policy authorities are manipulating inflation in a way that is at odds with inflation expectations there similarly is no natural rate of unemployment either. By "gravitates in the long run" I assume that Mankiw doesn't mean convergence. Rather, he means something more like mean reversion. Only when the monetary authority is catering rational expectations of inflation and labor market frictions are broadly stable that a natural rate of unemployment makes sense. It's going to be something more like a long run average rate of unemployment in that economy.


Help with Income Elasticity Exercise in Becker's Economic Theory On page 18 of his book Economic Theory, Gary Becker provides the reader with the following exercise (no answers given):

Exercise Statement:

Write the formula $\sum_j K_jN_j = 1$ where $N_j$ is the market income elasticity of demand for the $j$th good and $K_j$ is the fraction of total market income spent on $j$, in terms of the $\eta_{ij}$ and $k_{ij}$, where these are the income elasticities and shares of the $i$th person for the $j$th good. First derive the $N_j$ in terms of the $\eta_{ij}$. Is $N_j$ a simple average of the $\eta_{ij}$, or do higher income persons have a greater weight than lower income persons?

My Question:

What does $\sum_j K_jN_j = 1$ represent?

My first intuition was I understand why the sum of all $K_j$ shares would add up to a whole. The sum of all shares equals the total income which could be 1. So $K_j$ would then just be a percentage of the whole. But what then would $K_jN_j$ represent? This is where I got stuck.

EDIT:

Okay here's my first stab at the problem:

We know $\eta_{ij}$ represents the income elasticity of individual $i$ with respect to the $j$th good. So by definition, the income elasticity is defined as
\begin{equation}
\eta = \frac{\partial Q}{\partial I} \frac{I}{Q}
\end{equation}

We also know the fraction of total market income individual $i$ spends on good $j$ is $k_{ij}$. I reason that this should be just the amount spent on the good divided by the total income of individual. So it should be
\begin{equation}
k_{ij} = \frac{p_jq_j}{I}
\end{equation}

I still don't see how this should come out to $1$ though. Unless we are thinking that elasticities cancel out, such that for every $\eta_i$, $\exists$ $\eta_j = \frac{1}{\eta_i}$ such that $\eta_i\eta_j=1$.

The precise question the OP asked was what does $K_j N_j$ represent. As Alecos' response says, the statement  $\sum_j K_j N_j = 1$, i.e. the weighted average of the income elasticities equals one, means that if total income goes up by one percent then total expenditures/consumption also increases by one percent. The total market expenditure for some goods (with income elasticity of demand > 1) will go up more than one percent, for some goods (with income elasticity of demand between 0 and 1) will go up but less than one percent, and for some goods (with income elasticity <0) will go down. But taking all goods together, expenditures will go up one percent when total income goes up one percent.
(Becker makes this point in the context of an individual rather than the complete market on p. 16 and footnote 2 of the text.)

Now I provide the solution to the exercise statement:

Start with the notion that when individual $i$'s income $y_i$ increases by one percent, his demand for good $j$ increases by $\eta_{ij}$ percent. What effect does this have on total market demand for good $j$? It depends on what fraction $w_{ij}$ of the total demand for good $j$ individual $i$ accounts for. Total market elasticity for good $j$, $N_j$ is the weighted sum of the increases in demand of each individual: $N_j = \sum_i w_{ij} \eta_{ij}$

Algebra can get this in terms of $k_{ij}$ and $\eta_{ij}$ (and $y_i$) as the exercise statement requests.

First find an expression for $w_{ij}$, the fraction of total demand (or expenditure) of person $i$ for good $j$: Letting $q_{ij}$ denote $i$'s demand for $j$, this fraction is
$$w_{ij}=\frac{q_{ij}}{\sum_i q_{ij}} = \frac{k_{ij} y_i}{\sum_I k_{Ij} y_I}$$
 where the second equality comes from the definition $k_{ij} \equiv \frac{p_j q_{ij}}{y_i}$.

Then $N_j = \sum_i f_{ij} \eta_{ij} = \sum_i \frac{k_{ij} y_i}{\sum_I{k_{Ij} y_I}} \eta_{ij}$. The weight/fraction $w_{ij}$ is increasing in $y_i$: for a given $k_{ij}$ a higher income person's elasticity is weight more. (Actually, what matters for how heavily and individual's elasticity is weight is not just income but actually $k_{ij} y_i$, their expenditures on good $j$, relative to the total market expenditures on good $j$. This makes intuitive sense: the elasticity of a heavy consumer of a good will have a bigger effect on that good's market elasticity than that of a light consumer, regardless of income.)

The fraction of total market expenditures spent on good $j$ is $K_j = \frac{\sum_i k_{ij} y_i}{\sum_i y_i}$.

So with some simple algebra we have $K_j N_j = \frac{\sum_i k_{ij} y_i \eta_{ij}}{\sum_i{y_i}}$.

With more algebra and using the identity $\sum_j k_{ij}\eta_{ij} = 1$ (see p. 16) you can confirm that $\sum K_j N_j = \frac{\sum_i (y_i \sum_j k_{ij}\eta_{ij})} {\sum_i{y_i}} = 1$.


How will economy find long-term equilibrium in AD-AS model in case of a negative supply shock? Let's suppose that negative supply shock happened that affected SRAS, but not LRAS. Let's also assume that previously there was long-run equilibrium at point $A$. Due to negative supply shock SRAS decreased, meaning that economy will be either at point $B_1$ (real GDP supplied stayed the same, but price level increased) or at point $B_2$ (price level stayed the same, but real GDP supplied decreased). In both cases they will lead to short-term equilibrium at point $C$

But what will happen next? How will the economy find its long-term equilibrium in this situation? Judguing visually, there are two shortest ways to reach long-term equilibrium after negative supply shock. Either SRAS will increase to its old level or AD will increase so much that long-term equilibrium at point $B_1$ will be reached. But I don't see any reasons why would any of them happen (unless the government intervenes by detaxing/deregulating/subsidizing firms or by spending more). If anything, I would expect AD to decrease due to decreased real wealth (real wealth decreased because both inflation increased and GDP supplied decreased). But such shift wouldn't lead to long-term equilibrium. At the least not without consequent increase of SRAS. But why would such consequent increase happen (assuming no government intervention)?

The only way to shift the SRAS curve without also shifting the LRAS curve is through a temporary change in input prices. By definition temporary changes in input prices are temporary, thus they will return to their previous values. Thus the SRAS will return to its previous long-term value at $SRAS_1$


CAPM goodness of fit I want to test the CAPM. I have collected monthly data from 1-9-2012 to 1-9-2017. I have data from the return of Standard&Poor's 500 and data from various US companies. The beta's seem right, but my goodness of fit ($R^2$) are low: Ameren 0.0614, Apple 0.2456. My question is: Can this be right? If you're testing the CAPM or am I doing something wrong. I used the CAPM regression $R_{i,t}-R_{f,t}=\alpha_i+\beta_i(R_{M,t}-R_{f,t})+e_i$.

$\beta$ is the measure of the sensitivity of stock returns to market returns. This has nothing to do with the value of $R^2$.

Your results appear to be fine, you can get significant beta estimates but low $R^2$. Why?

As measured by $R^2$, 24.56% of variation in Apple returns is accounted for by the variation in the market index, $S$&$P 500$. Clearly, there must be other factors that determine the remaining 75.44$% of variation in the Apple returns. Other factors that you could include in the model are copmany size and market to book value (Fama and French Three-Factor Model). By including these omitted variables in your new model, you may achieve higher r-squared value.


is it better a low or high WACC for a company valuation? I'm doing a statistical report of some italian banks and I'm looking for correlation between Corporate governance practices and bank values. I'm focusing on WACC and I would like to understand if an high value of WACC it's better than a lower value or vice versa.

WACC is the weighted average cost of capital - the price of money for the firm. All else equal, lower is always better.


Why does Iceland have 5% interest but Sweden 0% interest with the same GDP growth? Both countries have their own currencies, similar GDP growth and low inflation.  Yet Sweden has 0% central bank interest rates while Iceland has 5%.

Can someone explain?

Here are some elements:

Considering the two countries independently (like a closed economy), it depends on the real interest rate in the domestic country. If the inflation is zero in both countries, the real interest interest is probably higher in Iceland than in Sweden. To go deeper on this path, look at the Taylor rule which is a good proxy for the monetary policy followed in practice.
In an open economy, it depends also on the "confidence" foreign agents have in your currency. If they are afraid of a future inflation (so their returns will shrink) they "ask" for a better remuneration. For example the ECB had for years higher interest rate than the FED, and some argued the lack of confidence in the euro was one motive. The interest rate parity is the key word for deeper research.


Theory behind financial flows not going to the most developing nations even though they have the highest growth rates I remember reading a bunch of articles on this a few years ago, but I can't find any of the references any more.

It has been a while since I looked at this, so here is a rough paraphrase of the theory and I was trying to find some good references for it. Basically there is a theory in development economics or economic growth where financial flows should go to the areas with the most potential economic returns, which usually means developing nations. But if I remember correctly, this result is not visible in the actual financial flows data, where most financial flows remain within developed nations. So the argument was that there is more to be gained from money flowing or concentrating in some higher returns industries within developed nations, rather than flowing to places which in principle might have higher returns.

Like I said, this is a very rough paraphrase to the point of being inaccurate. But if anyone know what this theory is called or the latest work in this area, that would really be appreciated.

Its called Lucas paradox and its actually specifically about flows of capital not financial flows per se. Also it is not an idea from developmental economics or growth theory but international macroeconomics (or at least that’s where it originated I am sure the idea could get home in other subfields as well).

The paradox arises because classical international macro theory would predict that capital should flow from capital rich countries to capital poor countries as in those the rate of return on capital should be higher. Hence rational investors should flock to those.

The paradox is actually relatively recent as it was proposed just 30 years ago in this paper:

Lucas, Robert (1990). "Why doesn't Capital Flow from Rich to Poor Countries?". American Economic Review. 80 (2): 92–96.

The interesting thing is that this paradox emerged only during 20th century as there is an evidence for large capital flows during the first wave of globalization (i.e. pre WWI) between capital rich an poor countries.

Some possible explanations offered in literature are that this is either due to market imperfections, sovereign risk, difference in institutions (or better said lack of good institutions in poor countries), or missing technology, infrastructure, or some other important factors of production such as human capital in developing countries.

Some of the recent work on this area includes:

Montiel, P. J. (2006, February). Obstacles to investment in Africa: Explaining the Lucas paradox. In high-level seminar Realizing The Potential for Profitable Investment in Africa.

Schularick, M., & Steger, T. M. (2008). The Lucas Paradox and the quality of institutions: then and now. Available at SSRN 1656282.

Azémar, C., & Desbordes, R. (2013). Has the Lucas Paradox been fully explained?. Economics Letters, 121(2), 183-187.

Akhtaruzzaman, M., Hajzler, C., & Owen, P. D. (2018). Does institutional quality resolve the Lucas Paradox?. Applied Economics, 50(5), 455-474.

You will also find other good sources cited inside the articles listed above, especially the first one has a good literature review.