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ECON2032 Project

May 2007


Introduction

Lawrence Klein (born in 1920) is an American economist. Much of Klein’s work focused on macro economic modelling and Klein developed several computer models. This project will focus on Klein’s ‘model 1’.

Klein Model 1:

Exogenous variables: G T W2 t

Model 1 was created to try and explain the cause and effects of the great depression in USA in the 1920s and 1930s. It tries to explain why the economy did so badly at the end of the 1920s then eventually recovered towards the end of the 1930s.

Basic Time Plot Analysis

We have plotted three important variables to graphically explain what Klein was trying to explain in his model. These three variables are consumption, investment and private wages.

Figure 1 shows the consumption levels every year from 1921 to 1943. In 1921 consumption is 39. Consumption rises each year steadily until 1930 where consumption is at 57.8. Consumption falls in 1931 and rapidly. It falls for a further two years and reaches a level of 45.6 in 1933. In 1934 the consumption levels start to rise again and do so for the next ten years except for a small dip in 1939.

Figure 2 shows the investment levels from 1921-1943. Investment starts at 2.7 in 1921. Here it falls the next year to -0.2%, after this in general it rises each year until 1927 where it reaches 5.6%. In the next six years it falls to -6.2% in 1933. After 1933 there is a sharp rise in investment every year until 1937 where it flattens at around 2% for two years. From 1939 Investment rises further and in three years it reaches 4.9%.

Figure 3 shows the private wages in the time period. In 1921 private wages are 28.8. They fall the following year, but increase at a steady pace to reach 41.3 in 1930. From 1931 to 1934 private wages fall rapidly to 28.5. Wages start to rise in 1935 and continue to do so except for a small fall in 1939 for the next four years. By 1938 wages have reached 41.

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This links in with Granger’s attempt to explain the great depression. As the figures show – investment falls then consumption and private wages fall with a slightly longer lag.

TWO STAGE LEAST SQUARES REGRESSION (TSLS)

Consumption

Using ordinary least squares (OLS) regression and TSLS the following results are obtained:

From these results one can say that significantly different estimations are obtained using TSLS rather than OLS for consumption. We can conclude also that the model is a good fit with R2 values of 0.97214 and 0.982007 for the OLS and TSLS regressions ...

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