macroeconomic background 1 m.pourhosseini. macroeconomic background in this tutorial we review some...

MACROECONOMIC BACKGROUND 1 MACROECONOMIC BACKGROUND 1

M.PourhosseiniM.Pourhosseini

MACROECONOMIC BACKGROUNDMACROECONOMIC BACKGROUND

• IN THIS TUTORIAL IN THIS TUTORIAL WE REVIEW SOME WE REVIEW SOME BASIC BASIC MACROECONOMIC MACROECONOMIC AGGREGATES AGGREGATES

• The purpose is to The purpose is to provide the students provide the students whose first degree is whose first degree is not economics with not economics with some basic tools some basic tools

• AGGREGATE AGGREGATE DEMANDDEMAND

• INJECTIONSINJECTIONS• WITHDRWALSWITHDRWALS• CONSUMPTIONCONSUMPTION• TAXESTAXES• IMPORTS IMPORTS • EXPORTS EXPORTS

aggregate demand

• Defining aggregate demand and national income

• This background is based on the KEYNESIAN THEORYThis background is based on the KEYNESIAN THEORY

• The 45° line diagram: the significance of the 45° line

• Defining aggregate demand and national income

• This background is based on the KEYNESIAN THEORYThis background is based on the KEYNESIAN THEORY

• The 45° line diagram: the significance of the 45° line

The 45The 45 line

O

Cd, W, J

Y

Cd + W (=Y)

O

Cd, W, J

Y

Cd + W (=Y)

£100bn

£100bn

The 45The 45 line

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption

– the consumption function

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption

– the consumption function

The consumption functionThe consumption functionC

onsu

mpt

ion

(£bn

)

Y

C

Y (£bn)

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

C

Y (£bn)

50

50

The consumption functionThe consumption function

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

C

Y (£bn)

50

50

The consumption functionThe consumption function

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

C

Y (£bn)

50

50

C = 8

Y = 10

mpc = C / Y = 8/10 = 0.8

The consumption functionThe consumption function

Different consumption functions (a)Different consumption functions (a)

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

C1

Y (£bn)

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Different consumption functions (b)Different consumption functions (b)C

onsu

mpt

ion

(£bn

)

Y

C2

Y (£bn)

Different consumption functions (c)Different consumption functions (c)

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

C3

Y (£bn)

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Different consumption functions (d)Different consumption functions (d)C

onsu

mpt

ion

(£bn

)

Y

C4

Y (£bn)

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

– other determinants of consumption

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

– other determinants of consumption

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

– other determinants of consumption

– short-run and long-run consumption functions

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

– other determinants of consumption

– short-run and long-run consumption functions

Long-run and short-run consumption functionsLong-run and short-run consumption functions

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

Clong run

Y (£bn)

Cnow

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

Clong run

Y (£bn)

Cnow

C5 years’ time

Long-run and short-run consumption functionsLong-run and short-run consumption functions

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

Con

sum

ptio

n (£

bn)

Y

Clong run

Y (£bn)

Cnow

C5 years’ time

C10 years’ time

Long-run and short-run consumption functionsLong-run and short-run consumption functions

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

– other determinants of consumption

– short-run and long-run consumption functions

– the consumption of domestically produced goods

• Defining aggregate demand and national income

• The 45° line diagram: the significance of the 45° line

• Consumption– the consumption function

– the mpc

– other determinants of consumption

– short-run and long-run consumption functions

– the consumption of domestically produced goods

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

The consumption of domestic productThe consumption of domestic productC

onsu

mpt

ion

(£bn

)

Y

C

Y (£bn)

0

20

40

60

80

100

120

0 20 40 60 80 100 120 140

The consumption of domestic productThe consumption of domestic productC

onsu

mpt

ion

(£bn

)

Y

C

Y (£bn)

Cd

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function

the mps

• Withdrawals– net saving: the saving function

the mps

The net saving function: (a) linearThe net saving function: (a) linear

O

Saving

Y

Cd + W (=Y)

The net saving function: (a) linearThe net saving function: (a) linear

O

Saving

Y

Cd + W (=Y)

S

The net saving function: (b) non-linearThe net saving function: (b) non-linear

O

Saving

Y

Cd + W (=Y)

S

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

Household saving as % of personal disposable incomeHousehold saving as % of personal disposable income

Source: Datastream

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mpt

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mpt

The aggregate net tax function: (a) lump-sum taxThe aggregate net tax function: (a) lump-sum tax

O

Taxes

Y

Cd + W (=Y)

The aggregate net tax function: (a) lump-sum taxThe aggregate net tax function: (a) lump-sum tax

O

Taxes

Y

Cd + W (=Y)

T

The aggregate net tax function: (b) proportional taxesThe aggregate net tax function: (b) proportional taxes

OY

Cd + W (=Y)

T

Taxes

The aggregate net tax function: (c) progressive taxesThe aggregate net tax function: (c) progressive taxes

OY

Cd + W (=Y)

T

Taxes

The aggregate net tax function: (d) regressive taxesThe aggregate net tax function: (d) regressive taxes

OY

Cd + W (=Y)

T

Taxes

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mptexpenditure taxes & Cd

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mptexpenditure taxes & Cd

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mptexpenditure taxes & Cd

– imports: import functions

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mptexpenditure taxes & Cd

– imports: import functions

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mptexpenditure taxes & Cd

– imports: import functionsthe mpm

• Withdrawals– net saving: the saving function

the mpsdeterminants of saving

– net taxes: tax functionsthe mptexpenditure taxes & Cd

– imports: import functionsthe mpm

The import function: (a) imports with low income elasticity of demandThe import function: (a) imports with low income elasticity of demand

OY

Cd + W (=Y)

Exp

endi

ture

on

Impo

rts

The import function: (a) imports with low income elasticity of demandThe import function: (a) imports with low income elasticity of demand

OY

Cd + W (=Y)

M

Exp

endi

ture

on

Impo

rts

The import function: (a) imports with high income elasticity of demandThe import function: (a) imports with high income elasticity of demand

OY

Cd + W (=Y)

MExp

endi

ture

on

Impo

rts

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function;

the mpsdeterminants of saving

– net taxes: tax functions;the mptexpenditure taxes & Cd

– imports: import functions;the mpmeffect of imports on Cd

• Withdrawals– net saving: the saving function;

the mpsdeterminants of saving

– net taxes: tax functions;the mptexpenditure taxes & Cd

– imports: import functions;the mpmeffect of imports on Cd

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function;

the mpsdeterminants of saving

– net taxes: tax functions;the mptexpenditure taxes & Cd

– imports: import functions;the mpmeffect of imports on Cd

– the withdrawals function

• Withdrawals– net saving: the saving function;

the mpsdeterminants of saving

– net taxes: tax functions;the mptexpenditure taxes & Cd

– imports: import functions;the mpmeffect of imports on Cd

– the withdrawals function

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Withdrawals– net saving: the saving function;

the mpsdeterminants of saving

– net taxes: tax functions;the mptexpenditure taxes & Cd

– imports: import functions;the mpmeffect of imports on Cd

– the withdrawals functionthe mpw

• Withdrawals– net saving: the saving function;

the mpsdeterminants of saving

– net taxes: tax functions;the mptexpenditure taxes & Cd

– imports: import functions;the mpmeffect of imports on Cd

– the withdrawals functionthe mpw

The The WW and and CCdd functions functions

OY

Cd + W (=Y)

Cd, W

The The WW and and CCdd functions functions

OY

Cd + W (=Y)

W

Cd, W

OY

Cd + W (=Y)

W

Cd, WThe The WW and and CCdd functions functions

Cd

OY

Cd + W (=Y)

W

Cd, W

Cd

100

100

70

30

The The WW and and CCdd functions functions

BACKGROUND TO KEYNESIAN THEORYBACKGROUND TO KEYNESIAN THEORY

• Injections

– investmentincreased consumer demand

expectations

cost and efficiency of capital

rate of interest

– government expenditure

– exports

– the injections function

• Injections

– investmentincreased consumer demand

expectations

cost and efficiency of capital

rate of interest

– government expenditure

– exports

– the injections function

THE DETERMINATION OF NATIONAL INCOMETHE DETERMINATION OF NATIONAL INCOME

• Equilibrium national income

– withdrawals equal injections

• Equilibrium national income

– withdrawals equal injections

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

OY

W

Cd, W, J

J

Y1

b

a

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

Y2

d

c

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

Ye

x

Deriving equilibrium national incomeDeriving equilibrium national income

THE DETERMINATION OF NATIONAL INCOMETHE DETERMINATION OF NATIONAL INCOME

• Equilibrium national income

– withdrawals equal injections

– income equals expenditure

• Equilibrium national income

– withdrawals equal injections

– income equals expenditure

OY

W

Cd, W, J

J

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

Cd

Deriving equilibrium national incomeDeriving equilibrium national income

OY

Y = Cd + W

W

Cd, W, J

J

Cd

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

Cd

Y = Cd + WE = Cd + J

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

Cd

Y = Cd + WE = Cd + J

Y1

f

e

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

Cd

Y = Cd + WE = Cd + J

Y2

h

g

Deriving equilibrium national incomeDeriving equilibrium national income

OY

W

Cd, W, J

J

Cd

Y = Cd + WE = Cd + J

Ye

x

z

Deriving equilibrium national incomeDeriving equilibrium national income