blch31 the goods market some definitions (or identities): –value of final production –total...
TRANSCRIPT
BlCh3 1
The Goods Market• Some definitions (or identities):
– Value of final production – Total output total output
• If aggregate sales is the same as aggregate purchases, we can break down Y into the
for it.
• i.e. we can focus on the
for output Y.
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Composition of aggregate demand Z
• C • I
– Fixed• Residential (consumers)• Non residential (firms)
– Inventories
• G• NX
– X– Less IM
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• Consumption– Consumer – Some might be some sort of consumers investment
like
• Investment (not financial)– Firms– Consumers
• Government (on goods and services only)– Excludes (e.g. medicare, S.S.)– and – (total would be called government )
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• Exports are (demand for Y)
so they should be included in Y as they are demand for domestic output.
• Imports are (goods produced abroad) - they should not be included in Y as they are not demand for domestic output. However as they are already included in consumption and other purchases, they
• Net Exports =
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• Inventories corresponds to goods
• To get an accurate account of production during the year, we must
• inventories at the beginning of the year (they were produced in the previous year)
• inventories at the end of the year (produced this year but not sold)
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Determination of aggregate demand Z• By definition (identity):
Z in an economy Z in a economy• Assumptions of the model:
– prices (short run Keynesian model)– (everything is in real term)– economy
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Short run - medium run - long run
• Short run - period too short to allow prices to adjust - fixed prices - unemployment possible
• Medium run - economy is always at full employment (labor market must adjust) - prices adjust to bring economy back to full employment - capital stock is fixed
• Long run - growth theory - capital stock increases through investment in the economy
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Determinants of consumption C
• Let’s define YD - - as
YD
• Consumption is determined by disposable income: C as YD
• so consumption is a function of YD
C =
this is a relation which can be specified with the following linear form:
C = c1 is the
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Consumption function
C
YD=Y-T
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Endogenous versus exogenous variables
• Definition– Endogenous variables are determined
– Exogenous variables are determined of the model, i.e. they are
• Investment I is considered as an variable in this chapter• Government spending G and taxes T are variables - they are policy instruments for the
government.
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Model
• C =
• I = (exogenous - given)
• G = (exogenous - policy variable)
• Z by definition
• Y = (equilibrium condition)
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Algebraic SolutionSince in equilibrium,
by replacing we get:
Y =
=
Ye =
is the multiplier m
and is autonomous spending Z0
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Graphical solution
Z
Y
Ye
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The multiplier• Assume a specific consumption function
C = i.e. MPC =
The multiplier m = 1/(1-c1) =
Since Ye = m (c0 + I + G - c1T)
If G increases by ∆G, Y will increase by
∆Y =
In the example above an increase in G equal to 100 will result in an increase in Y of
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Effect of an increase in G
Z
Y
Z0
Z = Z0+c1Y
Y=Z
Ye
∆G 1
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Explanation• Starting at 1, the economy is in equilibrium.• An increase in G equal to ∆G immediately translates into an
equal increase in aggregate demand : 1 to 2• In 2 the economy is not in equilibrium as Z > Y so firms must
increase production by ∆G to meet the additional demand: from 2 to 3
• In 3 the economy is still not in equilibrium (below ZZ’)• As production increases by ∆G , income increases equally so
consumption demand will increase by c1 ∆G: this is an additional increase in aggregate demand : 3 to 4
• Then production must increase again by c1 ∆G this time to meet this new increase in aggregate demand and so on…
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Rational
• Production depends on
as Y = in equilibrium
• Demand depends on
as Z =
and C =
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• When there is an exogenous increase in demand, production will increase equally, and this increase in production (i.e. in income) results in an additional increase in demand.
• However the additional increase in demand is smaller than the original increase because the marginal propensity to consume is less than 1 (some of the increase in income is saved): this process will not result in an infinite increase in output as the additional increases in demand get smaller and smaller and tend towards zero.
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Alternative calculation of the multiplier
Period
1 2 3 4Total increase
(many periods)
∆G ∆G ∆G
∆Y ∆G c1 ∆G c1
2 ∆G(1+c1+c1
2+ …) ∆G
∆C c1 ∆G c12 ∆G c1
3 ∆G (c1+c12+c1
3+ …) ∆G
∆Z ∆G c1 ∆G c12 ∆G c1
3 ∆G (1+c1+c12+c1
3+ …) ∆G€
= 1
1- c1
ΔG
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Alternative approach: Investment = saving
• Approach used by in the “General Theory of Employment, Interest and Money” 1936
• By definition, private saving is what
Sp
Hence Sp
or Y
The equilibrium condition of the model above was:
Y =
By replacing, it becomes I =
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Interpretation
• In a one person economy, investment equals savings because the decision to save and to invest is made by the same person.
e.g. Robinson Crusoe’s island
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Role of government:
• In the above equation, the government
1. takes a share of income in the form of tax
2. spends it in the economy in the form of G
so T - G corresponds to the amount of tax receipts that the government did not spend, i.e. that the government saved.
• In sum, T - G (the budget surplus) can be interpreted as the
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Solution of the model using the alternative equilibrium condition
• Let’s derive the saving function from the consumption function (c1 is the MPC)
C = and Sp
SP = YD =
Sp = with MPS =
– Note that MPC + MPS = 1 as mentioned earlier
• We can now use the saving function and the new equilibrium condition to find equilibrium Y (Ye)
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I = Sp + (T - G) (equilibrium condition)
= - c0 + (1 - c1)(Y - T) + T - G
= - c0 + (1 - c1)Y - (1 - c1)T + T - G
= - c0 + (1 - c1)Y - T + c1T + T - G
(1 - c1)Y = c0 + I + G - c1TFinally
as before.
€
Ye =1
1- c1
(c0 + I_
+ G - c1T)
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Problem # 2 P. 62
C = 160 + 0.6 YD
I = 150
G = 150
T = 100
a. In equilibrium Y =
i.e. Y - 0.6Y =
Y =
Y =
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b. YD = Y - T = c. C = Problem # 3a. Z = C + I + G = so Y = Z = (equilibrium condition)b. If G = 110 ∆G = as the multiplier m = 2.5 and ∆Y = m ∆G ∆Y = and the new equilibrium Y is
consumption drops by c1* ∆Y or and Z = C’ + I + G’ =
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c. Private savings Sp = Y - T - C
=
Government savings Sg = T - G
=
Equilibrium condition: I = Sp + Sg
I =150
Sp + Sg =