gdp in an open economy with govt.ppt

8/13/2019 GDP in an open economy with Govt.ppt

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GDP in an Open Economy withGovernment

Chapter 17


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Learning Outcomes

Government consumption contributes toaggregate spending in the same way asany other component of autonomousspending.

Taxes affect private consumption via theireffect on disposable income.

Net exports are negatively related todomestic income.


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Learning Outcomes

A necessary condition for GDP to be inequilibrium is that desired aggregate domesticspending is equal to national output.

The size of the multiplier is negatively relatedto the income tax rate and the marginalpropensity to import.


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GDP IN OPEN ECONOMY WITHGOVERNMENT

Government Spending and Taxes

Government consumption is part of autonomousaggregate spending.

Taxes minus transfer payments are called nettaxes and affect aggregate spending indirectly.

Taxes reduce disposable income, whereastransfers increase disposable income.


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Government Spending and Taxes

Disposable income, in turn, determines desiredprivate consumption, according to the

consumption function. The budget balance is defined as government

revenues minus government spending.

When this difference is positive, the budget is in

surplus; when it is negative, the budget is indeficit.


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When the budget is in surplus, there is positivepublic saving, because the government isspending less on the national product than the

amount of income that it is withdrawing from thecircular flow of income and spending.

When the government budget is in deficit, publicsaving is negative.

Government spending and tax rates areexogenous factors while tax revenue is anendogenous factor.


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Net Exports

Since desired imports increase as national incomeincreases, desired net exports decrease asnational income [GDP] increases, other things

being equal. Hence the net export function is negatively sloped

[net exports fall as GDP rises].

Shifts in the net export function are due to foreign

GDP and relative international prices. Changes inrelative international prices might be due tonational differences in inflation rates, exchangerate variation.


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Equilibrium GDP

GDP is in equilibrium when desired aggregateexpenditure, C + I + G + [X - IM], equals nationaloutput.

The sum of investment and net exports is callednational asset formation because investment is theincrease in the domestic capital stock and net exportsresult in investment in foreign assets.

At the equilibrium level of GDP, desired national

saving, S + T - G, is equal to national assetformation, I + X - IM.



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Changes in Aggregate Spending

The size of the multiplier is negatively related tothe income tax rate.

A shift in exogenous spending changes GDP by thevalue of the shift times the simple multiplier.

A shift in aggregate spending can be broughtabout by fiscal policy changes or by a change in

official interest rate.



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The budget surplus function(million)


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0

National Income [GDP][m]

1000 2000 3000 4000 5000 6000

0

Budget Surplus Function


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National Income [GDP][m]

1000 2000 3000 4000 5000 6000

T - G

0

0

-170

Budget Surplus Function


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The budget surplus function

The budget surplus is negative at low levels of GDPand becomes positive at high levels of GDP.

Tax revenue increases with GDP while government

spending is assumed not to vary with GDP. The slope of the budget surplus function is 0.1

when the income tax rate is assumed to be 10%.


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The net export function (million)


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1000 2000 3000

X = 540

540

ImportsandEx

ports[m]

Export and Import Functions

IM = 0.25Y

0

Real National Income [GDP] [m]

[i]. Export and Import Functions


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Export and Import Functions

1000 2000 3000

NetExports[m]

Real National Income [GDP]

[m]

[ii]. Net Export Function

(X - IM) = 540 - 0.25Y

0

540

2160


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The net export function

Net exports, defined as exports minus imports, arenegatively related to GDP.

Exports are assumed to be constant at 540

million while imports are 0.25 of National income. So the net export function is given by: 540-0.25Y


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The aggregate spendingfunction (million)


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AE

1060

1000 2000 3000 4000 5000

Real National Income [GDP] [m]

An Aggregate Spending Curve and Equilibrium GDP

Desired

Expenditure[m]

0

450

AE = Y

E0

2000


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Aggregate expenditure

The aggregate expenditure function is the sum ofdesired consumption, investment, governmentspending, and net exports.

Equilibrium GDP occurs at E0where the desiredaggregate expenditure line intersects the 450line.

Only when GDP is 2000 will desired spendingequal national output.


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AE0

Real National Income [GDP] [m]0

AE = Y

45o

AE1

Y0 Y0

DesiredExpend

iture[m]

The Effect of Change in Government Spending


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A change in government spending changes GDP byshifting the AE line parallel to its initial position.

The initial level of AE is at AE0 and GDP is Y0withdesired expenditures at e

0

.

An increase in government spending raises AE toAE1.

GDP rises to Y1at which level desired expendituresare e1.

The increase in GDP from Y0to Y1is equal to theincrease in government spending times themultiplier.

The Effect of Change in Government Spending

gdp in an open economy with govt.ppt

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