gsb728 lecture note topic 4b
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Economics for Management
GSB728
Topic 8:
National Income Determination
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Note: This lecture note was prepared based on the teaching material provided
by the publisher of the textbook Principles of Economics.
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Learning Objectives
1. The components of aggregate demand – What determines the demand for all goods and services?
2. The equilibrium level of gross domestic product – What determines the level of a country’s output in the short run?
3. The multiplier – What will be the effect on output of a rise in spending?
4. Types of unemployment – How can we easily classify unemployment?
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Learning Objectives (contd.)
5. Determinants of the level of unemployment – What causes unemployment?
6. Explanations of the business cycle – Why do countries suffer from periodic booms and recessions?
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Equilibrium Level of Gross Domestic Product
• What determines the demand for all goods and services?
AD = C + I + G + X - M
• Output in the short run can be represented in the circular flow of income.
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CdIncomes
The Circular Flow of Income
6Source: Sloman et al. (2014).
Cd
W = S + T + M
J = I + G + X
Incomes
The Circular Flow of Income (contd.)
7Source: Sloman et al. (2014).
Components of aggregate demand in Australia, 2007-08 (in percentage)
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Source: Sloman et al. (2014).
– Effects on output of a change in injections and/or withdrawals.
– The Multiplier Effect: An increase in aggregate demand (as a result of an increase in injections) of $x million leads to a rise in GDP greater than $x million.
– If J > W : GDP rises and W rises until J = W
– If W > J : GDP falls and W falls until J = W
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Equilibrium Level of Gross Domestic Product (contd.)
• The withdrawals and injections approach:
– The withdrawals curve (W).
– The injections curve (J).
– Equilibrium.
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Equilibrium in a Keynesian Model
0GDP
W
W, J
J
Equilibrium GDP: Withdrawals (W) and Injections (J)
Source: Sloman et al. (2014).11
0GDP
W
W, J
J
b
a d
c
x
GDPeSource: Sloman et al. (2014).
Equilibrium GDP: Withdrawals (W) and Injections (J) (contd.)
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• The income and expenditure approach:
– The 45° line income curve.
– The expenditure curve.
– Equilibrium
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Equilibrium in a Keynesian Model (contd.)
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0GDP
GDP = Cd + WCd, W, J
Deriving Equilibrium ofGross Domestic Product (“GDP”)
Source: Sloman et al. (2014).
150
GDP = Cd + W
J
Deriving of Equilibrium GDP (contd.)
Cd, W, J
GDP
x
Injection J adds to AD.
Cd
GDP0
Aggregate demand, AD = Aggregate expenditure
Source: Sloman et al. (2014).
0
Cd
GDP = Cd + W
J
Cd, W, J
GDP
z
x
Increase in aggregate demand (expenditure)
causes rise in equilibrium GDP from x to z
AD = E = Cd + J
GDP0 GDP1 Source: Sloman et al. (2014).
Deriving of Equilibrium GDP (contd.)
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The Multiplier
• The Multiplier (k):
– Number of times by which a rise in GDP exceeds the rise in injections that caused it.
k = ΔGDP/ΔJ
• Analysis using the withdrawals and injections approach:
– Shift in the J line.
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0 GDP
W
W, J
J1
The Multiplier: A Shift in Injections
E0
GDP0
J2
E1
GDP1
D JJ2
J1D W
D GDP
The Multiplier = DGDP / DJ
Marginal Propensity to Withdraw = DW / DGDP
18Source: Sloman et al. (2014).
The Multiplier (“k”)
– The Multiplier: k = 1/mpw where mpw represents the marginal propensity to withdraw
– The formula can also be expressed as: k = 1/(1–mpcd)
where mpcd represents the
marginal propensity to consume domestically produced goods and services.
mpw + mpcd = 119
The Multiplier (contd.)
• Analysis using the income and expenditure approach
– Shift in the E line.
– In the following diagram injections (J) increases by
20, inducing an increase in GDP of 60.
– The multiplier can be expressed in the form:
DGDP / D J
and is therefore 60/20, or 3.
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The Multiplier: A Shift in The Expenditure Curve
0GDP ($bn)
Cd, E, W, J
GDP = Cd + W
E1
100
Cd
100
E2
160
160
$bn
120
∆GDP = 60
∆GDP = 60
∆J = 20
∆Cd = 40
60
Source: Sloman et al. (2014).21
The Multiplier Process: A Shift in Injections
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Source: Sloman et al. (2014).
Types of Unemployment• Frictional (search) unemployment.
• Structural unemployment:• Changing patterns of demand.
• Improved production methods.
• Regional unemployment.
• Cyclical unemployment.
• What is full employment?
• When there is no cyclical unemployment.
• Full employment level of GDP: Level of GDP at which there is full employment of labour. 23
Determinants of the Level of Unemployment
• Unemployment at full employment:• Frictional unemployment.
• Structural unemployment.
• Unemployment above the full employment rate:• Deflationary gap.
• Unemployment below the full employment level:• Inflationary gap.
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0GDP
W
Cd,W, J
J
GDPe
The Deflationary Gap
GDPf
Deflationary gaps
Equilibrium GDP
Full employment GDP GDP
EE < GDP
J < W
Source: Sloman et al. (2014).25
0GDP
W
Cd,W, J
J
GDPe
The Inflationary Gap
GDPf
Equilibrium GDPFull employment GDP GDP
E
E > GDP
J > W
Inflationary gaps
26Source: Sloman et al. (2014).
Why are there booms and recessions?
• Instability of investment: The accelerator theory.
– The level of investment depends on the rate of
change of GDP, not on its level.
• Fluctuations in stocks: The stocks of finished goods that companies hold tend to fluctuate with the business cycle, which contributes to fluctuations in output.
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Keynesian Analysis of the Business Cycle
• Determinants of the business cycle:
– Why do booms and recessions persist?• Time lags.
• ‘Bandwagon' effects.
– Why do booms and recessions come to an end? What determines the turning points?
• Ceilings and floors.• Echo effects.• The accelerator.• Random shocks.• Changes in government policy.
Keynesian Analysis of the Business Cycle (contd.)
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References
Morales, L. E., Simons, P. and Valle de Souza, S. (2014). GSB728: Economics for Management [Topic Notes]. Armidale, Australia: University of New England, Graduate School of Business.
Sloman, J., Norris, K and Garratt, D. (2014). Principles of Economics (4th ed.). French Forest, Australia: Pearson.
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