1 / 25

Slides for Part III-B

Slides for Part III-B. These slides will take you through the basics of income-expenditure analysis. The following is based on Dornbusch & Fisher, Chapter 3 (on reserve). Introduction to the Keynesian system.

kaili
Download Presentation

Slides for Part III-B

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Slides for Part III-B These slides will take you through the basics of income-expenditure analysis. The following is based on Dornbusch & Fisher, Chapter 3 (on reserve)

  2. Introduction to the Keynesian system • The Keynesian system is based on the principle of aggregate demand, which can be stated as follows: in the short period (that is, the time period in which productive capacity is fixed within narrow limits), real output and employment are determined by aggregate demand. • Aggregate demand (AD) is defined as total or aggregate spending for newly produced goods and services.

  3. Components of Aggregate Demand (AD) For an open economy with government AD = C + I + G + NX C, I, and G mean the same thing as always; NX is net exports

  4. Equilibrium with constant AD AD = Y IU is unplanned inventory investment IU > 0 Aggregate demand E AD 6 IU < 0 450 0 6 Output

  5. Properties of equilibrium • Planned spending is equal to real output, meaning the plans of spending and producing units match up. • Unplanned inventory investment is equal to zero. • Firms on average have no reason to expand or contract the scale of production. Nor do they have a reason to offer more or less employment.

  6. $8 trillion is a disequilibrium value of real output AD = Y IU = Y - AD Aggregate demand IU = $2 trillion E AD 6 IU < 0 450 0 6 8 Output (trillions)

  7. “My spending is your income.” • Let: • Y is real output or real GDP. • YD is real disposable income.  For a closed economy without a public sector, the following must be true: AD = Y = YD [1]  In a closed economy with no public sector: AD = C + I [2]  Thus, developing a theory of aggregate demand logically begins with a theory of consumption and a theory of investment.

  8. The consumption function The consumption function is given by: 0 < c < 0 • C is the intercept of the consumption function, or the component of planned household spending determined independent of income. • c is the marginal propensity to consume-the change in consumption resulting from a one unit change in disposable income.

  9. The saving function The slope of the saving function is given by MPS S S = -30 + .3Y 30 0 200 Y 100 -30

  10. The consumption function and aggregate demand AD = Y E AD0 Aggregate demand 450 0 Y0 Income, Output

  11. The multiplier effect Kahn’s Problem a:What would be the limit of new employment created if the government undertook to stimulate employment growth by spending for public works projects? Chain of causation • Expenditure for public works • Increase in employment in construction trades and building supplies industries • Increase in income of people employed in these industries • Increase in spending for consumption goods increase in employment in consumption goods industries. a R.F. Kahn. “The Relation of Home Investment to Unemployment,” Economic Journal, June 1931.

  12. Example Let Y = C + I C = 100 +.75YD I = 300 Thus we have: Now, allow for a $100 increase in autonomous investment, that is:

  13. AD =Y AD2 AD1 Aggregate demand Y0 500 I 400 450 0 1600 2000 Y Output, Income

  14. Deriving the multiplier Let Y  C + I (1) Therefore: Y = C + I (2)where (3) (4) Let Thus: (5) Rearrange (5) (6)

  15. Rearrange (6) The multiplier Example:

  16. The multiplier

  17. Be advised that the multiplier effectworks in bothdirections

  18. The government sector • Let • YD denote disposable income; • TR is transfer payments; • TA is taxes Thus, we can say: YD = Y + TR – TA Also: (4a, p. 69)

  19. Specification of fiscal policy Fiscal policy is public policy with respect of government spending, transfer spending, and the structure of taxes or revenue collection We assume that: where t isthe marginal propensity to tax out of national income (Y), that is t = TA/Y, where 0 < t < 1

  20. The closed model with government (1) (2) (3) (4) (5) (6) Substitute (5) and (6) into (2) to obtain (7) (7)

  21. Substitute (7), (3) and (4) into (1) to obtain (8) (8) Rearrange (8) to obtain (9) (9) Let:

  22. Now rewrite (9) as follows: (10) Rearrange (10) to obtain (11): (11) tax multiplier To find equilibrium Y (Y0):

  23. Problem Use the following set-up to answer the questions on the next slide Y = C + I + G C = 75 + .75YDI = 110G = 180TR = 240TA = .2Y

  24. What is the value of the tax multiplier? • Solve for equilibrium output (Y0) and illustrate with an income expenditure diagram. • Calculate disposable income (YD) when Y = Y0. • Calculate saving (S) when Y = Y0 • Calculate the change in output (Y0) resulting from a $20 decrease in investment. • Assuming the equilibrium value of income is equal to that which you computed in (2) above, what is the value of unplanned inventory investment if actual output is equal to $1400?

More Related