macro economics ch5ppt

8/12/2019 macro economics ch5ppt

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Intermediate Macroeconomics

The Keynesian Model

1. Simple Keynesian model2. Aggregate expenditures3. Equilibrium4. Consumption function5. Autonomous spending6. Autonomous spending multiplier7. Government fiscal policy8. Automatic stabilizers


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1. Simple Keynesian Model

Macroeconomics in a recession: Classical macro theory:

Prices will fall thereby stimulating demand.

Interest rates will fall thereby stimulatinginvestment. Keynesian macro theory:

Prices, wages and interest rate are fixed.

Government fiscal policy stimulus needed.


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2. Aggregate Expenditures

AE = C + I + G + NX

C = ConsumptionI = Private Domestic InvestmentG = Government SpendingNX = Net Exports (Exports - Imports)


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3. Equilibrium

Y = AE

Undesired Inventory Build: Y > AE

Undesired Inventory Draw: Y < AE

where, Y = National Income AE = Aggregate Expenditures


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4. Consumption Function

C = C 0 + c Y

Co = Autonomous consumptionc = Marginal propensity to consume

out of income (MPC)Y = Income


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4. Consumption Function

0

1000

2000

3000

4000

5000

0 1000 2000 3000 4000 5000

Income

D e s

i r e

d C o n s

u m p

t i o

C 0 = 500

2500

c = MPC = slope of consumption function

= (2500 - 500) / (2500 - 0)= 0.8

Saving Dissaving

2500

C = C 0 + c

Y


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5. Autonomous Spending

Spending that is independent of anyother variable (e.g., income, prices,interest rate)

C0 = Autonomous Consumption I0 = Autonomous Investment G

0 = Autonomous Government

Spending

Autonomous ( adj .) - self-governing


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6. Autonomous Spending MultiplierEquilibrium model solution

Step 1. Restate aggregate expendituresStep 2. State the equilibrium condition

Step 3. Substitute aggregateexpenditures from Step 1 intoequilibrium condition in Step 2

Step 4. Solve for Y (national income)


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6. Autonomous Spending MultiplierStep 1. Aggregate expenditures restated

Given: AE = C + I + G + NXC = C 0 + c Y

I = I0G = G 0 NX = 0

Step 1 . Substitute into equation for aggregateexpenditures:

AE = C 0 + c Y + I0 + G 0


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6. Autonomous Spending Multiplier Aggregate expenditures curve

0

1000

2000

3000

4000

5000

6000

7000

0 1000 2000 3000 4000 5000 6000 7000

Income

E x p e n

d i t u r e s

5000

C0 + I 0 + G 0 + NX = 1000MPC = slope of consumption line

= slope aggregate expenditure line= (5000 - 1000) / (5000 - 0) = 0.8

5000

AE = (C 0 + I0 + G 0) + c

Y AE C

45 o Line (AE = Y)all possible equilibria


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6. Autonomous spending multiplierSteps 2 and 3

Step 2 . State the Equilibrium Condition:Y = AE

Step 3 . Substitute AE from Step 1 intoStep 2:Y = C0 + c Y + I0 + G 0

orY = (C0 + I0 + G 0) + c Y


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6. Autonomous spending multiplierStep 4. Solve for National Income (Y)

Y = (C 0 + I0 + G 0) + c Y

Y - c Y = C 0 + I0 + G 0

(1 - c) Y = C 0 + I0 + G 0

Y = 1 (C0 + I0 + G 0)1 - c


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6. Autonomous Spending Multiplier

Change in Y = Multiplier Change in C 0, I0,orG0

Equilibrium model solution:

Y = 1 (C0 + I0 + G 0)1 - c

Autonomous Spending Multiplier:1 or 1

1 - c 1 - MPC


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7. Government Fiscal Policy

Given Equations: AE = C + I + G + NXC = C 0 + c YD

I = I0, G = G 0, NX = 0YD = Y - t Y - T0 + TR

YD = disposable income

t Y = income tax revenuesT0 = lump sum taxTR = govt transfer payments


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7. Government Fiscal PolicyStep 1. Restate aggregate expenditures

AE = C + I + G + NX

= C 0 + c YD + I0 + G 0

= C 0 + c (Y - t Y - T0 + TR) + I 0 +G0

= C 0 + I0 + G 0 + c Y - c t Y - c T0 + c

TR


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7. Government Fiscal PolicySteps 2 and 3

Step 2 . State the Equilibrium Condition:Y = AE

Step 3 . Substitute AE from Step 1 intoStep 2:

Y = C0 + I0 + G 0+ c Y - c t Y - c T0 + c TR


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7. Government Fiscal PolicyStep 4. Solve for National Income (Y)

Y = C 0 + I0 + G 0 + c Y - c t Y - c T0 + c TR

Y = C 0 + I0 + G 0 - c T0 + c TR + (c - c t) Y Y = C

0+ I

0 + G

0 - c T

0 + c TR + c (1 - t) Y

Y - c (1 - t ) Y = C 0 + I0 + G 0 + c (TR - T 0)

[1 - c (1 - t )] Y = C 0 + I0 + G 0 + c (TR - T 0)

Y = 1 [C0 + I0 + G 0 + c (TR - T 0)][1 - c (1 - t )]


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7. Government Fiscal PolicyMultipliers

No IncomeTax

(t = 0.0)

Income Tax(t = 0.3)

AutonomousSpending

1 = 51 - c

1 = 2.31 c (1-t)

TransferPayment

c = 41 - c

c = 1.81 c (1-t)

Lump SumTax

- c = - 41 - c

- c = - 1.81 c (1-t)

Assume c (marginal propensity to consume) = 0.8


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7. Government Fiscal PolicyBalanced budget multiplier

$1 increase in governmentspending

matched by

$1 increase in lump sum taxes


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7. Government Fiscal PolicyBalanced budget multiplier

Spending multiplier (assume no income tax)1

1 c

Lump Sum tax multiplier- c 1 - c

Balanced budget multiplier:

spending multiplier lump sum tax multiplier1 - c = 1 c = 1

1 c 1 c 1 - c


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7. Government Fiscal PolicyBalanced Budget Multiplier

From Step 4 (assume t = 0):Y = 1 [C0 + I0 + G 0 + c (TR - T 0)]1 - c

Multiplier (assume C0 = I0 = TR = 0):

Y = 1 ( G0 - c T0)1 - cBalanced Budget ( G0 = T0):

Y = 1 ( G0 - c G0)1 - c

= 1 ( 1 c) G0 1 - c

= 1 G0 Multiplier = 1


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8. Automatic Stabilizers

Economy Moves IntoRecession Inflation

Desired PolicyGovernment Spending Increase Decrease

Taxes Decrease Increase

Actual Outcomes

G - Defense Spending n/c n/c

TR - Social Security Benefits n/c n/c

TR Unemployment Comp. Increase DecreaseTA Lump Sum Tax n/c n/c

t Y - Income Tax Receipts Decrease Increase

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macro economics ch5ppt