Lecture 18 notes
Lecture 18 notes ECON100
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Date Created: 11/23/15
Lecture 18 Equilibrium GDP where spending and output are equal If spending gt output 9 inventories are drawn down Businesses will see that inventories are lower than what they would like to be lt QE 0 Call producers to send more 0 Producers will make more 0 Output will increase gt QE 0 output gt spending 0 too much inventory 0 order less from producers o producers will cut output 0 real GDP lowers Where AE crosses the 45 degree right spending output 0 Inventories remain at levels businesses wishes them to be 0 QE AEE Keyes said that this equilibrium level of real GDP may not be at the economy s full employment output potential 0 May be far below full employment 0 May persist for a long time Kaynes 9 The equilibrium level of output real GDP is determined by level of spending Economy can produce different levels of total output Determined by levels of spending Equilibrium level of GDP where spending output Keynes said that this equilibrium level of real GDP may not be at the economy s full employment output potential May be far below full employment and may persist for a long time The multiplier sometimes known as national income multiplier Equilibrium level of real GDP will change in response to change in aggregate expenditures Investment expenditures are less stable than consumption spending 0 Assume that change in investment spending are what cause fluctuations in total spending in the economy 0 Investment in capital goods may vary I Get new equipment I Fix old equipment 0 Sudden increase or sudden decrease Begin with an original level of aggregate expenditures as given as AEo with an equilibrium level of real GDP being QO 0 Let something causes investment expenditures to increase from lg to I1 SSOB increase in business spending on plant and equipment I AE schedule result increase I Shift it up 503 from before 0 Causes GDP to increase by 51008 to 69T 0 Increase in total output GDP is twice the increase in spending Return to AEO and Q0 0 Let something cause investment expenditure to decrease from lg to Iz a 508 decrease in total spending 0 Cause GDP to decrease by 51008 to 67T o Decrease in output is twice the decrease in business spending THE MULTIPLIER quotE Q AGGREGATE EXPENDITLRES AIEE C H 45 ng XEU39 I C I39U39 A152 C 12 I REAL GDP Q Q2 Q0 7 7 711 367T 681quot mat 0 vertical distance from AEO to AE1 represents the 508 of new investment spending 0 the horizontal distance is longer relative to the vertical distance I 5508 of investment will generate 1008 of new output The eventual increase in total output and income will be greater than the original increase in aggregate expenditures 0 Result of the initial increase in investment spending plus the subsequent increases in output and income that it generates 0 National income multiplier 9 Increase in income and output will be some multiple of the initial change in spending The multiplier would have a value of 2 bc the change in real GDP is twice the initial change in spending 0 The multiplier would be equal to the change in GDP divided by the change in spending 0 M Change in GDP Change in AE Decrease in investment spending 0 Spending has been declining o More than enough capital to take care of future demands 0 Spend less than you intend to 0 Multiple decrease in output I RECl AEO t0 AEZ Equilibrium GDP is Q2 Difference between Q2 and Q3 is twice the distance between AEZ and AEO Net exports Third component of aggregate expenditures The difference between US exports and imports 0 Export domestically produced goods sold to foreigners I Produced in the US sold to foreigners I EX Harley Davidson motorcycles amp boeing airplanes 0 Imports purchase of foreign produced goods 0 Buying a Japanese car produced in the US is not an import I Adds to our GDP I bc produced within the US domestic production Short run 9 spending on exports and imports do not have to be equal 0 Possible that total US spending on foreign produced goods will exactly equal foreigners spending on our goods 0 Usually 2 amounts are unequal 0 We spend more on foreign produced goods than foreigners spend on our produced goods 0 Whenever we sell to foreigners more than we purchase from abroad we say that net exports are positive negative X gt M and XIn gt O 0 Whenever our spending on foreign produced goods exceeds foreigners purchases of our goods we say that net exports are negative X lt M and XIn lt 0 NET EXPORTS amp AGGREGATE EXPENDITURES AGGREGATE 739 Q EXPENDITL RES Am X1 m A130 X0 MO A112 x2 312 39 REAL GDP Q Q3 Q0 2 O 67T 68T 6quotT Government purchases aggregate expenditures and equilibrium The addition of the government sector includes a 4th spending component into the economy Government purchases in the final product market increase aggregate expenditures which ceteris paribus causes total output to increase GOVERNMENT PURCHASES AND AGGREGATE EXPENDITURES Q AGGREGATE EXPENDITL RES AEFC 1 xniiG 50013 AEO 7C I 11 a F REAL GDP Q 0 Q 360139 7039l 0 increase government spending shifts AE spending by same amount 0 begin with only private spending AEO C XIn I the equilibrium level of GDP will be Q0 60T 0 Assume that the quotgovernment sector introduces 5008 of additional spending I EX spending on defense highways police schools I Extra half trillion of spending will shift the AE schedule up to this amount ot become AEL 0 Because of the multiplier the final increase in GDP will be SlT to 70T Previously we introduced a new government purchases of 5008 0 Assuming a multiplier of 20 this alone would tend to cause GDP to increase by 10T to 70T 0 Not the end of analysis 0 The government needs to finance its spending by imposing taxes on the private sector I Medicare and social security taxes Government purchases and taxes 0 For simplicity assume that the government imposes 5008 of new taxes on household income 0 New taxes will reduce disposable aftertax income by 55008 How do people respond to these new taxes 0 They will have to decrease consumption spending but by how much I At first we might conclude that household consumption spending must fall by the full amount of the tax 9 not correct I Marginal propensity to consume I If MPC were 8 not only will we consumption spending increase by 80 of the increase in income but household spending must also decrease by 80 of a fall in income I A 55008 decrease in household disposable income will cause consumption spending to fall by 54008 O Where are the people going to get the other SlOOB they are losing to taxes Reduce savings by this 51008 GOVERNMENT PURCHASES TAXATION 35 AND AGGREGATE EXPENDITURES AEQ AGGREGATE EXPENDI39II RES 41 CHXnG J AEE iCcTi Xn G AEO Cii Xn REAL GDP Q a 06139 S ZOT o EDGIJT 35 IT
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