McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 11 The Aggregate Expenditures Model McGraw-Hill/IrwinCopyright © 2015 by McGraw-Hill Education. All rights reserved.

Goods Market Equilibrium Adjustments I. Adjustments to Goods Market Equilibrium Y = AE 1. What makes sure Y (supply) = AE (demand), given that P is fixed? (i)If Y > AE  what happens to inventory changes? How would the firms (the producers) react to this? (ii)If Y < AE  what happens to inventory changes? How would the firms (the producers) react to this? 2.Inventory changes play the role of “price” that equates Y (supply) = AE (demand).

Adding International Trade LO4 II. Adding Net Exports (NX) = Exports - Imports 1. Exports depend on two factors: (i) The exchange rate, e. - The exchange rate is the price of a US$ (or other $) in terms of Thai baht. - September 9 th 2016: US$ 1 = 35 baht Source: - For example: The price of 10-kg bag of jasmine rice is 350 baht. At e = 35, it is US$__________. If e = 40, it is US$ __________. - The (higher, lower) the e, the higher is Thailand’s export to the US. (ii)The income of our trade partner, such as the US. - The higher the US GDP, the (higher, lower) our exports to them.

Adding International Trade LO4 2.Imports also depend on the exchange rate, e. - Example: An imported US Washington apple = US$2/kilo. - The (higher, lower) the e, the higher is Thailand’s import from the US. 3.For now, until we have explained how the value of the e is determined in Chapter 21, we will assume that both exports and imports are constants, unless otherwise stated. 4.Incorporating NX into AE: AE=C+I+NX, where NX is a constant. 5.Because NX is a constant, it affects AE in the same ways consumer confidence and investment confidence do – shifts AE.

Adding Government LO4 III. Adding Government Expenditures 1.Government expenditure (G) - Recall that the government is also a consumer. - What should influence a government’s decision to increase or decrease G? 2.Economic contraction (recession) - If private firms and private consumers are not spending, the government should increase spending, create demand, and therefore create production and jobs to minimize unemployment. 3.Economic expansion (boom) - If private C+I are very high, strong demands can lead to (higher, lower) inflation, the G should decrease spending to decrease inflation. 4.Incorporating G into AE: AE=C+I+G, where G is a constant.

IV. Goods Market Equilibrium 1. Graphically, we can set Y = AE = C + I + G + NX and find the equilibrium (continue with Chapter 10’s example): (i) C = Y, I = 50, G = 50, NX = 25. (ii) AE = C + I + G + NX = ________________________________________. Goods Market Equilibrium

2.Solving for Y = AE (supply = demand): Example: C = YI = 50G = 50NX = 25 Goods Market Equilibrium

Adding Taxes V. Adding Taxes (T) 1.The government can also use income taxes (T) to affect the economy. - What should influence a government’s decision to increase or decrease T? (i) Economic contraction (recession) - If private firms and private consumers are not spending, the government should encourage higher C+I by cutting T. (ii)Economic expansion (boom) - If private C+I are very high, strong demands increase inflation, the government can dampen C+I by raising T.

2.How should we describe taxes (T)? (i)For simplicity, we will assume that the government charges a lump sum, constant tax. (ii)T is a constant, say, 50, which is independent of income. This is similar to movie ticket admissions: regardless of the income of the customers, all adults are charged a fixed amount. (iii)Benefits: Easy to calculate in model, easy to collect in reality. (iv)Costs: Often perceived as “unfair”. (v)For simplicity, let us incorporate T into C only, not both C and I. (vi)Incorporating T into AE: AE=C+I+G, but C=a + b(Y-T), where T is a constant number… back to Chapter 10 example. - Example: C = (Y – 50). Adding Taxes

Goods Market Equilibrium VI. Goods Market Equilibrium 1. Graphically, we set Y = AE = C + I + G + NX and find the equilibrium: (i) C = (Y – T), I = 50, G = 50, NX = 25, but T = 50. (ii) C = (Y – 50), which becomes C = _____________________________. (iii) AE = C + I + G + NX = ______________________________________________.

2.Solving for Y = AE (supply = demand): Example: C = (Y-T)I = 50G = 50NX = 25T = 50 Goods Market Equilibrium

Micro versus Macro VII. The Role of the Government 1.Micro-economists believe that when demand is not equal to supply, prices will change until demand = supply. The government does not have to do anything. 2.Macro-economists believe that because prices may not change quickly (prices are sticky) to give us demand = supply (especially during a recession, firms resist cutting prices), the government should actively intervene in the economy in order to achieve demand = supply. - If Y NRU, increase G and/or decrease T. - If Y > Yp or actual Un < NRU, decrease G and/or increase T.

Leakages and Injections VIII. Leakages and Injections 1. If a country’s NX > 0, is this country a lender or borrower? - Example 1: China (2015) = US$384 billion > 0. - Example 2: Thailand (2015) = US$44 billion > 0. 2.If a country’s NX < 0, is this country a lender or borrower? - Example 1: The US (2015) = - US$540 billion < 0. Source: 3.Question: If a country is borrowing (NX<0), who within the country are borrowing, and what can be done to decrease such borrowing?

Leakages and Injections 4. Answer: NX = (S - I) + (T - G). (i) Show that NX = (S – I) + (T – G) and the implications. (ii) Which variables are leakages, which variables are injections?