1. ECO 121 MACROECONOMICS Lecture Eight Aisha Khan Section L & M Spring 2010

2. Recap  Aggregate Model  Consumption schedule  Upward sloping with a slope = MPC  Saving schedule  Upward sloping with a slope = MPS  Investment Demand curve  Downward sloping

3. Next?  We have consumption and investment schedules  Can now put them together to find GDP– true?  GDP = C + I  Therefore by the identity we can find the total output/income

4. Equilibrium GDP Employ- ment levels GDP = DICSIC+I Unplanned  in inventories Tendency of income/output 40370375-520395-25  45390 020410-20  50410405520425-15  554304201020440-10  604504351520455-5  6547045020 4700~ 7049046525204855  75510480302050010  80530495352051515  85550510402053020 

5. Graphical Analysis Aggregate expenditure C+ I GDP 45  C C+I Aggregate Expenditure I = $20 billion C+I = GDP C = $450 billion

6. Other features of GDP 1. Savings = planned Investment  Savings is a “leakage” from spending stream 2. No unplanned changes in inventory  Look at table again

7. Aggregate Expenditures  We examine now why real GDP might be unstable and subject to cyclical fluctuations  We revise the model slowly towards a more realistic model

8. Changes in Equilibrium GDP  Equilibrium GDP changes in response to changes in consumption and investment schedules  (remember GDP = C + I)  Since consumption is more stable, this chapter focuses on the unstable investment spending and how its changes affect eq GDP

9. Investment changes  Suppose that investment spending rises by $5 billion  Due to profit expectations or changes in the interest rate

10. Aggregate expenditure C+ I GDP 45  450 C+I = GDP (C+I) 1 (C+I) 0 (C+I) 2 470 490

11. Multiplier Effect  A $5 billion change in investment causes a $20 billion change in GDP  multiplier effect  Multiplier =  in real GDP / initial  in spending

12.  Initial change in spending is usually associated with investment spending because its so volatile  The initial change refers to an upward/downward shift in aggregate spending due to a change in one of its components  Multiplier works in both directions

13. Multiplier and MPC  The size of the mpc and the multiplier are directly related  The size of the mps and the multiplier are inversely related  Multiplier =1/(1-mpc) = 1/mps

14. International Trade and Equilibrium Output  NX affect aggregate expenditures  Exports expand spending on domestic output  Imports contract spending on domestic output  Net export schedule  Independent of GDP, can be positive or negative

15.  Positive NX  ( exports > imports )  Expand spending  Expansionary effect  Again  multiplier effect  Negative NX  ( imports > exports )  Contract spending  Contractionary effect

16. Aggregate expenditure C+ I GDP 45  450 C+I = GDP (C+I) 1 +NX 1 (C+I) 0 (C+I) 2 +NX 2 470 490

17. International economic leakages  Prosperity abroad generally raises our exports  Trade barriers  Depreciation of dollar  lowers cost of US goods to foreigners  discouraging our exports

18. Adding the Public Sector  Simplifications  Government purchases don’t impact private spending  Net tax revenues as personal taxes  GDP = NI = PI  Tax collections are independent of GDP levels  Price level is assumed to be constant

19.  Increase in government spending boosts aggregate expenditure  Government expenditure is subject to the multiplier

20. Aggregate expenditure C+ I GDP 45  C+I = GDP (C+I) 1 +NX 1 + G (C+I) +NX C

21.  Taxes reduce DI  consumption and saving lowered at each level of GDP  Therefore the sum of leakages = sum of injections  S + M + T = I + X + G