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ECO 121 MACROECONOMICS Lecture Eight Aisha Khan Section L & M Spring 2010
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Recap Aggregate Model Consumption schedule Upward sloping with a slope = MPC Saving schedule Upward sloping with a slope = MPS Investment Demand curve Downward sloping
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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
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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
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Graphical Analysis Aggregate expenditure C+ I GDP 45 C C+I Aggregate Expenditure I = $20 billion C+I = GDP C = $450 billion
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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
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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
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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
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Investment changes Suppose that investment spending rises by $5 billion Due to profit expectations or changes in the interest rate
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Aggregate expenditure C+ I GDP 45 450 C+I = GDP (C+I) 1 (C+I) 0 (C+I) 2 470 490
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Multiplier Effect A $5 billion change in investment causes a $20 billion change in GDP multiplier effect Multiplier = in real GDP / initial in spending
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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
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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
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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
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Positive NX ( exports > imports ) Expand spending Expansionary effect Again multiplier effect Negative NX ( imports > exports ) Contract spending Contractionary effect
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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
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International economic leakages Prosperity abroad generally raises our exports Trade barriers Depreciation of dollar lowers cost of US goods to foreigners discouraging our exports
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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
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Increase in government spending boosts aggregate expenditure Government expenditure is subject to the multiplier
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Aggregate expenditure C+ I GDP 45 C+I = GDP (C+I) 1 +NX 1 + G (C+I) +NX C
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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
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