ECON Ch 23-26 Flashcards
What if we spend more than we produce—we produce 100 cars in 2017 and we sell 120 cars?
It’s possible. We’d use 20 cars from our inventory
But it isn’t sustainable— we could run out of inventory.
So, in 2018, we would produce more, forcing the gdp up.
So, AE is bigger than GDP, we force GDP up
Our inventories fall, we need to produce more. GDP increases and unemployment decreases
Aggregate expenditure model
A macroeconomic model that focuses on the short run relationship between the total spending and the real gdp, assuming price level is constant.
Focuses on short run determination of total output in an economy
What if we produce more than we spend?
Produce 120 cars and only sell 100
Yes it’s possible
We have a left over of 20 cars. Add to the inventory.
Not sustainable. Will produce less cars
So, the 2017 gdp is120, 2018 is projected to be less
Recession happens, as real gdp goes down. Production level down.
Here, AE < GDP and our inventories rise. So, we need to lower GDP. unemployment goes up
Aggregate expenditure
The total spending in the economy.
C + I + G+ NX
compare to output.
Consumption is most of it
Difference between AE and GDP
AE model uses planned investment, not actual investment
Planned investment does NOT include build up of inventories: goods that have been produced but not yet sold
Planned investment = actual investment - unplanned change in inventories
Y is the inventory investment
AE is planned inventories
If inventory investment higher than planned inventories, firms reduce output because Y is too big relative to AE
Macroeconomic eq
When AE =Gdp
When planned investment equals actual investment.
No unplanned change in inventories
Spending on output is equal to value of output produced
What can consumers do with their money?
Consumers / households earn money—> income
Some goes to taxes, which goes to government
Some is spent. Consume
Some is saved
But, this saved either goes to the banks. And a loan is issued and it goes to business firms who invest.
Or it goes to the stock market. Another investment
If this intermediate step is secure, savings =investment.
Healthy economy—> savings = investments. Consumers putting savings under their pillow isn’t healthy.
Consumer’s behavior
C as a function of variables.
Consumption is on the vertical axis and GDP (Y) is on the horizontal axis
Slope is between 0 and 1 because if income goes up, we will spend more, but also save more.
So, C = a + b(Y-T) where a is the intercept (still spend when income is 0) and b is the marginal prop to consume (MPC).
MPC
the marginal propensity to consume The amount by which consumption spending changes when disposable income changes The slope of the consumption function Calculated by Delta C / delta Y (GDP) Should be less than 1 and bigger than 0
Interpret the MPC
say it is .91
This means that say there is a 10 billion dollar increase in income
Then there will be a 9.1 billion dollar increase in consumption.
Marginal prop to save
MPS The amount by which savings change, when disposable income changes. MPS = delta S / Delta Y MPC + MPS = 1 Delta Y = delta C +delta S Divide by Y 1 = MPC + MPS This means that part of any increase in income is consumed and the rest is saved
Determinants of planned investment
Doesn’t depend on income
Depends on the interest rate.
Higher real interest rates result in less investment spending and lower real interest rates result in more investment spending
This is because since business investment is sometimes financed by borrowing, the real interest rate is an important conversation for investing.
So as r goes down, I up
Government spending
Generally increases over time. Except after the Great Recession
Doesn’t depend on income
What are net exports dependent on?
X -M
If US price level rises faster than foreign price levels, NX will go down because US goods become more expensive relative to foreign goods, so imports rise and exports fall
If US gdp grows faster than foreign gdp then NX will go down because us demand for imports rises faster than foreign demand for our exports
If US dollar rises in value relative to other currencies, US net exports will decrease because imports are cheaper and our exports are more expensive. So imports rise and exports fall
AE and GDP whole economy graph
We graph AE vs Y with AE on the vertical axis and Y on the horizontal Draw a 45 degree line (slope of 1) It must intersect our AE line because that has a slope of between 0 and 1. This point is the eq point. I, G, and NX are all constants I️ and G drive up our intercept NX is negative so it drives it down Only consumption depends on income.
Say equilibrium is at 10 trillion but real gdp is lower, say 8 trillion
Then AE is bigger than GDP, we aren’t producing enough. Need to produce more, since our inventory fell
So, increase our production and our gdp. Unemployment down. Meets at the eq point
Say we produce 150 cars but AE is only 130
Then Y > AE
We are producing 20 more cars than people want to spend money on.
We add 20 cars to our inventory. Investment.
We are overproducing. Need to produce less. Y goes down
Expansionary policies
Policies that lead to Y increasing
C, I, G, and/or NX go up
Lower taxes increase C Interest rates going down increase I G is controlled directly by government NX based on exchange rate policies X up and/or M down Reverse is contractionary policies
Multiplier effect
An increase in an autonomous expenditure (C,I,G,NX) shifts the aggregate exp line upward. When this happens, real gdp increases by more than the change in the AE. Miltiplier effect
The value of the increase in eq real gdp / increase in autonomous expenditures is the multiplier.
Understanding the multiplier
Say we increase government spending by 100
So, we increase G spending by 100 and it goes to a construction crew. The worker spends the MPC (say it is .75) and so, C goes up by 75 dollars. Say he buys a car. Salesman gets 75 dollars, spends 75 percent of it.
Inject money into the economy and keep multiplying by 0.75
So, the multiplier = 1/ (1-b) Or 1/(1-MPC)
Understanding multiplier with alg
Y = a + b(Y-T) + I + G + NX
Get it in terms of Y
Y = (1/(1-b)) (a -bT + I+ G + NX)
So multiplier is 1/(1-b)
Multiplier graphically
Horizontal shift by the multiplier. Vertical by amount
So say G up by 100,100 vertical shift. Say mult is 4. Horizontal shift by 400
Expansionary policies
T down, C up R down, I up Dollar weaker, NX up G up (government controls directly)
Multiplier interpretation
The effect of the change in AE on the GDP
Lowering taxes effect on multiplier
Say MPC = .8 and we increase G by 100 or decrease T by 100
Decreasing t by 100 leads to the multiplier here being b /(1-b)
So it is only a mult of 4
Increasing g by 100 leads to 1/(1-b) = 5
Mult more when increase G not decrease T
Doesn’t spend all of the tax cut, only 80
Aggregate demand curve
A curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government.
AD graph
Y axis is the price, X axis is the GDP
Downward sloping.
Shifts on the AD graph
Vertical shift up is inflation
Vertical shift down is deflation
Horizontal shift right is expansion
Horizontal shift left is contraction
AD shift
Don’t change the price, but the output changes. Any stimulus package R going down, I goes up, AE up, so Y up T going down, C goes up, AE up, so Y up Same with G and or NX up
Stimululous package Shifts AD right
Movement along AD curve
Price down, Y up. Or vice versa
Price down, households richer in real terms, so C goes up, so AE and Y up
Price down, usually r down, so I up and AE and Y up
P down, NX up, so AE up. Or X up or M down leads to it too
So, downward sloping AD curve.
Why do increased interest rates shift AD left?
Because higher interest rates raise the cost to households and firms of borrowing, reducing C and I
So shifts left.
This is monetary policy. Federal reserve can help control interest rates.
How does households expectations of their future incomes influence AD curve
Firms expectations of future profitability of investment spending?
Shifts right.
Become more optimistic about future, increase C or I
If exchange rate goes up what happens to AD?
Our exports become more expensive, so foreigners buy less of them (and we buy more imports). So AD shift left
If foreign incomes rise more slowly than ours, what happens to AD?
their imports of our goods fall. So we export left. AD shifts left.
