chapter 5.3

Question 1

what is the keynesian multiplier

Answer 1

• describes the economy in the very short run when prices are sticky and demand determines real GDP
  Y = C( Y-T, M/P, r ) + G + I(r) + NX( Y, Y, eP/P )
• since 2 components of expenditure (C and NX) are influenced by the real GDP, there is a 2 way link between aggregate expenditure (AE) and real GDP
• onther things remaining the same:
  → an increase in AE increases real GDP
  → an increase in real GDP increases AE
• the multiplier is the amount by which a change in an exgoneous component of AD is magnified or the multiplied to determine the change in equilibrium expenditure and real GDP

Question 2

Explain the keynesian multiplier in a closed economy. also assume no government and is exogenous ( or r is given)

Answer 2

• crucial understanding of the multiplier → related with the change in consumption induced by changes in desposabe income (which depend on GDP)
• marginal propensity to consume (MPC) → fraction of a change in desposable income spent on consumption instead of saved - slope of the consumption function
• MPC (0<MPC<1) is the (partial) derivative: 𝑀P𝐶= 𝜕𝐶/𝜕Y

Question 3

what is the consumption function

Answer 3

• relatioship between consumption expenditure and disposable income, other things remaining the same

Question 4

what is autonomous consumption and the induced consumption?

Answer 4

• autonomous consumption → amount of consumption expenditure that would take place in the short run even if people had no current income
• induced consumption → expenditue in excess of autonomous consumption: what is induced by disposable income

Question 5

what is the keynesian cross?

Answer 5

• used to understand how changes in planned expenditure affect real GDP
  the keynesian cross:
• simple closed economy model in which income is determined by expenditure
• the slope of planned expenditure is the same as of the consumption function: MPC
• with I exognous, the only component of (C+I) that changes when income changes is C. A one-unit increase in income causes C and planned expenditue to increase by the MPC
• equlibrium expenditure: when aggregate planned expenditure equals real GDP (45º line)

Question 6

How can planned expenditue differ from real GDP?

Answer 6

firms can end up with inventories that are greater or smaller than planned

Question 7

when does equilibrium of expenditure occur?

Answer 7

• when there are no unplanned changes in business inventories
  → if aggregate planned expenditure exceeds real GDP (PE>Y), there is an unplanned decrease in inventories. to restore inventories, firms hire workers and increase production. real GDP increases
  → if real GDP exceeds aggregate planned expenditure (PE<Y), there is an unplanned increases in inventories. to reduce inventories, firms lay off workers and decrease production. real GDP decreases

Question 8

what happens when planned autonomous expenditure changes? explain the multiplier effect

Answer 8

• an increase in autonomous expenditure brings and unplanned decrease in inventories
• so, firms increase production and real GDP increases
• with a higher level of real GDP induced expenditue also increases
• BUT the change in equilibrium expenditure is larger than the initial change in autonomous expenditure
• this is the MULTIPLIER EFFECT

Question 9

how large is the multiplier in a closed economy

Answer 9

• multiplier is given by the change in equilibrium expenditure divided by the change in autonomous expenditure: ∆𝑌/∆A
• the multiplier is greater than 1 because an increase in autonomous expenditure induces further increases in aggregate expenditure (throught induced expenditure)
• the slope of the aggregate planned expenditure curve (AE) determines the magnitude of the multiplier

multiplier = 1/(1-slope AE) = 1/(1-MPC)

Question 10

why does the slope of the AE curve determine the magnitude of the multiplier?

Answer 10

• the larger the MPC (and the steeper the AE curve) the larger the multiplier

Question 11

Explain the keynesian multiplier in an open economy

Answer 11

• planned expenditure = C + I + G + X - M
• slope of the AE curve will depend on the marginal propensity to consunsume (MPC) and on the marginal propensity to import (MPI)
• Slope AE = MPC – MPI
• All else equal, since MPI > 0, the
  slope of AE will be lower and the
  multiplier will be smaller.

∆Y/∆𝐴 = 1/(1 - 𝜕C/𝜕Y + 𝜕M/𝜕Y) = 1/(1 − 𝑀PC + 𝑀PI)
→ the larger the MPC or the smaller the MPI the larger the multiplier

If we introduce proportional taxes:
∆Y/∆𝐴 = 1/(1 - 𝜕C/𝜕Y (1-t) + 𝜕M/𝜕Y) = 1/(1 − 𝑀PC (1-t) + 𝑀PI)
→ the higher the tax rate (t) the smaller the multiplier

Question 12

explain the relatioship between the AE and the AD curves

Answer 12

• AE curve → shows how aggregate planned expenditure depends on realg GDP (through the effects of disposable income), other things remaining the same
  
  • AD curve → shows how equilibrium aggregate expenditure, which shifts the AE curve, generates a new level of equilibrium expenditure, and generates a new point on the AD curve
• a change in the price level changes autonomous expenditure, which shifts the AE curve, generates a new level of equilibrium expenditure, and generates a new point on the AD curve
• a change in autonomous expenditure at a given price level shifts the AE curve, generates a new level of equilibrium expenditure, and shifts the AD curve by an amount equal to the change in autonomous expenditure multiplies by the multiplier
• The same rise in the price level that lowers equilibrium expenditure brings a movement along the AD curve
• The same fall in the price level that
  increases equilibrium expenditure brings a movement along the AD curve
• if investment increases:
  → the AE curve shifts upwards
  → and the AD curve shifts rightward by an amount equal to the change in investment multiplied by the multiplier

Question 13

explain the multiplier in the long-run

Answer 13

• the multiplier ir the LR is 0