GDP Simple Model with Government and Trade Flashcards Preview

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Flashcards in GDP Simple Model with Government and Trade Deck (14):

List all autonomous components?

A) Government Purchases (G)

B) Exports (X)


List all induced components?

A) Net Tax revenue --> T = tY

B) Imports --> IM = mY

C) Total Induced expenditure = zY

*as national income rises by $1, how much does ___ rise?

*all induced components have a marginal propensity to ___


AE function in an open economy with government

At equilibrium

AE = C + I + G + NX

= [a + MPC(1 - t)Y] + I + G + [X - mY]

Autonomous expenditure: A
a + I + G + X

Induced expenditure:
MPC(1 - t)Y - mY
= [MPC(1 - t) - m]Y
where z = MPC(1 - t) - m


= (a + I + G + X) + ( b(1 - t)Y - m)Y

At equilibrium:
y = A/(1 - z)
= (a + I + G + X)/( 1 - (b(1 - t) - m) )


Characteristics to this new model

1) Yd is now Yd = Y - tY
Yd = (1 - t)Y

2) New AE function with G and Nx

3) New z = b(1 - t) - m


Introducing the Government:

1) Government Purchases (G0)

2) Net Tax Revenues (T)

1) G (desired government purchases) are directly part of desired aggregate expenditures
o Assume G is autonomous with respect to Y

*transfer payments enter the AE function indirectly through households and firms

2) Net Tax Revenues:
o Taxes REDUCE disposable income relative to national income
o Transfer payments RAISE disposable income relative to national income

Net Tax Revenue (T) = total tax revenue - transfer payments

T = tY where t = net tax rate
*Positive relationship
- as income rises, people pay MORE income tax (even though tax rates are unchanged)
- as income rises, government REDUCES transfers to households


Budget Balance

- budget surplus

- budget deficit

- balanced budget

Budget Balance = Tax revenue - Government purchases

o Budget surplus = when Tax Revenue > Government Expenditures

o Budget deficit = when Tax Revenue < Government Expenditures

o Balanced Budget = when Tax Revenue = Government Expenditures


Provincial and municipal governments?

- We must consider ALL levels of government when measuring the overall contribution of government to desired aggregate expenditure



Net exports = Exports - Imports

o Treat EXPORTS (X) as autonomous expenditures because exports will not change as a result of changes in Canadian national income (Y)

Imports are induced
- marginal propensity to import (m) = change in imports with $1 increase in national income

IM = mY

Net Export Function (NX) = X0 - mY
- downward sloping
- x axis = Y
- y axis = NX
- y intecept is X0
- x intercept is where X0 = IM


Shifts in Net Export Function - Determinants

1) Changes in Foreign Income:
- only affects exports (parallel shifts, changes to y-int)
o Increase in foreign income = increase Exports = X curve and NX shift parallel upwards

2) Changes in International Relative Prices
A) Appreciation in CAD
- more expensive to buy Canadian Goods = decrease exports = shift down
- cheaper foreign goods = increase imports = steeper slope (increase in m)
Result: NX function will shift down and be steeper

B) Depreciation in CAD
- less expensive to buy Canadian goods = increase in exports = shift up
- more expensive foreign goods = decrease imports = flatter slope (decrease in m)
Result: NX function will shift up and be flatter


Difference between MPCYd and MPCY

- the MPC out of national income is LESS than MPC out of disposable income

MPCYd = MPC(1 - t)Y


New marginal propensity to spend (z) versus b (MPC out of Yd)

z is smaller than MPC

- taxes reduce Yd (less spending)
- spending on imports reduces spending on domestic goods


Simple multiplier with government and trade

sub in z = b(1 - t) - m

*recall that the larger z, the larger the multiplier

The higher the m (marginal propensity to import), the lower the multiplier (because smaller z)

The higher the t (tax rate), the lower the multiplier (because smaller z)

*always consider the SIGN of change A (which will affect increase or decrease in Y)


Changes in equilibrium with multiplier caused by...

1) Net Exports:
- Recall determinants of net exports and shifts of the net export function
- Export changes is the change in A, so multiply change in A by the multiplier to get the change in the equilibrium national income

Fiscal Policy - used to stabilize national income = stabilization policy
- Reduction in net tax rate OR an increase in government purchases = shifts AE curve upward (slope steeper) = increase equilibrium national income
o When net tax rate falls, the marginal propensity to spend (z) rises, so slope becomes steeper (upward rotation)
- When net tax rate rises, there is a decrease in disposable income and decrease in desired consumption expenditure
o Results in a downward rotation of the AE curve, which decreases the level of equilibrium national income

*ONLY USE SIMPLE MULTIPLIER FOR changes in Autonomous Spending, not when AE function changes slope (i.e. changes in net tax rate)


MPC out of disposable income versus MPC out of national income?

MPC out of disposable income = b
where C = a + bYd

MPC out of national income = b(1 - t)
where C = a + b(1 - t)Y