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Transcript of 1 The Short-Run Macro Model Short-run macro model Macroeconomic model Changes in spending Affect...
1
The Short-Run Macro Model
• Short-run macro model– Macroeconomic model– Changes in spending– Affect real GDP– Short run
• Short run– Spending depends on income– Income depends on spending
2
Consumption Spending
• Consumption spending increases when:– Disposable income rises– Wealth rises– Interest rate falls– Optimistic about the future
3
Consumption and Disposable Income
• Consumption function– Relationship between consumption and
disposable income – Positive slope
• Autonomous consumption spending– Part of consumption spending – Independent of income– Vertical intercept - consumption function
4
U.S. Consumption and Disposable Income
• Figure 1 U.S. Consumption and Disposable Income, 1985–2005
5
Consumption and Disposable Income
• Marginal propensity to consume (MPC)– Slope of the consumption function– Amount by which consumption spending
rises when disposable income rises by one dollar
1MPC0income eΔDisposabl
onΔConsumptiMPC
6
Consumption and Disposable Income
• Representing the consumption with an equation
– C - consumption spending– a - autonomous consumption spending– b - MPC
Income) e(Disposabl b a C
7
The Consumption Function
ConsumptionFunction
1,000600
The consumption function shows the (linear) relationship between real consumption spending and real disposable income
and the slope of the line (0.6) is the marginal propensity to consume.
Rea
l Con
sum
ptio
n S
pend
ing
($
billi
ons)
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Real Disposable Income ($ billions)1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000
The vertical intercept ($2,000 billion) is autonomous consumption spending . . .
• Figure 2 The Consumption Function
8
Consumption and Income
• Consumption–income line– Aggregate consumption spending at
each level of income or GDP– Slope = MPC– If Tax is fixed, it shifts downward by
MPC Tax
9
The Consumption-Income Line
1. To draw the consumption-income line, we measure real income (instead of real disposable income) on the horizontal axis.
Consumption-Income Line
600
AB
Real Consumption Spending ($ billions)
1,000
2,000
3,000
4,000
5,0005,600
Real Income ($ billions)2,000 4,000 6,000 8,000
1,000
2. The line has the same slope as the consumption function in Figure 2 . . .
3. but a different vertical intercept.
• Figure 3 The Consumption-Income Line
10
Shifts in the Consumption-Income Line
• Move along – Change in income - changes
consumption spending
• Shift– Change in anything else except income –
changes consumption spending
line income -nconsumptio thealong rightwardMovement spendingn Consumptio
income Disposable Income
11
Shifts in the Consumption-Income Line
• Table 3 Shifts in the Consumption-Income Line
12
Shift the Consumption-Income Line
Consumption-Income Line When Net Taxes = $500 billion
Consumption-Income Line When Net Taxes = $2,000 billion
Real Consumption
Spending ($ billions)
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Real Income ($ billions)2,000 4,000 6,000 8,000
• Figure 4 A Shift in the Consumption-Income Line
13
Getting to Total Spending
• Investment Spending– Given
• Government purchases – Given
• Net exports = Total exports - Total imports– Given
14
Income and Aggregate Expenditure
• Aggregate expenditure=C+Ip+G+NX• Income increases
– Aggregate expenditure increases
ΔGDPMPCΔAE
15
Deriving the Aggregate Expenditure Line
C + IP + GC + IP + G + NX
C + IP
C
2. then add planned investment (IP) . . .
1. Start with the consumption-income line,
5. to get the aggregate expenditure line.
3. government purchases (G) . . .
4. and net exports (NX) . . .
Real Aggregate
Expenditure ($ billions)
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Real GDP ($ billions)2,000 4,000 6,000 8,000
• Figure 5 Deriving the Aggregate Expenditure Line
16
Finding Equilibrium GDP
• Equilibrium GDP in the short run– Output = aggregate expenditure
• Change in inventory– ΔInventories = GDP - AE
GDPin change No0sInventorieGDPAEGDP0sInventorieGDP AE
GDP0sInventorieGDP AE
17
Using a 45° to Translate Distances• Figure 6 Using a 45° to Translate Distances
450 B
A
1. Using a 45° line …
2. we can translateAny horizontaldistance (such as
0B) …
3. into an equal verticaldistance (BA).
18
Determining Equilibrium Real GDP
• If AE line – below the 45° line– AE<GDP– Inventories increase– Reduce output in the future
• If AE line – above the 45° line– AE>GDP– Inventories decline– Increase output in the future
19
Determining Equilibrium Real GDP• Figure 7 Determining Equilibrium Real GDP
45
12,000
8,000
4,000 8,000 12,000
4,000 J
E
A C+IP+G+NX
TotalOutput Aggregate
Expenditure
Increase inInventories
H
K
AggregateExpenditureTotal
Output
Decrease inInventories
20
Determining Equilibrium Real GDP
• Equilibrium GDP– AE line intersects the 45° line– Inventories will not change– Produce the same level of output in the
future
21
Equilibrium GDP and Employment
• Equilibrium GDP – Not necessarily full employment
• Cyclical unemployment – low spending– Low production– High unemployment
• Overheat economy – too high spending– Production > potential output– Unusually low unemployment
22
A Change in Investment Spending
• Increase investment spending– Sales revenue increases– Income/disposable income increases– Consumption spending increases
• Expenditure multiplier – Change in equilibrium real GDP– For $1 change in C, IP, G, or NX
MPC)(11Multiplier
23
A Change in Investment Spending
1,600
1,9602,176
2,3062,500
1,000
InitialRise in
IP
AfterRound
2
AfterRound
3
AfterRound
4
AfterRound
5
Increase inAnnual GDP
AfterAll
Rounds
• Figure 10 The Effect of a Change in Investment Spending
24
A Change in Investment Spending
• Increase investment spending– GDP increases by more than the initial
increase in investment• Decrease investment spending
– GDP falls by more than the change in spending
PΔIMPC)(11ΔGDP
25
A Graphical View of the Multiplier
• An increase in C, IP, G, or NX – Shift the AE line upward by the initial
increase in spending– Equilibrium GDP rises:
ΔSpendingMPC)(11ΔGDP
26
A Graphical View of the Multiplier
F
E
$2,500Billion
4,000 8,000 12,000
4,000
8,000
12,000
Real GDP($ billions)
Real Aggregate Expenditure ($ billions)
45°
AE2
AE1
Increase inEquilibrium GDP
$1,000
• Figure 11 A Graphical View of the Multiplier
27
Automatic Stabilizers and the Multiplier
• Automatic stabilizers– Reduce the size of the multiplier– Diminish the impact of spending changes
• Taxes.• Transfer payments• Interest rates• Imports• Forward-looking behavior
• Long-run: Multiplier = 0
28
Counterycyclical Fiscal Policy
• Short run– Demand-side effects on output and
employment• Countercyclical fiscal policy
– Change G or T• To reverse or prevent a recession or a boom
• ΔGDP=Multiplier×ΔG
29
Counterycyclical Fiscal Policy
A
B
9,000 10,000 Real GDP ($ billions)
Real Aggregate Expenditure ($ billions)
45°
AE1
AE2
• Figure 12 Counterycyclical Fiscal Policy
(Full-EmploymentOutput)
(RecessionOutput)
30
Problems with Counterycyclical Fiscal Policy
• Timing Problems• Irreversibility• Reaction of the Federal Reserve
31
The Recession of 2001
• Investment spending - downward– Decreased sharply during the second
quarter – Continued to fall throughout the year. – Shift AE line downward
• GDP - almost no growth– Dropped during the third quarter
• Employment fell
32
The Recession of 2001• Figure 13 The Recession of 2001
33
The Recession of 2001
• Internet - prompted investment began to fall.• Internet based new businesses - bankrupt• The terrorist attacks of September 11, 2001• Abnormal: consumption spending increased
– 10-year tax cut - June 2001– The Federal Reserve
34
Appendix 1
• Finding Equilibrium GDP Algebraically
b1NXGIbTaY
AEYNXGICAE
bY)bTa(C
)TY(baCTYY
bYaC
PP
D
D
35
Appendix 2: Tax Multiplier
• Tax multiplier = -(Spending multiplier-1)
TMPC-1MPC-GDP
MPC-1MPC-MultiplierTax