Transcript Part6

‫الجزء السادس‬
‫مكونات الطلب الكلي والدخل التوازني‬
‫‪Aggregate Demand Components‬‬
‫‪and Equilibrium income‬‬
‫د‪.‬إقبال الرحماني‬
‫‪2001‬‬
‫‪1‬‬
Recall:
Keynes believed that the government should intervene to
smooth the sharp fluctuations of the business cycle. This
intervention can be done through fiscal and monetary
policies, that affect directly and indirectly the aggregate
demand. Otherwise, the economy would face undesired
levels of unemployment and inflation.
To understand how can the government policies affect AD, we need
to further understand the different components of AD, and what are
the determinants of each component.
Recall, AD = C + I + G + (X - M)
2
First, Consumption expenditure
Consumption expenditure is the largest component in AD.
Therefore, understanding the determinants of consumption is
critical to understanding forces affecting AD; and hence the
required policies to change income and output.
Note: Total consumption
expenditure amounted to about
63% of total GDP in Kuwait,
2000. (65% private & 35%
government).
3
The main determinants of consumption expenditure:
Income: Households increase spending on goods &
services, when their income rises.
Wealth: An increase in household wealth (assets) will
increase consumption.
Taxes : Higher taxes will lower disposable income
of the household and reduce consumption.
4
Expectations: expectations regarding future economic
growth, jobs, social & political instability, price levels..etc.
affect consumption levels now.
Demographic change: population growth and its
distribution affect consumption levels. (younger and older
households generally consume more and save less than middle aged groups.
Emulation: The impact of the demonstration effect,
keeping up with others’ level of consumption.
5
Interest rate : When interest rates increase it
encourages more savings and hence reduced
spending.
Advertisement & consumer loans: Increased
levels of advertisements encourages more spending .
The availability of consumer loans finance further
consumption.
6
Keynes emphasized the impact of income on consumption. Assuming
other factors constant, there is a positive relationship between income
and consumption. Higher income levels are associated with higher
levels of consumption and saving. Hence we can say that consumption
is induced by income (induced consumption )
Q: What is the consumption level when income equals zero?
In the simple Keynsian consumption function, consumption consists
of two parts : autonomous consumption + induced consumption
7
Then,
Or:
C = a + ΔC / ΔY * Y
C=a+bY
Note : we are assuming other factors constant including taxes
Since Y = C + S
S = Y-C
S=Y- a+bY
Then, the saving function :
S = -a + (1- b) Y
8
Note: If fixed taxes are applied, then:
Disposable income (y) = Y - T
C = a + b (Y- T)
And,
S = -a + (1- b) (Y- T)
9
Example: The Silver Moon Economy
C
Y
C
0
150
100
200
200
250
300
300
400
350
500
400
600
450
500
450
400
350
300
250
200
150
100
50
0
0
Y
C
100
200
300
400
500
Note the consumption function : C = 150 + b Y
10
600
Y
Saving function
Y
0
C
150
S
S
-150
200
150
100
200
-100
200
250
-50
50
300
300
0
0
50
-50 0
400
500
350
400
100
S
100
-100
+S
100
-S
200
300
400
500
600
or
- 150 + Δ S / Δ Y* Y
-150
600
11
450
150
-200
ْNote : S= - 150 + ( 1-b) Y
Y
Average propensity to consume and save
Average propensity to consume : The fraction of total income
that households spend on consumption
APC = C / Y
Average propensity to save: The fraction of total income that
the households save
APS = S / Y
12
Example:
Y
C
S
0
150
-150
-
-
100
200
-100
2
-1
200
250
-50
300
300
0
1
0
400
350
50
.875
.125
500
400
100
0.8
0.2
600
450
150
0.75
0.25
13
APC APS
Q 1: What happens to APC
and APS as income increases?
1.25 -0.25
Q 2: Why does APC + APS = 1
at all levels of income?
Marginal propensity to consume and save
Marginal propensity to consume : The additional (change)
consumption that results from an additional (change) unit of
income
MPC = Δ C / Δ Y
Marginal propensity to save: The saving that results from an
additional unit of income.
MPS = Δ S / Δ Y
14
Example: The Silver Moon Economy
Y
C
S
ΔY
0
150
-150
-
-
-
-
-
100
200
-100
100
50
0.5
50
0.5
200
250
-50
100
50
0.5
50
0.5
300
300
0
100
50
0.5
50
0.5
400
350
50
100
50
0.5
50
0.5
500
400
100
100
50
0.5
50
0.5
600
450
150
100
50
0.5
50
0.5
Note: C = 150 + 0.5 Y
15
Δ
C
And,
MPC
Δ
S
MPS
S = -150 + 0.5 Y
Note 1:
MPC + MPS = 1
Note 2:
0 ≤ MPC ≤ 1
Note 3:
0 ≤ MPS ≤ 1
always why?
always why?
always why?
Note 4:
MPC represents the slope of the
consumption function
Q 1: From the previous example what is the
consumption level when income = 1000 ?
16
Q 2: Which is higher MPC for low income
households (countries) or for high income groups
(countries) ?
C
C1
Y
MPC 2 > MPC 1
(lower income) > (higher income)
17
Examples (assuming taxes = 0)
1: if income increased from KD 500 m
to 600 m. and as a result consumption level increased from
KD 300 m. to 360 m., what is the value of MPC & MPS ?
2: if C = 30 + 0.8 Y
Y = 400 ?
what is the value of APC at
3: if C1 = 340 , C2 = 500 when Y1 = 400 & Y2 = 600
what is the consumption and saving functions?
18
Answers:
1: MPC = 60%
MPS = 40%
2: C = 30 + 0.8 (400) = 350
APC = 350 / 400 = 0.875
3: b = 160 / 200 = 0.8
C=a+bY
340 = a + 0.8 (400)
C = 20 + 0.8 Y
S = -20 + 0.2 Y
19
a = 20
Movement along the consumption curve vs. movement of the curve
Q : What happens to consumption when:
a) income increases?
b) taxes decrease ?
c) consumer expectations
about future price level change ?
d) consumer loans increase, what is
the short-term and long-term effect ?
C
C2
C4
C3
C
C2
C1
Y
Y1
Y2
Note: all changes affecting consumption function affect AD
20
Second, Investment expenditure
Investment is business spending on capital goods and inventories.
Unlike consumption expenditure, investment is the least stable
component of AD.
Investment spending decision, generally, depends on the expected
profitability of such spending. There are many factors that affect
this expectation, which in turn, affect investment expenditure.
21
The main determinants of investment expenditure:
Real interest rate: Investment is negatively related
to interest rate (which is the cost of borrowed funds).
As interest falls (other things being equal),
investment increases
Technology: New technologies stimulate investment
expenditure.
Taxes & Subsidies: Higher corporate taxes will
increase costs of production and lower investment
(subsidies will reduce costs and increase investment.
22
Capacity utilization: As firms approach their full
production capacity, more investment expenditure is
required to expand output (excess capacity reduces
investment expenditure).
Costs of production: Higher costs of production will
lower expected profitability and hence reduce
investment.
Expectations: Investors expectations about future
such as about demand, social and political stability,
costs of production would affect their decisions and
hence investment expenditure.
23
Unlike consumption expenditure, investment is not generally stable
mainly to the different factors affecting investors’ confidence. The
high changes in investment is the main reason for changes in the
business cycle.
I
I
time
Note: in this course we will assume that investment
expenditure is constant.
24
Example: (Silver Moon economy)
Y
C
S
I
0
150
-150
100
100
200
-100
100
200
250
-50
100
300
300
0
100
400
350
50
100
500
400
100
100
600
450
150
100
25
I
I
Y
Q: if there were only two sectors, at which level of income does
equilibrium occurs?
26
Y
C
S
I
AE
0
150
-150
100
250
100
200
-100
100
300
200
250
-50
100
350
300
300
0
100
400
400
350
50
100
450
500
400
100
100
500
600
450
150
100
550
Recall,
AS = Y = AE
AS= Y = C + I
or
S= I
Q: What is the tendency of GDP (Y) direction at non
equilibrium levels ?
Y
C
S
I
AE
0
150
-150
100
250
100
200
-100
100
300
200
250
-50
100
350
300
300
0
100
400
400
350
50
100
450
500
400
100
100
500
600
450
150
100
550
27
e
Y
AE
C
500
450
400
350
300
250
200
150
100
50
0
0
Y(AS)
AE
C
I
100
200
300
400
500
600
Y
S
200
150
Y
S
e
I
100
50
0
-50 0
100
200
300
400
500
600
-100
-150
-200
28
e
Y at
S=I
Y
ْDetermination of equilibrium income through equilibrium equations
For the special case of a two sectors economy:
Note: since AS = AE
at equilibrium
Y = C+I
Y = a +b Y + I
then,
Y - bY = a + I
Y (1- b)= a + I
Then,
e
Y=a+I
1-b
Note, For the silver Moon economy : Y = 150 + 100
0.5
29
= 500
Third, government expenditure
Government expenditure on goods and services is an important
component of AD. The relative share of this component is
influenced by available resources & finance , political and
social orientation of the government, the economic conditions
of the economy and degree of its development. Changes in
government spending (fiscal policies) would affect AD directly.
Note 1: in this course we will also assume that government
expenditure is constant (independent of current income).
Note 2: When we introduce taxes it will only be fixed taxes
(Lump-sum taxes).
30
Note 3: Changes in government spending and taxes are
important tools of the Fiscal policy.
Example: (Silver Moon economy)
Y
C
S
I
G
0
150
-150
100
100
100
200
-100
100
100
200
250
-50
100
100
300
300
0
100
100
G
400
350
50
100
100
Y
500
400
100
100
100
600
450
150
100
100
700
500
200
100
100
31
G
Q: if there were only three sectors, at which level of income does
equilibrium occurs?
Y
C
S
I
G
AE
0
150
-150
100
100
350
100
200
-100
100
100
400
200
250
-50
100
100
450
300
300
0
100
100
500
400
350
50
100
100
550
500
400
100
100
100
600
600
450
150
100
100
650
700
500
200
100
100
700
32
Recall,
AS = Y = AE
C+S = C+I+G
or
S= I+G
(assuming no taxes)
Y(AS)
e
Y
AE2
AE1
AE
500
450
400
350
300
250
200
150
100
50
0
0
33
G
100
200
300
400
500
600 700
Y
ْDetermination of equilibrium income through equilibrium equations
For the special case of a three sectors economy with no taxes:
Then,
e
Y=a+I+G
1-b
Note, For the silver Moon economy : Y = 150 + 100 + 100
.05
34
=700
Appendix:
Note: since AS = AE
Y = C+I+G
Y = a +b Y + I
then,
Y - bY = a + I + G
Y (1- b)= a + I + G
Then,
35
e
Y=a+I+G
1-b
ْDetermination of equilibrium income through equilibrium equations
For the special case of a three sectors economy with fixed taxes:
Ye =
a - bT+ I + G
1-b
Note, Silver Moon economy : Y = 150 - 0.5(100) + 100 + 100
0.5
36
=600
Appendix:
Note: since AS = AE
Y = C+I+G
Y = a +b ( Y - T) + I + G
Y = a + b Y - bT + I + G
then,
Y - bY = a- bT + I + G
Y (1- b)= a - bT + I + G
Then,
37
e
Y = a - bT+ I + G
1-b
Forth, Net exports
Exports are mainly determined by conditions in other countries
such as income level, tastes, exchange rates, expectations,
government policy, and other political factors; while imports are
determined mainly by similar domestic factors.
Exchange rate (‫)سعر الصرف‬: The price in one country’s of one
unit of another country’s currency. (e.g: 1K.D = $ 3.3 = 12
Egyptian Pounds …etc. )
A depreciation of the domestic currency will make domestic
goods cheaper and make foreign goods relatively more
expensive, hence would increase net exports.
Q: What is the role of WTO in affecting international trade?
38
For the Kuwaiti economy (1995- 1999)(million KD):
Total exports (93% oil exports) = 3878.8
Total imports = 2455.2
The balance of trade = 1423.6
(‫)حجم التجارة الخارجية‬
Total external trade (X + M) = 6334
GDP = 8592.2
The degree of openness of the Kuwaiti economy
(‫ )درجة انفتاح االقتصاد‬:
= (Total external trade / GDP ) x 100 = 73.8
39
Export is mainly determined by exogenous factors . In this course
we will assume it constant. Imports on the other hand, is similar to
consumption expenditure ( of foreign goods).
Hence,
X=X
M = m0 + m1 Y
m1 = Δ M / Δ Y (marginal propensity to import)
40
Example: (Silver Moon economy)
Y
X
M
X-M
0
50
10
40
100
50
25
25
200
50
40
10
300
50
55
-5
400
50
70
-20
500
50
85
-35
600
50
100
-50
700
50
115
65 -
41
X, M
M
50
+
10
-
X
Y
Q: if there were four sectors, at which level of income does
equilibrium occurs?
Y
C
I
G
X-M
AE
0
150
100
100
40
390
100
200
100
100
25
423
200
250
100
100
10
460
300
300
100
100
-5
495
400
350
100
100
-20
530
500
400
100
100
-35
565
600
450
100
100
-50
600
700
500
100
100
65 -
635
42
Recall,
AE = C + I + G + (X-M)
and at equilibrium:
AS = Y = AE
Note: equilibrium income
for the four-sectors is less
than for the three-sectors
Silver Moon economy.
Why?
Y
AE2
e
Y
AE3
AE
500
450
400
350
300
250
200
150
100
50
0
0
43
AE2:Closed economy
AE3: Open economy
100
200
300
400
500
600 700
Y
ْDetermination of equilibrium income through equilibrium equations
For the case of a four sectors (open ) economy with no taxes:
e
Y = a + I + G + X - m0
1-b + m1
Note, Silver Moon economy : Ye= 150 + 100 +100 + 50 - 10
1- 0. 5 + 0.15
e
= 600
Q: What is Y for an open economy with fixed taxes ?
44
Appendix:
Note: since AS = AE
Y = C + I + G + (X- M)
Y = a +b Y + I +G +X - m0 - m1 Y
then,
Then,
45
Y - bY + m1 Y = a + I + G +X- m0
Y (1- b + m1) = a + I + G +X- m0
e
Y = a + I + G + X - m0
1-b + m1