Transcript Chapter 1
The Expanded Model of Income Determination Expanded model of income determination In chapter 14, a very basic Keynesian model of income determination was introduced This model serves as an introduction to income determination and capacity utilisation in the economy If is far to simple to be of any use in the real world, but it establishes some important points nevertheless Keynes, John Maynard, 1st Baron Keynes of Tilton (1883-1946) Expanded model of income determination Recall when Keynes was writing – mid thirties with massive unemployment Established theory until then had assumed that this would be a temporary phenomenon In a world with flexible prices, in the long run equilibrium will exist in all markets Keynes: In the long run, we are all dead Expanded model of income determination Keynes gave politicians theoretically sound arguments for intervening in the economy Keynes in particular focused on how the authorities could affect aggregate demand through fiscal policy, i.e. government purchases of goods and services and taxes In chapter 15, this is incorporated into the basic model of income determination. Expanded Model of Income Determination We introduce a public sector, with government purchases of goods and services G and taxes T. This model could be labelled a Keynes model for a closed economy with a public sector Later in the chapter, another sector is introduced – the foreign sector. Only goods transactions takes place, exports (X) and imports (Z) This chapter also provides a more satisfactory explanation of investment demand Investment demand Demand for investment goods (I) very much depends on the outlook for the economy Profitability depends on: Investment outlay Increased income due to the investment Costs of financing the investment Increased income – cost of investment = MEI (marginal efficiency of investment) Cost of financing: R Time value of money The investment outlay is paid for ”today” Income will accrue in the future, and value may be reduced due to: impatience and postponement of demand risk inflation Income must be discounted by an interest rate R Net Present Value Example: Investment outlay = 10 000 Income year 1: 6 000 Income year 2: 2: 6 000 Interest rate (R) = 5 % (0,05) What is the PV of the income? 6000 6000 PV 11156 2 1,05 1,05 Marginal Efficiency of Investment (MEI) I0 I1 I2 Rate of return (R) R1 Marginal efficiency of investment R2 Expectations change I2 I1 I0 Rate of return (R) Marginal efficiency of investment R0 Keynesian business cycle The accelerator changes in national income and induced investment the accelerator coefficient the instability of investment The multiplier / accelerator interaction GDP, Investment (% annual change) Fluctuations in UK real GDP and 20 investment: 1978-2002 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 GDP, Investment (% annual change) Fluctuations in UK real GDP and 20 investment: 1978-2002 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 1978 1980 GDP 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 GDP, Investment (% annual change) Fluctuations in UK real GDP and 20 investment: 1978-2002 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 1978 1980 Investment GDP 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Accelerator 1970-1999 in Norway 30,0 % GDP Investment 20,0 % 10,0 % 0,0 % 1974 -10,0 % -20,0 % -30,0 % 1978 1982 1986 1990 1994 1998 Accelerator theory capital output ratio = 2 Year 1 2 3 4 5 Sales 1 mill 1 mill 1,2 mill 1,5 mill 1,6 mill Required Net capital stock investment 2,0 mill 2,0 mill 0 2,4 mill 0,4 mill 3,0 mill 0,6 mill 3,2 mill 0,2 mill Accelerator theory Investments are dependent on expected changes in GDP or I = Y – a small change in income gives a large change in induced investment Accelerator This depends on the marginal ratio between capital and production In addition, we will have multiplier effects between I and Y Introducing the public sector Taxes T represent a withdrawal from the economic circulation (like savings S) The Governments demand for goods and services G represent an injection (like investments I) Equilibrium when realised withdrawals = realised injections S +T=I+G Keynes expanded model - 1 The public sectors demand for goods and services G is always exogenous Taxes (T) Version Version 1: Lump sum taxes T = T 2: Income taxes T = tY, where t is the (average) tax rate The model version 1 Y CIG C bYd II GG TT Equilibrium Y CIG Y b(Y T ) I G Y bY bT I G Y bY I G bT Y(1 b) I G bT 1 Y (I G bT ) 1 b An example Assume we have the following: C I = 0,8Yd = 60 G = 50 T = 50 1 Y (60 50 40) 350 1 0,8 The multipliers 1 Assume : G 10 Y G 1 1 b Y 10 50 0,2 1 Y I 1 b b Y T 1 b The model Example a I G T b = MPC Y 0 60 50 50 0,8 350 Consumption Government Investment Y = GNP 240 50 60 350 Multiplier 5,00 Haavelmos theorem What happens if an increase in public spending is financed by an equivalent tax increase, i.e. G= T? 1 b G T 1 b 1 b By assumpt ionG T , t hisgives 1 b Y G G 1 b 1 b 1 b Y G 1 b Y G, t hemult iplieris 1 Y The Model Version 2 Y CIG C bY(1 t) II GG T tY Equilibrium Y CIG Y bY(1 t) I G Y bY bYt I G Y bY bYt I G Y(1 b(1 t) I G 1 Y (I G) 1 b(1 t) The multipliers Assume : G 10, t 0,2 (20 %) 1 Y G 1 b(1 t) 1 Y 1 1 0,8(1 0 , 2 ) Y I 1 b(1 t) 2,78 10 27,8 T hemultiplieris reduced due to increased leakagesin theformof taxes The model Example a I G t b = MPC Y 0 60 50 0,3 0,8 250,00 Consumption Government Investment Y = GNP 140 50 60 250,00 Multiplier 2,27 Built in stabilisers T T G Government expenditure and Taxes G Yb Introducing the foreign sector Imports: Z and Exports: X Equilibrium when leakages = injections S+T+Z=I+G+X It is assumed that imports are endogenous and dependent on income Exports are exogenous Economic circulation The model Y CIGXZ C bY(1 t ) II GG T tY XX Z nY The multipliers 1 (I G X) Y 1 b(1 t) n 1 I Y 1 b(1 t) n 1 G Y 1 b(1 t) n 1 X Y 1 b(1 t) n The open economy model Input G I X t n b Y= G-T X- Z 20 16 30 0,2 0,3 0,8 100,00 0,00 0,00