Transcript The Saga of Bubba and Bubbaonia

When Bubba
gets a raise of $20
per week, he spends an extra
$15 on fishing gear and other stuff.
When Bubba gets laid-off, he still spends
$60 or so---by drawing down past savings.
Can you calculate Bubba’s marginal
propensity to consume.
Can you write the linear equations
that describe Bubba’s
consumption and saving
behavior?
Bubba’s MPC
is simply ΔC/ΔY:
ΔC/ΔY = 15/20 = 0.75
It’s the slope of the consumption equation,
the rise over the run.
$60 is the C that corresponds to a Y of zero.
It’s the vertical intercept, the C-intercept.
C = a + bY,
where a is Bubba’s zero-income spending,
and b is Bubba’s MPC.
C = 60 + 0.75Y
The general form of the
consumption equation is C = a + bY
Bubba’s consumption equation is
C = 60 + 0.75Y
The general form of the
saving equation is S = - a + (1 – b)Y
Bubba’s saving equation is
S = - 60 + 0.25Y
Notice
what happens when
we add Bubba’s consumption
equation and saving equation:
C = 60 + 0.75Y
S = - 60 + 0.25Y
We get: C + S =
Y
— which is to say that the part of Bubba’s
income that he spends plus the part of
his income that he doesn’t spend is
equal to all of his income.
In the wholly private
Economy of Bubbalonia,
total income (Y) stands at $8,000.
Consumption behavior (for the whole
economy) is given by C = 600 + 0.75Y.
Investment spending is $1,400.
Is Bubbalonia in a Keynesian equilibrium?
Is the Bubblalonian labor force
fully employed?
Spring
into action!!
Run the numbers!
C = 600 + 0.75Y
Y = 8,000
C = 600 + 0.75(8,000)
C = 600 + 6,000
C = 6,600
I = 1,400
C + I = 6,600 + 1,400
E = 8,000
Y=E
Bubbalonia is in a Keynesian equilibrium.
However, the labor force may not
be fully employed.
C = 600 + 0.75Y
S = -600 + 0.25Y
S = -600 + 0.25(8,000)
S = -600 + 2,000
S = 1,400
I = 1,400
S=I
Again, this is a Keynesian equilibrium
(but the labor force may not be
fully employed).
With increased
optimism, investment
spending rises and Bubbalonia achieves
a full-employment equilibrium (without
inflation) at an income level of $9,200.
Bubbalonia is still a wholly private economy;
consumer spending is still C = 600 + 0.75Y.
Just how much is the optimistic business
sector spending on investment goods?
And what can you say about the
unemployment rate in
Bubbalonia?
Y=E
Y=C+I
C = 600 + 0.75Y
C = 600 + 0.75(9,200)
C = 600 + 6,900
C = 7,500
Y=C+I
9,200 = 7,500 + I
I = 1,700
The unemployment rate
.
in Bubbalonia is the “natural
rate,” i.e., 5% - 6%.
C = 600 + 0.75Y
S = -600 + 0.25Y
S = -600 + 0.25(9,200)
S = -600 + 2,300
S = 1,700
S=I
I = 1,700
Again, the unemployment rate in Bubbalonia
is the “natural rate,” i.e., 5% - 6%,
Which means that Bubbalonia is
experiencing no cyclical
unemployment.
NOTE:
In the pre-optimism equilibrium:
I = 1,400; Y = 8,000.
In the post-optimism equilibrium:
I = 1,700; Y = 9,200.
When I rose by 300, Y rose by 1,200.
That is, ΔI = 300 implies ΔY = 1,200.
There’s some leverage here,
a multiplier of some sort.
Bubbalonia was
enjoying full-employment
(without inflation) while both
income and expenditures were $9,200.
Then, investors lost their nerve, got cold feet,
and cut back on investment spending by 500.
Still a wholly private economy with consumer
spending given by C = 600 + 0.75Y,
Bubbalonia went into a downward spiral.
At what level of income did
the spiraling cease?
Investors cut back on
investment spending by 500.
ΔI = - 500
The investment multiplier is in play here.
ΔY = [1/ (1- b)] ΔI
1/ (1-b) = 1/(1 – 0.75) = 1/0.25 = 4
ΔY = 4ΔI = 4(- 500) = - 2,000
The downward spiral ceased when
income fell from $9,200
to $7,200.
A further loss of
confidence in Bubbalonia’s
investment sector turned
recession into depression. The economy
finally found its macro-equilibrium at $5,600.
In desperation, the government hired Bubba
himself as its chief economist. Bubba’s staff
told him that C = 600 + 0.75Y and that fullemployment income would be $9,200.
Bubba thinks that the government
should do some spending.
But how much?
The government-spending
multiplier is in play.
The difference between full-employment
income ($9,200) and the current (equilibrium)
income ($5,600) is the needed ΔY, i.e., $3,600.
So, we write: ΔY = [1/(1- b)] ΔG,
realizing that 1/(1-b) = 1/(1 – 0.75) = 4.
ΔY = 4ΔG; $3,600 = 4ΔG
ΔG = $900.
That’s how much spending
Bubba recommends.
SENATOR SUSAN COLLINS
Collins(R-MAINE)
(R-Maine)
Senator Susan (Bubba)
supported the 2008 Stimulus Package of
$800,000,000,000.
She claimed that it would “help to create
three-to-four million jobs.”
$800,000,000,000
= $200,000 per job
4,000,000
What happened to the wage rate when the
level of income rose from $5,600 to $9,200?
Did it rise, fall, or stay the same?
What would have happened if the Bubba had
recommended $1,000 in new government
spending (instead of $900)?
The wage rate
remained unchanged
—because wage rates (and
prices) are “sticky downwards.”
Judged in the context of the depression,
the wage rate is stuck too high.
But judged in the context of full employment,
the wage rate is stuck just right.
Spending $1,000 would put upward
pressure on W x N with N at full
employment. Hence, the wage
rate would rise.
Bubbalonia
has now matured into a
full-fledged mixed economy.
The government taxes, spends, and
manipulates. Equilibrium income is $22,760,
but full-employment income is estimated to
be $23,000. Knowing that people save 25
cents out of each additional dollar of income,
Bubba suggests two alternative policies:
Spring
into action!!
Increase G by _____.
OR:Decrease T by _____.
Run the numbers!
ΔY = Yfe – Yeq
ΔY = 23,000 – 22,760
ΔY = 240
Gov’t spending multiplier = 1/ (1- b)
1/ (0.25) = 4
So, the needed ΔG is 60.
Tax multiplier = -b/ (1- b)
-0.75/ (0.25) = -3
So, the needed ΔT is -80.
Increase G by _____.
60
80
OR:Decrease T by _____.
Suppose that people are
concerned about government
budget deficits (because of the
uncertainty that they always entail).
What combination of fiscal actions (changes
in both G and T) will keep the budget in
balance while driving Bubbalonia from its
current equilibrium income of $22,760, to its
full-employment income of $23,000.
Increase G by _____
240
240
and increase T by _____.
CODA:
Frustrated with stimulus packages
and mushrooming government debt,
and with the general fiscal irresponsibility
of Keynesian policymakers,
Bubba retires to
the Isle of St. Canes.
When the Isle of St. Canes is functioning at full
employment, the Islanders earn $400 billion and
spend $330 billion.
During the last recession, when earnings fell to
$300 billion, the Islanders spent only $260 billion.
Can you write the equations
that describe the Islanders’
consumption behavior and
their saving behavior?
C = a + bY
What is the Marginal Propensity to consume on
the Isle of St. Canes?
C = 50 + 0.70Y
If total earnings on the Isle of St. Canes falls to
zero, how much will the Islanders spend?
S = – 50 + 0.30Y
S = – a + (1 – b)Y
C
MPC = b = 70/100 = 0.70
330
70
C = a + bY
260
C = a + 0.70Y
330 = a + 0.70 (400)
260 = a + 0.70 (300)
330 = a + 280
260 = a + 210
a = 330 – 280
a = 260 – 210
a = 50
a = 50
100
a
300 400
Y