Transcript National Income Accounts

Demand-Side Stabilization:
Overheating, Hard Landing and
Everything in Between
Part 2
The Multiplier Effect
C + I + G + (Exp – Imp) = Y
Assume G increase from 125 to 175 ($50 billion
increase).
Now E1 = 875 (see Table 5.1), an increase in Y of
125. Why?
Multiplier effect =
change in GDP/change in components of AD
The mechanism of the multiplier effect
MPC = change in consumption/change in national
income
=ΔC/ΔY
= (550-475)/(750-625) = 0.6
Multiplier = 1/(1-MPC)
Period 1:
60% of the initial injection ($50 billion) is spent (increases Y).
Period 2:
60% of the $30 billion (injected in the economy in period 1) is
spent (increases Y).
And so on… (see Table 5.2).
Changing Monetary Policy

An increase in the rate of growth of the money
supply (through open market operations) leads to
a fall in interest rates (i) which causes capital
investment to rise.
 A rise in capital investment is shown by an
upward shift in the expenditure line in the goods
market, which is reflected in the AD shifting right
(Fig. 5.4).
Tax Policy
CT = C + bYD
CT : consumption function with tax rate t.
C : Consumer confidence.
b : Marginal propensity to consume (MPC)
YD : Disposable income.
YD = Y – tY
= (1 - t)Y
CT = C + b(1 - t)Y
Thus, an increase in the tax rate (t) causes CT to fall.
This decrease in consumption causes a drop in the goods
market equilibrium and a shift to the left in AD.
For a summary of the three methods of shifting AD see
Figure 5.5.
Unemployment
Unemployment rate = Unemployed / Civilian labor force
Participation rate = Labor force / Population over 16

Frictional unemployment: Unemployment associated
with the ‘normal’ working of an economy (wait and search
unemployment).

Structural unemployment: Generally caused when
entire sectors of the economy shut down (e.g., textiles, steel,
…)

Cyclical unemployment: Unemployment that fluctuates
with the business cycle.

Full unemployment: When the economy has only
frictional and structural unemployment.

The Natural Rate of Unemployment is
sometimes known as the non-accelerating
inflation rate of Unemployment (NAIRU).
When unemployment is at its natural rate there
is no tendency for inflation to increase.

Congress enacted the Employment Act of 1946:
The Federal Government has the responsibility
“to promote maximum employment, production
and purchasing power.”
Inflation
 GDP
deflator and CPI were covered
In chapter 2.
 Inflation: A percentage increase in
the overall general price level.
 Deflation: Average decline in the
price level.
Examples: Great depression, Japan in
the late 1990s.
 Disinflation:
Declining rates of
inflation
Examples: US in the 1980s, inflation rate
fell from about 10% in 1980 to 3% in 1987.
In order to understand macroeconomic
phenomena such as soft-landing and
overheating we will link changes in the price
level to demand-side stabilization.
This process starts with a definition of different
types of inflation: demand-pull inflation, costpush inflation, and hyperinflation.
Two macroeconomic scenarios (see Fig. 5.6).
The index of Leading Economic
Indicators
The US leading Indicators Index has 10 components:
1. Average weekly hours of manufacturing
2. Initial claims for unemployment insurance
3. New orders, consumer goods, and materials
4. Vendor performance, slower deliveries
5. New orders, non-defense capital goods
6. Building permits
7. Stock prices, 500 common stocks
8. Index of consumer expectations
9. Money supply, M2
10. Interest rate spread, 10-year T-bonds less the
Federal funds rate
NAPM (ISM) Index
The monthly Institute for Supply Chain
Management (ISM) index of manufacturing
(formerly, the National Association of
Purchasing Management, NAPM).
An overall reading below 50 suggest that
the manufacturing sector is shrinking.
Note: Most recession in the US have begun
with a contraction in manufacturing
activity.
Articles 5.2 and 5.3 for class
discussion