Transcript Eco120Int_Lecture6

ECO 120
Macroeconomics
Week 6
Review of Weeks 1-5
Lecturer
Dr. Rod Duncan
Topics
• General topics covered in first 5 weeks:
– Consumption function
– AE function
– Calculation of equilibrium in the AE model
– Multiplier in the AE model
– AD/AS model
– Investment and the NPV concept
But first, the big picture
• We have one central
model in this subject,
which is the AD-AS
model.
• We draw the AD-AS
model, then our
prediction about the
economy is where the
AD and SR AS curves
intersect.
ASLR
P
ASSR
P0
AD
Y0
Yn
Y
The big picture
• We want to use the AD-AS model to
discuss the real world- to talk about the
consequences to the Australian economy
of:
– New government policies
– Changes in existing government policies
– Events happening outside Australia
– Changes within Australia, such as introduction
of new technologies or the aging of the
Australian population
The big picture
• But in order to do this, we have to know what
factors can affect our AD-AS model:
– Why the AD and AS curves slope the way they do?
– What changes will shift the AD and AS curves and the
direction of the shift?
• In order to know these things, we have to know
how the AD and AS curves are constructed.
• Once you understand where the AD and AS
curves come from, you understand how they
behave.
The big picture
• An alternative way to teach this class would be
to simply start with the AD-AS model (at Chapter
8) and then simply list the factors that shift the
AD and AS curves and the direction of change.
• You could do everything that we can do with the
AD-AS model, but you wouldn’t understand why,
for example, the AD curve shifts right if
consumers’ wealth rises.
• This understanding is why we started this
subject at the consumption function.
A linear consumption function
• C(Y) = a + b Y, a > 0 and b > 0
C(Y)
C(0) = a, so
even if
Y=0, C > 0.
a
Slope is b > 0,
so C is
increasing in Y.
Y
Linear savings function
Y*
S(Y*)
C(Y)
Y*
C(Y*)
S(Y)
Y’
Negative S
Y*
Positive S
Y
Y
Y’
Negative S
Positive S
Investment demand
• Then we add
investment demand
which depends on the
interest rate, i.
• But total spending on
goods and services is
a sum of:
AE = C + I + G + NX
i
i0
I
I0
I
Aggregate expenditure function
• This equation is a relationship between
income (Y) and aggregate expenditure
(AE).
AE = 200 + 0.5Y
$250bn
Slope is 0.5
$200bn
$100bn
Y
Equilibrium
Y
AE = 200 + 0.5Y
400
400
Y
• The equilibrium
value of Y is
where the 45
degree line and
the AE line
cross. Y* is at
$400bn.
Equilibrium
• Equilibrium occurs at
a price level where
goods demand (AD)
is equal to goods
supply (SR AS).
P
AS
P0
AD
Y0
Y
The big picture
P, Wealth, H/h Expectations,
H/h Taxes
C
P, i, Business Expectations,
Business Taxes
I
AE
Government policy, and?
P, and?
G
NX
AD
The big picture
• This is essentially the path the subject has
taken so far. In the next part of the
subject, we will be looking at what
determines G and NX, plus a lot of other
topics.