Transcript L` equilibrio del mercato dei beni: applicazioni

The goods market:
Exercises and applications
Lecture 19 – academic year 2014/15
Introduction to Economics
Fabio Landini
Questions of the day
What explains the variation of GDP in the short
period?
How much does the GDP vary following changes
in the demand components?
How can we explain phenomena such as the
expansion of US during the 90s or the recent
great recession (2008-09)?
Plan of the day
• Numerical examples to determine the
equilibrium level of GDP
• Effects of variation in autonomous
expenditure
• Explanation of multiplier
• Expansion in US during the 90s
• Great recession in Italy (2008-2009)
• Savings and investments in equilibrium
Examples on the determination of GDP
We write the equations which describe the components
of aggregate demand
Consumption is endogenous (behavioural equation)
C = 100 + 0,6YD
Investments, public expenditure and taxes are
exogenous (constant values)
I = 50
G = 250
T = 100
Which is the value of production in equilibrium (YE)?
Examples on the determination of GDP
Aggregate demand Z is equal to
Z=C+I+G
By substituting the equation C = 100 + 0,6 YD
Z = 100 + 0,6YD + I + G
By substituting the definition YD = Y-T
Z = C0 + c1 (Y-T) + I + G
By substituting the constant value for I, G e T
Z = 100 + 0,6 (Y-100) + 50 + 250
So that
Z = 0,6Y + 340
Examples on the determination of GDP
We impose the equilibrium condition Z=Y, so that
Y = 0,6Y + 340
(1- 0,6) Y = 340
1
Y=
340 = 850
1 - 0,6
Equilibrium income -> YE = 850
Which is the value of the multiplier?
1
Multiplier =
= 2,5
1 - 0,6
Variations in autonomous expenditure
Let’s examine the effects of a variations in one
component of autonomous expenditure on final
product.
Let’s suppose that something changes which affects
the consumption choices -> Aut. Consumption (C0)
C0 = 100 -> 200
For the other variables we maintain the same values.
Variations in autonomous expenditure
Which is the equilibrium value of final product ?
Z=C+I+G =
= 200 + 0,6 (Y-100) + 50 + 250 = 0,6Y + 440
Let’s impose the equilibrium condition Z=Y
Y = 0,6Y + 440
from which we get
1
YE =
440 = 1100
1 - 0,6
Variations in autonomous expenditure
We obtained that
C0 = 100 -> 200 caused YE = 850 -> 1100
An increase in C0 of about 100 caused an
increase in YE of about 250
Why?
Variations in autonomous expenditure
Explanation:
a)
Autonomous consumption (C0) ->
b) Since consumption is a component of aggregate
demand (Z=C+I+G) Aggregate Dem. ( Δ Z= Δ C0) ->
c) Since in equilibrium Y=Z
Production of the same degree
(Δ Y = Δ Z = Δ C0)
If the effect of C0 stopped here we would have Δ Y = Δ C0
Variations in autonomous expenditure
However the effects continues. Indeed:
d) Since GDP = Σ incomes
Δ Y = Δ Aggregate income ->
e) Since consumption depends on income (C=C0+c1YD),
new Consumption (equal to c1 × ΔYD ) ->
f) Since consumption is a component of aggregate
demand (Z=C+I+G), new Aggregate demand (Δ Z = c1
× ΔYD) ->
Variations in autonomous expenditure
g) Since in equilibrium Y=Z
New Production of the same dimension
(ΔY = ΔZ ) ->
h) New
Aggregate income -> …
The above described mechanisms starts again…
Variations in autonomous expenditure
In conclusion:
•
C0 causes a sequence of Y
• This happens because every increase in the
product causes an increase in income and
therefore a new increase in demand
• The increases get smaller and smaller because at
each new “passage” only a portion of the new
income is consumed (c1<1)
Variations in autonomous expenditure
The final increase in Y is greater than the initial one in
C0 in because of the mechanism that we have just
described
Analytically this mechanism is represented by the
multiplier (Multiplier -> “multiplies” the variations in
autonomous expenditure)
The mechanism the we have just described can be
expressed also graphically
Demand -> Z = SA+c1Y
Supply -> Line at 45°
Equilibrium -> Y=Z -> punto A -> Y=YA
Z, Y
ZZ
YA
A
45
°
Y
Let’s see the effects of an increase in C0
C0 -> Z
Z -> Y
Z,Y
ZZ’
ZZ
B
A
45
°
C
Y -> C -> Z
and so on…
Z -> Y
Z,Y
ZZ’
B
A
45
°
ZZ
D
C
E
Final effect: A -> A’ , so that YA -> YA’
The increase in Y is greater then the one in C0
Z,Y
ZZ’
YA’
B
YA
A
45
°
A’
D
C
E
ZZ
Variations in autonomous expenditure
The previous results hold for all component of autonomous
expenditure
In particular, since
1
YE =
AE
1 - c1
1
-> ΔYE =
ΔAE
1 - c1
where ΔAE is the variation in autonomous expenditure
Variations in autonomous expenditure
Δ AE = Δ of its components
so that
1
Δ YE = 1 - c (Δ C0 - c1 × Δ T0 + Δ I0 + Δ G0)
1
This implies that, in the short period, GDP depends
on:
•Variations in autonomous consumption (C0)
•Variations in the choices of investors (I0)
•Variations in the choices of government on taxes (T0) and
public expenditures (G0)
Variations in autonomous expenditure
The decomposition of demand in its different
component can be used to interpret some recent
events. In particular:
• Expansion of the United States in the 90s
• Great recession during the period 2008-09 in Italy
Expansion of the US during the 90s
In the period 1993 - 2000 the US underwent a phase of
great expansion (on average +3,7% a year; +4,1% from
1996 to 2000)
The average growth was superior to the average of the
other industrialized countries (for instance UE on average
+2%)
The previous analysis can help us to understand this fact
Expansion of the US during the 90s
We saw that
1
Δ YE =
(Δ C0 - c1 × Δ T0 + Δ I0 + Δ G0)
1 - c1
What happened in the US economy?
Mainly two things:
a) The development of new Information and
Communication Technologies (ICTs) lead firms to
innovate the productive processes -> I0
Expansion of the US during the 90s
b) There had been a very good trend in the stock
exchange indices (in particular the stocks associated
with the “new economy”) -> households’ financial
wealth -> C0
Expansion of the US during the 90s
In particular, on average:
Consumption
Investments
GDP
1993-2000
+ 3,4%
+ 6,7%
+ 3,7%
1996-2000
+ 4%
+ 8,4%
+ 4,1%
I0 and C0 explain Y
Important: Another component that contributed to
growth was the increase in productivity
(medium/long period phenomenon)
2008-2009 Great Recession
2nd semester of 2008 -> World financial crisis (“subprime
crisis”)
Recession (negative growth) in (almost) all biggest world
economies
Italy
France
Germany
EU
US
2007
1.6%
2.1%
2.5%
2.7%
2%
2008
-1.3%
0.3%
1%
0.5%
0.4%
2009
-5.1%
-2.5%
-4.9%
-4.1%
-2.4%
2008-2009 Great Recession
Let’s focus on the Italian economy
During the 2008-09 period the Italian economy
underwent a deep recession with a total decrease in
GDP greater than 5% in the two years.
What does this trend depend on?
How do we link this result with the trend in the
components of aggregate demand?
2008-2009 Great Recession
The financial crisis had an effect on investment and
consumption
On the investment side:
•Difficulties in firms’ external financing -> (in the current
model) I0
•Worsening of the expectations on profit -> (in the
current model) I0
2008-2009 Great Recession
On the consumption side:
•Decrease in income (increased unemployment) -> Yd ->
c1 Yd -> C
•Fall in stock indices (cause by the worsening of the
expectations on firms’ profitability) -> households’
financial wealth -> C0
•Worsening of the expectations on the future ->
C0
2008-2009 Great Recession
The dynamics of consumption and investments explain
the dynamics of GDP
ITALY
GDP
Consumption
Investments
2007
1.6%
1.6%
1.3%
2008
-1.3%
-0,4%
-4%
2009
-5.1%
-1.2%
-12.1%
Savings and investments in equilibrium
The equilibrium condition on the good market is Y=Z
We can obtain an equivalent condition based on
investment and savings
Let’s start from
Y=Z=C+I+G
We have
Y-C-G=I
By subtracting and summing T from/to the first term
Y-T-C+T-G=I
Savings and investments in equilibrium
Y-T-C+T-G=I
The expression Y - T – C is the difference between the
available income and consumption -> private saving (Spr)
The expression T – G is the difference between the
earnings and costs of the Government -> public
saving(Spu)
By substituting in the original expression, we get
Spr + Spu= I
Private saving + public saving = saving (S)
Therefore, the equilibrium condition suggests that
S=I
Savings and investments in equilibrium
In equilibrium, investments equal savings -> Say’s
Law
It is an alternative way of defining the equilibrium in
the goods market