Transcript Chapter 9 - Building the Aggregate Expenditures Model

Bonus Work Chapters 9-10-11-12
•
•
•
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Chapter 9 Bonus January 4
Quiz Chapter 9 January 4
Chapter 10 Bonus January 13
Chapter 9 and 10 due Exam
Day.
• Chapter 9-10-11-12 Material is
on the Final Exam:
– G, T, Deficit, Surplus impact on
GDP
– However, far we get!
• Unit Test After Semester 1
Building the
Aggregate Expenditures
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Model
CHAPTER NINE
Adam Smith
• Micro Economics
• The Laws of Supply
and Demand
formulated 1776
• Supply shifts outward
because of DIGTS!
• Equilibrium reached
through the invisible
hand of the market!
Wealth is based on the ability to produce goods & services!
David Ricardo Free Trade
1820’s
• Theories on Trade
• Comparative Advantage
• Trade is based on relative
opportunity cost.
• Countries specialize in
production of products
with the lowest
opportunity cost.
Wealth is increased through specialization and trade!
J. B. Say 1830’s
• Supply creates its own
demand!
• If you produce it they will
come!
• Aggregate supply is a vertical
line!
• Demand determines only the
price.
• Aggregate supply should be
increased to improve standard
of living!
Wealth is increased as output increases: “Supply creates Demand!
HISTORICAL BACKGROUND
Classical Economics & Say’s Law
Supply creates its own demand
Two Historical Events Weaken
Say’s Law??!!??
The Great Depression and WWII
John Maynard Keynes – 1930’s
• Father of Keynesian
Economics
• Macro economies may
be fine tuned!
• Fiscal policy may be
used to expand
aggregate demand.
• Aggregate supply is
horizontal not vertical
An absence of Demand makes Supply meaningless!
Simulate Aggregate Demand
Using Fiscal Policy
• Use Expansionary Fiscal
Policy during recessions
and depressions!
• G up
• T down
• TP up
• Deficits acceptable! “In
the long run we’re all
dead!”
Expand or Contract the
Economy by Changing $$$$
• The Federal Reserve
• Expands Money Supply
during recessions
• Contracts Money Supply
during periods of inflation
• Control of interest rate
yields control on RGDP
Milton Friedman 1950’s –
2000’s!
• A limited role for
government!
• No Fiscal or Federal
Reserve interventions
• Simply grow the
money supply at 3-5%
to grow the economy!
Increasing Money Supply will increase NGDP!
MS * V = NGDP
Rational Expectation Theorists
• It’s all Bull S***
because of lags
• People will counter the
planned changes in G,
T, TP, Budget
• Let the economy fix
itself using the
invisible hand of
Adam Smith
HISTORICAL BACKGROUND
Classical Economics & Say’s Law
Supply creates its own demand
The Great Depression and Keynes
1- The Great Depression
HISTORICAL BACKGROUND
Classical Economics & Say’s Law
Supply creates its own demand
The Great Depression and Keynes
1- The Great Depression
2- Keynes and
Keynesian Economics
Keynesian Noble Prize
Keynesian Proof!
•
•
•
•
Prove by Example
Prove by Model – Graphic Technique
Prove by Mathematics – The Multiplier
But before Keynes
– Activity 30
– Activity 31
Key Terminology:
• Fiscal Policy: Changes in Government
Spending and Taxation
• Expansionary Fiscal Policy: G up T down
used to counter a Recessionary Cycle
• Contractionary Fiscal Policy: G down T up
used to counter an Inflationary Cycle
• Discretionary Stabilization: A new law or
program enacted by Congress
• Automatic Stabilization: An existing law or
program used as a counter cyclical tool.
Automatic Stabilizers
Programs in Place that don’t
require new action by Congress
• Unemployment
Compensation
• Progressive Tax Rates
• Welfare, Food Stamps
• Farm Subsidy
Programs
Keynesian Cross/ Aggregate Expenditure Model
C + Ig + Xn + G
(billions of dollars)
C + Ig + Xn + G
C + Ig + Xn
C
Sa+M+T, Ig + X + G
(billions of dollars)
o
45
o
470
510
550
Real domestic product, GDP (billions of dollars)
S+M
Ig + X + G
Ig + X
50
30
0
470
510
550
Real domestic product, GDP (billions of dollars)
Keynesian Economics
Simplifications....
Keynesian Economics
Simplifications....
1- A Closed Economy
Keynesian Economics
Simplifications....
1- A Closed Economy
2- Ignore Government
Keynesian Economics
Simplifications....
1- A Closed Economy
2- Ignore Government
3- All Saving Is Personal
Keynesian Economics
Simplifications....
1- A Closed Economy
2- Ignore Government
3- All Saving Is Personal
4- Net Income Abroad Is
Zero
Recall from chapter 7....
Disposable Income =
Recall from chapter 7....
Disposable Income =
Consumption + Saving
Recall from chapter 7....
Disposable Income =
Consumption + Saving
Households consume most of
their disposable income
Recall from chapter 7....
Disposable Income =
Consumption + Saving
Households consume most of
their disposable income
Consumption & saving are
directly related to income
DI
Consumption + Saving
DI
Consumption + Saving
APC
Consumption / Disposable Income
DI
Consumption + Saving
APC
Consumption / Disposable Income
APS
Saving / Disposable Income
DI
Consumption + Saving
APC
Consumption / Disposable Income
APS
Saving / Disposable Income
MPC
Change in Consumption
Change in Disposable Income
DI
Consumption + Saving
APC
Consumption / Disposable Income
APS
Saving / Disposable Income
MPC
Practice
Activity 20
PG.111
Change in Consumption
Change in Disposable Income
MPS
Change in Saving
Change in Disposable Income
Consumption can exceed income...
Negative saving
Consumption can exceed income...
Negative saving
Income can exceed consumption...
Positive saving
Consumption can exceed income...
Negative saving
Income can exceed consumption...
Positive saving
Income can equal consumption...
Break-even income
Importance of MPC and MPS
• Marginal shows the change in!!
• Given a change in income, how much of it
will go to consumption?
• Using historical data can we see the impact
increases in DI has had on C and MPC??
DI
Consumption + Saving
Basic Idea – The amount of goods and services produced and the
level of employment depend directly upon the level of
total (aggregate) spending.
Keynes’ task is to prove the impact spending and saving
decisions have on output.
He does so by looking at the consumption schedule – the various
amounts households would plan to consume at each of the levels
of disposable income which could exist at some specific time.
Consumption
Graphically presented....
C
o
45
o
Saving
Disposable Income
S
o
Disposable Income
Consumption
Graphically presented....
C
Consumption
schedule
C
45
o
o
Saving
Disposable Income
Saving
schedule
o
S
Disposable Income
S
Graphically presented....
Consumption
SAVING
C
Consumption
schedule
C
45
o
o
Saving
Disposable Income
Saving
schedule
S
SAVING
o
S
Disposable Income
Graphically presented....
Consumption
SAVING
C
DISSAVING
Consumption
schedule
C
45
o
o
Saving
Disposable Income
DISSAVING
Saving
schedule
S
SAVING
o
S
Disposable Income
Graphically presented....
Consumption
SAVING
C
DISSAVING
Consumption
schedule
MPC = Slope of C
C
45
o
o
Disposable Income
Saving
MPS = Slope of S
DISSAVING
Saving
schedule
S
SAVING
o
S
Disposable Income
Graphically presented....
Consumption
SAVING
C
DISSAVING
Consumption
schedule
MPC = Slope of C
C
45
o
o
MPC + MPS = 1
Disposable Income
Saving
MPS = Slope of S
DISSAVING
Saving
schedule
S
SAVING
o
S
Disposable Income
GLOBAL PERSPECTIVE
AVERAGE PROPENSITY TO CONSUME - 1996
.80
Canada
United States
Britain
Germany
France
Netherlands
Japan
Italy
.85
.90
.95
1.00
GLOBAL PERSPECTIVE
AVERAGE PROPENSITY TO CONSUME - 1996
.80
Canada
United States
Britain
Germany
France
Netherlands
Japan
Italy
.85
.90
.95
1.00
.954
.951
.884
.876
.875
.872
.868
.866
Nonincome Determinants
of Consumption & Saving
Nonincome Determinants
of Consumption & Saving
1- Wealth
Real (real estate) and Financial
(stocks) assets.
Nonincome Determinants
of Consumption & Saving
1- Wealth
2- Expectations
Expectations about prices, the future level of your income,
state of the economy, technology.
Nonincome Determinants
of Consumption & Saving
1- Wealth
2- Expectations
3- Consumer Indebtedness
Borrowing allow households to spend more
To a point!! When indebtedness gets abnormally high C down
To pay off loans!! Hope I don’t find myself there!!!!
Nonincome* Determinants
of Consumption & Saving
1- Wealth
2- Expectations
3- Consumer Indebtedness
4- Taxation
T up C & S down! Remember
Fiscal Policy!!!
Shifts & Stability Key Terms:
Consumption
C
C
45
o
o
Saving
Disposable Income
o
S
Disposable Income
Autonomous
Versus
Induced.
AU are
Shifts
Of the C
Schedule.
S Induced are
Movements
Along the C
Schedule.
Shifts & Stability
Consumption
C
C
An
increase in
consumption...
C
C
45
o
o
Saving
Disposable Income
S
o
S
Disposable Income
Shifts & Stability
Consumption
C
C
An
increase in
consumption...
C
C
o
45
o
Saving
Disposable Income
Means
a decrease
in saving
S
S
o
SS
Disposable Income
Shifts & Stability
Consumption
C
C
A
decrease in
consumption...
C
C
o
45
o
Saving
Disposable Income
S
o
S
Disposable Income
Shifts & Stability
Consumption
A
decrease in
consumption...
C
C
o
45
o
Disposable Income
Saving
A change
In
Income is
Movement
Along the
Curve!
C
C
o
S
S
Disposable Income
Means
an increase
S in saving
S
The Paradox of Thrift
• Too much savings hurts the
economy?
• Japanese savings rates in
the 1990’s were among the
highest in the world at
about 40% of DI
• DI = C + S
• Part of their Recession was
>>>>> lack of consumption
Investment???
• Adding the I.
• We need to understand the
impact Investment has on
output as well as what drives
Investment.
• Marginal benefits versus
marginal costs.
• Will it make a profit?
– MEI (marginal efficiency of
investment)
– Interest Rate
• Real Interest rate compared to
expected rate of return on
investment.
INVESTMENT
Expected Rate of Net Profit,
r
INVESTMENT
Expected Rate of Net Profit,
Real Interest Rate,
i
r
INVESTMENT
Expected Rate of Net Profit,
Real Interest Rate,
r
i
Inverse relationship between
Investment and Real Interest
Rate. Invest up to r = i.
interest rate, i (percents), r
MEI
Graphically presented....
16
14
12
10
8
6
4
2
0
5
10
15
20
25
30
35
40
Investment (billions of dollars)
interest rate, i (percents), r
Graphically presented....
16
14
INVESTMENT
DEMAND, MEI
12
10
8
Activity PG. 119
6
4
2
D
0
5
10
15
20
25
30
35
40
Investment (billions of dollars)
SHIFTS IN INVESTMENT DEMAND
Am I an “induced” or “exogenous/autonomous” change?
• Acquisition, Maintenance,
and Operating Costs
Lower costs to operate and maintain equipment shifts I to Right.
SHIFTS IN INVESTMENT DEMAND
Am I an “induced” or “exogenous/autonomous” change?
• Acquisition, Maintenance,
and Operating Costs
• Business Taxes
Lower business taxes shifts I to right
SHIFTS IN INVESTMENT DEMAND
Am I an “induced” or “exogenous/autonomous” change?
• Acquisition, Maintenance,
and Operating Costs
• Business Taxes
• Technological Change
Technological improvement stimulates I shifts to Right
SHIFTS IN INVESTMENT DEMAND
Am I an “induced” or “exogenous/autonomous” change?
• Acquisition, Maintenance,
and Operating Costs
• Business Taxes
• Technological Change
• Stock of Capital Goods on
Hand
When understocked with production facilities and low inventories
I shifts Right.
SHIFTS IN INVESTMENT DEMAND
Am I an “induced” or “exogenous/autonomous” change?
• Acquisition, Maintenance,
•
•
•
•
and Operating Costs
Business Taxes
Technological Change
Stock of Capital Goods on
Hand
Expectations
The more optimistic about political affairs, population growth,
consumer tastes I shifts Right.
1. Rising stock market prices
2. Development of expectations by business that
business taxes will be higher in the future
3. Step-up in the rates at which new products and
production processes are being introduced
4. Business belief that wages may be lower in the
future
5. A mild recession
6. A belief that business is “too good” and the
economy is due for a period of slow growth
7. Rising costs in construction industry
8. A burst in population growth
9. A period of high investment in technology has
created excess inventories
GLOBAL PERSPECTIVE
Gross Investment Expenditures,
% of GDP 1996
40%
30%
20%
10%
0%
South
Korea
Japan Germany France United
States
Canada Mexico
Britain Sweden
GLOBAL PERSPECTIVE
Gross Investment Expenditures,
% of GDP 1996
40%
30%
20%
10%
0%
South
Korea
Japan Germany France United
States
Canada Mexico
Britain Sweden
GLOBAL PERSPECTIVE
Gross Investment Expenditures as a
Percentage of GDP, Selected Nations
d
d
40%
ifts,
30%
ment
and
20%
P
Next
lide
10%
0%
Japan
Mexico
South
Korea
Copyright McGraw-Hill/Irwin, 2002
Canada Germany United United France Sweden
States Kingdom
Source: World Bank
INVESTMENT AND INCOME
AUTONOMOUS INVESTMENT
Desired level of investment based
upon long term profit expectations.
INVESTMENT AND INCOME
AUTONOMOUS INVESTMENT
Desired level of investment based
upon long term profit expectations.
INDUCED INVESTMENT
Level of investment induced by
the level of current income.
illustrated...
Investment (billions of dollars)
The Investment Schedule:
Two Possibilities
60
40
Autonomous
Investment schedule
Ig
20
0
390
410
430
450
470
490
510
530
Real domestic product, GDP (billions of dollars)
Investment (billions of dollars)
The Investment Schedule:
Two Possibilities
60
40
Autonomous
Induced
Investment schedule Investment schedule
I’g
Ig
20
0
390
410
430
450
470
490
510
530
Real domestic product, GDP (billions of dollars)
Investment (billions of dollars)
The Investment Schedule:
Two Possibilities
60
40
Autonomous
Induced
Investment schedule Investment schedule
Planned Investment Unplanned Investment
I’g
Ig
20
0
390
410
430
450
470
490
510
530
Real domestic product, GDP (billions of dollars)
Instability of Investment
Even when interest rates change investment may not. Why?
Instability of Investment
• Durability
Often can patch up and postpone replacement of capital equipment.
Instability of Investment
• Durability
• Irregularity of Innovation
Cannot predict when genius happens, but when it does major
increases in investment.
Instability of Investment
• Durability
• Irregularity of Innovation
• Variability of Profits
Difficult to predict profits with 100% accuracy.
Instability of Investment
• Durability
• Irregularity of Innovation
• Variability of Profits
• Variability of Expectations
Equilibrium GDP:
Expenditures-Output Approach
GDP = C + Ig
Businesses will spend for production
at a certain level expecting to be able
to sell their product for that same
amount of money.
Equilibrium GDP:
Expenditures-Output Approach
GDP = C + Ig
Businesses will spend for production
at a certain level expecting to be able
to sell their product for that same
amount of money.
Planned vs. Unplanned Investment
Equilibrium GDP:
Expenditures-Output Approach
GDP = C + Ig
Equilibrium occurs where the
total output, measured by GDP,
and aggregate expenditures,
C + Ig are equal.
Private spending, C + I g (billions of dollars)
Equilibrium GDP:
Expenditures-Output Approach
C
Equilibrium
C
C
45
o
o
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP (billions of dollars)
Private spending, C + I g (billions of dollars)
Equilibrium GDP:
Expenditures-Output Approach
(C + I g = GDP)
Equilibrium
C
o
C
C + Ig
C
45
C + Ig
o
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP (billions of dollars)
Saving and Investment
(billions of dollars)
Equilibrium GDP:
Leakages-Injections Approach
Planned
I g = $20
S=Ig
60
40
20
Unplanned
Inventory
Decrease
Ig
At this level
of GDP
S
Ig
{
0
-5
S
(S = I g = $20)
Equilibrium
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP
(billions of dollars)
Saving and Investment
(billions of dollars)
Equilibrium GDP:
Leakages-Injections Approach
Planned
I g = $20
S=Ig
60
At this level
of GDP
40
20
(S = I g = $20)
Equilibrium
Ig
0
-5
S
S
{
}
S
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP
(billions of dollars)
Unplanned
Inventory
Increase
Ig
Investment???
• Leaks and Injections
– Savings = Investment
– Leaks = Injections
– Savings, Imports, Taxes are
leaks out of the circular
flow.
– Investment, Exports,
Government Spending are
injections in to the circular
flow.
Equilibrium GDP
Planned vs. Actual Investment
Equilibrium GDP
Planned vs. Actual Investment
Unintended or Unplanned
Changes in Inventories
Equilibrium GDP
Planned vs. Actual Investment
Unintended or Unplanned
Changes in Inventories
Achieving Equilibrium
Equilibrium GDP
Planned vs. Actual Investment
Unintended or Unplanned
Changes in Inventories
Achieving Equilibrium
Any questions?
• Say’s Law
• Keynesian economics
• consumption schedule
• saving schedule
• break-even income
• average propensity to consume
• average propensity to save
• marginal propensity to consume
• marginal propensity to save
• expected rate of return
• investment demand curve
Copyright McGraw-Hill, Inc.
• investment schedule
• aggregate expenditures-domestic
output approach
• aggregate expenditures schedule
• equilibrium GDP
• 45 degree line
• leakages-injections approach
• leakage
• injection
• planned investment
• actual investment
Next....
Aggregate Expenditures:
The Multiplier, Net Exports,
and Government
Chapter 10