Transcript ch22

Chapter 22
Adding
Government
and Trade to the
Simple Macro
Model
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
In this chapter you will learn to
1. Describe the relationship between national income and
government purchases and tax revenues.
2. Describe the relationship between national income and
exports and imports.
3. Explain the distinction between the marginal propensity to
consume and the marginal propensity to spend.
4. Explain why the presence of government and foreign
trade reduces the value of the simple multiplier.
5. Describe the effect of government fiscal policy on the level
of national income.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-2
Introducing Government
Government Purchases
Government purchases of goods and services (G) are part of
desired aggregate expenditures
- not including transfer payments
Net Tax Revenues
Net taxes (T) are total tax revenues net of transfer payments.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-3
Introducing Government
We assume net taxes are given by:
T=tY
where t is the net tax rate.
The Budget Balance
The budget balance is the difference between G and T:
- if G < T: a budget surplus
- if G > T: a budget deficit
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-4
Budget Balance and Saving
Private saving is the amount that household save:
= disposable income – consumption expenditure
Public saving is saving on the part of the government
=T–G
Budget surplus: public saving is positive
Budget deficit: public saving is negative
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-5
State and Local Governments
When measuring the overall contribution of government to
desired aggregate expenditure, all levels of government must
be included:
- federal, state, and local
- combined purchases of state and local
governments are larger than those of the federal
government.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-6
Summary
The presence of government affects our simple model by:
- adding directly to desired AE through G
- collecting tax revenue (T) and make transfer
payments
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-7
Introducing Foreign Trade
Net Exports
We make two central assumptions:
- U.S. exports are autonomous with respect to U.S.
GDP
- U.S. imports rise as U.S. GDP rises
For imports, we assume:
IM = mY
where m is the marginal propensity to import.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-8
Introducing Foreign Trade
Thus, net exports are given by:
NX = X - mY
Ceteris paribus, changes in domestic GDP lead to changes
in net exports:
- as Y rises, NX falls
- as Y falls, NX rises
The relationship between Y and NX is shown by the net
export function.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-9
Figure 22.1 The Net Export
Function
The NX function is drawn
holding constant:
• foreign GDP
• domestic and foreign prices
• the exchange rate
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-10
Shifts in the Net Export Function
An increase in foreign income leads to more foreign demand
for U.S. goods:
- increases X and shifts NX function upward
A rise in U.S. prices (holding foreign prices constant):
- decreases X
- IM function rotates up as Americans switch
toward foreign goods
 NX function shifts down and gets steeper
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-11
Figure 22.2 Shifts in the Net
Export Function
Illustration of a rise in U.S.
prices relative to foreign
prices.
This could be caused by:
- Δ exchange rate
- Δ price levels
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-12
Summary
The presence of foreign trade modifies our basic model by:
- foreign firms and households purchase U.S.-made
goods (X)
- all components of domestic expenditure (C, I, and
G) include some import content (IM).
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-13
Equilibrium National Income
Desired Consumption and National Income
With taxation, YD is less than Y.
If T = (0.1)Y, then YD = (0.9)Y.
C = 30 + (0.8)YD
C = 30 + (0.8)(0.9)Y
C = 30 + (0.72)Y
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
 The MPC out of national
income (0.72) is less than
the MPC out of disposable
income (0.8).
22-14
The Desired Consumption Function
From the numerical example above, we can generally write:
C = a + b(1 – t)Y
where b = MPC
t = tax rate
a = autonomous consumption
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-15
The AE Function
We then expand the AE function:
AE = C + I + G + (X – M)
Recall that the slope of the AE function is the marginal
propensity to spend out of national income.
Summing the four components of desired AE:
AE = a + b(1 – t)Y + I + G + (X – mY)
= [ a + I + G + X ] + [b(1 – t) – m]Y
We call: b(1 - t) - m = z
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-16
Equilibrium National Income
As before, output is assumed to be demand determined in
this model:
- equilibrium condition is Y = AE(Y)
In words, equilibrium Y occurs where desired aggregate
expenditure equals actual national income.
Whenever AE is not equal to Y, there are unintended
changes in inventories and firms have an incentive to change
production.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-17
Figure 22.3 The Aggregate
Expenditure Function
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-18
Changes in Equilibrium National
Income
The Multiplier with Taxes and Imports
Imports and taxes make z smaller:
• z = MPC(1 – t) – m
The simple multiplier is also smaller:
• multiplier = 1/{1 –[ MPC(1 – t) – m]}
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-19
Net Exports
As with other elements of AE:
- if NX function shifts upward, equilibrium Y rises
- if NX function shifts downward, equilibrium Y falls
Exports are autonomous with respect to domestic GDP, but
they depend on:
- foreign income
- domestic and foreign prices
- exchange rate
- tastes
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-20
Fiscal Policy
Fiscal policy is the use of the government’s spending and tax
policies.
Any policy that attempts to stabilize Y at or near Y* is called
stabilization policy.
It is often clear in which direction fiscal policy could be
adjusted, but less clear how much adjustment is necessary.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-21
Figure 22.4 The Objective of
Stabilization Policy
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-22
Changes in Government
Purchases
AE =Y
AE
Consider some G < 0.
E0
•
e0
Equilibrium national
income will fall:
e´1
Y = G x simple multiplier
e1
G
•
Y1
•
AE0
AE1
E1
Y
Y0
Y
For example, suppose z = 0.62 ==> multiplier = 2.63.
G = -$100 million ==> Y = - $263 million.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-23
Figure 22.5 The Effect of
Changing the Tax Rate
The government may
attempt to change
national income by
changing the net tax
rate.
- a lower t causes the
AE function to
become steeper
- a higher t causes
the AE function to
become flatter
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-24
Demand-Determined Output
Our simple macro model (Chapters 21 and 22) is based on
three central concepts:
• equilibrium national income
• the simple multiplier
• demand-determined output
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-25
Demand-Determined Output
Equilibrium National Income
The equilibrium level of national income is that level where
desired AE equals actual national income.
The Simple Multiplier
Simple multiplier; 1/(1-z)
Closed economy with no government: z = MPC
Open economy with government: z = MPC(1-t) - m
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-26
Demand-Determined Output
Demand-Determined Output
The model assumes a constant price level so that national income
is demand determined.
When is this a reasonable assumption?
1. When output is below potential, firms can increase output
without increasing their costs.
2. When firms are price setters they often respond to shocks
by changing output (and only later changing their price).
In the next chapter, we allow a variable price level:
- more complicated
- more realistic
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
22-27