Transcript AE Y
Investment, again: All spending by firms for newly built equipment and durable structures All changes in business inventories All spending by households for newly constructed residential housing The record shows that I is volatile--showing substantial variation from month to month or year to year. Investment is assumed to be an autonomous variable in our model. That is, I is presumed to be determined independent of current real output and income. More precisely, we can say that: I function shifts right due to increase in , ceteris paribus r 12 9 I = f(r, ), where • r is the interest rate; and • is expected profits from spending for tangible, capital goods I0 0 I2 I1 50 75 I Acquisition price of tractor trailer rig (known) $100,000 Expected revenue per year from shipping goods 168,000 Expected running expenses per year •Driver salary and benefits $54,000 •Diesel fuel 36,000 •Insurance 11,750 •Repairs, other 26,250 $128,000 Let Ignoring taxes, if the interest rate is less than 40 percent, the investment will be made •R denote expected revenue per year •C is expected cost per year •AC is the acquisition price of the capital good. •Thus we have: R C 168000 128000 40000 .40 AC 100000 100000 As r falls, firms can make investments with lesser expected returns Interest (%) A 9 H 6.5 B I1 0 60 85 I1 to I2: rising expected profitability of spending for capital I2 goods Investment I Function could shift down due to: •Increase in the interest rate, ceteris paribus. 85 60 •Diminished confidence about the future profitability of investment. Ia2 Ia1 0 YD Assume that r = 9% and the investment demand schedule is in position I1 Income YD $0 Consumption Investment C I $30 $60 Aggregate Expenditure (AE) $90 100 100 60 160 200 60 60 230 300 170 240 300 400 310 60 370 500 380 60 440 For a closed economy without a public sector: YC+I [1] C =Ca + cYD [2] I = Ia [3] Since there is no public sector nor retained earnings, we can say: Y = YD. Therefore, [2] can be rewritten as: C = Ca + cY [4] Substitute [4] and [3] into [1]: Y = Ca + cY + Ia [5] AE In equilibrium, AE = Y and unplanned inventory investment is zero AE = Y AE = Ca + Ia + cY C =Ca + cY There is no guarantee that Y* will correspond to potential GDP Ca + Ia c 0 Y* Y YC+I C = 30+ .70YD I = 60 AE = Y AE C 300 Thus: Y* = AE 60 + 30 1 - .70 90 Y* = 90/.30 = 300 30 0 300 Y Properties of Equilibrium in the Keynesian System Planned spending (AE) is equal to real output (Y) so that firms on average experience zero unplanned inventory accumulation or de-accumulation. Firms on average have no reason to expand or contract their output level; nor do they have any incentive to offer more or less employment. Equilibrium GDP might be equal to potential or full employment GDP (the “special” or “Classical” case], but there is no guarantee (as is true for the Classical model). The more likely outcome (or what Keynes referred to as the “general case” ) is “underemployment equilibrium.” UI is unplanned inventory investment AE = Y AE AE When Y = $200 • AE > Y by $30 •UI = ($30) UI 370 •Firms have an incentive to expand output and employment 230 When Y = $400 UI •AE < Y by $30 •UI = $30 200 300 400 Y •Firms have an incentive to decrease output and employment