Chapter 2 (part 1)

1

Chapter 2(part 1)

Demand: The goods and services market (IS)

2

1. The goods and services market

Components of aggregate demand

Y = C + I + G + (X – M)

That is, in equilibrium: _______________________________

3

Consumption (C)

4

Consumption Graphical representation in the Y (horizontal) and C (vertical) axis

Alternative functional forms?

What´s endogenous? Exogenous?

5

Investment (I) Usual functional form

_____ : autonomous investment(always greater or equal to_____)

_____ :marginal propensity to invest with respect to the interest rate(always between __ and ___)

r : interest rate

6

Investment Graphical representation in the I (horizontal) and r (vertical) axis

Alternative functional forms?

What´s endogenous? Exogenous?

7

Public expenditure (G) Usual functional form

Alternative functional forms Pro-cyciclical policy

Counter-cyclical policy

8

Net exports (X-M) If we consider a closed economy:

In an open economy:Usual functional form:

Other funtional forms

9

2. The IS curve The IS curve is the graphical representation of the

____________________________________

It´s the locus of all combinations of ( , ) such that the ________________________________ is in equilibrium

What do we mean by equilibrium? ____________ equals __________________

Which variables are endogenous?

10

Writing out the functional form of the IS (under usual assumptions)

How to do it: Start from equilibrium (Y=AD) and write out the functional

forms of every component of the IS

Solve for output (Y)

11

IS: mathematical expressionThe (usual) functional form of the IS

Do it!

12

IS: mathematical expressionThe (usual) functional form of the IS

13

Some concepts Self-contained goods and services market

The multiplier (or fiscal multiplier)

The autonomous demand is made up by the autonomous components of spending, and is the part of demand that does not depend on _________

14

IS: graphical representationHow to draw the IS

Graphical representation in the Y (horizontal) and r (vertical) axis Calculate the intersections with the axis

Calculate the slope

15

IS: graphical representationHow to draw the IS

Draw it in the Y-r axis:

What is the assumption behind drawing the IS as a straight line? We assume the slope to be constant (which may not be true)

16

IS: graphical representationHow to derive the IS graphically

We will use the “keynesian cross”, which relies on the concepts of actual and planned expenditure

Actual expenditure: the amount hh, firms and the gov´ spend in g&s

Planned expenditure: the amount hh, firms and the gov´ would like to spend in g&s

In a simple model only the _______ actual expenditure can deviate from its planned counterpart. Why?

17

How to derive the IS graphically The keynesian cross

Total planned expenditure in a closed economy may be written as:

If we represent it graphically in the _____ axis

18

How to derive the IS graphically The keynesian cross

Equm requires ______. Graphically:

What happens if we start off the Equm point?

19

IS: graphical representationHow to derive the IS graphically using the Keynesian cross

20

Movements of the ISMathematically

What happens if the government decides to enact expansionary fiscal policy (dG >0)? (assume r stays constant!)

21

Movements of the ISGraphically

What happens if the government decides to enact expansionary fiscal policy (dG >0)? (assume r stays constant!)

NOTE: the difference btw movement of the curve and movement along the curve

22

Movements of the ISEconomically

What happens if the government decides to enact expansionary fiscal policy (dG >0)? (assume r stays constant!)

23

Another point of view: I=S Total savings = private savings + public savings

Private savings (S): by consumers

Public savings: by the government

24

Another point of view: I=SEqum in the closed economy: Y = C+I+G

NOTE: The decision to consume and the decision to save are one and the same. We can define the marginal propensity to save