YOU ARE DOWNLOADING DOCUMENT

Please tick the box to continue:

Transcript
Page 1: Unit 3: Aggregate Supply & Demand

Unit 3: Aggregate Supply & Demand

Page 2: Unit 3: Aggregate Supply & Demand

Consumption FunctionDevelopment• John Maynard Keynes originated idea • Measures economic performance of an economy• Focuses on the relationship b/w Consumption &

Savings

Simplifications • Private/closed economy (no int’l influence & gov’t

ignored) • C + Ig

• Assume that all saving is personal • Depreciation & net foreign factor = 0 • Reminder: w/ no gov’t or foreign trade, GDP = NI = PI = DI (all the same!)

Page 3: Unit 3: Aggregate Supply & Demand

Consumption FunctionTools• Theory assumes that the level of output &

employment depend directly on the level of aggregate expenditures • Changes in output reflect changes in agg.

spending • Consumption

• The most important determinant of consumer spending is DI (income)

• 45° angle represents all points where consumer spending equals DI (1:1) • 45° line represents zero savings • If DI increases, both consumption & savings

will increase

Page 4: Unit 3: Aggregate Supply & Demand

Consumption FunctionTools• Consumption Schedule

• Historically, households spend a larger proportion of small income than of a larger income

• Breakeven: C = DI • total income level when H consume all

income • Dissavings occurs at low levels where

consumption exceeds income & households must borrow (credit cards)

Page 5: Unit 3: Aggregate Supply & Demand

Consumption FunctionTools• Non-income Determinants of Consumption &

Saving • Wealth• Expectations• Household Debt• Taxation

• Shifts & Stability • Consumption & saving schedules will shift in

opposite directions • UNLESS caused by a tax change

• Consumption & saving schedules are generally stable unless deliberately shifted by gov’t action

Page 6: Unit 3: Aggregate Supply & Demand

45°

1:1

Dissavings

Savings

Break Even

DI

Consumption

Consumption Function

$500

$500

Page 7: Unit 3: Aggregate Supply & Demand

DissavingsSavings

Break Even DI

Savings

Savings Function

Page 8: Unit 3: Aggregate Supply & Demand

Marginal Propensity to Consume & Save

• MPC: what effect a ∆ Income has on amount C• MPC = change in consumption

change in income• MPS: what effect a ∆ Income has on

amount S• MPS = change in saving

change in income• MPC + MPS = 1

Page 9: Unit 3: Aggregate Supply & Demand

Marginal Propensity to Consume & Save

• Calculate MPC/MPS• If disposable income changes from

$10,000 to $12,000 and consumption changes from $9,000 to $10,000: • What is MPC? • What is MPS?

• Why do MPC & MPS always equal 1?

Page 10: Unit 3: Aggregate Supply & Demand

MPC & MPSLevel of output & income

(NNP=DI)(1)

Consumption(2)

Saving(1)-(2)

(3)

MPCΔ(2)/Δ(1)

(4)

MPSΔ(3)/Δ(1)

(5)

$12,000 $12,100 -100 .90 .1

13,000 13,000 0 9/10 1/10

14,000 13,800 200 .8 .2

15,000 14,500 500 .7 .3

16,000 15,100 900 .6 .4

Page 11: Unit 3: Aggregate Supply & Demand

The Multiplier EffectWhy do cities want the Superbowl in their

stadium? An initial change in spending will set off a spending chain that is magnified in the economy.

Example:• A Seahawks fan spends $120 on dinner at John’s

diner.• John’s income has increased by $120.

• John spends $100 on a new bench from Carol’s furniture shop.

• Carol spends $80 on wood from Dan’s lumber yard. • Dan spends $50 on lunch at Sharon’s restaurant…

The Multiplier Effect shows how spending is magnified in the economy & doesn’t end at the initial purchase/investment.

Page 12: Unit 3: Aggregate Supply & Demand

Multiplier • Multiplier Effect

• Any increase in spending will result in an even larger increase in GDP due to the fact that every $ spent is spent again multiple times.

• Increases in spending can come from either government (G) or businesses (Ig)• Any money spent is someone else’s

income & thus subject to spending. • Contingent on MPC & MPS … WHY? • Limiting factor of multiplier is MPS

• Multiplier = 1/MPS or 1/(1-MPC)• Larger the MPC, larger the

multiplier

Page 13: Unit 3: Aggregate Supply & Demand

Multiplier • What is the multiplier if the MPC is equal to

¾? • 1 / (1 - 0.75) = 4

• What is the multiplier if the MPC is equal to 9/10? • 1 / (1 - 0.9) = 10

• What is the multiplier if the MPS is 1/5? • 1 / 0.2 = 5

Page 14: Unit 3: Aggregate Supply & Demand

Multiplier • Multiplier Effect

• Multiplier is used to calculate how any change in spending will change total spending (AD) or income (GDP)• ∆ Spending x Multiplier = ∆ AD/GDP

George Bush, in an effort to increase GDP during a recession, proposed a stimulus package which provided every American family with $200 more of disposable income. The marginal propensity to consume at that point in time was 0.75. Calculate the multiplier and identify how much more spending this would generate per family. 1/0.25 = 4 4 x 200 = $800

Page 15: Unit 3: Aggregate Supply & Demand

Multiplier • Would the multiplier be larger or smaller if

people saved more of their additional income? (MPS = .25 vs. .3) • Smaller ( 4 vs. 3.33)

• What would happen to the multiplier if people saved all of their income? • It would be 1 & thus spending doesn’t multiply

(Multiplier = 1/1)• What would happen if people spent all of their

income? • It would be infinite & thus spending would be

replicated for every transaction (Multiplier = 1/0)

Page 16: Unit 3: Aggregate Supply & Demand

Multiplier • If the multiplier were 4, how much money

would the gov’t spend to increase aggregate demand by $1 million? • $250,000 ( spending x 4 = 1,000,000 )

• If the gov’t needed to cut AD by $2 million and the multiplier were 4, how much would gov’t spending have to be reduced? • $500,000 ( spending x 4 =

2,000,000 )

Page 17: Unit 3: Aggregate Supply & Demand

Multiplier • How does the multiplier explain why

changes in investment spending cause large fluctuations in GDP? • Because increases in investment cause

endogenous increases in consumption, the ultimate increase in GDP is larger than the initial investment• i.e. minor injections/leakages cause

even greater growth of GDP ($1 M injection can yield growth of $5 M)

Page 18: Unit 3: Aggregate Supply & Demand

• If disposable income changes from $15,000 to $19,000 and saving changes from $10,000 to $11,000:

• MPS: .25

• MPC: .75

• The MULTIPLIER: 4

MPS/MPC & Multiplier

Page 19: Unit 3: Aggregate Supply & Demand

• If disposable income changes from $15,000 to $16,000 and consumption changes from $10,000 to $10,750:

• MPS: .25

• MPC: .75

• The MULTIPLIER: 4

MPS/MPC & Multiplier

Page 20: Unit 3: Aggregate Supply & Demand

Interest Rates & Investment Demand

• What is investment? • Investment decisions made using

cost/benefit analysis. • Benefit = expected rate of return (r)• Cost = interest rates – the “cost” of money

(i)• make sure i is adjusted for inflation

• Rules: • If expected return ≥ real interest –

INVEST • If expected return < real interest – DO

NOT

Page 21: Unit 3: Aggregate Supply & Demand

Interest Rates & Investment Demand

Why is the ID downward sloping?

Page 22: Unit 3: Aggregate Supply & Demand

Shifts in Investment Demand

• Cost of Production• Lower costs shift ID Higher shifts ID

• Business Taxes• Lower business taxes shift ID Higher shifts

ID • Technological Change

• New technology shifts ID • Stock of Capital

• Low on capital shifts ID High shifts ID

• Expectations • Positive expectations shifts ID Negative

shifts ID

Page 23: Unit 3: Aggregate Supply & Demand

Interest Rates & Investment Demand

The real interest rate is 2%. What is investment at that level?

Page 24: Unit 3: Aggregate Supply & Demand

Investment Schedulein

vest

me

nt

GDP = DI

$2 T

If real interest rate was 2%, we would assume that businesses are investing $2T at all levels of output.

The amount invested is very unstable/volatile, however, and investment can & does occur irregularly.

Ig

Ig0$1.8

Page 25: Unit 3: Aggregate Supply & Demand

• Measures Aggregate Demand/Expenditures against real GDP

• POLICY GOAL IS TO MOVE IT UP (increase GDP)

• Leakages (withdrawal of spending from income/expenditure stream)

imports, taxes, savings • Injections (addition of spending to the

income/expenditure stream) spending (G or Ig), investment, net

exports• Must equal each other: S( savings) + M ( imports) + T

( taxes) = I ( investments) + X ( exports) + G( government purchases)

Aggregate Expenditures Model

Page 26: Unit 3: Aggregate Supply & Demand

GDP (NI, NO)

AD/AE

45°

1:1

CC + Ig

Aggregate Expenditures Model

Equilibrium GDP is the intersection of ____ & ____.

Page 27: Unit 3: Aggregate Supply & Demand

International Trade & Equilibrium Output

• Xn & Aggregate Expenditures • Closed economy:

• AE = C + Ig

• Open economy: • AE = C + Ig + Xn

• Measuring AE for domestic goods (X – M)

Page 28: Unit 3: Aggregate Supply & Demand

Government Purchases & Equilibrium GDP

• A mixed economy – adding gov’t spending & taxes.

• Government spending is subject to the multiplier. • Balanced Budget Multiplier: a change in

G is more powerful than a tax change of the same size \• (spend & tax at same amount will yield

growth)• Taxes are leakages

• Lump Sum: tax that provides equal amounts of revenue at each level of GDP• a tax increase shifts AE downward only

by the amount of the tax times the MPC

Page 29: Unit 3: Aggregate Supply & Demand

GDP (NI, NO)

AD/AE

45°

1:1

CC + Ig

C + Ig + GC + Ig + G + (Xn)

C + Ig + G + Xn

U. S.

Aggregate Expenditures Model

Page 30: Unit 3: Aggregate Supply & Demand

Government Purchases & Equilibrium GDP

• Recessionary Gap: • The amount by which AE at full employment

GDP falls short of those required to achieve full employment GDP

• Inflationary Gap• The amount by which an economy’s AE at

full employment exceeds those just necessary to achieve full employment

Page 31: Unit 3: Aggregate Supply & Demand

GDP (NI, NO)

AD/AE

45°

1:1

C

C + Ig

Aggregate Expenditures Model

Page 32: Unit 3: Aggregate Supply & Demand

AE Model AD Curve

GDP

AD

/A

E

45°

1:1

AE1 (at P1)

3500 4000

AE2 (at P2)

GDP

Pric

e Le

vel

0

AD

3500 4000

P1

P2

Thus, GDP is less at P2 (higher price level) than P1

Page 33: Unit 3: Aggregate Supply & Demand

Aggregate Demand• Shows the amounts of real GDP that buyers

desire to purchase at each price level. • If the price level:

• Increases (inflation), then Real GDP demanded ___

• Decreases (deflation), then Real GDP demanded ___Price

Level

Real domestic output (GDPR)

AD = C + I + G + Xn

Page 34: Unit 3: Aggregate Supply & Demand

Aggregate DemandWhy downward slope? • Real-Balances Effect:

• price level reduces purchasing power – GDP • Interest Rate Effect:

• price level leads lenders need to charge higher interest rates – GDP

• Foreign Purchases Effect: • price level reduces foreign D of U.S. goods &

increases U.S. D of foreign goods – GDP (due to –Xn)

Page 35: Unit 3: Aggregate Supply & Demand
Page 36: Unit 3: Aggregate Supply & Demand

Determinants of Aggregate Demand

An increase in spending shifts AD right & decrease in spending shifts AD left.

Price Level

Real domestic output (GDP)

AD = C + I + G + Xn

AD1

AD2

Page 37: Unit 3: Aggregate Supply & Demand

1.Change in Consumer Spending Consumer Wealth (Boom in the stock

market…)Consumer Expectations (People fear a

recession…)Household Indebtedness (More consumer

debt…)Taxes (Decrease in income taxes…)

2. Change in Investment SpendingReal Interest Rates (Price of borrowing $...)Rate of Return: Future Business Expectations (High

expectations…) Productivity and Technology (New robots…) Business Taxes (Higher corporate taxes…)

Determinants of Aggregate Demand

Page 38: Unit 3: Aggregate Supply & Demand

3.Change in Government Spending (War…)(Decrease in defense spending…)

4.Change in Net Exports (X-M) Exchange Rates(If the us dollar depreciates relative to the

euro…) National Income Abroad

AD = GDP = C + I + G + Xn

Determinants of Aggregate Demand

Page 39: Unit 3: Aggregate Supply & Demand

Aggregate Supply• Shows the level of real GDP that firms will

produce at each price level. • Three ranges:

Price Level

GDPR

A B

C

D

Q1 Q2 Q3

Keynesian

Classical

Page 40: Unit 3: Aggregate Supply & Demand

Cost-Push Inflation vs. Demand Pull Inflation

• Outcome on price level is the same, but GDP differs.

Price Level

GDPR

A B

C

D

Q1 Q2 Q3

Keynesian

ClassicalADAS

Page 41: Unit 3: Aggregate Supply & Demand

SRAS & LRAS• AS differentiates b/w short-run & long-run

• SRAS: immediately after change in PL (input costs haven’t yet adjusted to change in PL)

• LRAS: measures potential output / NRU; point at which input prices have adjusted to change in PL

Page 42: Unit 3: Aggregate Supply & Demand

Actual GDP = SRASPotential GDP = LRAS

Page 43: Unit 3: Aggregate Supply & Demand

SRAS & LRAS• The LRAS & SRAS curves also indicate our PPF &

can be used to identify GDP gaps.

Price Level

GDPR

A

B

C

LRAS SRAS

500 550 600

P1

Capital Goods

Con

sum

er G

oods

Page 44: Unit 3: Aggregate Supply & Demand

Determinants of Aggregate Supply

• Firms are able to produce more or less at every price level.• per-unit production costs change for reasons

outside changes in real GDP • SRAS shifters mostly

Price Level

GDPRQ1 Q2 Q3

AS1 AS2AS3

Page 45: Unit 3: Aggregate Supply & Demand

1.Inputs• Costs of Domestic Resources

Factors of Production• Cost of Imported Resources

Exchange rate value• Market Power

Competition

Determinants of Aggregate Supply

Page 46: Unit 3: Aggregate Supply & Demand

2. Legal-Institutional Environment• Business taxes & subsidies • Gov’t regulation:

Anti-trust laws Labor laws Environmental laws

3. Productivity worker education management skilltechnology

Determinants of Aggregate Supply

Page 47: Unit 3: Aggregate Supply & Demand

Equilibrium Price Level & Real Output

• Shifts in SRAS/AD will reveal inflationary/recessionary gaps.

Price Level

GDPR

Inflationary Gap

Recessionary Gap LRAS

Page 48: Unit 3: Aggregate Supply & Demand

• The use of government spending (the BUDGET) & revenue collection (TAXES) to influence the economy

• Fiscal yearoOctober 1- September 30

• Federal Budget: o Revenues = Spending… Balanced Budget o Revenues > Spending… Budget Surplus o Revenues < Spending… Budget Deficit

Fiscal Policy

Page 49: Unit 3: Aggregate Supply & Demand

National DebtFederal Debt = accumulated deficits - accumulated surpluses $17.3 T

Page 50: Unit 3: Aggregate Supply & Demand

TOOLS

Types of Fiscal Policy

Contractionary: works to fight inflation but can lead to a fall in GDP. 1. Raise taxes: take money out of

circulation2. Reduce gov’t spending: cuts back on

funding social programs & business contracts

Results in…• Budget surplusResolves inflationary / recessionary gap.Republicans would prefer which option?

Page 51: Unit 3: Aggregate Supply & Demand

TOOLS

Types of Fiscal Policy

Expansionary: works to fight deflation, unemployment, & recessions. Used to raise the level of output in the economy. 1. Reduce taxes: gives consumers more to

spend & less to pay the gov’t2. Increase gov’t spending: gov’t spends

money on social programs & business contracts

Results in…• Budget deficitResolves inflationary / recessionary gap

Republicans would prefer which option?

Page 52: Unit 3: Aggregate Supply & Demand

• Focuses on changing AD• Gov’t or consumer spending to help the

economy. • Policy used traditionally by Democrats• John Maynard Keynes (1883-1946)o Gov’t should depend more on public works to

fix unemployment.o Gov’t should decrease spending to fix inflation.

Demand Side Economics

Page 53: Unit 3: Aggregate Supply & Demand

• Focuses on changing AS• Stresses influence of taxation on the

economy, especially businesses • Gov’t should cut taxes on personal &

corporate income• Gov’t should reduce regulations to decrease

the costs of production• John Baptiste Sayo Says Law: supply creates it’s own demand?o If you make a product, people will get paid and

have money to spend and therefore purchase more goods

• Reaganomics

Supply Side Economics:

Page 54: Unit 3: Aggregate Supply & Demand

Nondiscretionary/Automatic Fiscal Policy

• Built-in Stabilizers: automatic changes in G & T as the economy changes• Don’t require new legislation – already

embodied in law• e.g. unemployment compensation,

food stamps, SS, Medicare • Progressive Tax System

• Recession: as incomes drop, ppl pay less of their income in taxes – more to spend

• Inflation: as incomes rise, ppl pay more of their income in taxes – less to spend


Related Documents