Download Ch 11 Notes

Chapter 11
The Aggregate Expenditures Model
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Copyright © 2015 by McGraw-Hill Education. All rights reserved.
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Goods Market Equilibrium
Adjustments
I.
Adjustments to Goods Market Equilibrium Y = AE
1.
What makes sure Y (supply) = AE (demand), given that P is fixed?
(i)
If Y > AE  what happens to inventory changes? How would the firms
(the producers) react to this?
(ii) If Y < AE  what happens to inventory changes? How would the firms
(the producers) react to this?
2.
Inventory changes play the role of “price” that equates
Y (supply) = AE (demand).
Adding International Trade
II. Adding Net Exports (NX) = Exports - Imports
1.
Exports depend on two factors:
(i)
The exchange rate, e.
- The exchange rate is the price of a US$ (or other $) in terms of Thai baht.
- September 9th 2016: US$ 1 = 35 baht
Source: http://www.xe.com/currencyconverter/convert/?From=USD&To=THB
- For example: The price of 10-kg bag of jasmine rice is 350 baht. At e = 35,
it is US$__________ . If e = 40, it is US$ __________.
- The (higher, lower) the e, the higher is Thailand’s export to the US.
(ii) The income of our trade partner, such as the US.
- The higher the US GDP, the (higher, lower) our exports to them.
LO4
Adding International Trade
2.
Imports also depend on the exchange rate, e.
- Example: An imported US Washington apple = US$2/kilo.
- The (higher, lower) the e, the higher is Thailand’s import from the US.
3.
For now, until we have explained how the value of the e is
determined in Chapter 21, we will assume that both exports and
imports are constants, unless otherwise stated.
4.
Incorporating NX into AE: AE=C+I+NX, where NX is a constant.
5.
Because NX is a constant, it affects AE in the same ways consumer
confidence and investment confidence do – shifts AE.
LO4
Adding Government
III. Adding Government Expenditures
1.
Government expenditure (G)
- Recall that the government is also a consumer.
- What should influence a government’s decision to increase or decrease G?
2.
Economic contraction (recession)
- If private firms and private consumers are not spending, the government
should increase spending, create demand, and therefore create production and
jobs to minimize unemployment.
3.
Economic expansion (boom)
- If private C+I are very high, strong demands can lead to (higher, lower)
inflation, the G should decrease spending to decrease inflation.
4.
LO4
Incorporating G into AE: AE=C+I+G, where G is a constant.
Goods Market Equilibrium
IV. Goods Market Equilibrium
1. Graphically, we can set Y = AE = C + I + G + NX and find the
equilibrium (continue with Chapter 10’s example):
(i) C = 100 + 0.8Y, I = 50, G = 50, NX = 25.
(ii) AE = C + I + G + NX = ________________________________________.
Goods Market Equilibrium
2. Solving for Y = AE (supply = demand):
Example: C = 100 + 0.8Y
I = 50
G = 50
NX = 25
Adding Taxes
V. Adding Taxes (T)
1.
The government can also use income taxes (T) to affect the
economy.
- What should influence a government’s decision to increase or decrease T?
(i)
Economic contraction (recession)
- If private firms and private consumers are not spending, the
government should encourage higher C+I by cutting T.
(ii) Economic expansion (boom)
- If private C+I are very high, strong demands increase inflation, the
government can dampen C+I by raising T.
Adding Taxes
2. How should we describe taxes (T)?
(i)
For simplicity, we will assume that the government charges a lump sum,
constant tax.
(ii)
T is a constant, say, 50, which is independent of income. This is similar to
movie ticket admissions: regardless of the income of the customers, all
adults are charged a fixed amount.
(iii) Benefits: Easy to calculate in model, easy to collect in reality.
(iv) Costs: Often perceived as “unfair”.
(v)
For simplicity, let us incorporate T into C only, not both C and I.
(vi) Incorporating T into AE: AE=C+I+G, but C=a + b(Y-T), where T is a constant
number… back to Chapter 10 example.
- Example: C = 100 + 0.8 (Y – 50).
Goods Market Equilibrium
VI. Goods Market Equilibrium
1. Graphically, we set Y = AE = C + I + G + NX and find the equilibrium:
(i) C = 100 + 0.8 (Y – T), I = 50, G = 50, NX = 25, but T = 50.
(ii) C = 100 + 0.8 (Y – 50), which becomes C = _____________________________.
(iii) AE = C + I + G + NX = ______________________________________________.
Goods Market Equilibrium
2. Solving for Y = AE (supply = demand):
Example: C = 100 + 0.8 (Y-T)
I = 50
G = 50
NX = 25
T = 50
Micro versus Macro
VII. The Role of the Government
1.
Micro-economists believe that when demand is not equal to
supply, prices will change until demand = supply. The government
does not have to do anything.
2.
Macro-economists believe that because prices may not change
quickly (prices are sticky) to give us demand = supply (especially
during a recession, firms resist cutting prices), the government
should actively intervene in the economy in order to achieve
demand = supply.
- If Y < Yp or actual Un > NRU, increase G and/or decrease T.
- If Y > Yp or actual Un < NRU, decrease G and/or increase T.
Leakages and Injections
VIII. Leakages and Injections
1.
If a country’s NX > 0, is this country a lender or borrower?
- Example 1: China (2015) = US$384 billion > 0.
- Example 2: Thailand (2015) = US$44 billion > 0.
2.
If a country’s NX < 0, is this country a lender or borrower?
- Example 1: The US (2015) = - US$540 billion < 0.
Source: http://data.worldbank.org/indicator/BN.GSR.GNFS.CD
3.
Question: If a country is borrowing (NX<0), who within the
country are borrowing, and what can be done to decrease
such borrowing?
Leakages and Injections
4. Answer: NX = (S - I) + (T - G).
(i) Show that NX = (S – I) + (T – G) and the implications.
(ii) Which variables are leakages, which variables are injections?