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GIVEN: C = 100 + 0.8Y ECON 2030 STUDY PROBLEM IN KEYNESIAN MACROECONOMICS I = 50 G = 60; T = 0 Yfe = 1300 GIVEN: C = 100 + 0.8Y ECON 2030 STUDY PROBLEM IN KEYNESIAN MACROECONOMICS I = 50 G = 60; T = 0 Yfe = 1300 What is the value of the MPC? MPC = b = 0.8 What is the value of the MPS? MPS = 1 - b = 0.2 Note that the two marginal propensities sum to one. C What is the significance of the “100” in the equation C = 100 + 0.8Y? People spend “100” on consumption goods even when their income is temporarily zero. b a = 100 1 0<b<1 Where does the b = 0.8 show up on this graph? The coefficient of Y (symbolized by “b” and always between 0 and 1) is the slope of the consumption equation. Y C Calculate the investment multiplier and the government spending multiplier. The spending multipliers are given by the expression 1/(1 – b). b a = 100 1 1/(1 – b) = 1/(1 – 0.8) = 1/ 0.2 = 5 Y S,C Write the saving equation that corresponds to the given consumption equation. C = a + bY C = 100 + 0.8Y S = -a + (1 – b)Y b 1 a = 100 S = -100 + 0.2Y 1 1-b Y At what income does saving equal zero? S,C S = -100 + 0.2Y = 0 C = 100 + 0.8Y -100 = - 0.2Y Y = 100/0.2 Y = 500 b 1 a = 100 S = -100 + 0.2Y 1 500 1-b Y E How much is aggregate demand when income is equal to 1100? C+I+G C+I C C = 100 + 0.8Y C = 100 + 0.8(1100) C = 100 + 880 C = 980 C = 980 a = 100 I = 50 G = 60 C + I + G = 1090 500 Y E How much is aggregate demand when income is equal to 1100? When Y = 1100 C + I + G = 1090 C+I+G C+I C Y>C+I+G a = 100 Is the economy in equilibrium when income is 1100? No. There are excess inventories in the amount of 1100 – 1090 = 10. 500 Y E Locate Y = 1100 and Yfe = 1300 relative to equilibrium income. C+I+G C+I C When Y = 1100 C + I + G = 1090 Excess inventories = 10 Y>C+I+G a = 100 G = 60 I = 50 C = 980 500 1100 1300 Y How do C, F, & O calculate GDP at Y=1100 E Here’s the onealternative way: way: C+I+G C+I C GDP = Y C =+ 1100 I + G + Excess Inv. GDP = 980 + (50+10) +60 Excess inventories = 10 G = 60 I = 50 a = 100 GDP = 1100 C = 980 500 1100 1300 Y What is the economy’s equilibrium income? E Y=C+I+G C+I+G C+I C Y = 100 + 0.8Y + 50 + 60 Y – 0.8 Y = 210 Excess inventories = 10 G = 60 I = 50 0.2Y = 210 a = 100 Y = 1050 C = 980 500 1050 1100 1300 Y E Describe the market process that brings about this Keynesian equilibrium. C+I+G C+I C Excess inventories result in cutbacks and layoffs. Y and C spiral downward. Excess inventories = 10 a = 100 G = 60 I = 50 C = 980 500 1050 1100 1300 Y E Describe the market process that brings about this Keynesian equilibrium. C+I+G C+I C Excess inventories result in cutbacks and layoffs. Y and C spiral downward. a = 100 The spiraling stops when there are no longer any excess inventories and when Y = C + I + G. 500 1050 1100 1300 Y a = 100 The demand for labor is not sufficiently strong to clear the labor market at the W going wage rate. C+I+G C+I C S Going wage rate Y= 1050 E What does the labor market look like when this Keynesian equilibrium is established? D N 500 1050 1300 Y E Suppose that the government increases government spending by 30. What does this do to equilibrium income? C+I+G C+I C Y = 1/(1-b) G Y = 5 (30) Y = 150 a = 100 G = 30 Y = 150 500 1050 1200 1300 Y E How much more government spending is required to achieve full employment? C+I+G C+I C G = 20 S W G = 30 a = 100 Y= Y = 150 YGoing = 5wage Grate 100 = 5 G D G = 20 1300 Y = 100 N 500 1050 1200 1300 Y John Maynard Keynes 1883-1946