Download Lecture 13

Constructing Multipliers
Lecture 13
Dr. Jennifer P. Wissink
©2016 Jennifer P. Wissink, all rights reserved.
March 14, 2016
Prelim 1 Epilogue
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REGRADE DEADLINE: Monday March 21 IN CLASS!
Wissink’s OH today – moved to 2-4pm for today only.
Frugal Economy Equilibrium Y* Review
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Aggregate output/income ≡ Y
Aggregate desired expenditure = AEd(Y) = C(Y) + Id
Equilibrium Y* where: Y = AEd(Y), or Y* = C (Y*) + Id
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SUPPOSE: Y > [C(Y) + Id]
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Actual aggregate output/income > aggregate desired expenditure
So inventory investment is greater than planned
So actual investment is greater than planned investment
So something will change!
SUPPOSE [C(Y) + Id] > Y
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Aggregate desired expenditure > actual aggregate output/income
So inventory investment is smaller than planned
So actual investment is less than planned investment
So something will change!
Frugal Economy Equilibrium Y* Graphed
Macro Model Comparative Statics
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Suppose something that we are holding
FIXED in the background changes, like…
– subsistence level of consumption.
– exogenous amount of desired investment.
Would throw us out of equilibrium.
 We’d get a new Y*.
 How would the new Y* compare to the old Y*?
 A great comparative statics question!
 A macro multiplier question.
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Comparative Statics and “Multipliers”
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A multiplier(K) is the change in the equilibrium level of output
(Y*), given a change in some exogenous/autonomous variable.
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It’s always:
K AV
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Y *
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AutonomousVariable
For our simple frugal economy we could have two autonomous
changes and thereby the following:
– An investment multiplier
– A (subsistence) consumption multiplier
Example: The Investment Multiplier
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Do the math... suppose C = 100+.75Y and Id=25
Example: The Investment Multiplier
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Do the series... suppose C=100+.75Y and Id=25
Example: The Investment Multiplier
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the graph... suppose C = 100+.75Y and Id=25
$AEd
45°
$Y
The Frugal Economy: General Multiplier Analysis
Use of Multipliers: A Typical Question
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Suppose you know the following:
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Y*0 is currently $5,000
You’d like Y* to be $6,000
KI = 4
So, how much would desired investment have to
increase from current levels to generate the Y*
you want?
The Size of the Multiplier in the Real World
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The size of the “Keynesian” AEd multiplier in
the U.S. economy is often said to be about 2.0
(based on CFO Chapter 8, 11th edition).
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For example, a sustained increase in
autonomous spending of $10 billion into the
U.S. economy can be expected to raise real
GDP over time by $20 billion.
The Paradox of Thrift
 So…
you think saving is good for the economy.
 But... when households become concerned about
the future and decide to save more, the
corresponding decrease in consumption leads to a
drop in spending and a DROP in Y*.
 The
paradox:
Households end up
consuming less,
but they have not saved any
more.
The Paradox of Thrift
$S, $Id
0
$Y
From The New York Times
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February 15, 2009, Economic View
Go Ahead and Save. Let the Government Spend. By ROBERT H. FRANK,
http://www.nytimes.com/2009/02/15/business/economy/15view.html?_r=1&sq=robert%20frank&st
=cse&scp=5&pagewanted=print
A PSYCHOTHERAPIST friend says that several of her patients are fretting about whether they
have an obligation to help the nation spend its way out of the current downturn. Some of them are
having a hard time making ends meet, she said, yet are reluctant to cut back for fear they would
cause the economy to slide further.
The role of consumers has had considerable attention in the press because the economy
desperately needs additional spending right now. But it is not — and should not be — the
responsibility of middle-income families to provide that spending. If financially comfortable families
want to support their favorite restaurants during hard times by eating out more often, who could
object? But if others are inclined to pay down their bills or save a little more, concerns about the
economy shouldn’t stop them.
Government is in a far better position to provide immediate economic stimulus. It is in fact the only
player that can significantly alter the economy’s short-run trajectory. In a recession, as in ordinary
times, a family’s first economic priority should be to spend its income prudently.
The “paradox of thrift,” a celebrated chestnut first described by John Maynard Keynes in the
1930s, has been the source of much confusion about how saving affects the health of the
economy. Intuition suggests, correctly, that if any one family saves an extra $100 this year, its
bank balance at year’s end will be higher by that amount. According to the paradox of thrift,
however, if everyone tries to save more at once, total savings will actually fall.
How could that happen? The explanation begins with the observation that, to save more, a family
must spend less. Because consumption spending is part of national income, which in turn is the
total amount spent by everyone in the economy, more saving causes national income to fall.
Income will actually fall by more than the initial decline in consumption, because when one family
spends less, other families earn less and respond by cutting their own consumption. When the
dust settles, the story concludes, each family ends up saving less than before.
From The New York Times
January 11, 2009, Economic View
Is Government Spending Too Easy an Answer?
By N. GREGORY MANKIW
http://www.nytimes.com/2009/01/11/business/economy/11view.html?pagewanted=print
WHEN the Obama administration finally unveils its proposal to get the economy on the road to recovery,
the centerpiece is likely to be a huge increase in government spending. But there are ample reasons to
doubt whether this is what the economy needs.
Arguably, the seeds of the spending proposal can be found in the classic textbook by Paul A. Samuelson,
“Economics.” First published in 1948, the book and others like it dominated college courses in introductory
economics for the next half-century. It is a fair bet that much of the Obama team started learning how the
economy works through Mr. Samuelson’s eyes. Most notably, Lawrence H. Summers, the new head of the
National Economic Council, is Mr. Samuelson’s nephew.
Written in the shadow of the Great Depression and World War II, Mr. Samuelson’s text brought the insights
of John Maynard Keynes to the masses. A main focus was how to avoid, or at least mitigate, the recurring
slumps in economic activity.
“When, and if, the next great depression comes along,” Mr. Samuelson wrote on the first page of the first
edition, “any one of us may be completely unemployed — without income or prospects.” He added, “It is
not too much to say that the widespread creation of dictatorships and the resulting World War II stemmed
in no small measure from the world’s failure to meet this basic economic problem adequately.”
Economic downturns, Mr. Keynes and Mr. Samuelson taught us, occur when the aggregate demand for
goods and services is insufficient. The solution, they said, was for the government to provide demand when
the private sector would not. Recent calls for increased infrastructure spending fit well with this textbook
theory.