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LECTURE 1
INCREASE IN INVESTMENT
PROSPECTS
THE MACRO ECONOMIC MODEL
Introduction to Economics
Charles R. Plott
California Institute of Technology
I
a
Spending
I1+a1
I1
Y1
i
i
I1
a1
I
UNKNOWNS
.Y income
.C consumption
.I investment
.i interest rate
.P price level
.L employment
.MD money demand
.MDT transaction demand P
for money
.MDS speculative demand
for money
.w nominal wages level
GIVENS
G Government spending
X net exports
M nominal money supply
b marginal propensity to
consume
EQUATIONS
.Y=C+I+G+X
.C=a(i)+bY
.I=I(i)
.M/P = MD
.MD=MDT+MDS
.MDT = MDT(Y)
.MDS = MDS(i)
.DL(w/P)-SL(w/P)=0
.L=SL(w/P)
.Y=F(L,..)
Y2
Y
i
i
a
Y
MD
MDT
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
Lecture 1
THERE IS A SHIFT IN
INVESTMENT EXPECTATIONS
EXPECTATIONS BECOME MORE
OPTIMISTIC
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
AGGREGATE DEMAND
EXCEEDS AGGREGATE
SUPPLY AND PRICES BEGIN
TO DRIFT UPWARD
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
THE LABOR MARKET AND
AGGREGATE SUPPLY
RESPOND AS LABOR
PERCEPTIONS AND
EXPECTATIONS OF PRICE
INCREASES LAG THE ACTUAL
INCREASES
AGGREGATE SUPPLY
TEMPORARILY EXCEEDS THE
POTENTIAL GDP
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
NOMINAL WAGE INCREASES
WITH LAGGING KNOWLEDGE OF
PRICE INCREASES HAVE
CREATED AGGREGATE SUPPLIES
ABOVE THE POTENTIAL GDP.
AS EXPECTATIONS ARE BROUGHT
INTO LINE WITH REALITY THE
REAL WAGE RETURNS TO THE
EQUILIBRIUM LEVEL AND
AGGREGATE SUPPLY RETURNS
TO THE POTENTIAL GDP.
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P
PRICE INCREASES (INFLATION)
SHRINKS THE REAL MONEY
SUPPLY. THIS CAUSES
FURTHER INTEREST RATE
INCREASES AND CHOKES OFF
INVESTMENT SPENDING.
AGGREGATE DEMAND IS
BROUGHT BACK INTO LINE
WITH POTENTIAL GDP.
I
a
Spending
I1+a1
I1
Y1
i
i
I1
Y2
Y
i
I
a1
i
a
Y
MD
MDT
P
P
M/P
T
Y
M/P
P
P*
W /P
Y
Y
M*/P
*
M/P