Jan 27/Feb 3 Flashcards
in chapter 7, what do we introduce?
- government purchases
- tax revenues
- exports and imports
see how they relate to national income
government purchases of goods and services (G) add directly to…
the DEMAND for economy’s current output of goods and services
transfer payments
also affect AE but only through the EFFECT these transfers have on HOUSEHOLD INCOME
are G and transfer payments part of desired AE?
G is part of it
but transfer payments aren’t (they are incorporated indirectly through their affect income)
net taxes (T)
total tax revenues net of transfer payments
T = t * Y
where t is the net tax rate
t
the net tax rate
as Y rises, a tax system with given tax rates will…
yield MORE REVENUE (net of transfers)
what kind of variable is the tax rate?
autonomous policy variable
budget balance
difference between T and G
BB = T - G
BB = tY - G
if G < T…
there’s a budget surplus
if G > T…
there’s a budget deficit
in a budget deficit, what must government do?
BORROW excess spending revenues
does this by issuing additional gov debt (bonds or treasury bills)
what levels of gov are to be included when measuring the overall contribution of government to desired AE?
all levels of government
particularly important in Canada
combined purchases of provincial and municipal governments are LARGER than those of federal gov
G will be treated as an ________ _______ in our model
autonomous expenditure
net tax revenues (T) is positively related to what?
Y
how does T enter the AE function?
indirectly, through its effect on disposable income (YD)
YD = Y - T
YD = Y - tY
YD = (1 - t) Y
2 central assumptions we make about net exports
- canada’s exports are autonomous with respect to Canadian GDP
- imports rise as Canadian GDP rises
imports equation
IM = mY
m
marginal propensity to import
m = change in imports/change in income
net exports equation
NX = X - mY
changes in domestic GDP lead to _______ in net exports
changes
- as Y rises, NX falls
- as Y falls, NX rises
as Y rises, what happens to NX?
as Y rises, NX falls
as Y falls, what happens to NX?
as Y falls, NX rises
what function shows relationship between Y and NX?
the net export function
NX function is drawn holding what constant?
- foreign GDP
- domestic and foreign prices
- the exchange rate
NX - an increase in foreign income leads to…
more foreign demand for Canadian goods
increases X and SHIFTS NX function UP
NX - a rise in Canadian prices (holding foreign prices constant) leads to…
lower X
IM function ROTATES UP as Canadians switch towards foreign goods (m increases)
NX function SHIFTS DOWN and GETS STEEPER
what 2 things could cause rise in Canadian prices relative to foreign prices?
- rise in the exchange rate
- rise in price levels
the marginal propensity to consume out of national income is _____ than the marginal propensity to consume out of disposable income
less
EXPLANATION: the marginal propensity to consume out of national income is LESS than the marginal propensity to consume out of disposable income
because YD = Y - T
if T = (0.1)Y then YD = 0.9Y
C = 30 + (0.8)YD
C = 30 + (0.8)(0.9)Y
C = 30 + (0.72)Y
marginal propensity to consume out of national income (0.72) is less than the marginal propensity to consume out of disposable income (0.8)
expanded AE function
AE = C + I + G + NX
consumption function
C = a + b * YD
YD function
YD = (1 - t) Y
summing the 4 components of desired AE in terms of AUTONOMOUS expenditure and INDUCED expenditure
autonomous = [a + I + G + X]
induced = [b (1 - t) - m] Y
autonomous part of desired AE
a + I + G + X
induced part of desired AE
[b (1 - t) - m] Y
autonomous and induced AE function altogether
AE = [a + I + G + X] + [b (1 - t) - m] Y
AE = constant + slope * Y
constant: a + I + G + X
slope: b (1 - t) - m
z in this mode
z is the marginal propensity to spend - it’s the SLOPE of the AE function
z = b (1 - t) - m
z = MPC (1 - t) - m
is output demand determined in this expanded model?
yes
equilibrium condition is Y = AE (Y)
equilibrium condition in words
equilibrium Y occurs where desired aggregate expenditure equals national income
whenever AE isn’t equal to Y, there are…
unintended changes in INVENTORIES and firms have an INCENTIVE to CHANGE PRODUCTION
back to ch 6: why must savings = investment when in equilibrium?
when Y = AE, savings = investment
Y = value of goods & services produced
this must match the desire to spend
when this happens, savings = investment (with NO GOV and NO TRADE)
national savings = to what?
national asset formation
S + (T - G) = I + (X - IM)
(X - IM) are net exports
and net exports are a way of repping accumulating assets
net exports represent what?
accumulating assets
ie. if X is larger than IM, we have additional unused value in the economy which we send to another economy
in exchange, we get ASSETS instead of goods
assets: foreign currency, stock, bond etc
if exports are larger than imports, the economy is…
accumulating GAINS against other economies
whereas if imports are larger than exports, other economies have claims against your economy
in this economy, do S = I?
no, because of introduction of trade
because people can buy assets, goods and services from FOREIGN ECONOMIES
imports can be larger than exports (or vice versa)
possible that investment in the economy be larger than savings - because maybe people with savings from OTHER ECONOMIES are INVESTING IN YOUR ECONOMY
essentially, investments are financed by using savings from abroad
investment
today’s production that will yield services in the FUTURE rather than the present
an economy that invests is adding to its assets
net exports = central to determining rate at which a country…
central to determining the rate at which a country ACQUIRES CLAIMS on foreigners
ie. if Canada sells more goods and sergices to other countries than they buy from them (X exceeds IM), Canadian accumulate FOREIGN ASSETS
^ these assets could be in form of FOREIGN CURRENCY, STOCKS, BONDS, FOREIGN LANDS and FACTORIES
in this model, the economy is in equilibrium when desired national savings are equal to what?
desired national asset formation
S + (T - G) - I - (X - IM) = W
Y - T - C + T - G - I - X + IM = W
Y - (C + G + I + X - IM) = W
Y - AE = W
W
the difference between desired national savings and desired national asset formation
imports and taxes do what to z?
make it smaller
z = MPC (1 - t) - m
(marginal propensity to spend gets smaller)
multiplier intuition: presence of imports and taxes reduces…
the marginal propensity to spend out of national income
and thus reduces the value of the simple multiplier (slope of AE)
the higher is m, the ________ is the simple multiplier
lower
the lower is m, the ________ is the simple multiplier
higher
comparing the 2 multipliers
WITHOUT GOV/TRADE
z = MPC
simple multiplier = 1 / (1 - MPC)
WITH GOV/TRADE:
z = MPC (1 - t) - m
multipler = 1 / 1 - [MPC (1 - t) - m]
fiscal policy
use of government’s SPENDING and TAX policies
goal is to stabilize Y
stabilization policy
any policy that attempts to stabilize Y at or near Y*
ie. in response to inflationary and recessionary gaps
what pertaining to fiscal policy is often clear and what is less clear?
the DIRECTION in which fiscal policy should be adjusted is often clear
but HOW MUCH it should be shifted is less clear
2 main effects of fiscal policy
- reduction in t or increase in G > AE curve goes up > multiplier effect > increase equilibrium national income
- increase in t or decrease in G > AE curve goes down > decrease equilibrium national income
what does increasing G do? what about lowering t?
increasing G shifts up the constant so the whole AE curve shifts up
lowering t makes z steeper
when output is high, in order to pay out debt, gov may…
reduce G and increase t
when economy is doing well, it’s smart to reduce G and increase t to balance the budget
need to keep debt levels low
if G falls, what will happen to equilibrium national income?
it will fall, and be subject to the multiplier
change in Y = change in G times the simple multiplier
ie. z = 0.25 so simple multiplier = 1.30
change in G = -$100 million
so change in Y = -$100 million x 1.30
equals -$130 million
a higher t does what to the AE function? what about a lower t?
higher t causes the AE function to become FLATTER
lower t causes the AE function to become STEEPER
if the shock affects the slope, can you use the simple multiplier?
no
can only use the simple multiplier if the shock affects the constant
if NX function shifts up, what happens to equilibrium Y?
it rises
if NX function shifts down, equilibrium Y falls
exports are autonomous with respect to domestic GDP, but they depend on…
- foreign income, domestic and foreign prices, exchange rate and tastes
if exports increase by $1 billion, then equilibrium national income will increase by $1 billion times the simple multiplier
if t changes, do we use the simple multiplier?
no because this shifts the slope of the AE curve
only use simple multiplier for shocks that affect the constant!
if exports increase by $1 billion, then how do we calculate the change in equilibrium national income?
equilibrium national income will increase by $1 billion times the simple multiplier
a lower m does what to the AE function?
lower m causes the AE function to become STEEPER
because a lower marginal propensity to import means that more domestic income is being spent on domestic goods and services rather than foreign ones
a higher m does what to the AE function?
higher m causes AE function to become flatter
because a higher marginal propensity to imports means that more income is being spent on foreign goods, diverting it away from domestic goods
our simple macro model is based on 3 central concepts
- equilibrium national income
- the simple multiplier
- demand-determined output
(the second and third are closely connected to our assumption of a CONSTANT PRICE LEVEL)
when is the assumption that there’s a constant price level reasonable?
- when output is BELOW POTENTIAL, because then firms can increase output without increasing costs
- when firms are PRICE SETTERS they often respond to shocks by changing output (and only later changing their price) g
