Theory of output, N & Y determination (10) Flashcards
Endogenous vs exogenous variable
endogenous = variable which affect other variables but is also affected by them. dependent.
exogenous = variable which affects other variables but is not affected by them. independent.
ex: Consumption and Y both affect each other and are affected by each other
while X will affect Y but X is not affected by Y. so it affects them but is not dependent of them. (exogenous)
AE =
C + I+ G + X - M
C = consumption
I = fixed capital investment expenditure
G = current gov exp
X-M = export - import
Aggregate Demand
Ad = willingness to consume + ability to spend
-force that drives econ’s engines
In this model for chapter 11 : AD = AE
Willingness to consume
W = consumer confidence + interest rate (r)
-confidence: contagious. feeling/ emotional attitude
-interest rate : short term borrowing and deposit rate
**confidence rises and rates fall = more spending = boost in demand = growth in econ
**confidence falls & rate rise = less spending = decrease demand = no growth
Willingness to consume = Marginal propensity to consume = MPC
change in C / change in Y
in the SR flow of Consumption expenditure is influenced by 3 factors
1) variation in HDI
2) level of consumer confidence
3) variation interest rates
confidence + rate : influence willingness
HDI determines ability to spend
John Maynard Keynes
shaping the rate of consumption and investment expenditure in the economy: his theory of the concept of Marginal propensity to consume (MPC) and save (MSPS) = willingness to pay
The rate of interest
price of credit which also reflects the opportunity cost of consumption
- households split their income between saving and consumption. the higher the return on their saving, the less they will use their money to consume (higher opportunity cost of consumption)
Wealth effect
when rates fall they cause the value of assets to rise which makes ppl feel wealthier = greater degree of confidence = people save less and spend more
Personal savings
= spending power reserved for a future period
postponed consumption
Consumption and personal saving function
C = a + bY
consumption = autonomous consumption (constant) + rate at which we spend the money (slope of the function) x household income per period
a = always positive, minimum amount to cover basic needs
b = bigger than 0 smaller than 1
the more you earn the more you spend
MPC
change in consumption / change in income
= b
= slope of the function
= rate of spending
= willingness to spend
personal saving function
Sp = Yd - C
Sp = Yd - (a + bY)
Sp = Yd -a -bY
Sp = -a + (1-b) Y
Yd = C + Sp
how much of their income households choose to spend (MPC) determines how much they will save (MPS)
So: MPC + MPS = 1
MPS = 1 - MPC = 1 - b
Fixed capital investment expenditure (I)
spending on durable fixed assets such as plant buildings, engineering structures, machinery and equipment
3 types:
1) business capital invest. (BI)
2) public invest. (PI)
3) invest. in residential housing (HI)
I = BI + PI + HI
investment is essential for growth SR and LR and raising living standards
Cash flow
undistributed profits (retained earnings) + CCA (capital cost allowance - depreciation)
Business saving (Sb)
cash on hand (liquidity) + cash flow
Cost of capital
direct cost such as the interest payments on the funds raised and the opportunity cost which is the income that is forgone by not applying it to an alternative use
Rate of return
for an investment to make sense the rate of return must exceed the rate of interest it pays to finance
The simple model
consumption and investment expenditure
AE = C + I
Y = C + I
when C + I are bigger than Y = level of production and income and employment will rise
when it is equal will stop rising at this intersection. equilibrium level. no tendency for the economy to either expand or contract further.
I = S equilibrium when total investment equals total savings
current government expenditure (G)
consolidated expenditure of all three levels of government: municipal, provincial, federal
-government operating expenditures EX: supplies, heating, printing, salaries paid to civil servants
does not include transfer payments to households such as old age pensions
Transfer payments
paid to households such as old age pensions, employment insurance, child tax benefit are not included in G
Budgetary expenditures (BG)
current gov expenditure (G) + cap invest. expenditure (PI) + Gov transfer payments (TP) + interest on the public debt
Marginal propensity to be taxed (MPT)
ratio of the change in government tax receipts to the change in the level of income
-known as the marginal tax rate
-change in gov tax / change in income Y
-effective MPT in Canada is around 0.35 & is the slope of the gov tax function
Gov budget balance
T - BG
gov tax - budgetary expenditures
when T is bigger = we will have a budget surplus
when T is smaller = we budget deficit
when T- BG = 0 we have balanced budget
Tax rate
rise in tax rate = reduce the total income that people earn in the SR
we pay more tax on our income it reduces our disposable income and reduces the amount we will spend to buy goods and services
-Reduce consumption = reduce aggregate demand = decrease in level of output, employment, and national income
Trade surplus
when exports exceed imports
X - M bigger than 0
Trade deficit
when exports fall short of imports
X - M smaller than 0
Marginal propensity to import
MPM = change in import / change in Y = m
When C, I, G, X increase
rise in output, employment, income
-but when the MPS MPT MPM rise = country output, employment and income fall
AE bigger AS
aggregate expenditure bigger than supply = inventories fall, level of production (GDP), employment and income rise
AE smaller than AS
inventories rise, level of prod, employment, income fall
AE = AS
inventories remain constant, level of prod, employment and income remain constant
Equilibrium level of income
Aggregate expenditure and supply approach
when AS = AE
AE= C + I + G + X - M
AS = Y = GDP
injection leakages approach
injections = money which is spent during a given period in the econ but which was not generated during the same period within the econ (spending that comes out of our savings- from the past)
J = I + G + X
Leakages or withdrawals = money which is earned during a given period but not spent inside the econ during the same period.
Sum of savings, taxes and imports
L = S + T + M
Marginal propensity to withdraw
MPW = MPS + MPT + MPM = change in L / change in income Y
when J bigger than L = inventories fall, gdp, n, y rise
J smaller than L = inventories rise, gdp, n, Y fall
J = L = inventories constant, gdp, n, y constant equilibrium
Inventory
inventory bc impossible to perfectly forecast the demand
inventory to sale ratio = total stock of inventory/ monthly sales
when drop in demand = undesired accumulation of inventories
firm will cut back production , reducing employment, income
increase in G spending effect on the equi level of income
case of parallel shift
AE will move up parallel
J = I + G + X = will move up parallel
increase tax rates on the equi level of income
rotational shift
same y intercept but rotate down AE
L = S + T + M will rotate up, same y intercept
The multiplier effect
income multiplier K effect
every dollar of expenditure injected in the econ creates more than a dollar’s worth of output and income
k = change in Y / change in J is bigger than 1
income multiplier factor K by which every dollar spent gets multiplied in the process of income creation and is found by calculating ratio of change in income that results from the change in autonomous expenditure J
K = 1 / MPS + MPT + MPM
k = 1 / MPW
in Canada ranges between 1.6 and 2
k = 1 / 1- MPCd
MPCd = MPC - MPM = marginal propensity to consume domestically
full employment level of income (Yf)
Ye = Yf = Potential GDP
Yf - Ye = GDP Gap
Expenditure gap = gdp gap / multiplier k
expenditure gap x multiplier k = gdp gap
change in AE X k = change in income
GDP gap will be on the x axes (GDP)
Expenditure gap will be on the y axes (AE, AS)
determining level of income using algebra
1) MPC is slope of consumption function, MPM is slope of the import function
2) MPS = 1- MPC
3) find the saving function subtract C from Y. S = Y- C
4) find income multiplier k : K = 1/ 1- mpcd
MPCd = MPC - MPM (that we already have)
5) find income equi level Ye : set AS = AE
since AS = Y, set Y = AE and solve
Y = AE
Y = C + I + G + X - M
Ye = eg 800 billion
