This document discusses macroeconomic equilibrium and the components of aggregate expenditure. It defines equilibrium as occurring when aggregate demand equals aggregate supply. The key components of aggregate demand are defined as private consumption, investment, government spending, and net exports. Private consumption depends on disposable income, while investment depends on factors like demand and business expectations. The document also discusses aggregate supply and how it is represented by a 45-degree line, indicating firms will supply whatever level of output is demanded.
This document discusses the natural rate of unemployment and its causes. It begins by defining the natural rate of unemployment as the average rate around which the actual unemployment rate fluctuates over the business cycle. It then presents a model showing how the natural rate is determined by the rates of job separation and job finding. Frictional unemployment results from the time it takes to search for and transition between jobs, while structural unemployment stems from wage rigidities that prevent wages from adjusting downward to clear the labor market. The document explores factors like minimum wages, unions, efficiency wages, and sectoral shifts that contribute to real wage rigidity and the natural rate of unemployment.
This chapter discusses how to determine national income and its fluctuations. It introduces the concepts of aggregate expenditure (AE), equilibrium income, the consumption function, savings function, investment, and the multiplier. AE is the total planned spending in the economy. Equilibrium occurs when AE equals national income (Y). The chapter shows that an increase in investment (I) or autonomous consumption will increase AE and equilibrium Y through the multiplier effect. It also discusses the "paradox of thrift" where an increase in savings can reduce income.
Macroeconomics is the study of the economy as a whole, including issues like growth, inflation, and unemployment. Economists use models to help explain and address these issues. Models make simplifying assumptions, like whether prices are flexible or sticky in the short-run. The chapter introduces concepts like endogenous and exogenous variables. It provides an example model of supply and demand for cars and how it can be used to analyze changes. The chapter outlines the topics that will be covered in the macroeconomics textbook, including classical theory, growth theory, and business cycle theory.
The document summarizes the aggregate supply (AS) and aggregate demand (AD) model. It defines AS and AD as relationships between price levels and real GDP. The intersection of the AS and AD curves determines equilibrium output and price levels. The document outlines the components of aggregate demand as consumption, investment, government spending, and net exports. It also discusses factors that can cause shifts in the AS and AD curves, such as income, wealth, interest rates, and exchange rates.
This document summarizes key points from a chapter about government debt. It discusses several topics:
1. The size of government debt in various countries, with Japan having the highest debt-to-GDP ratio at 159% and the U.S. at 64%.
2. Traditional and Ricardian views on the effects of government debt. The traditional view is that debt crowds out investment, while the Ricardian view is that debt has no real effects due to forward-looking consumers.
3. Problems in measuring budget deficits, such as not accounting for inflation, capital assets, or future liabilities for programs like Social Security. Correcting for these issues can significantly change deficit estimates.
Aggregate Demand and Aggregate Supply and Curvesshahroze11
The document discusses aggregate demand and aggregate supply. It defines aggregate demand as the total demand for final goods and services in an economy at a given time and price level. The key components of aggregate demand are consumption, investment, government spending, exports and imports. It also discusses how aggregate demand is downward sloping. The document then defines aggregate supply as the total supply of goods and services in an economy. It describes how the aggregate supply curve slopes upward in the short-run but is vertical in the long-run.
This document discusses short-run economic fluctuations using the aggregate demand and aggregate supply model. It explains that in the short-run, the aggregate supply curve slopes upward due to sticky wages and prices. Shifts in aggregate demand or supply can cause fluctuations in output and unemployment. Recessions occur when aggregate demand decreases, causing output and employment to fall.
Production Possibility Frontier (Revision Presentation)tutor2u
The document discusses the production possibility frontier (PPF), which shows the maximum output combinations of two goods an economy can produce with full employment of resources. It explains key concepts like opportunity cost, diminishing returns, and shifts in the PPF due to changes in resources or technology. Causes of outward shifts include higher productivity and new resources, while inward shifts may occur after natural disasters, conflict, or recession that reduce resources and investment.
This document discusses the natural rate of unemployment and its causes. It begins by defining the natural rate of unemployment as the average rate around which the actual unemployment rate fluctuates over the business cycle. It then presents a model showing how the natural rate is determined by the rates of job separation and job finding. Frictional unemployment results from the time it takes to search for and transition between jobs, while structural unemployment stems from wage rigidities that prevent wages from adjusting downward to clear the labor market. The document explores factors like minimum wages, unions, efficiency wages, and sectoral shifts that contribute to real wage rigidity and the natural rate of unemployment.
This chapter discusses how to determine national income and its fluctuations. It introduces the concepts of aggregate expenditure (AE), equilibrium income, the consumption function, savings function, investment, and the multiplier. AE is the total planned spending in the economy. Equilibrium occurs when AE equals national income (Y). The chapter shows that an increase in investment (I) or autonomous consumption will increase AE and equilibrium Y through the multiplier effect. It also discusses the "paradox of thrift" where an increase in savings can reduce income.
Macroeconomics is the study of the economy as a whole, including issues like growth, inflation, and unemployment. Economists use models to help explain and address these issues. Models make simplifying assumptions, like whether prices are flexible or sticky in the short-run. The chapter introduces concepts like endogenous and exogenous variables. It provides an example model of supply and demand for cars and how it can be used to analyze changes. The chapter outlines the topics that will be covered in the macroeconomics textbook, including classical theory, growth theory, and business cycle theory.
The document summarizes the aggregate supply (AS) and aggregate demand (AD) model. It defines AS and AD as relationships between price levels and real GDP. The intersection of the AS and AD curves determines equilibrium output and price levels. The document outlines the components of aggregate demand as consumption, investment, government spending, and net exports. It also discusses factors that can cause shifts in the AS and AD curves, such as income, wealth, interest rates, and exchange rates.
This document summarizes key points from a chapter about government debt. It discusses several topics:
1. The size of government debt in various countries, with Japan having the highest debt-to-GDP ratio at 159% and the U.S. at 64%.
2. Traditional and Ricardian views on the effects of government debt. The traditional view is that debt crowds out investment, while the Ricardian view is that debt has no real effects due to forward-looking consumers.
3. Problems in measuring budget deficits, such as not accounting for inflation, capital assets, or future liabilities for programs like Social Security. Correcting for these issues can significantly change deficit estimates.
Aggregate Demand and Aggregate Supply and Curvesshahroze11
The document discusses aggregate demand and aggregate supply. It defines aggregate demand as the total demand for final goods and services in an economy at a given time and price level. The key components of aggregate demand are consumption, investment, government spending, exports and imports. It also discusses how aggregate demand is downward sloping. The document then defines aggregate supply as the total supply of goods and services in an economy. It describes how the aggregate supply curve slopes upward in the short-run but is vertical in the long-run.
This document discusses short-run economic fluctuations using the aggregate demand and aggregate supply model. It explains that in the short-run, the aggregate supply curve slopes upward due to sticky wages and prices. Shifts in aggregate demand or supply can cause fluctuations in output and unemployment. Recessions occur when aggregate demand decreases, causing output and employment to fall.
Production Possibility Frontier (Revision Presentation)tutor2u
The document discusses the production possibility frontier (PPF), which shows the maximum output combinations of two goods an economy can produce with full employment of resources. It explains key concepts like opportunity cost, diminishing returns, and shifts in the PPF due to changes in resources or technology. Causes of outward shifts include higher productivity and new resources, while inward shifts may occur after natural disasters, conflict, or recession that reduce resources and investment.
This document provides an overview of microeconomics concepts including:
1. Economics is defined as the study of how scarce resources are allocated among alternative uses.
2. Key concepts in microeconomics include rational choice, incentives, marginal analysis, and opportunity cost.
3. Economic systems must answer questions about what to produce, how to produce it, and who receives it given the constraints of scarce resources.
This document discusses macroeconomic equilibrium. It defines macroeconomic equilibrium as being determined by aggregate demand and aggregate supply. Equilibrium occurs when aggregate demand equals aggregate supply (AD=AS) and income equals expenditure (Y=E). The document provides details on the components of aggregate demand (consumption, investment, government spending, exports) and aggregate supply (consumption, savings, taxes, imports). It also discusses concepts like the consumption function, marginal propensity to consume, and how equilibrium can be shown using schedules, equations, and graphs.
Aggregate demand is the total planned expenditure in an economy at a given price level. It is composed of consumption (C), investment (I), government spending (G), and net exports (X-M). Each component is influenced by various economic factors - consumption depends on disposable income and credit availability, investment depends on interest rates and profit levels, government spending depends on public opinion and the state of the economy, and net exports depend on domestic and foreign income and exchange rates. Changes in any component will cause the aggregate demand curve to shift right for an increase or left for a decrease on a graph with real output on the x-axis and price level on the y-axis.
aggregate demand and aggregate supply for 2nd semester for BBAginish9841502661
The document discusses aggregate demand and aggregate supply. It defines aggregate demand as being underpinned by consumers, investors, government and foreigners. Aggregate supply reflects a positive relationship between price level and output in the short run due to price-cost dynamics. In the long run, aggregate supply is vertical as output is determined by fixed resources and technology. Macroeconomic equilibrium occurs where aggregate demand and supply intersect.
This document provides an overview of key concepts in macroeconomics, including:
1) Macroeconomics deals with the performance and decision-making of the entire economy, including factors like GDP, unemployment, and inflation.
2) The document outlines different macroeconomic schools of thought including Keynesian, neoclassical, monetarist traditions.
3) It also summarizes tools and models used in macroeconomics like fiscal/monetary policy, aggregate supply/demand, and circular flow analysis.
The document discusses the production possibilities frontier (PPF), which graphs the combinations of two goods an economy can produce with full employment of resources. It is used to illustrate concepts like scarcity, opportunity cost, efficiency, and economic growth. The slope of the PPF shows the tradeoff between goods, and the curvature indicates increasing opportunity costs as production shifts from one good to another due to differences in resource allocation.
This document discusses aggregate demand, which is the total planned spending on goods and services in an economy. It has four main components: consumer spending, investment spending, government spending, and net exports. Changes in aggregate demand are caused by factors like monetary policy, fiscal policy, business and consumer confidence, and external economic conditions. A rise in aggregate demand leads to increased output and employment as the economy expands along the aggregate demand curve, while a fall in aggregate demand causes contraction. The document examines how each of the components and various demand-side factors can influence aggregate demand in the UK economy.
The document defines the investment multiplier as the ratio of change in national income due to a change in investment. It explains that an initial increase in investment can lead to an even greater increase in national income through subsequent rounds of spending. The multiplier effect is dependent on the marginal propensity to consume. The document also outlines the assumptions, workings, and limitations of the multiplier model.
This document provides an overview of aggregate supply and the short-run tradeoff between inflation and unemployment known as the Phillips curve. It discusses three models of aggregate supply - the sticky-wage model, imperfect-information model, and sticky-price model - and how they each imply a positive relationship between output and the price level in the short run. The Phillips curve relationship is then derived from the aggregate supply relationship. The document also discusses concepts like adaptive expectations, inflation inertia, cost-push vs demand-pull inflation, and the sacrifice ratio.
This document provides an overview of key macroeconomic statistics including Gross Domestic Product (GDP), the Consumer Price Index (CPI), and the unemployment rate. It discusses how GDP can be measured through expenditures, income, and value added. The components of GDP expenditures are defined as consumption, investment, government spending, and net exports. Real GDP is introduced to control for inflation. The GDP deflator and inflation rates are also explained.
Theory of the Firm
1. The document discusses several theories of the firm including the economic theory of profit maximization, behavioral theories such as Simon's satisficing model and Cyert and March's model, and alternative objectives like sales maximization. 2. It also explains key concepts like the firm, industry, and market, and compares accounting profit versus economic profit. 3. The theories aim to explain how firms make decisions and set objectives in different market structures under conditions of uncertainty.
This document provides an overview of the Solow growth model, which examines how economic growth and standards of living are determined in the long run. It introduces key concepts such as the production function, saving rate, depreciation rate, capital accumulation, and steady state. The steady state is the level of capital where investment just offsets depreciation and capital remains constant. The model predicts that countries with higher saving and investment rates will have higher levels of capital and income per worker in the long run. It also discusses finding the optimal saving rate and capital stock, known as the Golden Rule, which maximizes consumption.
The document summarizes several economic theories of consumption:
1) John Maynard Keynes theorized that consumption depends on current income, while later models incorporated expected future income and wealth.
2) Irving Fisher introduced intertemporal choice theory, assuming consumers maximize lifetime utility subject to budget constraints.
3) Franco Modigliani's life-cycle hypothesis proposes consumption varies over a person's life cycle as they save during working years and dissave in retirement.
4) Milton Friedman's permanent income hypothesis views current income as having permanent and transitory components, with consumption based on permanent income.
Lecture slides for an undergraduate course on Basic Macroeconomics that I taught in the Fall of 2007.
This lecture introduces national income accounts.
Market failure and government interventions slidesgilem488
The document discusses market failures and government interventions in markets. It defines several key economic concepts like allocative efficiency, production efficiency, and market failures that occur due to externalities, public goods, and other conditions not being met. It then describes different roles of government in regulating markets, allocating resources, redistributing income, and stabilizing growth. The government provides public goods through taxation since the private market fails to do so. It may also intervene by taxing "demerit goods" and subsidizing "merit goods".
Firms must consider the macroeconomic environment when making production and pricing decisions. Key indicators of an economy's performance include aggregate output, price levels, investment, consumption, and balance of payments. The macro economy represents the aggregation of individual households and firms. Common measures used to evaluate price movements are the consumer price index, wholesale price index, and GDP deflator.
This document provides an overview of a macroeconomic model that examines national income. It discusses how total output is determined by factors of production like capital and labor. It then explains how factor prices, like wages and rental rates, are set through supply and demand in factor markets. The model shows how total national income is distributed to factor payments. It also outlines the components of aggregate demand, like consumption, investment, and government spending, and how their equilibrium in the goods market determines total output.
This chapter introduces macroeconomics and the issues studied in the field. It discusses important macroeconomic concepts like GDP, unemployment, inflation, and recessions. The chapter explains that economists use different models to study different macroeconomic questions in both the short-run when prices are sticky and long-run when prices are flexible. It provides an example model of supply and demand for cars and how the model can be used to analyze the effects of changes in income and costs.
Measuring National Output and National IncomeNoel Buensuceso
The document discusses key concepts related to measuring national output and national income. It defines GDP as the total market value of all final goods and services produced within a country in a given period. GDP can be calculated using the expenditure approach, which sums consumer spending, investment, government spending, and net exports, or the income approach, which sums compensation, profits, interest, and rents. The document also discusses related concepts like GNP, NNP, personal income, and disposable personal income.
The document discusses the theory of cost, including various cost concepts and cost curves. It covers accounting concepts such as opportunity cost and actual cost as well as analytical concepts such as fixed and variable costs. The document also examines cost functions including linear, quadratic and cubic forms. It analyzes short-run and long-run cost curves, discussing total cost, average cost and marginal cost. Finally, the document addresses economies and diseconomies of scale and assigns further reading on the economics of scale.
The document defines key macroeconomic concepts including aggregate expenditure, output, income, consumption, saving, investment, government spending, taxes, imports, exports, and equilibrium. It also discusses the consumption function, marginal propensity to consume, marginal propensity to save, and the multiplier effect.
The document defines key macroeconomic concepts including aggregate expenditure, output, income, consumption, saving, investment, government spending, taxes, imports, exports, and equilibrium. It also discusses the consumption function, marginal propensity to consume, marginal propensity to save, and the multiplier effect.
This document provides an overview of microeconomics concepts including:
1. Economics is defined as the study of how scarce resources are allocated among alternative uses.
2. Key concepts in microeconomics include rational choice, incentives, marginal analysis, and opportunity cost.
3. Economic systems must answer questions about what to produce, how to produce it, and who receives it given the constraints of scarce resources.
This document discusses macroeconomic equilibrium. It defines macroeconomic equilibrium as being determined by aggregate demand and aggregate supply. Equilibrium occurs when aggregate demand equals aggregate supply (AD=AS) and income equals expenditure (Y=E). The document provides details on the components of aggregate demand (consumption, investment, government spending, exports) and aggregate supply (consumption, savings, taxes, imports). It also discusses concepts like the consumption function, marginal propensity to consume, and how equilibrium can be shown using schedules, equations, and graphs.
Aggregate demand is the total planned expenditure in an economy at a given price level. It is composed of consumption (C), investment (I), government spending (G), and net exports (X-M). Each component is influenced by various economic factors - consumption depends on disposable income and credit availability, investment depends on interest rates and profit levels, government spending depends on public opinion and the state of the economy, and net exports depend on domestic and foreign income and exchange rates. Changes in any component will cause the aggregate demand curve to shift right for an increase or left for a decrease on a graph with real output on the x-axis and price level on the y-axis.
aggregate demand and aggregate supply for 2nd semester for BBAginish9841502661
The document discusses aggregate demand and aggregate supply. It defines aggregate demand as being underpinned by consumers, investors, government and foreigners. Aggregate supply reflects a positive relationship between price level and output in the short run due to price-cost dynamics. In the long run, aggregate supply is vertical as output is determined by fixed resources and technology. Macroeconomic equilibrium occurs where aggregate demand and supply intersect.
This document provides an overview of key concepts in macroeconomics, including:
1) Macroeconomics deals with the performance and decision-making of the entire economy, including factors like GDP, unemployment, and inflation.
2) The document outlines different macroeconomic schools of thought including Keynesian, neoclassical, monetarist traditions.
3) It also summarizes tools and models used in macroeconomics like fiscal/monetary policy, aggregate supply/demand, and circular flow analysis.
The document discusses the production possibilities frontier (PPF), which graphs the combinations of two goods an economy can produce with full employment of resources. It is used to illustrate concepts like scarcity, opportunity cost, efficiency, and economic growth. The slope of the PPF shows the tradeoff between goods, and the curvature indicates increasing opportunity costs as production shifts from one good to another due to differences in resource allocation.
This document discusses aggregate demand, which is the total planned spending on goods and services in an economy. It has four main components: consumer spending, investment spending, government spending, and net exports. Changes in aggregate demand are caused by factors like monetary policy, fiscal policy, business and consumer confidence, and external economic conditions. A rise in aggregate demand leads to increased output and employment as the economy expands along the aggregate demand curve, while a fall in aggregate demand causes contraction. The document examines how each of the components and various demand-side factors can influence aggregate demand in the UK economy.
The document defines the investment multiplier as the ratio of change in national income due to a change in investment. It explains that an initial increase in investment can lead to an even greater increase in national income through subsequent rounds of spending. The multiplier effect is dependent on the marginal propensity to consume. The document also outlines the assumptions, workings, and limitations of the multiplier model.
This document provides an overview of aggregate supply and the short-run tradeoff between inflation and unemployment known as the Phillips curve. It discusses three models of aggregate supply - the sticky-wage model, imperfect-information model, and sticky-price model - and how they each imply a positive relationship between output and the price level in the short run. The Phillips curve relationship is then derived from the aggregate supply relationship. The document also discusses concepts like adaptive expectations, inflation inertia, cost-push vs demand-pull inflation, and the sacrifice ratio.
This document provides an overview of key macroeconomic statistics including Gross Domestic Product (GDP), the Consumer Price Index (CPI), and the unemployment rate. It discusses how GDP can be measured through expenditures, income, and value added. The components of GDP expenditures are defined as consumption, investment, government spending, and net exports. Real GDP is introduced to control for inflation. The GDP deflator and inflation rates are also explained.
Theory of the Firm
1. The document discusses several theories of the firm including the economic theory of profit maximization, behavioral theories such as Simon's satisficing model and Cyert and March's model, and alternative objectives like sales maximization. 2. It also explains key concepts like the firm, industry, and market, and compares accounting profit versus economic profit. 3. The theories aim to explain how firms make decisions and set objectives in different market structures under conditions of uncertainty.
This document provides an overview of the Solow growth model, which examines how economic growth and standards of living are determined in the long run. It introduces key concepts such as the production function, saving rate, depreciation rate, capital accumulation, and steady state. The steady state is the level of capital where investment just offsets depreciation and capital remains constant. The model predicts that countries with higher saving and investment rates will have higher levels of capital and income per worker in the long run. It also discusses finding the optimal saving rate and capital stock, known as the Golden Rule, which maximizes consumption.
The document summarizes several economic theories of consumption:
1) John Maynard Keynes theorized that consumption depends on current income, while later models incorporated expected future income and wealth.
2) Irving Fisher introduced intertemporal choice theory, assuming consumers maximize lifetime utility subject to budget constraints.
3) Franco Modigliani's life-cycle hypothesis proposes consumption varies over a person's life cycle as they save during working years and dissave in retirement.
4) Milton Friedman's permanent income hypothesis views current income as having permanent and transitory components, with consumption based on permanent income.
Lecture slides for an undergraduate course on Basic Macroeconomics that I taught in the Fall of 2007.
This lecture introduces national income accounts.
Market failure and government interventions slidesgilem488
The document discusses market failures and government interventions in markets. It defines several key economic concepts like allocative efficiency, production efficiency, and market failures that occur due to externalities, public goods, and other conditions not being met. It then describes different roles of government in regulating markets, allocating resources, redistributing income, and stabilizing growth. The government provides public goods through taxation since the private market fails to do so. It may also intervene by taxing "demerit goods" and subsidizing "merit goods".
Firms must consider the macroeconomic environment when making production and pricing decisions. Key indicators of an economy's performance include aggregate output, price levels, investment, consumption, and balance of payments. The macro economy represents the aggregation of individual households and firms. Common measures used to evaluate price movements are the consumer price index, wholesale price index, and GDP deflator.
This document provides an overview of a macroeconomic model that examines national income. It discusses how total output is determined by factors of production like capital and labor. It then explains how factor prices, like wages and rental rates, are set through supply and demand in factor markets. The model shows how total national income is distributed to factor payments. It also outlines the components of aggregate demand, like consumption, investment, and government spending, and how their equilibrium in the goods market determines total output.
This chapter introduces macroeconomics and the issues studied in the field. It discusses important macroeconomic concepts like GDP, unemployment, inflation, and recessions. The chapter explains that economists use different models to study different macroeconomic questions in both the short-run when prices are sticky and long-run when prices are flexible. It provides an example model of supply and demand for cars and how the model can be used to analyze the effects of changes in income and costs.
Measuring National Output and National IncomeNoel Buensuceso
The document discusses key concepts related to measuring national output and national income. It defines GDP as the total market value of all final goods and services produced within a country in a given period. GDP can be calculated using the expenditure approach, which sums consumer spending, investment, government spending, and net exports, or the income approach, which sums compensation, profits, interest, and rents. The document also discusses related concepts like GNP, NNP, personal income, and disposable personal income.
The document discusses the theory of cost, including various cost concepts and cost curves. It covers accounting concepts such as opportunity cost and actual cost as well as analytical concepts such as fixed and variable costs. The document also examines cost functions including linear, quadratic and cubic forms. It analyzes short-run and long-run cost curves, discussing total cost, average cost and marginal cost. Finally, the document addresses economies and diseconomies of scale and assigns further reading on the economics of scale.
The document defines key macroeconomic concepts including aggregate expenditure, output, income, consumption, saving, investment, government spending, taxes, imports, exports, and equilibrium. It also discusses the consumption function, marginal propensity to consume, marginal propensity to save, and the multiplier effect.
The document defines key macroeconomic concepts including aggregate expenditure, output, income, consumption, saving, investment, government spending, taxes, imports, exports, and equilibrium. It also discusses the consumption function, marginal propensity to consume, marginal propensity to save, and the multiplier effect.
PUBLIC FINANCE- ECO 204 For Economic Studentsanatomygrandger
This document provides an overview of public finance concepts including government expenditure, revenue, budgets, taxation, and theories of public expenditure growth. It discusses why governments intervene in economies and outlines key types of taxes including direct taxes like income tax and indirect taxes. Government budgets are described as needing to be in equilibrium with balanced revenue and expenditure. Theories of increasing public spending such as Wagner's Law and Peacock-Wiseman's displacement theory are summarized.
1. The document discusses measuring GDP and economic growth. It defines GDP and explains how the Bureau of Economic Analysis measures US GDP using the expenditure and income approaches.
2. Real GDP is discussed as a way to separate economic growth from inflation. It explains how real GDP is calculated using base year prices or chain-weighted indexes.
3. The limitations of using real GDP as a welfare measure are outlined, as it does not capture all aspects of economic well-being.
This document provides an overview of macroeconomics and key macroeconomic concepts. It discusses that macroeconomics is concerned with the performance of the overall economy or large sectors, and attempts to explain fluctuations in total output and the business cycle. It also covers national income accounting, which provides aggregate measures of the economy, and its importance. The document discusses the circular flow model and how a more comprehensive model incorporates the government and foreign sectors. It defines gross national product and gross domestic product as measures of aggregate output and how they are calculated. It also summarizes different approaches to measuring GNP/GDP.
AGGREGATE DEMAND CURVE IN LONG RUN CONCEPTT HARI KUMAR
This document discusses the concept of aggregate demand in the long run. It defines aggregate demand as the total demand for final goods and services in an economy at a given time and price level. In the long run, aggregate demand is represented by the equation: AD = C + I + G + (X-M), where C is consumption, I is investment, G is government spending, and (X-M) is net exports. Key variables that influence aggregate demand include consumption, investment, government spending, imports and exports. The aggregate demand curve slopes downward because as price levels increase, consumption decreases due to income and substitution effects. Factors that can cause the aggregate demand curve to shift include changes in income, wealth, population,
Because of the close co-movement between the budget deficit and the .pdfrufohudsonak74125
Because of the close co-movement between the budget deficit and the current account deficit, the
two are often referred to as “twin deficits”. Explain in detail how an increase in the budget deficit
that is due to an increase in government spending (not matched with an increase in taxes) will
generate a current account deficit. Clearly explain the role of the interest rate and the exchange
rate for the link between the budget deficit and the current account deficit. B) Describe the
various factors that investors take into account when operating in the context of an open
economy and discuss, in detail, how each of these factors affects their decisions to invest
domestically or abroad. Give examples to illustrate your answers.
Solution
A)
A common view held by economists is that an increasing current account deficit indicates that a
nation is “living beyond its means” – with excessive domestic demand boosting imports and
fuelling inflation, which undermines the competitiveness of the nation and restricts exports.
They point to the fact that the current account deficit is a measure of the nation’s overseas
borrowing. So for each quarter that the economy is in external deficit, its stock of foreign
liabilities increase. These liabilities can be in the form of debt or equity participation in local
firms.
Following this logic, an increasing current account deficit indicates that local consumption and
investment is becoming increasingly dependent on the whims of foreign lenders.
They also argue that there is a strong and direct relationship between the national economy’s
current account balance and its government budget balance and can become twinned” – that is,
move together dollar-for-dollar. This is the twin deficit hypothesis.
The hypothesis is based on national accounting relationships that can be used to show that a
current account deficit measures the difference between total domestic (public and private)
saving and investment.
This viewpoint considers “national” saving to be the sum of private saving and budget surpluses
and total investment to be the sum of private and public capital formation. Accordingly, if the
budget moves into deficit, they consider national saving to have fallen and/or national investment
to have risen, depending on whether the rise in the deficit is driven by public consumption or
investment spending.
Accordingly, other things equal, an increase in the budget deficit will result in a rise in the
current account account deficit
Further, if the nation has an increasing budget deficit, it is to be increasingly dependent on the
foreign purchases of its debt to supplement domestic savers’ purchases of government debt.
So both a rising budget deficit and rising current account deficit indicate an increased reliance on
foreign debt purchases, which according to this viewpoint renders the domestic economy
vulnerable to unexpected and sudden changes in economic fortunes. Proponents of this
viewpoint suggest that the risk of t.
The document describes the circular flow of income model and its evolution from a simple two-sector model to a more complex five-sector model. It explains the key components of each model - households and firms in the two-sector model and the additions of government and foreign sectors in later models. It also discusses the concept of equilibrium between total leakages (savings, taxes, imports) and injections (investment, government spending, exports) and how disequilibrium can cause economic expansion or contraction until equilibrium is regained.
Government fiscal policy and the size of the government budget deficit can impact aggregate demand and economic output. A higher budget deficit occurs when government spending exceeds tax revenue. Increased government spending raises aggregate demand, leading to higher economic output and tax revenue. However, the size of the budget deficit alone does not indicate whether fiscal policy is expansionary or contractionary. The structural budget, which accounts for the output gap between actual and potential GDP, provides a better measure of the stance of fiscal policy.
Aggregate demand and aggregate supply determine macroeconomic equilibrium. Aggregate supply depends on labor, capital, and technology and can be either long-run or short-run. Aggregate demand depends on consumption, investment, government spending, and net exports. The intersection of the aggregate demand and supply curves determines equilibrium output and price levels in the short-run. Changes in factors like expectations, fiscal policy, and the world economy cause the aggregate demand curve to shift, affecting equilibrium.
GDP is used to measure economic growth and compare economic well-being over time and across countries. Real GDP measures the value of final goods and services produced adjusted for inflation. It is calculated using the chained-weighted output index method, which values one year's output using the previous year's prices and the current year's prices. While real GDP provides useful information, it does not perfectly measure economic welfare due to factors like quality improvements, household production, and environmental costs that are excluded from its calculation.
This document discusses national income accounting and the circular flow of income in economies with different numbers of sectors. It begins by defining key concepts like GDP, the expenditure and income approaches. It then examines two, three and four sector economies, defining sectors like household, business, government and foreign. It provides equations to represent the expenditure and income components in each economy, like consumption functions, investment, taxes and transfers. Overall, the document provides an overview of national income accounting and circular flow models in different types of economies.
National income is generated as households supply factors of production to firms and firms supply goods and services in return. Factors of production earn income which contributes to national income.
The circular flow of income shows how income and spending flow between households and firms. Income from the sale of goods leads to more spending, which generates more income and spending in a continuous cycle. Savings, investment, taxes, government spending, imports and exports can inject or withdraw from the circular flow and influence national income.
The circular flow of income model describes the reciprocal flow of money between households and firms. Households supply factors of production like labor to firms and receive income, while firms supply goods and services to households in exchange. This forms a continuous loop referred to as the circular flow of income, with payments in each direction. The model can be expanded to include government and foreign trade. It helps explain macroeconomic concepts like GDP, equilibrium, and the effects of policies.
National income is a measure of the total value of goods and services produced in an economy over a period of time, usually one year. It can be measured as the total income earned from production or the total spending on production. There are several definitions of national income but they generally refer to it as the total output or income of a nation. National income is commonly measured using Gross Domestic Product (GDP), Gross National Product (GNP), Net Domestic Product (NDP), and Per Capita Income (PCI). It is calculated using the Product Method, Income Method, and Expenditure Method by considering factors like consumption, investment, government spending, and trade flows.
Class Lecture Notes Measuring the MacroeconomyProfessor Shari Lyman,.docxmccormicknadine86
Class Lecture Notes Measuring the MacroeconomyProfessor Shari Lyman, Ph.D.
GDP Measures
GDP is Gross Domestic Product
GDP is the value of all final goods and services produced within a country’s borders by its own citizens or foreign citizens in a given time period.
GNP is Gross National Product
GNP is the value of all final goods and services produced by a country’s citizens within the country’s borders or in foreign lands in a given time period. http://www.diffen.com/difference/GDP_vs_GNP
Intermediate goods are used to produce other goods. For example, when Pizza Hut buys cheese to produce pizzas, the cheese is an intermediate good.
Final goods are purchased by the end user. When the Lyman household purchases cheese, the cheese is a final good.
GDP is represented by the variable Y in macroeconomic calculations.
The formula for GDP is:
Y=Consumption(C)+Investment(I)+Government Expenditures(G)+Net Exports(X-M).
Consumption (durable and non-durable goods and services for individual household consumption)
Investment (Consumption of new physical capital and new housing such as factories, machines, tools, transportation systems, new houses, etc.) Investment is purchased using financial capital instruments.
Government expenditures (all Federal, State, and Local government purchases from paper clips to aircraft carriers).
Net Exports (Trade Balance=Exports-Imports)
Macroeconomic Measures introduces the student to 3 different methods of measuring GDP:
1.the incomes approach (simplified circular flow model-resource flow approach)
2.the expenditures approach (simplified circular flow model (D) money flow approach)
3.the output approach (simplified circular flow model (S) product flow approach).
Incomes Approach (Input/resource approach)
GDP (also known as national income which is indicated by Y) is equal to the inputs used in the production process. The inputs include:
land in the form of rent
labor in the form of wages
capital in the form of interest
entrepreneurship in the form of profit.
Y = rent + wages + interest + profit.
Expenditures Approach (Demand side approach)
GDP (also known as aggregate demand (AD) which is indicated by Y) is equal to the total output demanded in the economy. The outputs include:
consumption
investment
government expenditures
net exports
Y=Consumption(C)+Investment(I)+Government Expenditures(G)+Net Exports(X-M)
Output Approach (Supply side approach)
GDP (also known as national output which is indicated by Y) is equal to the outputs supplied to the economy. The outputs include:
household goods (durable and nondurable goods and services)
investment goods (new housing and capital)
government (durable and nondurable goods and services)
net exports (goods for export minus goods imported)
Y = Household (C) + Firm and HH (I) + (G) + Net Exports (X-M)
The Keynesian Consumption (Spending) Multiplier
The Keynesian Consumption Multiplier is based on the assumption that for each additional dollar a household receives some ...
The document defines key macroeconomic concepts such as aggregate demand, aggregate supply, and their components. It discusses how equilibrium output is determined by the intersection of the aggregate demand and aggregate supply curves. The saving-investment approach to determining equilibrium is also covered, where equilibrium occurs at the point where planned saving equals planned investment. Factors that can cause excess demand and deficient demand are explained, along with their impacts and appropriate policy responses.
Here are the steps to calculate the level of GDP using the data provided:
Consumption (C) = £800bn
Government spending (G) = £300bn
Gross capital formation (I) = £250bn
Exports (X) = £400bn
Imports (M) = £350bn
Using the expenditure method formula:
GDP = C + I + G + (X - M)
= £800bn + £250bn + £300bn + (£400bn - £350bn)
= £800bn + £250bn + £300bn + £50bn
= £1400bn
Therefore, the level of GDP using the data provided
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2. 5. Students Investigates Determining of
Macroeconomic Equilibrium.
2
5.1 Investigates the components of aggregate
expenditure.
5.2 Investigates the way of determinates
equilibrium in a two sector model.
5.3 Demonstrates the changes in equilibrium
level of income due to aggregate expenditure
components using the multiplier process.
5.4 Investigates determination equilibrium in a
closed economy.
5.5 Investigates determination equilibrium in
an open economy.
3. Introduction
3
In this chapter we introduce the concepts of
aggregate demand and supply, explaining
the shapes of the aggregate demand and
supply curves and forces causing them to
shift.
Aggregate demand is the total quantity of
goods and services demanded by
households, firms, government and
foreigners at different price levels.
Aggregate supply is the quantity of goods
and services that all the firms in the country
4. Macroeconomic Equilibrium
4
Equilibrium is a state in which the opposing forces
cancel one another and produce no overall change or
variation. An economy reaches equilibrium when its
aggregate demand equals to aggregate supply.
This occurs when the total demand for all gods and
services (AD) is equal to the total supply of these
goods and services (AS). That is, for the equilibrium
level of income to be achieved, we require that;
Aggregate Demand = Aggregate Supply
E = Y
Withdrawals (Leakages) = injections
W = J
5. Aggregate Demand (AD)
5
The aggregate demand of an economy is the
total of spending incurred by households,
firms, government and the rest of the world.
It consists of private consumption
(consumption expenditure), private
investment(investment expenditure),
government spending(government
expenditure) and net exports.
E = C + I + G + X [2.1]
Where,
E = Aggregate demand or spending.
C = Private consumption.
I = Private investment.
G = Government spending.
6. 6
Some of the components of aggregate
demand are relatively stable and change
only slowly over time (e. g. consumption
expenditure); others are much more
volatile and change rapidly, causing
fluctuations in the level of economic
activity (e. g. investment expenditure).
Aggregate demand interacts with
aggregate supply to determine the
equilibrium level of national income.
Governments seek to regulate the level of
aggregate demand in order to maintain full
employment, avoid inflation, promote
7. Aggregate Demand Schedule.
7
A schedule depicting the total
amount of spending on domestic
goods and services at various
levels of national income.
It is constructed by adding
together the consumption,
investment, government
expenditure and net exports
8. AGGREGATE DEMAND SCHEDULE; This
graph shows how AD varies with the
level of national income.
8
AGGREGATE
DEMAND
C + I + G + X
NATIONAL INCOME
TOTALEXPENDITURE
0
FIGURE - A
9. 9
A given aggregate demand
schedule is drawn up on the
usual CETERIS PARIBUS
conditions.
It will shift upwards or
downwards if some
determining factors
changes. See the below
graph B.
10. Shifts in the AD schedule due to determining factor
changes. E. g. if there is an increase in the propensity to
consume, the consumption schedule shifts upwards. A
reduction in government spending will shift the schedule
downwards.
10
AD1 (C + ∆C + I + G + X)
AD (C + C + I + G + X)
AD2 (C + I + G + ∆G + X)
NATIONAL INCOME0
TOTALEXPENDITURE
FIGURE - B
11. 11
Alternatively , the aggregate demand
schedule can be expressed in terms
of various levels of real national
income demanded at each price
levels as shown in below graph C.
This alternative schedule is also
drawn on the assumption that other
influences on spending plans are
constant. It will shift rightwards or
leftwards if some determining factors
change. See graph D.
12. The graph plots the quantity of
real national income demanded
against the price level.
12 FIGURE - C
AGGREGATE
DEMAND
C + I + G +X
REAL NATIONAL INCOME
PRICELEVEL
0
13. Shifts in the schedule due to determining factor changes,
if there is a increase in propensity to consume, the AD
will shift rightwards, a reduction in government spending
will shift leftwards.
13 FIGURE - DREAL NATIONAL INCOME
PRICELEVEL
0
AD
2
AD
AD1
14. Aggregate Supply (AS)
14
The aggregate supply is equivalent
to the total production or output of
the economy.
The economy generates income by
purchasing goods ad services.
Thus the aggregate supply is
synonymous with the concepts of
aggregate output and aggregate
15. 15
Aggregate income is used [1] to buy
consumer goods and services (= C), [2]
to meet import payments (=Z), (3) to
pay taxes and (4) to make savings (=S).
This relationship can be expressed as
follows:
Y = C + Z + T + S [2.2]
Where, Y = Total income
C = Consumption of domestic goods
and services
Z = Imports of goods and services
16. 16
Using the same argument, we can also say
that an economy reaches equilibrium when
aggregate demand (=E) is equal to
aggregate supply (=Y).
E = Y [2.3]
Substituting equations [2.1 and [2.2] in
equation [2.3],
C+I+G+X = C+Z+T+S [2.4]
Cancelling C (consumption ) from both sides,
I+G+X = Z+T+S [2.5]
17. 17
The left hand side of the above equation shows
the injections and the right side shows leakages
of the circular flow diagram. So the economy
reaches equilibrium when total injections are
equal to total leakages.
Total Injections = Total Leakages
I+G+X = S+T+Z
Rearranging equation [2.5], we get
(S-I) + (T-G) + (X-Z) [2.6]
The above equation shows the following 3 gaps in
the economy.
S-I = Gap between savings and investment.
T-G = balance on the government budget
X-Z = balance on the current account of the
18. 18
It shows us a very important macroeconomic
relationship. The sum of (S-I) and (T-G), which is
on the let side of the equation, is the domestic
savings gap. The term (X-Z) on the right side is the
foreign savings gap. This implies that a deficit in
domestic savings should be matched by a surplus
in foreign savings.
Simply, what it means is that a country should
borrow from abroad to finance its savings-
investments gap and budget deficit. We can draw
some useful conclusions from this relationship as
follows;
When I > S and G > T, the country faces a
current account deficit in the balance of
19. Aggregate Supply Schedule
19
Aggregate supply schedule is a schedule depicting
the total amount of domestic goods and services
supplied by business and government at various
levels of total expenditure.
The aggregate supply schedule is generally drawn
as a 45 angle line because business will offer any
particular level of national output only if they expect
total spending (aggregate demand) to be just
sufficient to sell all of that output.
Thus, in the below figure $100 million of
expenditure calls for $100 million of aggregate
supply, $200 million of aggregate supply calls worth
20. NATIONAL PRODUCT = NATIONAL INCOME
20
45
˚
AGGREGATE
SUPPLY
$ MILLIONYf20
0
100
10
0
20
0
$
MILLIONS
AGGREGATEDEMAND
(TOTALEXPENDITURE)
21. 21
However, for once an economy's
resources are fully employed in supplying
products then additional expenditure
cannot be meet from additional domestic
resources because the potential output
ceiling of the economy has been reached.
Consequently, beyond the full
employment level of national product, Yf,
the aggregate supply schedule becomes
vertical.
22. Components of Aggregate
Expenditure
22
Aggregate expenditure is
measure of national income. It
is defined as the value of
planned goods and services
produced in an economy and a
way to measure the gross
domestic product (GDP); a
measure of the level of
23. Personnel Disposable Income.
23
Consumption means spending on
consumer goods and services like food,
cloths, medicine or durable gods.
Consumption mainly depends on
personnel disposable income.
Disposable income is equal to
household income plus transfers from
the government to households minus
taxes paid by households to the
government.
24. 24
Disposable Income = Household
Income – Taxes.
So, disposable income is
spent for consumption, and
the balance is saved;
Disposable Income = Consumption + Saving
Yd = C + S
25. 25
Therefore, the privet consumption
expenditure depends on the
disposable income. This is
illustrated as follows;
C = f (Yd)
Where,
C = Consumption
F = Function
Yd = Disposable Income.
26. The Determinants of Private
Consumption.
26
Disposable income.
The wealth of
households.
Levy of taxes by the
government.
Loans of households.
27. The Components Of Aggregate
Expenditure.
27
Private Consumption
Government
Consumption
Expenditure
Investment Expenditure
Net Export
28. Private Consumption
Expenditure Comprises;
28
Buying durable consumer goods
Buying non durable consumer
goods
Buying services
The expenditure on capital goods
is, investment expenditure
Example: Machinery, tools,
housing and etc.
29. Government Expenditure
29
Government expenditure spent to
purchase goods and services from
private sector to provide various
economic activities to the
consumers.
Example:
Provide public goods.
Provide merit goods.
National security.
33. Net Exports
33
This means the difference
between export income
and the import
expenditure. This may be
a deficit or a surplus.
Net Exports = Exports - Imports
34. Macroeconomic Equilibrium in a
Two Sector Economy (Simple
Economy).
34
Equilibrium is a state in which the opposing forces
cancel one another and produce no overall change or
variation. An economy reaches equilibrium when its
aggregate demand equals to aggregate supply.
This occurs when the total demand for all gods and
services (AD) is equal to the total supply of these
goods and services (AS). That is, for the equilibrium
level of income to be achieved, we require that;
Aggregate Demand = Aggregate Supply
E = Y
Withdrawals (Leakages) = injections
W = J
35. 35
As we noted earlier, the macroeconomic
equilibrium can be illustrated by 2 basic
methods.
Income - Expenditure Approach.
Total Expenditure = Total Output =
Total Income
∑E = ∑O = ∑ Y
Leakages – Injections Approach.
Leakages = Injections
W = J
36. Income - Expenditure Approach In
a Two Sector Economy.
36
In this approach, the total income equals
total expenditure. Therefore,
Total Income = Total Expenditure
Y = E
The total expenditure consists of private
consumption expenditure (C) and investment
expenditure(I). Therefore,
E = C + I
The total income also consists of private
consumption expenditure (C) and private savings
(S). Therefore,
Y = C + S
37. Leakages – Injections Approach In a
Two Sector Economy.
37
In this approach, savings equals leakages
and investment equals injections to the
economy. Therefore, with assuming the
earlier equations of total income and total
expenditures were given below. We must cut
off consumption (c) from both equations.
Y = C + S E = C + I
Y = E
C + S = C + I
38. Injections / Inflows (J)
38
Injections add to the total volume of the
basic circular flow of income model. That is ,
they “inject” revenue into the product market
that is, used for factor payments and
becomes households income. They are
considers as outside cash floes to the
income model. Following components can
be seen as injections.
Investment (I)
Government Purchases (G)
Exports (X)
39. Withdrawals/ Leakages (W)
39
Leakages subtract from the total volume of
the basic circular flow of income model. That
is, they “leak” income away from the product
markets, making less available for factor
payments and households income. Leakages
will shrink the income flow. Following
components can be seen as leakages.
Savings (S)
Personal Income Tax (T)
Imports (M)
W = S + T + M
40. The Consumption Function In a
Two Sector Economy.
40
The consumption function shows the
relationship between planned and
disposable income. This consumption
function indicates how much will be spent on
consumption at different level of income.
There is a direct or positive relationship
between planned consumption and
disposable income. i.e. as disposable
income rises planned consumption also
rises. The consumption function is a single
mathematical function to express consumers
41. 41
The consumption function can
be illustrated as follows.
C = a + bYd
Where,
C = Total Consumption.
a = Autonomous Consumption (a > 0 )
b = Marginal Propensity to Consume
(Induced Consumption, 0 < b <1)
y = Disposable Income.
42. 42
As we noted that there is no government in our two
sector economy, total national income can be
considered as disposable income. So we can
express the relationship between income and
consumption in the following example of a
consumption function;
C = 100 + 0.75 Yd [2.1]
Where, C = planned household consumption, and
Yd = disposable income.
The above equation indicate that households
maintain a basic autonomies consumption level of
100, irrespective of the income level. Autonomous
consumption does not depend on income.
(autonomous here means “independent of income”).
In other words, households are prepared to spend
say Rs. 100, even their income is zero. When
43. 43
For example, if the households
income rises by R. 1000 (= 1000
x 0.75), they use Rs. 750 of that
additional income to buy goods
and services. This coefficient
known as the marginal propensity
to consume.
45. Autonomous Consumption
45
This is a part of the consumption
expenditure that does not vary with changes
in national income or disposable income. In
the short term, consumption expenditure
consists of induced consumption
(consumption expenditure that varies
directly with income) and autonomous
consumption.
Autonomous consumption represents some
minimum level of consumption that is
necessary to sustain a basic standard of
46. Consumption Schedule/
Function more Illustrated Curve.
46
A schedule depicting the relationship between
consumption expenditure and the level of
national income or disposable income, also
called consumption function.
At low levels of disposable income,
households consume more than their current
income,
Drawing on past savings, borrowings or selling
assets in order to maintain consumption at
some desired minimum level (autonomous
consumption).
47. Consumption Function Curve
47
Consumption schedule; a simple consumption
schedule that takes the linear form C = a + bY ,
where C is consumption and “a” is the minimum
level of consumption expenditure at zero-disposable
income (autonomous consumption).
Thereafter, consumption expenditure increases as
income rises (induced consumption), and “b” is the
proportion of each extra currency (Rs. or $) of
disposable income that is spent.
The 45 degree line 0 E shows what consumption
expenditure would have been had it exactly matched
disposable income.
The difference between 0 E and the consumption
expenditure schedule indicates the extent of
dissavings or savings at various income levels. The
slope of the consumption schedule is equal to the
marginal propensity to consume.
48. 48
45
˚
E
Consumption
Schedule
C = a + bYd
Induced
Consumption
Autonomous
Consumption
Disposable Income
Consumption/Savings
0
Dissavings
Savings
49. Marginal Propensity to Consume
(MPC)
49
The fraction of any change in national income that
is spent on consumption, alternatively the change
in consumption can be expressed as a proportion
of the change in disposable income.
In other words, the MPC is equal to the ratio of
change in consumption to change in income. The
MPC measures change in consumption as a
proportion of the change in income. Where “b” is
equal to MPC. Symbolically,
MPC = ∆C / ∆Y
MPC = Change in Consumption
50. The MPC
50
∆ C
∆ Y
Autonomous Consumption
C = a + bY
0 Income (Rs.)
Consumption
(Rs.)
51. The Saving Function in a Two
Sector Economy.
51
This is a mathematical relationship between
saving and income by the household sector.
The saving function can be stated as an
equation, usually a simple linear equation, or
as a diagram designated as saving line. This
indicates the saving income relationship.
The level of savings is equal to
national income minus
consumption expenditure;
S = Y – C [2.2]
52. 52
By substituting the earlier consumption
function in the above expression, we can
derive the following savings function (Since
C = 100 + 0.75Y);
S = Y – (100 + 0.75Y)
= Y – 100 – 0.75Y
(Y – 0.75) = - 100 + 0.25 Y
The above equation tells us that households
save 0.25 of their increased income. In the
earlier example, households save Rs. 250
(=1000 x 0.25) of their additional income of
Rs. 1000. the coefficient 0.25 is called the
53. Marginal Propensity to Save
(MPS)
53
The MPS defines the relationship between change in
saving and change in income. It is the change in
saving divided d by the change in income.
MPS = ∆ S / ∆ Y
MPS = Change in Saving
Change in Income
We can show the relationship between MPC and
MPS as follows;
C + S = Y [2.3] see equation 2.2
∆ C + ∆ S = ∆ Y
(∆ C / ∆ Y) + (∆ S / ∆Y) = 1
MPC + MPS = 1
54. Continued…….MPS
54
Where,
∆ = Change
∆ Y = Change in income
∆ C = change in consumption
∆ S = change in saving
The MPC and MPS, will always be constant at
all the levels of income in our examples. The
MPS + MPC must always to be equal to 1.
because any change in income is either
consumed or saved, that balance share of
additional income that is not consumed, it
must be saved.
55. Saving Function (Algebraic)
55
Saving function also can be illustrated as
S = -a + (1-b) yd
Where,
S = Savings
-a = Autonomous Savings
(1-b) = Marginal Propensity to Save
(MPS)
57. Continued………..Savings
57
The saving schedule is a schedule that depicts
the relationship between savings and the level
of income. In the simple two sector model, all
consumption and savings accounted for by
households.
At low levels of disposable income ,
households consume more than their current
income (dissavings). At higher levels of
disposable income, they consume only a part
of their income and save the rest, see the
above graph.
58. Investment Function in a Two
Sector Economy
58
Investment means spending on capital goods
( plant, equipment, inventory) that are used
in the production of other goods and
services. Business investment depends on
various factors such as interest rates,
expectations and future rates of return.
However, the relationship between business
investment and current level of income is
generally weak. Therefore we assume that
investment is autonomous. As a function of
income, autonomous investment is drawn as
60. 60
The Equilibrium in a simple
economy can be computed with,
a schedule
graphical presentation
Equations
Let us see how the equilibrium in
a simple economy (2 sector
economy) by a hypothetical
schedule and according to that
table we can present the graphical
curve.
62. 62
10
0
20
0
30
0
40
0
500
600
700
100 200 300 400 500 600 700
E = Y
C + I
C
I
E
Aggregate
Expenditure [E]
Aggregate Income [Y]0
According to the
diagram, the
equilibrium national
Income is illustrated
with the point E.
63. The Changes in Equilibrium Level
of Income due to Aggregate
Expenditure Components Using
the Multiplier Process.
63
The Change in equilibrium in a
simple economy depends on the
following components.
Change in consumption function.
Change in investment.
64. 64
The Change in consumption
function depends on two
factors.
1. Change in Autonomous
Consumption.
2. Change in Marginal
Propensity to Consume
(M.P.C).
65. The Change in consumption function
can be illustrated as a change in
Autonomous Consumption.
65
C
Yd
50
0
100
C1 = a1 + by
C = a + by
A
C
66. In the above diagram we can see how the
consumption curve shifts when the
autonomous consumption changes. As a
result of this the aggregate expenditure
curve also shifts. Therefore the equilibrium
point changes (see the diagram below).
66
10
0
50
120 1500
Y = E
E1 = C1 + I
E = C + I
A
B
67. The change in equilibrium due to the
change in Marginal Propensity to
Consume MPC.
67
C1 = a +b1y
C = a + b y
Y10000
200
300
C
68. The slop of the consumption curve changes as a
result of the change in MPC. Due to this , the slope
of the aggregate expenditure also changes leading
to a change in the equilibrium level of output.
68
Y = E
C1
C
E
A
B
Y
1000 12000
1200
1500
The Equilibrium point also
changes from A to B.
69. The change in investment will
affect the equilibrium of a simple
economy.
69
E 1 = C + I1
E = C + I
I 1
I
Output Y
Expenditure
100
50
0
70. When the investment changes the investment curve
shifts. Then the aggregate expenditure curve also
shifts. As a result of this, equilibrium output and
the points also will change.
70
Y = E
E1
E
C
D
0
Expenditure
Output Y
71. The Multiplier Effect in a
Simple Economy.
71
The multiplier principle states that with
an injection of money into the circular
flow income, the national income, thus
generated would be many times more.
The value of the multiplier can be given
as;
k = ∆ Y
∆ J
And the increase in the level of income
can be calculated by the formula;
72. 72
Thus an injection of money cause a multiple
increase in the income and a withdrawal of
money from the circular flow of income
cause a multiple decrease in the national
income. Here the multiplier works reverse.
In a two sector economy, i. e. an economy
which has no government and foreign trade,
investments would be the only injection and
savings is the only withdrawal. Due to this
reason the multiplier is weakened by only
one factor, savings. The multiplier is
calculated by below formula.
k = 1 1
1- MPC or MPS
73. 73
If there is a change in autonomous
expenditure, the change in the output
can be calculated as follows.
∆ Y = 1
[1-b] x ∆ I
Where,
∆ Y = change in income
∆ I = change in autonomous
investment
b = MPC
74. Example
74
Assuming Marginal Propensity to consume is
0.75 when investment (I) is increased from 50
to 100. find the change in the level of output.
∆Y = 1 x ∆ I
(1-b)
∆Y = 1 x [100 – 50]
(1 – 0.75)
∆Y = 1 x 50
(0.25)
∆Y = 4 x 50 = 200.
75. This is illustrated in a diagram.
75
Y = E
E = C + I 1
E = C + I
1000 1200
100
50
0
Y
E
∆ Y
∆ I
76. Determining the Equilibrium
in a Closed Economy.
76
As the government enters to our simple economy, it
changes into a closed economy or 3 sector
economy. Therefore, the aggregate income and
expenditure components include Taxes (T), Government
purchases (G) and transfers (Tr). Here only autonomous
taxes are considered as taxes.
The following components are used to compute the
equilibrium in the closed (3 sector) economy.
Consumption (C)
Savings(S)
Autonomous taxes (T)
Government Purchases (G)
Transfers (TR)
Investment (I).
77. 77
By using the above components the equilibrium can
be explained with two approaches.
Income - Expenditure Method.
Aggregate expenditure in a closed economy can be
explained as the sum of private consumption
expenditure (C) Investment (I) and government
purchases.
E = C + I + G
Y = E
Y = C + I + G
Aggregate income (Y) in a closed economy equal
the sum of expenditure on private consumption (C)
Personal savings (S) and Autonomous taxes (T).
Y = C + S + T
78. 78
Withdrawals - Injections Method.
E = C + I + G
Y = C + S + T
Y = E
C + I + G = C + S + T
I + G = S + T
Where,
S = Savings.
T= Autonomous taxes.
I = Investment
G = Government purchases. Injections
Leakages
79. The consumption function in a
closed economy can be
illustrated as,
79
C = a + b ( Y-T+TR )
Where ,
a = Autonomous consumption
b = Marginal Propensity to consume
T = Autonomous taxes
TR = Transfers
80. 80
Output
Y
C S T I G E Y - E
585 460 115 10 45 95 600 -15
630 500 120 10 45 95 640 -10
675 540 125 10 45 95 680 -5
720 580 130 10 45 95 720 0
765 620 135 10 45 95 760 5
810 660 140 10 45 95 800 10
855 700 145 10 45 95 840 15
• Consider the example table below.
81. The point “A” is the Equilibrium in
the Closed Economy
81
Y = E
E = C + I + G
C = a + b [Y – T + Tr]
S + T
I + G
OUTPUT [Y]
C,I,S,T,G,E
EXPENDITURE
0
A
82. Determining the Equilibrium in
an Open Economy [4 Sector].
82
When a closed economy (3 sector
economy) is changing into a 4 sector
economy, by introducing international
trade, it is called an open economy.
The basic model of an open economy
is the same as that of a closed
economy and we should add exports
(X) and imports (M); due to
international trade.
83. The components that are used to compute
the equilibrium in an open economy are as
follows.
83
Consumption (C)
Savings (S)
Investment (I)
Government purchases (G)
Transfers (Tr)
Autonomous taxes (T)
Imports (M)
Exports (X)
84. The Equilibrium in an Open
Economy under Income-
Expenditure Approach.
84
Y = C+I+G+ (X-M)
Where,
Consumption = (C)
Investment = (I)
Government purchases = (G)
Imports = (M)
Exports = (X)
85. The Equilibrium in an Open
Economy under Withdrawals -
Injections Approach.
85
Withdrawals = S + T + M
Injections = I + G + X
W = J
S + T + M = I + G + X
Savings (S), autonomous taxes (T) and Imports
(M) are considered as withdrawals.
Investment (I) Government purchases (G) and
Exports ( X) are considered as injections.
87. Bibliography
87
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88. 88
Colombage. S. S. ”Principles of
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89. 89
Begg, David K. H., et al, Economics, 4th Eds.
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