This document provides an introduction to macroeconomic equilibrium and the concept of the Keynesian multiplier. It discusses how (1) an economy starts in equilibrium, (2) a disturbance such as an increase in government spending can occur, and (3) the economy transitions to a new equilibrium level of output and income through the multiplier process. Specifically, it explains that each additional round of spending leads to progressively smaller increases in overall output until a new equilibrium is reached, and the size of the multiplier depends on the marginal propensity to consume.

1. INTRO TO MACROECONOMICS
Tutorial 4
Raj.Chande@bristol.ac.uk

2. EQUILIBRIUM: GET USED TO THE CONCEPT
 Economic equilibrium is a state of the world where
economic forces are balanced and in the absence of
external influences the (equilibrium) values of economic
variables will not change (Wikipedia).
 Many questions will follow this format:
Equilibrium > Disturbance > Transition >
New Equilibrium
 Explain the transition and describe the differences
between the two equilibria

3. Q)1)
 Start at an equilibrium. How do we know it is an
equilibrium?
Because Z = Y
 Disturbance?
An increase in G is the best example of a
disturbance. Why?

4. OK... SO NOW WHAT? TRANSITION
 A 1 unit increase in G leads to a 1 unit increase in
Y, the extra unit on government production has to
be received by someone as income
 But a 1 unit increase in Y leads to an increase in C
by c1 (c1 x 1 unit) which means Y has increased by
c1, which means C will increase by c1 x c1 and so
on and so on.
 Each increase in Y is smaller than the last, so we
converge to a new equilibrium level of Y
 The ultimate increase in Y as a result of a 1 unit
increase in G is 1/(1-c1)
 In this case, 1/(1-c1) is the Keynesian Multiplier

5. JUST TO REPEAT
EQUILIBRIUM: Z0 = Y0
DISTURBANCE: ΔG
TRANSITION: Δ Y > Δ C > smaller Δ Y...
NEW EQUILIBRIUM: Z1 = Y1
(Y1-Y0) = Δ G / (1-c1)

6. 2) GENERALLY GOOD
 Write the equation each time, dull but necessary
iii) Δ Y = Δ G / (1-c1)
So if Δ Y = 100, then 100 = Δ G / (1-0.75)
Δ G = 25
Tax equivalent? Δ Y = -c1(Δ T)/(1-c1)
Δ T = -33.33

7. 2)IV)
 Now taxes are:
T = 80 + 0.25Y Note that T=f(Y)
Equilibrium income (Y = Z) is now:
Y = 60 + 0.75(Y – 80 – 0.25Y) + G + I
So now each increase in C leads to a smaller
increase in Y.
Y = 250/0.4375 = 571.43

8. KM IS NOT ALWAYS THE MPC
 In the second case, T=f(Y)
 If Y increases, there is less Y left for C after taxes,
i.e. Yd is lower than it would have been before
 The new multiplier is actually 2.29, lower than
before