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Basic Keynesian Model Keynesian Cross Diagram

Basic Keynesian Model Keynesian Cross Diagram. Measuring the macroeconomy. GNPpm = GDP – factor incomes from abroad + factor incomes of foreigners NetNPpm = GNPpm - Depreciation

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Basic Keynesian Model Keynesian Cross Diagram

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  1. Basic KeynesianModel Keynesian Cross Diagram

  2. Measuringthemacroeconomy • GNPpm = GDP – factor incomesfromabroad + factor incomes of foreigners • NetNPpm = GNPpm - Depreciation • NNP at factor costs = Net NationalProduct – Net indirecttaxes + Subsidies (NNP=net nationalproduct at factor costs) • NI (NationalIncome) = NNPcf • Personal DispousableIncome (PDI = Familyincome = NI – Directtaxes + Transfers - Profits + Undistributedprofits • Personal DisposableIncome (PDI = Familyincome )= ConsumptionSpending+ Savings • Consumerpriceindex: the CPI measuresthepriceincrease of a merketbasketfogoodsrepresentative of thepurchases of a typicalhousehold • TheUnemploymentrate: Theunemployed are peoplewhowanttowork and are activelylookingforjobsbuthavenotyetfoundone. Theunemploymentrateisequaltothenumber of unemployedpeopledividedbythe total labor force.

  3. Macroeconomicmodel

  4. Key concepts • GDP composition • The demand of goods and services • The equilibrium

  5. Intendedexpenditureoraggregatedemandcomponents

  6. EXPENDITURE (FLOW OF EXPENDITURE) MARKET GOODS & SERVICES MONETARY FLOW HOUSEHOLDS FIRMS (CONSUMPTION) (PRODUCTION) MERCADO DE FACTORES DE PRODUCCION INCOMES –WAGES ((FLOW OF INCOMES) REAL FLOW FACTORS The circular flow of economicactivity GOODS AND SERVICES Demandvaries, production Productionvaries, incomevaries Incomevaries, demandvaries

  7. National income identity • Production is equal to income. Then: • This last equation states that savings should be sufficient for financing the investment spending, the budget deficit and the trade deficit. In other words, increases in budget or trade deficits unless accompanied by an equal increase in savings will lead to the crowding out of investment

  8. Short-runmacroeconomicmodels • Keynesianmodel (Endogenous variable: Income) • Fixedprices • Pureexchangeeconomy. No money • IS-LM Model (Endogenous variables: income-interest rate) • Fixedprices • Monetaryeconomy • Open economywithout capital flows • IS-LM with capital mobility (Mundell-Fleming) (Endogenous variables: Income-interestrates) • Fixedprices • Monetary economy • Open economywithcapital flows • Aggregate supply and demand model (Endogenous variables: Prices-Income). AS-AD diagram • Sticky prices • Monetary economy • Dynamic AS-AD model (endogenous variables: inflation rates and income)

  9. Keynesianmodel: assumptions • Government sector: (0<t<1) • Budget deficit (BS) isdefinedbythedifferencebetweentaxes and thesum of government purchases (G) and transfers (TR). • Open Economy: net export is a decreasing function of national income. The coefficient m, is the marginal propensity to import. • No money • Fixedprices: no inflationnordeflation

  10. Keynesianmodel • In thismodel a macroeconomicequilibriumisreachedwhen actual ouput Y, isequaltointendedspending. Hence, thelevel of theaggregatedemand determines theincomelevel. • AD Components • Consumptionspending (C), • Investmentspending (I), • Governmentpurchases, G, • Investmentspending, I. • Therefore Y+Q-X isequalto: and Being X and Q, export and import, respectively.

  11. Keynesianmodel • Equations: • Susbtracting (7) - (8), s:

  12. Keynesianmodel • Ecuaciones del modelo: • Substituting (4) in (3)

  13. Simple keynesianmodel • Substituting (5), (6), (9) y (10) in (2)

  14. Keynesianmodel • Equations are now: • Substituting (11) into (1) :

  15. Keynesianmodel • In compact form: • ¿Qué dice aquí? • Theequilibriumlevel of incomeisdeterminedbythemultiplier and bytheautonomousexpenditurecomponent. • Anyincrease in autonomousspendingoranyincrease in themultiplierwillchangenationalincome. • Proof:

  16. Keynesianmodel • dAo: • Interpretation • Anychange in autonomousconsumptionspending, autonomousinvestmentspending, marginal propensityto consume out of disposable personal income , ttransfers, governmentpurchasesorautonomous net exportwillincreaseautonomousspending . • Ontheotherhand, anychange in t, m or c willchangethemultipliervalue

  17. Check • By using the last equation • we can check that

  18. Types of changes in theexogenous variables • Exogenous variables in themodel can besplittedintotwogroups: a) variables dependingontheindividual’sdecisions: (c, I, m); variables determinedbyauthorities (Governmentor Central Bank):G, TR, XN, t. Changes in G, TR, XN and t are fiscal and trade policy variables. Changes in this variables are policy shocks. • Sincechangesin G, TR y t, will lead changes in budget surplus, they are defined as fiscal policyinstruments. • Changes in tariffsor in theexchangerate in ordertochangeNXo, are tradepolicyinstruments.

  19. Expansionary vs. Contractionarypolicies • If as a result of anykind of policy shock incomeincreases, thispolicyisexpansionary. The so-calledcontractionarypolicies lead incomedecreases. • Forinstance, • Increase in G : Fiscal policyexpansionary • A taxcut: Fiscal policyexpansionary • Decrease in TR: Fiscal policycontractionary • A cut in tariffs: Tradepolicycontractionary • A decreaase in the marginal propensityto consume (NO policy)

  20. Themodel HORIZONTAL AXIS: INCOME (Y) VERTICAL AXIS: DEMAND(AD) Demand (AD), Production (Y) Renta,Y

  21. 45º LINE: EQUILIBRIUM CONDITION Y=DA 45o LINE Y=AD Demand (AD), Production (Y) SLOPE= 1 Y1 INCOME,Y Y1

  22. THE INTENDED EXPENDITURE OR AD 45o LINE AD AD SLOPE AD=c(1-t)-m Ao Y

  23. THE EQUILIBRIUM AD 45o LINE AD E EQUILIBRIUM: Y = DA AUTONOMOUS SPENDING Y

  24. AD1=A1+(c(1-t)-m)Y E’ Y1 E Yo 45º Yo Y1 ¿HOW AN INCREASE IN NET EXPORT WOULD AFFECT THE EQUILIBRIUM INCOME? AD Y=AD ADo=Ao+(c(1-t)-m)Y A1 Ao INCOME,Y

  25. HIGHLIGHTS • C and I will decrease in recessions • Howver, Government could increase G (government purchases): • Government intervention vs. laissez faire-laissez-passer. • Key argument: multipliereffect. From this model, what are the recipes for the crisis

  26. Multiplier effect • For simplicity suppose that we are in a closed economy, and suppose that Government increases the government purchases. • The increase in government purchases by 1 euro changes intended spending by 1 euro and income in 1 euro. After tax, 1-t euros will be disposable for consumption . Therefore, the consumption spending will increase in c(1-t) euros, so the intended spending goes up and income will also increase in c(1-t). • This new increase in income, will lead a new increase in consumption spending of …. • The sum of the initial effects and the rest of induced effects determines that the multiplier will be higher than 1.

  27. Fiscal policy and Budget surplus How an increase in G would affect the budget deficit?

  28. How an increase in G would affect the budget deficit? • Taking differences • The increase in income from the increase in government purchases is , dY=αdG then:

  29. Extensions

  30. AD1=A1+(c(1-t)-m)Y E’ Y1 Yo E 45º Yo Y1 An increase in the Government purchases AD Y=AD ADo=Ao+(c(1-t)-m)Y A1=C0+I0+G1+cTRo+NXo Ao=C0+I0+G0+cTRo+NXo Income,Y

  31. AD1=A1+(c(1-t)-m)Y E’ Y1 Yo E 45º Yo Y1 An Increase in the Transfers AD Y=AD ADo=Ao+(c(1-t)-m)Y A1=C0+I0+G0+cTR1+NXo Ao=C0+I0+G0+cTRo+NXo INCOME,Y

  32. AD0=Ao+(c(1-t)-m)Y E Yo 45º Y1 An increase in the tax rate AD Y=AD AD1=Ao+(c(1-t1)-m)Y Y1 E’ Ao=C0+I0+G0+cTRo+NXo Income,Y Yo

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