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ECO 120 Macroeconomics Week 6

ECO 120 Macroeconomics Week 6. Review of Weeks 1-5 Lecturer Dr. Rod Duncan. Topics. General topics covered in first 5 weeks: Consumption function AE function Calculation of equilibrium in the AE model Multiplier in the AE model AD/AS model Investment and the NPV concept.

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ECO 120 Macroeconomics Week 6

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  1. ECO 120 MacroeconomicsWeek 6 Review of Weeks 1-5 Lecturer Dr. Rod Duncan

  2. Topics • General topics covered in first 5 weeks: • Consumption function • AE function • Calculation of equilibrium in the AE model • Multiplier in the AE model • AD/AS model • Investment and the NPV concept

  3. We have one central model in this subject, which is the AD-AS model. We draw the AD-AS model, then our prediction about the economy is where the AD and SR AS curves intersect. But first, the big picture ASLR P ASSR P0 AD Yn Y0 Y

  4. The big picture • We want to use the AD-AS model to discuss the real world- to talk about the consequences to the Australian economy of: • New government policies • Changes in existing government policies • Events happening outside Australia • Changes within Australia, such as introduction of new technologies or the aging of the Australian population

  5. The big picture • But in order to do this, we have to know what factors can affect our AD-AS model: • Why the Ad and AS curves slope the way they do? • What changes will shift the AD and AS curves and the direction of the shift? • In order to know these things, we have to know how the AD and AS curves are constructed. • Once you understand where the AD and AS curves come from, you understand how they behave.

  6. The big picture • An alternative way to teach this class would be to simply start with the AD-AS model (at Chapter 8) and then simply list the factors that shift the AD and AS curves and the direction of change. • You could do everything that we can do with the AD-AS model, but you wouldn’t understand why, for example, the AD curve shifts right if consumers’ wealth rises. • This understanding is why we started this subject at the consumption function.

  7. A linear consumption function • C(Y) = a + b Y, a > 0 and b > 0 C(Y) C(0) = a, so even if Y=0, C > 0. Slope is b > 0, so C is increasing in Y. a Y

  8. Linear savings function Y* S(Y*) C(Y) Y* C(Y*) S(Y) Y Y Y’ Y’ Y* Negative S Positive S Negative S Positive S

  9. Then we add investment demand which depends on the interest rate, i. But total spending on goods and services is a sum of: AE = C + I + G + NX Investment demand i i0 I I0 I

  10. Aggregate expenditure function • This equation is a relationship between income (Y) and aggregate expenditure (AE). AE = 200 + 0.5Y $250bn Slope is 0.5 $200bn Y $100bn

  11. Equilibrium • The equilibrium value of Y is where the 45 degree line and the AE line cross. Y* is at $400bn. Y AE = 200 + 0.5Y 400 Y 400

  12. Equilibrium occurs at a price level where goods demand (AD) is equal to goods supply (SR AS). Equilibrium P AS P0 AD Y0 Y

  13. The big picture P, Wealth, H/h Expectations, H/h Taxes C P, i, Business Expectations, Business Taxes I AE AD Government policy, and? G NX P, and?

  14. The big picture • This is essentially the path the subject has taken so far. In the next part of the subject, we will be looking at what determines G and NX, plus a lot of other topics.

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