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ECO 121 Macroeconomics

ECO 121 Macroeconomics. Spring 2009. Aisha Khan Section F & G. Lecture Nine. Aggregate Expenditures. M&B - Chapter 10 We examine now why real GDP might be unstable and subject to cyclical fluctuations We revise the model slowly towards a more realistic model. Changes in Equilibrium GDP.

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ECO 121 Macroeconomics

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  1. ECO 121 Macroeconomics Spring 2009 Aisha Khan Section F & G Lecture Nine

  2. Aggregate Expenditures • M&B - Chapter 10 • We examine now why real GDP might be unstable and subject to cyclical fluctuations • We revise the model slowly towards a more realistic model

  3. Changes in Equilibrium GDP • Equilibrium GDP changes in response to changes in consumption and investment schedules • (remember GDP = C + I) • Since consumption is more stable, this chapter focuses on the unstable investment spending and how its changes affect eq GDP

  4. Investment changes • Suppose that investment spending rises by $5 billion • Due to profit expectations or changes in the interest rate

  5. (C+I)1 (C+I)0 C+I = GDP Aggregate expenditure C+ I (C+I)2 45 GDP 490 450 470

  6. Multiplier Effect • A $5 billion change in investment causes a $20 billion change in GDP  multiplier effect • Multiplier = in real GDP / initial  in spending

  7. Initial change in spending is usually associated with investment spending because its so volatile • The initial change refers to an upward/downward shift in aggregate spending due to a change in one of its components • Multiplier works in both directions

  8. Multiplier and MPC • The size of the mpc and the multiplier are directly related • The size of the mps and the multiplier are inversely related • Multiplier = 1/mps =1/(1-mpc)

  9. International Trade and Equilibrium Output • NX affect aggregate expenditures • Exports expand spending on domestic output • Imports contract spending on domestic output • Net export schedule • Independent of GDP, can be positive or negative

  10. Positive NX  ( exports > imports ) • Expand spending • Expansionary effect • Again multiplier effect • Negative NX  ( imports > exports ) • Contract spending • Contractionary effect

  11. (C+I)1 +NX1 (C+I)0 C+I = GDP Aggregate expenditure C+ I (C+I)2 +NX2 45 GDP 490 450 470

  12. International economic leakages • Prosperity abroad generally raises our exports • Trade barriers • Depreciation of dollar  lowers cost of US goods to foreigners  discouraging our exports

  13. Adding the Public Sector • Simplifications • Simplified investment and NX schedules  independent of GDP • Government purchases don’t impact private spending • Net tax revenues on from personal taxes • GDP = NI = PI • Tax collections are independent of GDP levels • Price level is assumed to be constant

  14. Increase in government spending boosts aggregate expenditure • Government expenditure is subject to the multiplier

  15. (C+I)1 +NX1 + G (C+I)+NX C+I = GDP Aggregate expenditure C+ I C 45 GDP

  16. Taxes reduce DI  consumption and saving lowered at each level of GDP • Therefore the sum of leakages = sum of injections • S + M + T = I + X + G

  17. Say’s Law “Supply creates its own demand” Classical versus Keynes

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