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ECO 121 Macroeconomics

ECO 121 Macroeconomics. Spring 2010. Aisha Khan Section L & M. Lecture Ten. Recap - Aggregate Expenditures. M&B - Chapter 10 Changes in AE  due to investment changes Multiplier effect Introduce Net exports and Government Purchases S+T+M=I+G+X. Taxation.

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ECO 121 Macroeconomics

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  1. ECO 121 Macroeconomics Spring 2010 Aisha Khan Section L & M Lecture Ten

  2. Recap - Aggregate Expenditures • M&B - Chapter 10 • Changes in AE  due to investment changes • Multiplier effect • Introduce Net exports and Government Purchases • S+T+M=I+G+X

  3. Taxation • Government also collects taxes • Suppose it imposes a lump sum tax • Tax of a constant amount • Yielding a constant amount of tax revenue at each eq GDP • An increase in taxes lowers AE according to the MPC

  4. Balanced budget muiltiplier • Curious result • Equal increases in G and T simultaneously cause an equal rise in equilibrium GDP • Increase in G by $20 billion and an offsetting increase in T by $20 bullion cause Equilibrium GDP to rise by $20 billion

  5. Rationale • Increase in G is direct and adds $20 billion to AE • An increase in T has an indirect effect through the C and S schedules (T reduces disposable income and then C falls by the amount of the tax times MPC) • Balanced budget multiplier = 1 • Different MPC/ multipliers yield the same balanced budget multiplier

  6. Equilibrium vs Full employment GDP • Recessionary gap • When equilibrium GDP is less than full employment GDP • The amount by which the AE must shift upwards to achieve full-employment GDP • Inflationary gap • When AE exceed full employment GDP • The amount by which the AE must shift downwards to achieve full-employment GDP

  7. Recessionary gap AE0 C+I = GDP Aggregate expenditure C+ I AE1 Recessionary gap 45 GDP Full-employment GDP

  8. Inflationary gap AE2 C+I = GDP AE0 Aggregate expenditure C+ I Inflationary gap 45 GDP Full-employment GDP

  9. Limitations to the Model • Model can account for demand pull inflation but does not indicate the extent of inflation when there is an inflationary gap • Doesn’t explain how inflation is possible before reaching full employment levels

  10. Doesn't indicate how output beyond full-employment is possible • Model doesn’t address the possibility of cost-push inflation

  11. Read at home Read section : Application to the Model

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