1 / 19

The Full Aggregate Expenditure Model

The Full Aggregate Expenditure Model. Adding investment, taxes, government and the foreign sector. The Partial Model. Previous model put most of the emphasis on household consumption Had autonomous and induced consumption Especially ignored the effect of taxes on household consumption

driscoll-mooney
Download Presentation

The Full Aggregate Expenditure Model

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The Full Aggregate Expenditure Model Adding investment, taxes, government and the foreign sector

  2. The Partial Model • Previous model put most of the emphasis on household consumption • Had autonomous and induced consumption • Especially ignored the effect of taxes on household consumption • Basic equilibrium conditions still hold • But want a richer understanding of how different sections interact

  3. The Full AE Model • Fully specify all behavior actions • Richer induced behavior • Keep some elements exogenous • Government purchases • Exports • Investment (although will change this when we bring money into the economy) • Make taxes and imports endogenous

  4. Mathematical Model • Starts with the same identity for AE AE = C + I + G + X – M • Add behavioral equations for components • Consumption C = c0 + c1*(Y-T) (Y-T) is called disposable income c0 is autonomous consumption, c1 is the MPC • Imports M = m*Y All imports are induced, m is the marginal propensity to import

  5. Mathematical Model (cont) • Taxes are also endogenous T = t0 + t1*Y • Autonomous part (t0) are things like property taxes • Induced part (t1*Y) includes things like income taxes. Think of t1 as the marginal tax rate (a parameter) • Y is, of course, national product (which equals national income) • Keep government (G), exports (X) and investment (I) as exogenous

  6. Mathematical Model (cont) • Final component is equilibrium condition • Y = AE • So substitute the component equations into the identity for AE

  7. Mathematical Model (cont) Y = AE = c0+c1*[Y-(t0+t1*Y)] + I + G + X – mY collecting terms we get Y = [c0-c1*t0+I+G+X] + [c1*(1-t1)-m]*Y which we can write as Y = a0 + a1*Y where a0 =c0-c1*t0+I+G+X and a1 = [c1*(1-t1)-m]

  8. Mathematical Model (cont) • We have autonomous and induced spending • a0 is autonomous • a1*Y is induced • a1 is the marginal propensity to spend • The portion of each additional dollar spent • It will be between 0 and 1 • An increase in the MPC increases a1 • Increases in the marginal tax rate (t1) or the marginal propensity to import (m) decreases a1

  9. Mathematical Model (cont) • The equilibrium value of Y is Ye = a0/(1-a1) • Increases in autonomous spending, decreases in autonomous taxes will increase Ye

  10. Changes in autonomous spending

  11. Mathematical Model (cont) • Increases in MPC, decreases in t1 or m will increase Ye • Expenditure multiplier is 1/(1-a1) • It also increases as MPC goes up, or t1 or m go down

  12. Changes in marginal propensity to spend

  13. Policy Questions • Autonomous Taxes and Government Spending • Which has a bigger effect on the economy, cuts of autonomous taxes or spending increases • Hint, look at how each is affected by the multiplier • An increase in G is multiplied by 1/(1-a1) • A decrease is autonomous taxes increases C by c1*t0, so the cut in t0 is multiplied by c1/(1-a1) • Which is bigger?

  14. Policy Questions (cont) • Marginal Tax Rates • Affects the expenditure multiplier • Thus, has a bigger effect by increasing (if t1 is cut) the multiplicative effect on all autonomous spending • How does this compare to cutting t0 • Trade Policy • Do changes in imports and exports have different effects?

  15. Equilibrium in another context • Equilibrium requires that the circular economy is in equilibrium • That is, we assume leakages=injections • So I + X + G = S + M + T • Rearrange equilibrium of injections and leakages (T – G) + S = I + X - M • The left hand side is total economy savings • The right hand side is total economy investment

  16. Equilibrium in another context (cont) • T-G is the total savings (or dissavings, if G>T) by the government • X-M tells us how much is gained (or lost if M>X) by foreign trade, which can be invested in the economy (but see below) • So still need (total) savings = (total) investment for equilibrium

  17. Equilibrium in another context (cont) • Rearrange equilibrium of injections and leakages once more so we can where I comes from I = S + (M-X) + (T-G) • I is the amount available to invest in growth – for future consumption • Government deficits (when G>T) reduces investment (assuming S constant)

  18. Equilibrium in another context (cont) • Trade deficits (when M>X) increases private investment because of more foreign investment in the US (assuming S constant) • Foreign owners gain US capital • So a trade surplus, (X>M) means private investment in US is lower (holding all else constant. • We’ll see that foreign exchange markets push that surplus into US investment in other countries • US gains ownership of foreign capital

  19. Policy Questions • Kerry promises he has a funding source for all new programs he plans to institute • If taxes increase to cover new government spending, will DGP increase or decrease? • Will it matter if the funding is through autonomous or induced taxes? • HINT: think about changes in autonomous spending against changes in the multiplier.

More Related