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The Macro Saga of Bubba and Bubbalonia

The Macro Saga of Bubba and Bubbalonia. When Bubba gets a raise of $20 per week, he spends an extra $15 on fishing gear and other stuff. When Bubba gets laid-off, he still spends $60 or so---by drawing down past savings. Can you calculate Bubba’s marginal propensity to consume.

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The Macro Saga of Bubba and Bubbalonia

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  1. The Macro Saga of Bubba and Bubbalonia

  2. When Bubba gets a raise of $20 per week, he spends an extra $15 on fishing gear and other stuff. When Bubba gets laid-off, he still spends $60 or so---by drawing down past savings. Can you calculate Bubba’s marginal propensity to consume. Can you write the linear equations that describe Bubba’s consumption and saving behavior?

  3. Bubba’s MPC is simply ΔC/ΔY: ΔC/ΔY= 15/20 = 0.75 It’s the slope of the consumption equation, the rise over the run. $60 is the C that corresponds to a Y of zero. It’s the vertical intercept, the C-intercept. C = a + bY, where a is Bubba’s zero-income spending, and b is Bubba’s MPC. C = 60 + 0.75Y

  4. The general form of the consumption equation is C = a + bY Bubba’s consumption equation is C = 60 + 0.75Y The general form of the saving equation is S = - a + (1 – b)Y Bubba’s saving equation is S = - 60 + 0.25Y

  5. Notice what happens when we add Bubba’s consumption equation and saving equation: C = 60 + 0.75Y S = - 60 + 0.25Y We get: C + S = Y — which is to say that the part of Bubba’s income that he spends plus the part of his income that he doesn’t spend is equal to all of his income.

  6. In the wholly private Economy of Bubbalonia, total income (Y) stands at $8,000. Consumption behavior (for the whole economy) is given by C = 600 + 0.75Y. Investment spending is $1,400. Is Bubbalonia in a Keynesian equilibrium? Is the Bubblalonian labor force fully employed? Spring into action!! Run the numbers!

  7. C = 600 + 0.75Y Y = 8,000 C = 600 + 0.75(8,000) C = 600 + 6,000 C = 6,600 I = 1,400 C + I = 6,600 + 1,400 E = 8,000 Y = E Bubbalonia is in a Keynesian equilibrium. However, the labor force may not be fully employed.

  8. C = 600 + 0.75Y S = -600 + 0.25Y S = -600 + 0.25(8,000) S = -600 + 2,000 S = 1,400 I = 1,400 S = I Alternatively: Again, this is a Keynesian equilibrium (but the labor force may not be fully employed).

  9. With increased optimism, investment spending rises and Bubbalonia achieves a full-employment equilibrium (without inflation) at an income level of $9,200. Bubbalonia is still a wholly private economy; consumer spending is still C = 600 + 0.75Y. Just how much is the optimistic business sector spending on investment goods? And what can you say about the unemployment rate in Bubbalonia?

  10. Y = E Y = C + I C = 600 + 0.75Y C = 600 + 0.75(9,200) C = 600 + 6,900 C = 7,500 Y = C + I 9,200 = 7,500 + I I = 1,700 . The unemployment rate in Bubbalonia is the “natural rate,” i.e., 5% - 6%.

  11. C = 600 + 0.75Y S = -600 + 0.25Y S = -600 + 0.25(9,200) S = -600 + 2,300 S = 1,700 S = I I = 1,700 Alternatively: Again, the unemployment rate in Bubbalonia is the “natural rate,” i.e., 5% - 6%, Which means that Bubbalonia is experiencing no cyclical unemployment.

  12. NOTE: In the pre-optimism equilibrium: I = 1,400; Y = 8,000. In the post-optimism equilibrium: I = 1,700; Y = 9,200. When I rose by 300, Y rose by 1,200. That is, ΔI = 300 implies ΔY = 1,200. There’s some leverage here, a multiplier of some sort.

  13. Bubbalonia was enjoying full-employment (without inflation) while both income and expenditures were $9,200. Then, investors lost their nerve, got cold feet, and cut back on investment spending by 500. Still a wholly private economy with consumer spending given by C = 600 + 0.75Y, Bubbalonia went into a downward spiral. At what level of income did the spiraling cease?

  14. Investors cut back on investment spending by 500. ΔI = - 500 The investment multiplier is in play here. ΔY = [1/ (1- b)] ΔI 1/ (1-b) = 1/(1 – 0.75) = 1/0.25 = 4 ΔY = 4ΔI = 4(- 500) = - 2,000 The downward spiral ceased when income fell from $9,200 to $7,200.

  15. A further loss of confidence in Bubbalonia’s investment sector turned recession into depression. The economy finally found its macro-equilibrium at $5,600. In desperation, the government hired Bubba himself as its chief economist. Bubba’s staff told him that C = 600 + 0.75Yand that full-employment income would be $9,200. Bubba thinks that the government should do some spending. But how much?

  16. The government-spending multiplier is in play. The difference between full-employment income ($9,200) and the current (equilibrium) income ($5,600) is the needed ΔY, i.e., $3,600. So, we write: ΔY = [1/(1- b)] ΔG, realizing that 1/(1-b) = 1/(1 – 0.75) = 4. ΔY = 4ΔG; $3,600 = 4ΔG ΔG = $900. That’s how much spending Bubba recommends.

  17. SENATOR SUSAN COLLINS (R-MAINE) Senator Susan (Bubba) Collins (R-Maine) supported the 2008 Stimulus Package of $800,000,000,000. She claimed that it would “help to create three-to-four million jobs.” $800,000,000,000 $200,000 per job = 4,000,000

  18. What happened to the wage rate when the level of income rose from $5,600 to $9,200? Did it rise, fall, or stay the same? What would have happened if the Bubba had recommended $1,000 in new government spending (instead of $900)?

  19. The wage rate remained unchanged —because wage rates (and prices) are “sticky downwards.” Judged in the context of the depression, the wage rate is stuck too high. But judged in the context of full employment, the wage rate is stuck just right. Spending $1,000 would put upward pressure on W x N with N at full employment. Hence, the wage rate would rise.

  20. Bubbalonia has now matured into a full-fledged mixed economy. The government taxes, spends, and manipulates. Equilibrium income is $22,760, but full-employment income is estimated to be $23,000. Knowing that people save 25 cents out of each additional dollar of income, Bubba suggests two alternative policies: Increase G by _____. OR:Decrease T by _____. Spring into action!! Run the numbers! .

  21. ΔY = Yfe – Yeq ΔY= 23,000 – 22,760 ΔY = 240 Gov’t spending multiplier = 1/ (1- b) 1/ (0.25) = 4 So, the needed ΔG is 60. Tax multiplier = -b/ (1- b) -0.75/ (0.25) = -3 So, the needed ΔT is -80. Increase G by _____. OR:Decrease T by _____. 60 80 .

  22. Suppose that people are concerned about government budget deficits (because of the uncertainty that they always entail). What combination of fiscal actions (changes in both G and T) will keep the budget in balance while driving Bubbalonia from its current equilibrium income of $22,760, to its full-employment income of $23,000. Increase G by _____ and increase T by _____. 240 240 .

  23. CODA: Frustrated with stimulus packages and mushrooming government debt, and with the general fiscal irresponsibility of Keynesian policymakers, Bubba retires to the Isle of St. Canes. .

  24. When the Isle of St. Canes is functioning at full employment, the Islanders earn $400 billion and spend $330 billion. During the last recession, when earnings fell to $300 billion, the Islanders spent only $260 billion. Can you write the equations that describe the Islanders’ consumption behavior and their saving behavior? C = a + bY C = 50 + 0.70Y S = –a + (1 – b)Y S = –50 + 0.30Y What is the Marginal Propensity to consume on the Isle of St. Canes? If total earnings on the Isle of St. Canes falls to zero, how much will the Islanders spend? C MPC = b = 70/100 = 0.70 330 70 C = a + bY 260 C = a + 0.70Y 330 = a + 0.70 (400) 330 = a + 280 a = 330 – 280 a = 50 260 = a + 0.70 (300) 260 = a + 210 a = 260 – 210 a = 50 100 a Y 300 400

  25. The Macro Saga of Bubba and Bubbalonia

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