EC4004 LECTURE 18. LAST TIME Full Keynesian Model: AE = C + I + G + X-M NEWS. TODAY. Aggregate Expenditure & Aggregate Demand.

Transcription

1 EC4004 LECTURE 18 Keynesian Model gets a workout LAST TIME Full Keynesian Model: AE = C + I + G + X-M NEWS. TODAY. Aggregate Expenditure & Aggregate Demand. UE Increases to 13.5%, growth reduction to -7.5% of Real GDP. Sees further tax hikes and spending cuts for next 3 years.

2 Fig 5.2: ROI relationship between net migration and total housing completions e This even includes a replacement demand element for demolished stock using recent rates of demolition and an assumption that the average number of persons per dwelling will continue to fall slightly in the coming years which may not be the case (school leavers, graduates etc may live with parents for longer or in higher density rented accommodation). Though if a high proportion of new build is say 1-bed apartments then the projected excess supply may be lower (as this type of housing would have a lower occupancy rate / average number of persons ratio). Ernst & Young Report on Ireland, Making basic assumptions about the average number of persons per dwelling (which is a critical assumption and depends on range of actors including the type of new build), and using the Economic Eye population forecast, suggests a very modest demand for housing going forward in the short-run (Table 5.1). This is especially in ROI. Note this analysis takes no account of potentially ka_faõ[yfl mfkgd\ ny[yfl klg[c l`gm_` al \g]k lyc] Y[[gmfl g^ demand to replace demolished housing. It is though worth saying that we suspect actual number of completions will not drop as low as 10,000 pa and could turn out close to 20,000 in 2009 and 10,000-15,000 in 2010 and 2011 (note our indicative projections exclude public sector new build but are still a useful indicator of demand). Nevertheless indicative housing demand in ROI drops to no higher the projected level required in NI, a major turnaround from recent years, due to overall stronger population growth in NI (where migration is forecast to contract much more modestly as it did not reach the same peak). L`gm_` l`]k] `gmkaf_ \]eyf\ Õ_mj]k k`gmd\ fgl Z] [gfka\]j]\ Y forecast (as many other demand factors are not considered), it does demonstrate the potential impact of migration on the wider economy and particularly the construction industry and supplychain sectors (and tax revenue from stamp duty etc). Data from the Department for the Environment, Heritage and Local Government shows 2009 Q1 housing completions of 7,600. Pro rata over the year would give an annual projection of some 20,000-25,000 new homes in 2009 (this appears to be the current consensus forecast for completions in ROI in 2009). Table 5.1: All-Island housing completion trends and indicative demand l`ak ogmd\ Z] o]dd YZgn] l`] fmez]j Ëj]imaj]\Ì af l`] indicative projection estimates produced by the basic Economic Eye housing model. Mismatches in the spatial distribution of demand and supply, plus replacement of stock (which may be greater in Any initial change in spending causes a chain reaction of more spending MULTIPLIER IN ECONOMICS MULTIPLIER

3 Initial increase in government spending Operates through a multiplier Larger increase in real GDP Spending Multiplier Effect Round Δ Spending All other rounds Total spending Formula:!500!250!125!63!62!1,000 1 / (1 MPC) (or) 1 / MPS DEBATE CURRENTLY RAGING ON IS MULTIPLIER >1 OR NOT AGGREGATE EXPENDITURE MODEL GDP Gap: The amount by which aggregate expenditures fall short of the amount required to achieve full employment equilibrium Keynes Solution: Increase autonomous spending by the amount of the recessionary GDP gap. Govt. Should manage AD to maintain full employment

4 ROUTES TO KEYNESIAN SOLUTIONS When Y/Y <0, 1.Increase government spending 2.Lower taxes Aggregate Supply & Aggregate Demand. NOW. 3.Raise transfer payments REMEMBER The sum of all expenditure in the economy over a period of time AD = C+I+G+(X-M) = AE (in equilibrium) C= Consumption Spending I = Investment Spending G = Government Spending (X-M) = difference between spending on imports and receipts from exports (Balance of Payments) WHEN AE ISN T EQUAL TO AD Aggregate Expenditure is a relationship showing, for a given price level, planned spending at each level of income, i.e. total C + I (Planned) + G + X - M at each level of aggregate income. The aggregate demand curve (AD) tells us, at each price level, how much aggregate output will be demanded If planned spending > output, inventories fall, firms increase output, households get more $$, buy more, (but less and less) each time.

5 MARKET VS AGGREGATE MODELS AGGREGATE DEMAND (WRITE THIS DOWN) AD curve shows the level of real GDP purchased by everyone at different price levels during a time period, ceteris paribus The market model measures physical units whereas the aggregate model measures value AGGREGATE DEMAND CURVE (WRITE THIS DOWN) Inflation At a higher rate of This The lower oflevel output of At anlevel inflation level inflation (3.0%) will National be associated Income of 2%,interest the AD rates curve rising with requires a particular fewer units levelof gives a level mean that C, I of and of unemployment labour output of Y1 (X-M) all have unemployment which we will call rises U =to negative effects on 7% shown 5% by U = 7% AD NY falls to Y2 3.0% Increase in the aggregate demand curve 2.0% AD Y2 U = 7% Y1 U = 5% Real National Income Increase in C,I, G, (X-M)

6 SHIFTS IN THE AGGREGATE DEMAND CURVE Inflation 2.0% Y1 U = 5% Y2 U = 2% Shifts in AD will be This caused Any would exogenous cause a by changes in factors rise in affecting causing national C, C, I, G income (economic I and or (X-M) G to (exogenous rise, or a growth) trade factors) and lead to surplus e.g. increasing a fall in income unemployment causes tax rates a shift affect (U to = 2%) the (and consumption right vice in versa) AD AD AD2 Real National Income CHANGES IN AD: CONSUMPTION Exogenous factors affecting consumption: Tax rates Incomes short term and expected income over lifetime Wage increases Credit Interest rates Wealth Property Shares Savings Bonds CHANGES IN AD: INVESTMENT CHANGES IN AD: GOVERNMENT Spending on: Influenced by: Defence Machinery Expected rates of return Health Equipment Interest rates Social Welfare Industry Buildings Infrastructure Expectations of future sales Expectations of future inflation rates Education Foreign Aid Regions Law and Order

7 KEY VARIABLES KEY POLICIES (Write these down) Inflation Growth Unemployment Balance of Payments (X-M) Monetary Policy Don t have one. (ECB) Fiscal Policy Government spending & government income (taxes & borrowing) Supply-Side Policy Aggregate supply. Next lecture! WRITE DOWN 2 THINGS YOU REMEMBER FROM TODAY.

8 EC4004 LECTURE 18 Keynesian Model gets a workout