IS Curve Figure S = I + G T + NX. In case of (1) closed economy: NX = 0 (2) balanced budget: T = G S = I

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Gilbert Blake
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1 Curve Figure = + G T + NX n case of (1) closed economy: NX = 0 (2) balanced budget: T = G = Private aving = nvestment Note that if G-T or NX changes then so do and nvestment and Real nterest Rate i (exp.) B. When real interest rate (i) increases companies investments () decrease. Private aving and ncome A. When ncome () increases both Consumption (C) and Private avings () increase.

2 Curve Figure = + G T + NX G increases, T decreases n case of (1) closed economy: NX = 0 (2) balanced budget: T = G (fiscal expansion) = X increases, m decreases Private aving = nvestment Note that if G-T or NX changes then so do and (depreciation=weakening of currency) nvestment and Real nterest Rate i (exp.) B. When real interest rate (i) increases companies investments () decrease. Expected Profitability of increases (less regulation, smaller corp. taxes, ) Private aving and ncome Willingness A. When ncome to save () increases both Consumption (C) and Private avings () (consumers scarred, ) increase.

3 Curve Figure LM curve curve Li Ms = Li +L L

4 Curve Figure fiscal expansion or depreciation LM curve curve Li Ms = Li +L L

5 Curve Figure less regulation, smaller corp. taxes (with unchanged budget deficit) LM curve curve Li Ms = Li +L L

6 Curve Figure consumers scarred LM curve curve Li Ms = Li +L L

7 Curve Excess demand for goods Excess supply of goods hort-run Production Equilibria ( curve) Production = Total demand (expenditures) We will derive curve based on these three facts: A. When ncome () increases both Consumption (C) and Private avings () increase. B. When real interest rate (i) increases companies investments () decrease. C. n equilibrium: Total Demand (ZZ) = Production () = ncome (). curve Figure. curve Equation

8 Curve Equation Production, Output, GDP = C + + G + X - M nvestment is the sum of nonresidential investment, residential investment AND ACTUAL CHANGE N PRVATE NVENTORE. The Total Demand The total demand (Z) for goods and services is also written as: Z = C + + G + X - M nvestment is the sum of nonresidential investment, residential investment AND PLANNED, WANTED CHANGE N PRVATE NVENTORE. C. n equilibrium: Total Demand (ZZ) = Production () = ncome () Economy s production is in a HORT RUN equilibrium when - the planned inventories match the actual inventories. - the total demand Z matches the output Complication: Z depends on (see next).

9 Curve Equation Consumption: C = C( D ) The function C( D ) is called the consumption function. t is a behavioral equation, that is, it captures the behavior of consumers. A more specific form of the consumption function is this linear relation: C = c0 + c1 D This function has two parameters, c 0 and c 1 : c 1 is called the (marginal) propensity to consume, or the effect of an additional dollar of disposable income on consumption. c 0 is the intercept of the consumption function. ( + )

10 Curve Equation Consumption: C = C( D ) ( + ) Disposable income, D = T, is the income that remains once consumers have paid taxes and received transfers from the government. (Net) Taxes, T = t TR, is the government tax revenue that remains once transfers are paid to consumers. Tax revenue depends on output.

11 Curve Equation nvestment: = A bi nvestment in Z includes WANTED, PLANNED change in private inventories. This may differ from actual change in private inventories. ome investment here is taken as given, or treated as an exogenous, others may decrease with interest rate: Government pending: G Government spending, G, together with taxes, T, describes fiscal policy the choice of taxes and spending by the government. f the government ran a balanced budget, then T=G. We shall assume that G = G is exogenous as governments do not behave with the same regularity as consumers or firms. Net exports: X M X = X M = M + c m We let export be, and import be. Just like consumption, import depends on disposable income. D

14.02 Principles of Macroeconomics Problem Set # 2, Answers

14.02 Principles of Macroeconomics Problem Set # 2, Answers 14.0 Principles of Macroeconomics Problem Set #, Answers Part I 1. False. The multiplier is 1/ [1- c 1 (1- t)]. The effect of an increase in autonomous spending is dampened because taxes respond proportionally