ECON MACROECONOMIC PRINCIPLES Instructor: Dr. Juergen Jung Towson University

Transcription

1 ECON MACROECONOMIC PRINCIPLES Instructor: Dr. Juergen Jung Towson University J.Jung Chapter 11 - Income-Expenditure Model Towson University 1 / 40

2 Disclaimer These lecture notes are customized for the Macroeconomics Principles 202 course at Towson University. They are not guaranteed to be error-free. Comments and corrections are greatly appreciated. They are derived from the Powerpoint c slides from online resources provided by Pearson Addison-Wesley. The URL is: These lecture notes are meant as complement to the textbook and not a substitute. They are created for pedagogical purposes to provide a link to the textbook. These notes can be distributed with prior permission. This version was compiled on: October 26, J.Jung Chapter 11 - Income-Expenditure Model Towson University 2 / 40

3 Chapter 11 - The Income-Expenditure Model J.Jung Chapter 11 - Income-Expenditure Model Towson University 3 / 40

4 The Income-Expenditure Model - Topics 1 Discuss the income-expenditure model 2 Identify the two key components of the consumption function 3 Calculate equilibrium income in a simple model 4 Explain how government spending and taxes affect equilibrium income 5 Discuss the role of exports and imports in determining equilibrium income 6 Explain how the aggregate demand curve is related to the income-expenditure model J.Jung Chapter 11 - Income-Expenditure Model Towson University 4 / 40

5 Income Expenditure Model At any point on the 45 degree line, the distance to the horizontal axis is the same as the distance to the vertical axis J.Jung Chapter 11 - Income-Expenditure Model Towson University 5 / 40

6 Equilibrium Output J.Jung Chapter 11 - Income-Expenditure Model Towson University 6 / 40

7 Adjustment to Equilibrium Output J.Jung Chapter 11 - Income-Expenditure Model Towson University 7 / 40

8 Consumption Function J.Jung Chapter 11 - Income-Expenditure Model Towson University 8 / 40

9 The Consumption Function The consumption function shows the relationship between desired spending and the level of income C = C a + b y J.Jung Chapter 11 - Income-Expenditure Model Towson University 9 / 40

10 The Consumption Function J.Jung Chapter 11 - Income-Expenditure Model Towson University 10 / 40

11 Changes in the Consumption Function J.Jung Chapter 11 - Income-Expenditure Model Towson University 11 / 40

12 Equilibrium Output and the Consumption Function in a Closed Economy J.Jung Chapter 11 - Income-Expenditure Model Towson University 12 / 40

13 Formula for Equilibrium Output output=planned expenditures y = C + I C = (C a + b y), so that y = (C a + b y) + I. Rearranging y by = C a + I, so that y = Ca+I 1 b J.Jung Chapter 11 - Income-Expenditure Model Towson University 13 / 40

14 Savings and Investment J.Jung Chapter 11 - Income-Expenditure Model Towson University 14 / 40

15 Savings and Investment in a Closed Economy without a Government Savings equals output minus consumption S = y C S = I J.Jung Chapter 11 - Income-Expenditure Model Towson University 15 / 40

16 Investment Divided into 3 Components Remember that with a foreign sector (open economy) and a government we had: I = S + (T G) + (Im Ex), J.Jung Chapter 11 - Income-Expenditure Model Towson University 16 / 40

17 Understanding the Multiplier J.Jung Chapter 11 - Income-Expenditure Model Towson University 17 / 40

18 Multiplier for Investment For the original level of investment at I 0 we have y 0 = C a + I 0 1 b For the new level of investment I 1 we have The difference in output is then y 1 = C a + I 1 1 b y = y 1 y 0, y = C a + I 1 1 b C a + I 0 1 b, y = I 1 I 0 1 b, y = 1 1 b I, J.Jung Chapter 11 - Income-Expenditure Model Towson University 18 / 40

19 Alternative Derivation of Multiplier y = $1 + ($1 b) + ( $1 b 2) + ( $1 b 3) +... or y = $1 ( 1 + b + b 2 + b ) This is an infinite series which can be written as y = $1 1 1 b J.Jung Chapter 11 - Income-Expenditure Model Towson University 19 / 40

20 Government Spending and Taxation J.Jung Chapter 11 - Income-Expenditure Model Towson University 20 / 40

21 Fiscal Multipliers Multiplier for government spending ( ) 1 Y = G 1 b Investment multiplier Consumption multiplier Y = Y = ( ) 1 I 1 b ( ) 1 C 1 b Tax multiplier Y = ( b 1 b ) T J.Jung Chapter 11 - Income-Expenditure Model Towson University 21 / 40

22 Government Spending and Taxes C a + b (y T ) output = planned expenditures or y = C + I + G, y = (C a + b (y T )) + I + G, y by = (C a bt ) + I + G, y = C a bt + I + G, 1 b Using this formula and the method just outlined, we can find the multiplier for changes in government spending and the multiplier for changes in taxes J.Jung Chapter 11 - Income-Expenditure Model Towson University 22 / 40

23 Proof Government spending multiplier: Then y 0 = Ca bt +I+G 0, 1 b y 1 = Ca bt +I+G 1, 1 b y = y 1 y 0 = C a bt + I + G 1 1 b = G 1 G 0 1 b, ( ) 1 y = G. 1 b C a bt + I + G 0,, 1 b J.Jung Chapter 11 - Income-Expenditure Model Towson University 23 / 40

24 Proof (cont.) Tax multiplier: y 0 = Ca bt 0+I+G, 1 b y 1 = Ca bt 1+I+G, 1 b Then y = y 1 y 0 = C a bt 1 + I + G 1 b = bt 1 ( bt 0 ), 1 b = b (T 1 T 0 ), 1 b ( ) b y = T. 1 b C a bt 0 + I + G,, 1 b J.Jung Chapter 11 - Income-Expenditure Model Towson University 24 / 40

25 Balanced Budget Multiplier Increasing T and G by equal amounts will Y G has larger multiplier than taxes T Increase of y due to G outweighs the decrease of y due to T Balanced budget multiplier BBM = 1 1 b + b 1 b, BBM = 1 b 1 b, BBM = 1 J.Jung Chapter 11 - Income-Expenditure Model Towson University 25 / 40

26 Growth Rates of U.S. GDP, J.Jung Chapter 11 - Income-Expenditure Model Towson University 26 / 40

27 Automatic Stabilizers J.Jung Chapter 11 - Income-Expenditure Model Towson University 27 / 40

28 Understanding Automatic Stabilizers Automatic stabilizers are taxes and transfer payments that stabilize GDP without requiring policymakers to take explicit actions When income is high, the government collects more taxes and pays out less transfer payments C When output is low, the government collects less taxes and pays out more in transfer payments C Automatic stabilizers prevent C from falling as much in bad times (reduce multiplier when y is low) C from rising as much in good times (reduce multiplier when y is high) Automatic stabilizers reduce the multiplier! J.Jung Chapter 11 - Income-Expenditure Model Towson University 28 / 40

29 Understanding Automatic Stabilizers J.Jung Chapter 11 - Income-Expenditure Model Towson University 29 / 40

30 Understanding Automatic Stabilizers If consumption depends on after-tax income, we have the following consumption function: Adjusted MPC = b (1 τ) slope {}}{ C = C a + b (1 τ) y An increase in tax rates decreases the slope of the C + I + G line The tax lowers output and reduces the multiplier 1 1 New Multiplier: 1 b (1 τ) is smaller than 1 b J.Jung Chapter 11 - Income-Expenditure Model Towson University 30 / 40

31 Exports and Imports Consumers will import more goods as income rises M = m y The fraction m is known as the marginal propensity to import We subtract this fraction from b, the overall marginal propensity to consume, to obtain the MPC for spending on domestic goods, b m J.Jung Chapter 11 - Income-Expenditure Model Towson University 31 / 40

32 Equilibrium Output with Government Spending, Taxes, and the Foreign Sector Output equals planned expenditures y = C + I + G + X M Substituting C = C a + b (y T ) and M = m y we get y = (C a + b (y T )) + I + G + X m y, y by + my = (C a bt ) + I + G + X, y = C a bt + I + G + X, 1 b + m y = C a bt + I + G + X, 1 (b m) J.Jung Chapter 11 - Income-Expenditure Model Towson University 32 / 40

33 U.S. Equilibrium Output in an Open Economy J.Jung Chapter 11 - Income-Expenditure Model Towson University 33 / 40

34 U.S. Equilibrium Output in an Open Economy Output equals planned expenditures: y = C + I + G + X M Substituting C = C a + b (y T ) and M = m y we get y = C a + b(y T ) + I + G + X my so that the new expenditure function is: intercept slope {}}{{}}{ y = C a + I + G + X bt + (b m)y J.Jung Chapter 11 - Income-Expenditure Model Towson University 34 / 40

35 How Increases in Exports and Imports Affect GDP J.Jung Chapter 11 - Income-Expenditure Model Towson University 35 / 40

36 Fiscal Multipliers in Open Economy are Smaller Multiplier for government spending ( Y = Investment multiplier ( Y = Consumption multiplier ( Y = Export multiplier Tax multiplier ( Y = 1 1 (b m) 1 1 (b m) 1 1 (b m) 1 1 (b m) ) G ) I ) C ) X ( ) b Y = 1 (b m) T J.Jung Chapter 11 - Income-Expenditure Model Towson University 36 / 40

37 Locomotive Effect From the early 1990s until quite recently, the United States was what economists term the locomotive for global growth Our demand for foreign products increased. U.S. imports increased along with output during this period The increased demand fueled exports in foreign countries and promoted their growth Studies have shown that the increase in demand for foreign goods was actually more pronounced for developing countries than for developed countries Conclusion: The United States was truly a locomotive, pulling the developing countries along J.Jung Chapter 11 - Income-Expenditure Model Towson University 37 / 40

38 Income Expenditure Model and AD Curve J.Jung Chapter 11 - Income-Expenditure Model Towson University 38 / 40

39 The Income-Expenditure Model and the Aggregate Demand Curve J.Jung Chapter 11 - Income-Expenditure Model Towson University 39 / 40

40 The Income-Expenditure Model and the Aggregate Demand Curve J.Jung Chapter 11 - Income-Expenditure Model Towson University 40 / 40