Chapter 3. Continued. CHAPTER 3 National Income. slide 0

Transcription

1 Chapter 3 Continued slide 0

2 Notes The equilibrium is stable If r > r* S > I: More people want to save relative to demand for funds: excess supply; r decreases If r < r* I > S: More demand for funds then available: excess demand: r increases slide 1

3 Digression: Mastering models To master a model, be sure to know: 1. Which of its variables are endogenous and which are exogenous. 2. For each curve in the diagram, know a. definition b. intuition for slope c. all the things that can shift the curve 3. Use the model to analyze the effects of each item in 2c. slide 2

4 Mastering the loanable funds model Things that shift the saving curve public saving fiscal policy: changes in G or T private saving preferences tax laws that affect saving slide 3

5 Changes in Saving: The Effects of Fiscal Policy in the LONG RUN So far we assumed G and T are fixed. What happens if these variables change due to FP? Increase in G (expansionary FP) Recall: Y Assuming that everything else in the economy remains the same, if the government increases its share from the pie, somebody else needs to get less (remember our long-run assumption): C( Y T ) I( r) G slide 4

6 Which group will get a smaller share? Consumption remains the same because Y C( Y T ) I( r) G Investment is the group that will get a smaller share through a change in r. When G, T G = Public saving. Total savings (= supply of loanable funds) r. slide 5

7 r S 2 S 1 r 2 r 1 I (r ) I 2 I 1 S, I slide 6

8 Crowding Out When r, I We say government spending crowds out investment slide 7

9 CASE STUDY: The Financial Crisis of 2007 US government policies during the crisis: increases in government spending: G > 0 tax cuts: T < 0 Both policies reduce national saving: S Y C ( Y T ) G G S T C S slide 8

10 CASE STUDY: The Financial Crisis 1. The increase in the deficit reduces saving r S 2 S 1 2. which causes the real interest rate to rise r 2 r 1 3. which reduces the level of investment. I 2 I 1 I (r ) S, I slide 9

11 Notes Why would the US Government engage in policies that would reduce investment? If we look at the data in ten years from now, we may not necessarily see a decline in investment, despite our model s predictions. Why? slide 10

12 Mastering the loanable funds model, continued Things that shift the investment curve some technological innovations to take advantage of the innovation, firms must buy new investment goods tax laws that affect investment investment tax credit slide 11

13 An increase in investment demand r S raises the interest rate. But the equilibrium level of investment cannot increase because the supply of loanable funds is fixed. r 2 r 1 An increase in desired investment I 1 I 2 S, I slide 12

14 Changing one of the assumptions What if we make the following change in our model? C = C(Y T, r): Make consumption a function of real interest. Intuitively: as r, you might prefer to consume less today and save more to earn interest income. As r, C, (Y C G) increases: Upward sloping savings- curve. slide 13

15 Saving and the interest rate How would the results of an increase in investment demand be different? Would r rise as much? Would the equilibrium value of I change? slide 14

16 An increase in investment demand when saving depends on r An increase in investment demand raises r, which induces an increase in the quantity of saving, which allows I to increase. r r 2 r 1 S( r) I(r) 2 I(r) I 1 I 2 S, I slide 15

17 End of chapter problem 7 Increase in T by $100, MPC = 0.6. What happens to the following a) Public Saving b) Private Saving c) National Saving d) Investment slide 16

18 S (Public)=100 S (Private)=-40 S (National)=60 I=60 Graphically, this would be a rightward shift of the savings curve that lowers the real interest rate. slide 17

19 End of chapter problem 9 Y=C+I+G Y=5000 G=1000 T=1000 C= (Y-T) I= r slide 18

20 S (Private)=750 S (Public)=0 S (National)=750 Equlibrium r =5% slide 19

21 End of Chapter problem 10 G= T What happens to r and I? slide 20