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Econ chapter 22 jan 28 lecture

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Professor Cottrel

Ch 21 In this case: z=0.8 K= Slope of Y/Slope of A = 1/1-Z =1/1-0.8 = 1/0.2 =5 Initial increase in I of $100 Raises total spending [Y] by $500 Note: Higher MP to spend out of national income raise multiplier [z Increases as K increases] Diagrammatically fig 1 jan. 28 lec: Example 1: Z= 0.5 (AE has shallow slope) Multiplier = 1/(1-Z) 1/(1-0.5) 1/(0.5) =2 Eg. If Investment increases by $100, Y rises by $200 Example 2: Z= 0.8 (AE has steep slope) Multiplier = 1/(1-Z) = 1/(1-0.8) =1/(0.2) = 5 Eg. If investment increases by $100, Y rises by $500 In Canada: AE has shallow slope 2 main reasons: - Imports are large - So spending “leaks” out of circular flow of income - Taxes are also a leakage from circular flow of income - Reducing spending - Slope of AE line (Z) is about 0.2 - Multiplier is about 1.25 - K = 1/(1-z) Self-Fulfilling Prophecies Economic fluctuations can result from expectations. If businesses expect boom, they invest and increase GDP. If consumers expect recession, they reduce spending and GDP falls. Expectations may be self-fulfilling The study of economics does not seem to require any specialized gifts of an unusually high order. – John Maynard Keynes. No one in our age was cleverer than Keynes, nor made less effort to conceal it. – Sir Roy Harrod Ch. 22: Adding Government and Trade to the Simple Macro Model Introducing Government Government is an important variable in the economy. Fiscal Policy: • Government purchases • Taxation Government Spending • Government purchases are part of desired Aggregate Expenditures Transfer payments: eg. Pensions not included as Government purchase • Not government purchases so not G • Only a flow of funds from government to Households • Affects disposable income and Household spending • Greater disposable income, you have more money to spend Tax Revenues Net taxes, T: • Total tax revenue minus total transfer payments Tax Rates are autonomous policy variables, but revenues vary with GDP: T=tY Where t = marginal propensity to tax. Note: t includes all taxes, So when Y rises by $1, tax revenues rise by t x $1 The Budget Balance: [T – G] Government purchases (G) is autonomous, independent variable so do not change with GDP Tax rates are induced [T-G] revenue minus expenditures If T > G, we have a budget surplus If T < G, we have a budget deficit As income (Y) increases, T(net taxes) rises • Tax revenues rise • Transfers payments fall Provincial and Municipal Governments • Government purchases (G) includes all levels of government in desired Aggregate Expenditure (AE) in public saving • [In Canada – combined purchases of provincial and municipal governments is larger than federal government.] The Net Export Function Exports: X • Autonomous with respect to Canadian national income Imports: IM = mY • Rise as national income increases • Not autonomous • Induced or depends on GDP Marginal propensity to import: • Change in imports caused by a $1 in GDP • Change in M / change in Y • MPM = m = 20/100=0.2 IM=my M = change in m/ change in y What happens if the economy is increasing, expanding? If there is more money in all economy, we want more consumption goods and we also want more imported goods NX= X-IM =X-my As Y increases, x- (my increases) increases So net exports decreases Imports are induced Whenever the level of y change, then the level of m changes, and you know it becomes more induced Net export function: NX = X – IM • Falls as national income rises • X constant, autonomous, come from beyond the system • Our imports increase because they are dependent on national income (Y) so as Imports increase, GDP (Y) increase If X > IM: • Foreigners buy more Canadian $. • To buy exports, foreigners need to buy more Canadian $ • Uses foreign currency to buy foreign income-earning assets • Similar to investment ( I ) • Produces future income for Canadian Y X IM X-IM 0 60 0 60 100 60 20 40 200 60 40 20 300 60
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