Class Notes (839,470)
Canada (511,354)
Brock University (12,137)
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ECON 1P92 (65)

Chapter 22

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Marilyn Cottrell

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Chapter 22 – Adding Government and Trade to the Simple Macro Model Government is an important variable in the economy. Fiscal Policy: • Government purchases • Taxation Government Spending • G is part of desired AE Does not include: Transfer payments: e.g. Pensions • Not government purchases • Only a flow of funds from government to HH (Household) • Affects disposable income and Household spending 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] G is autonomous Tax Rates are included [T-G] revenue minus expenditures If T > G – budget surplus If T < G – budget deficit AS Y increases, T rises Tax revenues rise Transfer payments fall Provincial and Municipal Governments • G includes all levels of government in desired 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 wrt (with respect to) Canadian national income. Imports: IM = mY • Rise as national income increases o Not autonomous o Induced or depends on GDP Marginal Propensity to Import: • Change in imports causes by a $1 change in GDP • Change-m / Change-Y • MPM = m = 20/100 = 0.2 Diagram 9 Net export function: NX = X – IM • Falls as national income rises • X constant IM increase as GDP[Y] increases. If X > IM: • Foreigners buy more C$ • To buy exports • Canada accumulates more foreign currency • Use foreign currency to buy foreign income earning assets. • Similar to Investment (I) • Produces future income for Canadians Y X IM X-IM 0 60 0 60 100 60 20 40 200 60 40 20 300 60 60 0 400 60 80 -20 Diagram 10 If IM > X: • Canadians sell more C$ • Buy more imports from foreigners • Canada’s trading partners accumulate C$ • C$ used to buy Canadian assets • Liability for Canada • Income will flow to foreigners January 30, 2014 Imports are induced Shifts in the Net Export Function: Foreign Income: If foreign income increases • Ceteris Paribus, Canadian Exports [X] increase o They don’t just want more of the goods from there country, but the goods that the import too. • Shifts up the NX function • Image 1 Jan 30 GDI = W + S, i, business profits < the G says we have to add depreciation. NNI = W+S, interest, business profits (at Factor Cost) GNI = NNI + Depreciation + Indirect Taxes – Subsidies (at Market Prices) Depreciation is what moves us from Net to Gross. (Indirect Taxes – Subsidies) is what goes from Factor to Market Know what NNI is at Factor Cost Know that if you have Gross, or say even if you went GDP = C + I + G + X – IM, you can easily get to NNI by subtracting Depreciation, subtracting Indirect Taxes, and adding in subsidies. We have a definition for NNI, from NNI -> GNI/GDI Domestic and Foreign Prices: A rise in Canadian prices relative to foreign prices: • Reduces Canadian Exports • X function shifts down • Imports increase – cheaper • IM function rotates up • NX function shifts down, and gets steeper • Image 2 Jan 30 Exchange rates cause relative prices to change. Appreciation of Canadian dollar: • Increases Canadian prices relative to foreign prices Depreciation of Canadian dollar: • Decreases Canadian prices relative to foreign prices Equilibrium GDP Only at Equilibrium does AE = Y • Where desired aggregate expenditure (AE) equals national income (Y) • AE = Y Include: • Government (T-G) • Net exports (NX = X – IM) Adjust Consumption (Where most errors are made): • With government, national income (Y) is not the same as disposable income (Y ) d • Y d Y – T Y has a numerical coefficient of 1 in front of it. 1Y – T With taxes: • Disposable Income (Y ) < national income (Y) d Suppose T = 0.1Y. (Taxes = 10% of Y) Then Y d Y – 0.1Y = 0.9Y (Disposable income is 90% of Y) Consumption function (out of Y ):d C = 10 + 0.8Y d C = 10 + (0.8)(0.9Y) C = 10 + 0.72Y With income taxes: • MPC out of national income (0.72) • Is less than the MPC out of disposable income (0.8) o MPC
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