• Entire value of the economy (GDP), Y = C+I+G+XM
• As we go through the notes, simplify this equation
• C+I+G=E (E = expenditure)
• Expenditure (E) = a + bY
o Consumption spending is probably driven by all sorts of things beyond income,
so this model is erroneous
o In this simple world, however, a = intercept of the straight line (in diagram 1),
the vertical axis is expenditure, even if income is 0 there is some expenditure
going on. The slope of the line is less than one
o Later in the model, we will claim that ‘a’ can be manipulated at will by
government maybe because ‘a’ is in part government spending or maybe they
can stimulate consumption by sending out food stamps or sending out
cheques in the mail
• Imports (M) = μ Y (it is a function of Y)
• Exports (X) is just a number, it is a constant, isn’t determined by what income is. We can
therefore make exports anything we want
• In China, export growth is still the strategy they’re following even though its causing
them a lot of trouble
• Another element in this list of equations, D = trade deficit = M – X
• Put imports first, typically when people talk about the deficit they say X – M and then
talk about a negative number. For the algebra though, it makes more sense to do M –
X and have a positive number
• E = a + bY
• D = M – X
• Y = (a + x) / (1 – B + μ) ▯ called a reduced form equation because it captures all the other
equations we talked about
• Given the variables (on page with graphs), economists believe they can make a point type
• Once you do the arithmetic to find out what income is expected to be, then you can calculate all
the other variables. All the steps on the other page
• Expenditure > income. How? Trade deficit, we are importing more than we are exporting
because the imports > exports
• At the moment, these numbers are fixed, it’s a prediction and you cant do anything about them.
Some people disagreed and said we could use stimulus, jack up government spending and
shift the E curve upward (diagram 1).
• We’ve already contested this by asking where does the stimulus money come from.
This model, however, forgets about all that • The Keynesians and planners go on in this fashion, they say income in the model is
80, but at an income of 80 and expenditure 84, there are unemployed people. So we
need to stimulate the economy to create jobs and reduce unemployment. So, we want
income to be 100, lets do it by having a stimulus. What do they mean? Go back to this
reduced form equation, where we have a + X is 20 + 20, if we make ‘a’ = 30, then we
have 50/.5, we could increase income to 100
• Indeed, all the other numbers in the model change, changing the injections (the ‘a’),
stimulating the economy not only changes income, but it also changes inflation,
imports, expenditure and the deficit. There are 4 things in our list of outcomes, so not
only did income change but imports changed from 24 ▯ 30, expenditures went to 110
• The idea of planning takes the next dangerous step, the Keynesians say well yes we’ve now
solved the unemployment problem but we do have this trouble now with the deficit which has
gone up from 4 ▯ 10 and we don’t like deficits. So Obama makes speeches about how we
should stimulate exports. How do they fix the deficit?
• Keynesians say give us another instrument to increase our control over the economy.
In linear systems like these we can achieve as many goals as we have instruments.
this model will try to persuade you that a bigger/more government is better because
the more you could accomplish.
• If income is 100, then imports are 30. To get the deficit equal to 0 then exports also
need to be 30. Is there a way to get both income to be 100 and exports to be 30? Yes.
If we control exports, then we can have this state of affairs.
o Set ‘a’ = 20 and ‘X’ = 30, we get income 100 and a deficit of 0 since incomes
and exports are 30. We can do this by taking over 2 big parts of the economy: