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Lecture 6

ECO349H5 Lecture 6: eco100

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University of Toronto Mississauga
Michael H O

Desired Consumption: MPC: Marginal propensity to consume(MPC): △C/△Y (Slope Df consumption function) MPS: Marginal propensity to save: △S/△Y D Disposable income = consumption + savings: MPS + MPC = 1 Shifts of the consumption function 1. Arise in household wealth shifts consumption up 2. Arise in interest rates shifts consumption function down 3. Optimism leads to upward shift of consumption function Desired Investment: 1. Real interest rate: Affects:Inventories, residential construction, new plant and equipment Higher the real interest rate, higher the opportunity cost of investment, lower the investment 2. changes in sales: Affects: inventories 3. business confidence: Desired aggregate expenditure: AE Actual national income: Y AE = zY +A Simple Multiplier: △Y/△A= 1/(1-z) Ais autonomous expenditure zY is induced expenditure z is marginal propensity to spend out of nation income • Larger marginal propensity to spend - steeper theAE function - larger the simple multiplier • horizontal AE:marginal propensity to spend = 0,simple multiplier = 1 Import and Export IM = mY, m is marginal propensity to import NX=X-mY Shifts in NX function • increase in foreign income shifts NX function up • Increase in Canadian (domestic) price, NX function will shift down and and be steeper Multiplier with tax and imports Simple multiplier = 1/(1-z) z = MPC(1-t)-m Fiscal stabilization policy YY*: inflationary gap reduce purchases, increase tax, reduce transfer payments to shift AE function downward Gap inAS/AD model Recessionary gap occurs when y < y . Unemployment leads to wage reductions and 2 0 downward shifts ofAS that will (ultimately) close the gap. An inflationary gap occurs when y > y .2Overe0ployment leads to wage increases and upward shifts ofAS that will close the gap. Change in Tax rate onAE curve Decrease in tax rotateAE to a steeper slope Aggregate demand curve Why negative slope: 1. Fall in price level - rise in wealth - increases desire
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