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Lecture 4

Lec- Week 4

27 Pages
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Department
Economics for Management Studies
Course Code
MGEA06H3
Professor
Iris Au

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1
ECMA06 – Aggregate Expenditure (with government and foreign sector)
Aggregate Expenditure with Government & Foreign
Sector
Outline
Extend the simple model developed last week by including
government and foreign sector in the model.
National saving in an open economy.
Consider the effects of a change in aggregate expenditure on
national income and budget balance.
www.notesolution.com
2
Enriching the Model – Including Government and Foreign Sector
The Government Sector
The government enters the model in the following ways:
1) Collecting taxes, T
The government collects taxes from households and firms to
finance its spending.
Assumption: Taxes are positively related to income.
Tax function:
T = T0 + t1Y,where T0 = autonomous taxes
t1 = tax rate & 1 > t1 > 0.
www.notesolution.com
3
ECMA06 – Aggregate Expenditure (with government and foreign sector)
2) Making transfer payments, TR
Transfer payments refer to payments from the government to
individuals that are not in exchange for goods and services.
Examples include employment insurances (EI), public
pension, and etc.
Assumption: Transfer payments are inversely related to
income.
Transfer payments function:
TR = TR0 – tr1Y,where TR0 = autonomous transfer
tr1 = benefit reduction rate &
1 > tr1 > 0
3) Spending on final goods and services, G
It is also called government purchases, and it is the
government expenditure on final goods and services.
Assumption: G is an autonomous variable, (i.e., its value is
given), i.e.,
G = constant.
www.notesolution.com

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Description
1 ECMA06 Aggregate Expenditure (with government and foreign sector) Aggregate Expenditure with Government & Foreign Sector Outline Extend the simple model developed last week by including government and foreign sector in the model. National saving in an open economy. Consider the effects of a change in aggregate expenditure on national income and budget balance. www.notesolution.com 2 Enriching the Model Including Government and Foreign Sector The Government Sector The government enters the model in the following ways: 1) Collecting taxes, T The government collects taxes from households and firms to finance its spending. Assumption: Taxes are positively related to income. Tax function: T = T +0t Y,1 where T = 0utonomous taxes t1= tax rate & 1 > t > 1. www.notesolution.com 3 ECMA06 Aggregate Expenditure (with government and foreign sector) 2) Making transfer payments, TR Transfer payments refer to payments from the government to individuals that are not in exchange for goods and services. Examples include employment insurances (EI), public pension, and etc. Assumption: Transfer payments are inversely related to income. Transfer payments function: TR = TR t0 Y, 1here TR = auton0mous transfer tr1= benefit reduction rate & 1 > tr > 0 1 3) Spending on final goods and services, G It is also called government purchases, and it is the government expenditure on final goods and services. Assumption: G is an autonomous variable, (i.e., its value is given), i.e., G = constant. www.notesolution.com 4 The Foreign Sector When an economy trades with foreign countries, this economy is an open economy. Exchange Rate Exchange rate (E) is the price of a countrys currency in terms of another currency. In our class, exchange rate measures the value of C$ in foreign currency (i.e., the # of foreign currency needed to exchange 1 C$). Example: If E = US$ 0.875/C$, then the value of 1 C$ is equivalent to US$ 0.875 (US$ 0.875 per C$). Question: What happens when E changes? Answer: If E , then C$ appreciates (increasesagainst the US$ because it takes more US$ to exchange 1 C$. If E , then C$ depreciates (decreases)against the US$ because it takes fewer US$ to exchange 1 C$. www.notesolution.com
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