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Lecture

# Topic 17 National Income and the Price Level.pdf

9 Pages
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School
University of Toronto St. George
Department
Economics
Course
ECO100Y1
Professor
James Pesando
Semester
Fall

Description
Topic 17 – National Income and the Price Level Jan 31 – Feb 7 th 1. Overview 2. Simple Model 2.1 Consumption & Savings 2.2 Investment 2.3 National Income Determination 2.4 The Multiplier 2.5 Injections/Withdrawals 3. Extended Model 3.1 Government Spending and Taxes 3.2 Export and Imports 3.3 National Income Determination 3.4 The Multiplier  Overview Question: How is national income(synonymously national output)determined? Answer: Where desired spending – called Aggregate Expenditure (AE) equals national income (output)  Simple Model: AE=C+I Assume price level is fixed ( Nominal GDP = Real GDP) to simplify analysis: Consumption (C)=planned (desired) consumption by households; -- Households’ consumption (C) depends upon income (Y) -- Savings (S) = Income Not Consumed = Y-C -- Key Concepts: Marginal-Propensity-to-Consume (mpc) = %△C/%△Y Marginal-Propensity-to-Save (mps) = %△S/%△Y mpc+mps=1. (For every dollar of the income is either saved or consumed;) Investment (I)= planned (desired) investment by firms -- Firms undertake investment (I) in anticipation of earning a profit; -- Will treat as fixed (I=25) in First Example  Consumption & Savings Example: Consumtion Function (\$) Y - Income C - Consumption S - Savings mpc mps 0 20 -10 - - 100 100 0 0.9 0.1 200 190 10 0.9 0.1 300 280 20 0.9 0.1 Consumtion Function: C = 10 + 0.9Y mpc = 0.9 Savings Function: S = Y – C = Y - (10 + 0.9Y) = - 10+0.1Y mps = 0.1 DC (\$) o Observation: 45 Line 1. The consumption function cuts the 45 Line at C = 0.9Y + 10 the breakeven level of income (income = consumption); 100 o 2. The vertical distance between C and the 45 Line 10 45o is the height of S (Y-C); 0 100 200 300 Y (\$) DS (\$) 3. The slope of the consumption function is mpc; S = 0.1Y - 104. The slope of the savings function is mps; 10 0 100 200 300 Y (\$)  Autonomous/Induced Expenditures: Autonomous Consumption/Savings: Change in consumption/savings that’s independent of change in income; Induced Consumption/Savings: Change in consumption/savings that’s brought about by change in income; Why: -- Consumers respond to factors other than income when making consumption decisions Sources: -- Change in wealth -- Change in interest rates -- Change in expectations about future; e.g.1. C = 10 + 0.9Y VS C’ = 20+0.9Y 1) Autonomous consumption has increased by 10; 2) Consumption function shifts up by 10 e.g.2. Deep Recession in U.S.2009 Why? A: Consumption (68% of U.S. GDP ) fell sharply Why? A: Large decline in household wealth (housing)  downward shift in consumption function  Firms’ Investment 1. New plant and equipment 2. Residential construction 3. Inventories Insight: Undesired (unplanned) fluctuations in inventory investment  firms have to change production Undesired inventory investment (actual sales < planned sales)  reduce production Undesired inventory disinvestment (actual sales > planned sales)  increase production Example: Firm Produces/Sells Shirts Desired Inventory: 5000 shirts Current Production: 10,000 shirts (per month) Sales Change in Inventory Production 10,000 0 No Change 12,000 -2,000 Increase production (unintended inventory disinvestment) 6,000 4,000 Reduce production (unintended inventory investment)  National Income (Output) Determination Y C I AE ( C + I ) National Income 250 235 25 260 Expands 300 280 25 305 Expands 350 325 25 350 Equilibrium 400 370 25 395 Contracts 450 415 25 440 Contracts AE > Output Y  Inventories involuntarily decline (disinvestmnFirms increase production AE < Output Y Inventories involuntarily rise (investmetFirms reduce production AE = Output Y Inventories are at desired levels  Firms have no incentive to change production) Equilibrium National Income occurs when Aggregate Expenditures = National Income Recall example from previous lecture:C = 0.9Y + 10; I =25; AE = C + I = 0.9y + 35 National Income (Output) Determination AE o 45 Line Observation: AE = 0.9Y + 35 C = 0.9Y + 10 Equilibrium National Income occurs when AE=Y; 35 AE function intersects with the 45 line. 10 45o national Income Y Summary: 1. Simple model: AE=C+I (AE=desired spending) 2. Equilibrium: C+I = AE = Y (Desired spending = Output) Remember: national income = national output 3. If not in equilibrium: unintended inventory investment/disinvestment  The Multiplier Recall previous consumption model: C=10+0.9Y I=25 Question: if firms increase investment from 25 to 35, will Y increase by more than, less than, or exactly 10? Answer: more than 10. Recall & Continue Stats table from page 3: Y C I AE ( C + I ) National Income 250 235 35 270 Expands 300 280 35 315 Expands 350 (previous E) 325 35 360 Expands 400 370 35 405 Expands 450 415 35 450 Equilibrium o Observation: AE 45 Line AE’ = 0.9Y + 45 △ I =10; increase from 25-35 △Y=100; increases by multiplied amount AE = 0.9Y + 35 C = 0.9Y + 10 45 35 10 o 45 350 450 Y
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