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Lecture

GDP__

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Department
Economics
Course
ECO101H1
Professor
James Pesando
Semester
Winter

Description
GDP measures: 1) national output and 2) national income Question: How is national income determined? Answer: -Where desired spending- called Aggregate expenditure (AE) – equals national income (output) Simple Model: AE= C + I AE= Aggregate expenditure = desired spending C= planned (desired) consumption by households I= planned (desired) investment by firms (Price level is fixed) Price level is fixed Nominal GDP = Real GDP Simplifying assumption to start analysis. Eg; International Monetary Fund (IMF) January 2011 projections of real GDP (measure of output) Country Real GDP Growth 2008 2009 2010 2011 canada 0.4 -2.6 2.6 3.6 U.S. 0.4 -2.5 2.7 2.4 China 9.6 8.7 10.0 9.7 Russia 5.6 -9.0 3.6 3.4 World 3.0 -0.8 3.9 4.3 Consumption: 1. households’ consumption (C) depends upon income (Y) Savings (S) = income not consumed 2. Key concepts Marginal- propensity-to-consume (mpc)= ΔC/ΔY Marginal-propensity-to-save (MPS) = ΔS/ΔY www.notesolution.com mpc+mps = 1 INVESTMENT 1. firms undertake investment ( I ) in anticipation of earning a profit. 2. Will treat I as fixed ( I = 25 in example #1) Example: Consumption Function Y C S(=Y-C) ΔC/ΔY ΔS/ΔY 0 10 -10 - - 100 100 0 .9 .1 200 190 10 .9 .1 300 280 20 .9 .1 C= 10 + 0.9Y mpc=0.9 S = Y – C = Y – (10 +0.9Y) = -10 + 0.1 Y mps = 0.1 Diagram #1) Consumption Function Autonomous Consumption If there is no change in Y, but C changes, result is change in autonomous consumption. C = 10 + 0.9Y Vs. C1 = 20 + 0.9Y 1) autonomous consumption has increased by 10. 2) Consumption function shifts up by 10. Change in Autonomous consumption is change not due to change in income Sources: -change in wealth ( if wealth increases, so does spending) www.notesolution.com -change in interest rates -change in expectations about future U.S. 2009 Deep recession Why? Consumption (68% of GDP in U.S.) fell sharply Why? 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 cause firms to change production. Undesired inventory investment (actual sales < planned sales) reduce production Undesired inventory disinvestment (Actual sales > planned sales) expand production example; Firm Produces/Sells shirts Desired inventory: 5,000 shirts Current Production: 10,000 shirts (per month) Sales (month) Δin inventory production 10,000 0 no change www.notesolution.com 12,000 -2,000* increase 6,000 +4,000** reduce • *unintended inventory disinvestment • **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 Involuntary inventory investment AE > Output inventories involuntarily decline firms increase production AE < Output inventories involuntarily rise firms reduce production AE = Output inventories are at desired levels (so firms have no incentive to change production) st REFER TO DIAGRAM #2 (jan 31 ,2011) SUMMARY: 1. simple model AE = C + I 2. Equilibrium C + I = Y Desired spending = output (remember: national income = national output) 3. If notin equilibrium: www.notesolution.com Unintended inventory investment or disinvestment Canada 2009, $Billions C 901 (59.1%) I 268 (17.5%) G 394 X 428 M 466 1,525 GDP Model (as before) C = 10 + 0.9Y I = 25 Question: if firms increase investment [I] from 25 to 35: Will Y increase by more than 10? Exactly 10? Less than 10? The Multiplier Y C I AE(C+I) National Income 350 325 35 360 Expands 400 370 35 405 Expands 450 415 35 450 Equilibrium Note: ΔI = 10 (i.e., increases from 25 to 35) ΔY = 100 (i.e., increases by multiplied amount) www.notesolution.com Diagram #3, jan 31 2011 C= 10 + 0.9Y I = 25 => C + I = 35 +0.9Y = AE I’ = 35 C + I’ = 45 + 0.9Y = AE’ Autonomous Expenditure Varies independent of Y Induced Expenditure Varies due to changes in Y
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