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ECO102H1 (155)
Lecture

ECO100 - FEB 4 Simple model, the multiplier, exports and imports

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Department
Economics
Course
ECO102H1
Professor
James Pesando
Semester
Fall

Description
1. Summary of the Simple Model of National Income ● Its simple since the price level is fixed and no government or trade ● Equilibrium Income (Y) occurs when aggregate expenditures (planned/desired expenditures) are equal to actual expenditure ● If out of equilibrium, there will be unplanned changes in inventory that will be corrected by changing production. ○ by monitoring inventory ● Reach equilibrium by adjusting production 2. Simple Model Example ● Consider a simple economy with fixed prices where the following relationships hold: ○ C = 30 + 0.9Y ■ 30: autonomous consumption, independent of income in the economy ■ 0.9Y: 90% of every other dollar earned is attributed to induced consumption ■ 10% has gone into savings ○ I = 15 ■ Investments: inventory ○ G = X = M = 0 (Simple Model) ● 1. Calculate the AE Schedule? ○ AE = C + I + G + X - M ○ AE = 30 + 0.9Y + 15 = 45 + 0.9Y (Autonomous C + Induced C) ● 2. Calculate the equilibrium level of national income? ○ In equilibrium, plan equals to reality, AE = Y ■ AE = Y* ■ 45 + 0.9Y* = Y* ■ 450 = Y* ● 3. Graph the AE schedule. Clearly label the axes, the equilibrium level of national income, and any intercepts ● 4. If national income were higher than equilibrium, what would be the relationship between desired and actual inventory investment by firms? ○ Y (actual) > 450 (planned), if all else constant, I is too high ○ If Y were greater than 450, then sales would be less than what was actually expected (produced). ○ Actual is greater than planned national income ○ Production was greater than expected sales ○ As a result, there would be involuntary inventory investment ○ That is, actual inventory > desired inventory 3. The Multiplier ● Recall: ○ C = 30+0.9Y and I=15 ○ G = X = M = 0 (Simple Model) ● 5. How much will Y* increase if I increase to 35? ○ If I = 20, Y* = ? ○ It is an autonomous change ● Consider graphically: ○ Look back to D1 ● I = 20 ○ Change is autonomous expenditure is a shift in AE schedule ○ Does Y* = I? ● Y* > I Because of the multiplier - Autonomous expenditure change will impact induced expenditure through the money cyc
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