Conference sheet 3.doc

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Department
Economics (Arts)
Course
ECON 295
Professor
Christopher Ragan
Semester
Winter

Description
McGillUniversity Econ295 Professor Paul Dickinson Discussion Questions #3 The Basics of the Short-Run Macro Model 1. Desired Versus Actual Expenditure. From national income accounting (Chapter 20), we know that actual national income equals actual national expenditure and also equals actual national production. But central to the theory of national-income determination is the distinction between “desired” aggregate expenditure and “actual” aggregate income. All measures of income here are real as opposed to nominal (since the price level is assumed to be constant. Also, the model at the moment has no government and no foreign trade. a) Explain the concept of desired consumption expenditure and how it relates to actual national income. b) Explain the concept of desired investment expenditure and how it relates to actual national income. c) Now explain what desired aggregate expenditure is and how it relates to actual national income. d) Imagine a level of actual national income (hereafter GDP) such that desired aggregate expenditure exceeds GDP. Explain how desired aggregate expenditure can exceed GDP even though actual aggregate expenditure cannot. Show this distinction in the 45-degree line diagram that we developed in class. If consumers are actually spending their desired amount, would there be a contradiction here? Explain why/whynot. e) Now imagine a level of GDP such that desired aggregate expenditure is less than GDP. Explain how desired aggregate expenditure can be less than GDP even though actual aggregate expenditure cannot be. What is making up the difference? Show this distinction in the 45-degree line diagram that we developed in class. *********** 2. The 45 Line Diagram. a) Draw the diagram which has (desired) aggregate expenditure (AE) on the vertical axis and (actual) national income (Y) on the horizontal axis. What does the AE curve look like? What is the economic interpretation of its slope? b) What is the interpretation of the 45 line inthis diagram? c) Explain the concept of equilibrium national income in this setting (we will call the equilibrium value of income Y E. Explain why if GDP is less than Y ,Ewe expect GDP to rise in the near future. What is going on here? d) If GDP is greater than YE, why do we expect GDP to fallin the near future? What is going on? 2 e) Comment on the following statement: “Economists are clearly confused. First they say that output always equals consumption plus investment. In fact, they say this is an accounting identity. Next they say that equilibrium is where Y = C + I. Then they have the audacity to say that output isn’t always in equilibrium. It’s amazing that anybody takes these clowns seriously!” . *************** 3. The Consumption Function and AE. Consider the simple macro model with no government and no international trade. Suppose pr
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