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ECN204 Lectures 6-11 Guide

7 Pages
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Department
Economics
Course Code
ECN 204
Professor
Amy Peng

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Lecture 6 Ch8.4, Ch9 (omit 9.3)
Basic Keynesian Model:
- Assumption: price is fixed in short run
- AE is planned total spending on final goods & services; AE = C + I; Savings = Investment
Multiplier Effect
- Ratio of change in equilibrium GDP to change in autonomous expenditure (investment spending)
- Changes in GDP = multiplier * initial change in spending
- Rationale: spending generates income, change in income cause both consumption & saving to change
Multiplier
- MPS & multiplier inversely related
- Multiplier = 1 / MPS = 1 / (1 t MPC)
- /QHPELHEAN L:¿EJ)&2KQPLQP;:¿EJ#';
Adding Government Sector
- Assumptions: government purchases do not cause shift in consumption/investment schedules
x Net tax revenues derived totally from personal taxes; taxes do not vary with GDP
x Government spending (G is autonomous expenditure), shifts AE up = higher equilibrium GDP
x Taxes affect disposable income
Keynesï Solution to Recessionary Gap
- 2 different policies government may pursue to close gap & achieve full employment:
1. Increase government spending
2. Lower taxes
Lecture 7 Ch10
Aggregate Demand t amounts of real output that buyers collectively desire to purchase at each possible price level (inverse)
x Slopes downward due to these effects of change in price level:
o Real-balances effect t inverse relationship of price & real value of financial assets with fixed money value
o Interest-rate effect t direct relationship of price & money demand, affects interest rates, total spending
o Foreign trade effect t inverse relationship of net exports & price relative to price of trading partners
x AD Shifts = DEMAND SHOCK; due to factors other than price changing behaviour
Determinants of AD
x Consumer Spending
x Consumer wealth, consumer expectations, taxes,
household borrowing
x Government Spending
x Investment Spending
x Real interest rates
x Expected returns t expectations about future
business conditions, technology, degree of excess
capacity, business taxes
x Net Export Spending
x National income abroad, exchange rates
Aggregate Supply
Aggregate supply t level of real domestic output that will be produced at each price level; production responses differ:
- Immediate short run, both input prices & output prices are fixed; horizontal @ price level
- Short run, input prices are fixed but output prices vary; upward curve, per-unit production costs rise
o Per-unit production cost = total input cost / units of output
www.notesolution.com
o Economy operating below full-employment GDP has idle capital & labour : little upward on cost
o Economy operating beyond full-employment GDP, most available resources employed : costs increase
- Long run, input & output prices vary; AS = vertical @ full-employment output (potential GDP)
- AS Shifts = SUPPLY SHOCK; due to cost of production; increase cost = left, decrease cost = right
Determinants of AS
Change in input prices
- Domestic resource price
- Price of imported resources
- Market power
Change in legal-institutional environment
- Business taxes & subsidies
- Government regulation
Change in productivity
Productivity ($ per input) = total output / total input
Per-unit production cost = total input cost / total output
Equilibrium GDP & Changes in Equilibrium
- Occurs at price level = amount of real output demanded & supplied
Shifts in AD
x Increases in AD: Demand-Pull Inflation t price level being pulled up by increase in AD : inflationary gap
o For any initial increase in AD, resulting greater increase in price level & small increase in real GDP
x Decreases in AD: Deflation : recessionary gap (AD too low, equilibrium GDP is below potential)
o Real output most impact of decline in AD since product prices are ^sticky_ in short run
Wage contracts, morale, effort & productivity, minimum wage, fear of price wars
Menu costs t costs associated with changing the prices of goods & services
Shifts in AS
x Decrease in AS: Cost-Push Inflation t as output decreases, price level increases
x Increase in AS: Full employment with price-level stability : inflation
From Short Run to Long Run
- Nominal wages & other input prices remain constant in short run, even though prices changed
- Once contracts have expired & nominal wage adjustments have been made, economy enters long run
Stagflation
- When inflation accelerated, unemployment relatively high
- Stagflation = Inflation + Stagnation
- Phillips Curve t shows relationship between unemployment rate & annual rate of increase in price level (inverse)
o Vertical long-run Phillips curve drawn at natural rate of unemployment
o Short-run PC t relationship of actual unemployment & inflation rate for given inflationary expectations
o Expectations of inflation t inflation rate involves looking at past experience
Lecture 8 Ch11
Government Expenditure, Taxes & Equilibrium Real GDP
- Aggregate Expenditure AE = C + I + G
- Taxes & Transfer payment affect consumption, Net Tax NT = tY, where t = net tax rate, Y = real GDP
- Disposable Income (after taxes) = Y t NT = (1-t)Y
Multiplier
- Net Tax (increasing tax rate) reduces DI, which lowers consumption & slope of AE & C = MPC * (1 t t)
- Multiplier = 1 / [1 t MPC*(1 t t)]
- Change of equilibrium GDP is given by G * multiplier
www.notesolution.com

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Description
Lecture 6 Ch8.4, Ch9 (omit 9.3) Basic Keynesian Model: - Assumption: price is fixed in short run - AE is planned total spending on final goods & services; AE = C + I; Savings = Investment Multiplier Effect - Ratio of change in equilibrium GDP to change in autonomous expenditure (investment spending) - Changes in GDP = multiplier * initial change in spending - Rationale: spending generates income, change in income cause both consumption & saving to change Multiplier - MPS & multiplier inversely related - Multiplier = 1 / MPS = 1 / (1 J MPC) - /302-L0-)N L :-J K32L32;:-J; Adding Government Sector - Assumptions: government purchases do not cause shift in consumption/investment schedules N Net tax revenues derived totally from personal taxes; taxes do not vary with GDP N Government spending (G is autonomous expenditure), shifts AE up = higher equilibrium GDP N Taxes affect disposable income Keynes Solution to Recessionary Gap - 2 different policies government may pursue to close gap & achieve full employment: 1. Increase government spending 2. Lower taxes Lecture 7 Ch10 Aggregate Demand J amounts of real output that buyers collectively desire to purchase at each possible price level (inverse) N Slopes downward due to these effects of change in price level: o Real-balances effect J inverse relationship of price & real value of financial assets with fixed money value o Interest-rate effect J direct relationship of price & money demand, affects interest rates, total spending o Foreign trade effect J inverseelationship of net exports & price relative to price of trading partners N AD Shifts = DEMAND SHOCK; due to factors other than price changing behaviour Determinants of AD N Consumer Spending N Government Spending N Consumer wealth, consumer expectations, taxes, N Investment Spending household borrowing N Real interest rates N Net Export Spending N Expected returns J expectations about future N National income abroad, exchange rates business conditions, technology, degree of excess capacity, business taxes Aggregate Supply Aggregate supply J level of real domestic output that will be produced at each price level; production responses differ: - Immediate short run, both input prices & output prices are fixed; horizontal @ price level - Short run, input prices are fixed but output prices vary; upward curve, per-unit production costs rise o Per-unit production cost = total input cost / units of output www.notesolution.como Economy operating below full-employment GDP has idle capital & labour : little upward on cost o Economy operating beyond full-employment GDP, most available resources employed : costs increase - Long run, input & output prices vary; AS = vertical @ full-employment output (potential GDP) - AS Shifts = SUPPLY SHOCK; due to cost of production; increase cost = left, decrease cost = right Determinants of AS Change in input prices Change in productivity - Domestic resource price Productivity ($ per input) = total output / total input - Price of imported resources - Market power Per-unit production cost = total input cost / total output Change in legal-institutional environment - Business taxes & subsidies - Government regulation Equilibrium GDP & Changes in Equilibrium - Occurs at price level = amount of real output demanded & supplied Shifts in AD N Increases in AD: Demand-Pull Inflation J price level being pulled up by increase in AD : inflationary gap o For any initial increase in AD, resulting greater increase in price level & small increase in real GDP N Decreases in AD: Deflation : recessionary gap (AD too low, equilibrium GDP is below potential) o Real output most impact of decline in AD since product prices are ^sticky_ in short run Wage contracts, morale, effort & productivity, minimum wage, fear of price wars
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