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Final

Finals Prep.docx


Department
Economics
Course Code
ECN 204
Professor
Amy Peng
Study Guide
Final

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1
Shifts in the Invest Demand Curve
Acquisition, Maintenance and Operating Costs
Business Taxes
Technological Change
Stock of Capital Goods on Hand
Expectations
Fluctuations of Investment
Durability
Irregularity of Innovation
Variability of Profits
Variability of Expectations
Summary: Equilibrium GDP
The equilibrium output is that out put which creates total spending just sufficient to produce
that output
Other features of equilibrium GDP
Saving equals planned investment
saving represents a leakage of spending
investment can be thought of as an injection of spending
No unplanned changes in inventories
Through a multiplier effect, an initial change in investment spending can cause a magnified change in
domestic output.
Multiplier
the ratio of a change in the equilibrium GDP to the change in investment
Changes in GDP = multiplier x initial change in spending
The “initial change in spending”
associated with investment spending because of investment’s volatility
associated with investment spending results from either a change in the real interest
rate or a shift of the ID curve

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2
may create a multiple increase in GDP and a decrease in spending may be multiplied
into a large decrease in GDP
Rationale:
spending generates income
change in income will cause both consumption and saving to change
The larger the MPC (and the smaller the MPS), the greater the size of the multiplier
Summary: Basic Keynesian Model
Assumption: price is fixed in the short run
Aggregate expenditure is the planned total spending on final goods and services
AE = C + I (no government, no trade)
The equilibrium output is that out put which creates total spending just sufficient to produce
that output (Y = AE)
Saving equals planned investment (S = I)
No unplanned changes in inventories
Suppose that France has an MPC (Marginal Propensity To Consume) of 0.22 and a real GDP (Gross
Domestic Product) of $431 billion. Also suppose that its investment spending decreases by $9 billion.
Calculate (correct to 1 decimal place) France's new level of real GDP in the aggregate
expenditures model.
Recall ΔYe = Δ(C0 + Ig)/(1-c)
ΔYe = = $9/(1-0.22) = $11.54 billion
New GDP = Old GDP + change in GDP (-) = $431 - $11.54 = $419.46 billion
Adding the Government Sector
Simplifying Assumptions
government purchases do not cause any shift in consumption or investment schedules
net tax revenues are derived totally from personal taxes
taxes do not vary with GDP
Government spending (G is autonomous expenditure
Taxes affect disposable income
Increases in public spending shift the AE schedule upward and result in higher equilibrium GDP
Examples
suppose government add 40 billion of purchases
suppose government impose 40 billion of lump-sum tax
The Transmission Mechanism
1. With prices constant, changes in money supply change nominal and real interest rates
2. Changes in real interest rates change consumption expenditure
3. Change in real interest rate also cause changes in planned investment expenditure
4. Changes in nominal interest rate also cause changes in exchange rates, which change the price
competitiveness and profitability of trade.

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3
Keynes’s Solution to a Recessionary Expenditure Gap
Two different policies that a government might pursue to close a recessionary expenditure gap
and achieve full employment:
1. Increase government spending
2. Lower taxes
Both work by increasing aggregate expenditures
France is falling 2.0% above its targeted income of $18,000 and has a marginal propensity to consume of
0.6.
By using the multiplier model, what change in government expenditures would be needed to
achieve this target?
Recall, Multiplier = ΔYe/ΔAE
Multiplier = 1/(1-MPC) = 1/(1-0.6) = 2.5
ΔYe= 2%*$18,000 =$360
ΔAE = $360 / 2.5 = $144
Government must increase its expenditure by $144 to close the output gap.
The aggregate demandaggregate supply model
Shows how economic factors and policies can simultaneously affect the overall price
level as well as real output
Deals with changes in the overall price level of the economy
Consumer Price Index not inflation
The general level of prices directly determines the purchasing power of money
Stagflation was difficult to explain with the Keynesian cross model
Aggregate Demand (AD) - The amounts of real output that buyers collectively desire to purchase at
each possible price level
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