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ECN204 Lectures 6-11 Guide

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ECN 204
Amy Peng

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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