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INTRO MACROECONOMIC THEORY Test 2 Notes - 4.0ed this test!

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University of Pittsburgh
ECON 0110

Test 2 Notes Macroeconomics Lecture 15 We tend to overstate inflation • Indexed wages rise too fast - Other workers seek similar increases • SS benefits rise too fast - Tax Brackets ^ too much - Treasury will lose tax rev WHY??? - quality improvement underestimated - Substitution - New goods: price \/ when more widely produced (less valuable essentially.) Inflation types / causes • Demand pull inflation (1960’s) - Caused by increase in aggregate demand - Occurs when economy is near full employment - Caused by increased spending by 4 sectors • Cost Push Inflation (1970’s) - Caused by increase in production costs. 1. ^ fuel costs 2. ^ Int. Rates 3. ^ wage rates (near full employment) 4. Input shortages (strikes) 5. Stricter env. Regs 6. Stricter safety regs 7. ^ costs of fringe benefits (health insurance or retirement) 8. ^ S.S. & medicare taxes Consumption Function {C(Y)} (Simplified to be straight line (y-axis = Household consumption, x-axis = income (Y)) 1. Spend it (C) What people generally do with extra money…. 2. Save it (S) Y = C + S + T Y 0 disposable income 3. Pay Taxes (T) Y 0 Y – T = C + S Influences on level of consumption: - Wealth, expected future income, expected inflation rates, level of interest rates  Wealth = value of assets – liabilities (debts) - Bottom 40% = in debt, mid-20% = even, 2 highest 20% = save a little, top 20% = saves more Draw 45 line on Consumption (y-axis) vs. Income graph (x-axis): o Want to be BELOW 45 line: i.e. spend less than take in C = consumption function = C +ompcY o - Part of spending: autonomous = Y – intercept o Does not depend on income - Slope = change in consumption caused by change in income = mpcY o Autonomous spending - In economy: spending that doesn’t depend on level of GDP - Consumption, investment, Govn’t, foreign spending (exchange rates) Parallel Shifts in consumption function 1. Increase in wealth  upward shift (rise in stock market) 2. Decrease in interest rates  upward shift (borrowing less expensive) 3. Increase in expected future income  upward shift (job promotion) Average propensity to consume \/ as income ^ C Y APC 13 10 1.3 20 20 1.0 27 30 0.9 34 40 0.85 Lecture # 16 Investment: replacement investment = fairly constant Total investment = highly volatile; mostly dependent on interest rates / business expectations Investment spending = - Non-res & res structures - durable equip - inventories Total gross private investment – depreciation = Net investment Autonomous investment – inv. spending that doesn’t depend on level of GDP Induced Consumption – spending that occurs as result of GDP increases/ decreases Desired investment spending = amount businesses wish to spend on new plants / equip. + amount contractors wish to spend on res. Construction + amount that businesses wish to spend to add to their stock of inventory Desire investment will not necessarily equal actual investment spending o businesses cannot necessarily achieve their desired change in their inventory Changes inAutonomous investment - Factors which ^ level of autonomous investment spending 1. ^ in expected profits 2. Decrease in Interest Rates 3. Technological change & new products End section 16 Equilibrium level of Output - Level of output in which planned or desired purchases equals actual aggregate output by 4 sectors Predict 90K units sold, 90K actually sold. - When in equilibrium – producers have no incentive to inc. or decrease output. Equilibrium:Aggregate planned expenditures = Total actual output If output for sale < desired purchases - Should ^ output If output > desire - Should \/ output If output = desire - Output should remain the same Equilibrium Income in Keynesian Model definitions - Actual output = actual level of C + I + G + NX Eq. output = Y = level of output such that producers have no incentive to change e scale of production Desired spending =Actual spending = Y e Y e C + I + G + NX - Assume no income taxes Ex: C = 100 + .75Y e - Assume all spending = autonomous - I = Io G = G o NX = NX o A =oI +oG + No o Ex: assumeA = 25o Then Y =eC + I + G + NX= (100+.75Y ) + 25 e Y = 500 e “If consumers want 100 + .75X level of output, then 500 produced units will satisfy all parties” General Solution for Y e C = C +ompc*Y e Y e C + I + o + NX o C + mpo*Y + o + G + NX e o o o Y e [1/(1-mpc)] X (C + I + o + No ) o o Change in C by ohanging IR’s, change in I by tax breoks, change in G by increasing o spending, change in NX by chaoging imports and exports. Consumptions (C) vs. income (Y) . = direct relationship with positive Y-intercept. - Planned investment = constant o - 45 line tells how much people want to buy @ any output o When planned aggregate expenditure function is below 45 - People want to buy less than produced Equilibrium = no incentive to change level of production Multiplied process: When AE is shifted upwards X, then Y increases by eX. - Unplanned change in inventory (Y- (c+i)) The amount we produce = “# everyone wants to buy” *planned aggregate expenditure functions as Y (aggregate output) AE(y) = ……. Section 18 - Autonomous spending multiplied in model w/out taxes… Every $ stimulus spending  $4 increase in output Autonomous spending = Y-intercept - Level of spending regardless of GDP ^Autonomous consumption by ^ stock market (capital gains not part of GDP, thus can increase wealth w/out changing the GDP level) ^Autonomous Investment by IR \/  Corps borrow more money and build new factories. ^ Govn’t spending- decides to build new highway….autonomous spending mostly ^Autonomous export spending- Chinese economy booms and thus foreigners visit US more frequently to spend $ Effect of ^ in autonomous spending - When autonomous spending ^, some sector of economy is purchasing more than previously & causes an increase in output. - Increase in Output  ^ incomes of workers producing the output. - ^ in income  ^ consumption spending of the producers This is called induced consumption spending Conclusion:Any ^ in output spending  ^ in output. Multiplied = ΔY / Δ(eutonomous spending) ΔY =eYe – Y1= [1/e0-mpc)]x(G -G ) 1 o Test Q?... Suppose spending ^ by 100, & output ^ by 400, what’s the multiplier? - 4 …ratio of the output: change in spending Autonomous Spending Multiplier C = 100 + .75 Y e I = 100 G = 300 NX = 100 Solve for Y : e0= (Ce0 I + G0+ NX0)/(1-0pc) 0 ΔY /eG = 1/ (1-mpc) = Multiplier General Solution: C = C + mpc0 Y e ΔY =eY – Ye1 1/(1e0pc) * ΔG Operation below full employment = output @ level Y u Full employment = Y f - Thus GDP gap = Y - Y f u To increase GDP to eliminate gap? - Increased G by amount ΔG - Multiplier = ΔY /eG = 1/ (1-mpc) Y e? Higher income = low mpc Lower income = high mpc - Complicated to find actual multiplier in reality…. Influences in multiplier: “crowding out effect” & taxes - Our analysis OVERSTATES mpc - Ceteris paribus – other things equal Crowding out effect - Increases in G to course offsetting reductions in spending in the private sector - Consumers or businesses decrease their spending in other areas. No net gain “govn’t replaces what citizens would have done” C.O. effect as a result of higher interest rates. Ceteris paribus {^ borrowing (might) ^ int. rates… {^ int. rates –(might) \/ borrowing for consumption spending and investment spending…. Conclusion: ^ govn’t spending might lead to decrease in private citizen spending in those areas. ^ autonomous govn’t spending has CROWDED out consumption and investment spending that would have occurred in the absence of govn’t spending. MPC = marg. Propensity to consume…..Δreal consumption/ΔDisposable income - Income tax rate = t - Multiplier w/out taxes = 1-mpc - Multiplier w/taxes = 1/ [1-mpc(1-t)] Conclusion: ^ mpc  multiplier^ ^t  multiplier \/ Policy conclusion: If rich people = \/
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