Textbook Notes (290,000)
CA (170,000)
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ECN 204 (300)
Chapter 11

ECN 204 Chapter Notes - Chapter 11: Potential Output, Autarky, Equilibrium Level


Department
Economics
Course Code
ECN 204
Professor
Eric Kam
Chapter
11

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11.1# The#Aggregate#Expenditure#Model:#
Consumption#and#Saving
GDP$=$DI
Fundamental*assumption*behind*the*aggregate*expenditures*model*is*
that*prices*in*the*economy*are*fixed
Consumption*spending
Investment*spending
Begin*with*private,*closed*economy
11.2# Consumption#and#Investment#Schedules
Consumption,*C
Gross*Investment,*Ig
Aggregate# Expenditures
To*add*investment*decisions*of*business*to* the*consumption* plans*of*
households,*construct*an*investment*schedule*showing*the*amounts*
business*firms*collectively* intend*to*invest*at*each*possible*level*of*
GDP
Planned#Investment
Shows*the*amount*of*investment*forthcoming*at*each*level*of*GDP
Investment#Schedule
11.3# Equilibrium#GDP:#C$+$Ig=$GDP
Firms*willing* to*produce*anyone*of*these*10*levels*of*output*just*as*
long*as*the*revenue*that*they*receive*from*selling*any*particular*level*
equals*or*exceeds*the*costs*they*would*have*to*incur*to*produce*it
Real#Domestic#Output
Consists*of*consumption*plus*investment
Shows*the*amount (C$+$Ig)$ that*will* be*spent*at*each*possible*output*
or*income*level
Aggregate# Expenditures
Equilibrium*output*creates*total*spending*just*sufficient*to*produce*
that*output
C$+$$Ig=$GDP
Equilibrium*level*of*GDP*is*the*level*at*which*the*total*quantity*of*
goods*produced*(GDP) equals*the*total*quantity*of*goods*purchases*(C$
+$Ig)
No*overproduction,*which*would*result*in*a*piling*up*of*unsold*goods*
and*consequently*cutbacks*in*the*production*rate
Equilibrium#GDP
No*level*of*GDP*other*than*the*equilibrium*level*can*be*sustained
Disequilibrium
Saving*and*planned*investment*are*equal* (S$=$$Ig)
No*unplanned*changes*in*inventories*occur
11.4# Other#Features#of#Equilibrium#GDP
Saving*is*a*leakage or*withdrawal* of*spending*from*the*income-
expenditures*stream
Injection$of*spending*into* the*income-expenditures*stream,*therefore*
a*potential*replacement*for*the*leakage*of*saving
Savings#Equals#Planned#Investment
Occur*at*equilibrium*GDP;*characteristic*of*equilibrium*GDP*in*the*
private*closed*economy
Unplanned*increases*in*inventories*result*when*firms*produce*above-
equilibrium GDP*output*level
Unplanned*decreases*in*inventories* result*when*firms*produce*below-
equilibrium GDP*output*level
No#Unplanned#Changes#in#Inventories
Multiplier$=$change$in$real$GDP/initial$change$in$spending
Multiplier$=$1/MPS
In*a*private*closed,*economy,*the*equilibrium*GDP*will*change*in*
response*to*changes*in*either*the*investment*schedule*or*the*
consumption*schedule*
Changes*in*investment*schedule*are*the*main*sources*of*instability
11.5# Changes#in#Equilibrium#GDP#and#the#Multiplier
11.6# Adding#International#Trade
Net#Exports (Exports$[X]$-Imports$[M],$Xn$- can$be$positive/negative)
Exports*create*domestic*production,*income*and*employment*for*a*
nation
Add*exports*as*a*component*of*Canada's*aggregate*expenditure
Foreign*spending*on*Canadian*goods*and*services*increases*
production*and*creates*job*and*incomes*in*Canada
Xn=$X$- M
C$+$Ig+$Xn
Avoid*overstating*the*value*of*domestic*production,*subtract*
expenditures*from*imports
Net#Exports#and#Aggregate#Expenditures
If*GDP*in*other*countries*is*growing,*demand*for*our*exports*will*
increase
Our*imports* are*dependent*on*our*own*GDP
Depreciation
Appreciation
Both*imports*and*exports*are*affected*by*the*exchange*rate
The#Determinants#of#Imports#and#Exports#and#the#Net#Export#
Schedule
MPM$=$ΔM$(import)$/$ΔGDP
MPM*is*the*slope*of*net*export*schedule
Marginal$Propensity$to$Import$(MPM)$the*change*in*imports* divided*
by*a*change*in*GDP*
The*closed*economy*the*multiplier* is*1/MPS
Expenditure*on*imports*is*a*leakage
Open$economy$multiplier$=$1/$(MPS$+$MPM)
Open*Economy* Multiplier
Imports#and#the#Multiplier
A*decline*in*new*exports*decreases*aggregate*expenditures*and*
reduces*GDP
A*rise*in*net*exports*increases*aggregate*expenditures*and*increases*
GDP
Net#Exports#and#Equilibrium#GDP
Prosperity*abroad
Exchange*rates
Tariffs*and*devaluations
International#Economic#Linkages
11.7# Adding#the#Public#Sector
Increases*in*public*spending,*like*increases*in*private*spending,*shift*
the*aggregate*expenditures*schedule*upward*and*result*in*a*higher*
equilibrium*GDP
Government# Purchases#and#Equilibrium#GDP
Lump-sum$tax which*is*a*tax*yielding*the*same*amount*of*tax*
revenues*at*all*levels*of*GDP
Differential$Impacts -equal*changes*in*G*and*T*do*not*have*
equivalent*impacts*on*GDP
Sa+$M$+$T$=$Ig$+$X$+G
Injections/Leakages/Unplanned$Changes$in$Inventories:
Taxation#and#Equilibrium#GDP
11.8# Equilibrium#Vs.#Full-Employment#GDP
Insufficient*aggregate*spending
Spending*below*full-employment* GDP
increase*G*and/or*decrease*T
The*amount*by*which*aggregate*expenditures*fall*short*of*those*
required*to*achieve*the*full-employment* GDP*(potential*GDP)
Recession#Expenditure#Gap
Too* much*aggregate*spending
Spending*exceeds*full-employment*GDP
Decrease*G*and/or*increase*T
The*amount*by*which*an*economy's*aggregate*expenditures*exceed*
those*just*necessary*to*achieve*the*full*employment* level*of*GDP
Inflationary#Expenditure#Gap
Chapter*11:*The*Aggregate*Expenditures*Model
Saturday,*March*5,*2016
4:24*PM

Only pages 1-2 are available for preview. Some parts have been intentionally blurred.

11.1# The#Aggregate#Expenditure#Model:#
Consumption#and#Saving
GDP$=$DI
Fundamental*assumption*behind*the*aggregate*expenditures*model*is*
that*prices*in*the*economy*are*fixed
Consumption*spending
Investment*spending
Begin*with*private,*closed*economy
Assumptions#and#Simplifications
11.2# Consumption#and#Investment#Schedules
Consumption,*C
Gross*Investment,*Ig
Aggregate# Expenditures
To*add*investment*decisions*of*business*to* the*consumption* plans*of*
households,*construct*an*investment*schedule*showing*the*amounts*
business*firms*collectively* intend*to*invest*at*each*possible*level*of*
GDP
Planned#Investment
Shows*the*amount*of*investment*forthcoming*at*each*level*of*GDP
Investment#Schedule
11.3# Equilibrium#GDP:#C$+$Ig=$GDP
Firms*willing* to*produce*anyone*of*these*10*levels*of*output*just*as*
long*as*the*revenue*that*they*receive*from*selling*any*particular*level*
equals*or*exceeds*the*costs*they*would*have*to*incur*to*produce*it
Real#Domestic#Output
Consists*of*consumption*plus*investment
Shows*the*amount (C$+$Ig)$ that*will* be*spent*at*each*possible*output*
or*income*level
Aggregate# Expenditures
Equilibrium*output*creates*total*spending*just*sufficient*to*produce*
that*output
C$+$$Ig=$GDP
Equilibrium*level*of*GDP*is*the*level*at*which*the*total*quantity*of*
goods*produced*(GDP) equals*the*total*quantity*of*goods*purchases*(C$
+$Ig)
No*overproduction,*which*would*result*in*a*piling*up*of*unsold*goods*
and*consequently*cutbacks*in*the*production*rate
Equilibrium#GDP
No*level*of*GDP*other*than*the*equilibrium*level*can*be*sustained
Disequilibrium
Saving*and*planned*investment*are*equal* (S$=$$Ig)
No*unplanned*changes*in*inventories*occur
11.4# Other#Features#of#Equilibrium#GDP
Saving*is*a*leakage or*withdrawal* of*spending*from*the*income-
expenditures*stream
Injection$of*spending*into* the*income-expenditures*stream,*therefore*
a*potential*replacement*for*the*leakage*of*saving
Savings#Equals#Planned#Investment
Occur*at*equilibrium*GDP;*characteristic*of*equilibrium*GDP*in*the*
private*closed*economy
Unplanned*increases*in*inventories*result*when*firms*produce*above-
equilibrium GDP*output*level
Unplanned*decreases*in*inventories* result*when*firms*produce*below-
equilibrium GDP*output*level
No#Unplanned#Changes#in#Inventories
Multiplier$=$change$in$real$GDP/initial$change$in$spending
Multiplier$=$1/MPS
In*a*private*closed,*economy,*the*equilibrium*GDP*will*change*in*
response*to*changes*in*either*the*investment*schedule*or*the*
consumption*schedule*
Changes*in*investment*schedule*are*the*main*sources*of*instability
11.5# Changes#in#Equilibrium#GDP#and#the#Multiplier
11.6# Adding#International#Trade
Net#Exports (Exports$[X]$-Imports$[M],$Xn$- can$be$positive/negative)
Exports*create*domestic*production,*income*and*employment*for*a*
nation
Add*exports*as*a*component*of*Canada's*aggregate*expenditure
Foreign*spending*on*Canadian*goods*and*services*increases*
production*and*creates*job*and*incomes*in*Canada
Xn=$X$- M
C$+$Ig+$Xn
Avoid*overstating*the*value*of*domestic*production,*subtract*
expenditures*from*imports
Net#Exports#and#Aggregate#Expenditures
If*GDP*in*other*countries*is*growing,*demand*for*our*exports*will*
increase
Our*imports* are*dependent*on*our*own*GDP
Depreciation
Appreciation
Both*imports*and*exports*are*affected*by*the*exchange*rate
The#Determinants#of#Imports#and#Exports#and#the#Net#Export#
Schedule
MPM$=$ΔM$(import)$/$ΔGDP
MPM*is*the*slope*of*net*export*schedule
Marginal$Propensity$to$Import$(MPM)$the*change*in*imports* divided*
by*a*change*in*GDP*
The*closed*economy*the*multiplier* is*1/MPS
Expenditure*on*imports*is*a*leakage
Open$economy$multiplier$=$1/$(MPS$+$MPM)
Open*Economy* Multiplier
Imports#and#the#Multiplier
A*decline*in*new*exports*decreases*aggregate*expenditures*and*
reduces*GDP
A*rise*in*net*exports*increases*aggregate*expenditures*and*increases*
GDP
Net#Exports#and#Equilibrium#GDP
Prosperity*abroad
Exchange*rates
Tariffs*and*devaluations
International#Economic#Linkages
11.7# Adding#the#Public#Sector
Increases*in*public*spending,*like*increases*in*private*spending,*shift*
the*aggregate*expenditures*schedule*upward*and*result*in*a*higher*
equilibrium*GDP
Government# Purchases#and#Equilibrium#GDP
Lump-sum$tax which*is*a*tax*yielding*the*same*amount*of*tax*
revenues*at*all*levels*of*GDP
Differential$Impacts -equal*changes*in*G*and*T*do*not*have*
equivalent*impacts*on*GDP
Sa+$M$+$T$=$Ig$+$X$+G
Injections/Leakages/Unplanned$Changes$in$Inventories:
Taxation#and#Equilibrium#GDP
11.8# Equilibrium#Vs.#Full-Employment#GDP
Insufficient*aggregate*spending
Spending*below*full-employment* GDP
increase*G*and/or*decrease*T
The*amount*by*which*aggregate*expenditures*fall*short*of*those*
required*to*achieve*the*full-employment* GDP*(potential*GDP)
Recession#Expenditure#Gap
Too* much*aggregate*spending
Spending*exceeds*full-employment*GDP
Decrease*G*and/or*increase*T
The*amount*by*which*an*economy's*aggregate*expenditures*exceed*
those*just*necessary*to*achieve*the*full*employment* level*of*GDP
Inflationary#Expenditure#Gap
Chapter*11:*The*Aggregate*Expenditures*Model
Saturday,*March*5,*2016 4:24*PM
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