Chapter 16 Notes

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Economics for Management Studies
Iris Au

Chapter 16: Output and the Exchange Rate in the Short Run Determinants of Aggregate Demand (AD) in an Open Economy There are 4 sources of AD in an open economy: 1) Consumption (C) C is determined by disposable income, Y T. C = C(Y T) = Autonomous C + MPC (Y T) 2) Investment (I) I is determined autonomously. 3) Government spending (G) G is determined autonomously. 4) Net exportCA CA is determined by (Y T) and q. CA = CA(Y T, q) = Autonomous CA MPI (Y MT) + CA q 1 The Equation of AD * D = C ( T )+ +G + CA q = E P , Y T P P * D = D( (+, ) )+ ,(+ ,)= E ) + P) How Output is Determine in the Short Run ECMC61 Chapter 16 1 Output market equilibrium is given by AD = AS = Output (Y). * Y = D( Y , T , I , G ,E ) + )( + )+( ) )P (+ ) In the short run, P are P* are held fixed. Output Market Equilibrium in the Short Run: The DD Schedule The DD schedule: it shows the relationship between output and the exchange rate for which the output market is in short-run equilibrium. Deriving the DD Schedule Along the D = Y line, the output market is in equilibrium. Along any aggregate demand curve (D), autonomous C, I, G, T, autonomous CA, E, P and P* are held constant. Keynesian Cross Diagram D Y = D 0 D(E ) A 45o Y 0 Y E E0 A 0 Y Y ECMC61 Chapter 16 2
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