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Sunday, October 14, 2007

Econ -Unit 3- Chap 3 Notes

SIMPLIFACATIONS

  • Private Closed Economy (no international trade or gov.)
    • GDP=DI

    CONSUMPTION AND INVESTMENT SCHEDULES

  • Two factors of aggregate expenditures are consumption (C) and gross investment (Ig)
  • Need an investment schedule to know planned investment at each possible level of GDP
    • Represents investment plans of businesses in the same way consumption schedule represents consumption plans of households
  • Investment schedule shows amount of investing forthcoming
  • Interest rate and investment demand curve together to determine amount


    EQUILIBRIUM GDP: C + Ig = GDP

Possible Levels of Employment

Real Domestic Output

Consumption

Savings

Investment

Expenditures

Unplanned Changes in Inventories

Tendency of E,O & I

40

$370

$375

$-5

$20

$395

$-25

Increase

45

390

390

0

20

410

-20

Increase

50

410

405

5

20

425

-15

Increase

55

430

420

10

20

440

-10

Increase

60

450

435

15

20

455

-5

Increase

65

470

450

20

20

470

0

Equilibrium

70

490

465

25

20

485

5

Decrease

75

510

480

30

20

500

10

Decrease

80

530

495

35

20

515

15

Decrease

85

550

510

40

20

530

20

Decrease

Tabular Analysis

  • Columns 2-5 repeat consumption and saving schedules and the investment schedule

    Real Domestic Output

  • Column2= possible output levels

    ECT.

  • Equilibrium=good
    • Total number of good produced=total number of good purchased
    • C+Ig

    Disequilibrium

  • Not where it should be
  • Below=economy wants to spend at higher levels
    • To fix: Businesses adjust by stepping up production; greater output increases employment and total income
  • Above: Total outputs don't generate needed spending to clear shelves of goods; causing bussinesses to cut back production
    • To fix: Businesses adjust by cutting back on rate of production
      • Lower output=fewer jobs and decline in total income


    Graphical Analysis

  • 45˚
    • Any point=value measured on X=value of what is being measured on Y (x=y)?
    • Graphical statement of equilibrium condition


    OTHER FEATURES OF EQILIBRIUM GDP

  • 2 more characteristics of GDP:
    • Saving and planned investments are equal
    • No unplanned changes in inventories


    Saving Equals Planned Investment

  • Saving=Leakage or withdrawal from spending
  • Causes consumption to be less than total output or GDP
  • Investment is an injection of spending into the income-expenditures stream
  • If leakage of saving (LAS) exceeds the injection of investment then C+Ig will be less than GDP (cannot be sustained)
  • If Injection of investment (IOI) exceeds leakage of saving then C+Ig will be greater than GDP (drives GDP up)


    No Unplanned Changes In Inventories

  • No unplanned changes in inventories at equilibrium
  • Unplanned changes in inventories act as balancing item the equates the actual amounts saved and invested


    CHNAGES IN EQUILIBRIUM GDP AND THE MULITPLIER

  • Change in response to changes in either the investment schedule or the consumption schedule
  • Expected rate of return on investment rises or the real interest rate falls=upward shift of investment schedule
  • ^opposite=downward shift


    ADDING INTERNATIONAL TRADE

  • OPEN ECONOMY!
  • X=exports
  • M=imports


    Net Exports and Aggregate Expenditures

  • Exports=Domestic production, income, and employment for a nation
  • Included in AE because increase production and creates jobs and income
  • Open Economy= C+Ig+(X-M)


    The Net Export Schedule

  • Lists amount of net exports that will occur at each level of GDP


    Net Exports and Equilibrium GDP

  • In open economy next exports can be positive or negative

    Positive Net Exports

  • Net export schedule= Xn1
  • C+Ig+Xn1
  • Other things equal positive exports increase aggregate expenditures and GDP beyond that of closed economy
  • Exports= lower stock available and boosts real GDP (by increasing expenditures on domestically produced output

    Negative Net Exports

  • Negative = Xn2
  • C+Ig+Xn2
  • Other things equal negative exports reduce AE and GDP (Imports add to stock of goods, but diminish GDP by reducing expenditures on domestically produced products)


    International Economic Linkages

    Prosperity Abroad

  • Rising level of real output and income among US trading partners allows US to sell more good abroad, raising net exports
  • They do good and they buy form us, we get more money and buy from them
  • Prosperity abroad=prosperity here

    Tariffs

  • When a foreign economy raises tariffs on imports they increase production in their economies, stimulating it; this reduces US exports and depresses our economy

    Exchange Rate

  • Depreciation of dollar
    • enables people abroad to get more dollars in exchange for their own currency
    • Price of US goods in terms of that currency to fall stimulating increase in purchase of US exports
    • US citizens will find that they need more dollars to buy foreign goods and reduce spending on imports
    • INCREASES NET EXPORTS & GDP


    ADDING THE PUBLIC SECTOR

  • Public open economy
    • Adding taxes and government purchases
  • Gov purchases do not cause any movement in schedules
  • Net tax revenues come from person taxes
  • Fixed amount of taxes is collected regardless of GDP


    Government Purchases and Equilibrium GDP

  • Increase in public spending shift the AE upward and produce higher equilibrium GDP
  • C+Ig+Xn+G


    Taxation and Equilibrium GDP

  • Lump-sum tax=tax of a constant amount or a tax yielding the same amount of tax revenue at each level of GDP
  • Taxes reduce disposable income relative to GDP by the amount of taxes
  • Decline in DI reduces consumption and saving at each level of GDP
  • Tax increases lower the AE schedule relative to the 45˚ line and reduce the equilibrium GDP
  • Decreases in existing taxes will raise the AE schedule


  • Ca+Ig+Xn+G=GDP


    Injections, Leakages, and Unplanned Changes in Inventories

  • Imports and taxes are added leakages
  • Saving importing, and paying taxes=uses for income that subtract from potential consumption (PC)
    • Consumption is will be less than GDP (creating potential spending (PS) gap) in amount of after tax saving(S), imports(M), and taxes(T)
    • Exports(X), gov. purchases(G), and investments(Ig) are injections into the income expenditures stream
    • Sa+M+T=Ig+X+G
  • Because AE=GDP: all goods and services produced will be purchased


    EQUILIBRIUM VERSUS FULL-EMPLUYMENT GDP

  • The economy doesn't always need to produce full employment and price level stability


    Recessionary Gap

  • Recessionary gap (RG) in the amount by which AE at the full employment GDP fall short of those required to meet full employment GDP
  • Graphically the RG is the vertical distance by which the actual AE schedule lies below the hypothetical AE schedule


    LIMITATION OF THE MODEL

  • Does not show price-level changes:
    • Can account for demand-pull inflation, but does not include how much the price level will rise when AE are excessive
    • Does not measure inflation
  • Ignores premature demand-pull inflation
    • Does not explain why mild d-p can occur
  • Limits real GDP to the full-employment level of output
    • Economy can actually expand beyond full-employment real GDP, AE model does not show this
  • Does not deal with cost-push inflation
    • AE does not address
  • Does not allot for "self-correction"
    • AE does not contain features that may correct RG

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