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 (I_g)
  
• 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+I_g
    

  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+I_g will be less than GDP (cannot be sustained)
  
• If Injection of investment (IOI) exceeds leakage of saving then C+I_g 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+I_g+(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= X_n1
  
• C+I_g+X_n1
  
• 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 = X_n2
  
• C+I_g+X_n2
  
• 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+I_g+X_n+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
  

  
  

• C_a+I_g+X_n+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(I_g) are injections into the income expenditures stream
    
  • S_a+M+T=I_g+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