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1、MOTIVATING QUESTION,How is output determined in the short run?Output is determined by equilibrium in the goods market by the condition that supply equals demand. This condition always determines output, but in the short run, we assume that production adjusts automatically to output without changes i
2、n price.in the short run, output is effectively determined by demand.in this chapter, investment is exogenous (and therefore independent of the interest rate), so there is no need to consider simultaneous equilibrium in the goods and financial markets.,2 of 32,9-3,Introduction,One of the central que
3、stions in macroeconomics is why output fluctuates around its potential levelIn business cycle booms and recessions, output rises and falls relative to the trend of potential outputThis chapter offers a first theory of these fluctuations in real output relative to trend Cornerstone of this model is t
4、he mutual interaction between output and spending: spending determines output and income, but output and income also determine spendingThe Keynesian model of income determination develops the theory of ADAssume that prices do not change at all and that firms are willing to sell any amount of output
5、at the given level of prices AS curve is flat,The Keynesian Cross,Keynes ：in the short run，an economys total income was determined largely by the spending plans of households, businesses, and government.Actual expenditure is the amount households, firms, and the government spend on goods and service
6、sPlanned expenditure is the amount households, firms, and the government would like to spend on goods and services.actual expenditure differ from planned expenditure. Why?firms might engage in unplanned inventory investment because their sales do not meet their expectations,4 of 32,The Keynesian Cro
7、ssa simple model,A simple closed economy model in which income is determined by expenditure. (due to J.M. Keynes)Notation: I = planned investmentE = C + I + G = planned expenditureY = real GDP = actual expenditureDifference between actual & planned expenditure = unplanned inventory investment,Elemen
8、ts of the Keynesian Cross,consumption function:,for now, planned investment is exogenous:,planned expenditure:,equilibrium condition:,govt policy variables:,actual expenditure = planned expenditure,Graphing planned expenditure,income, output, Y,Eplannedexpenditure,Graphing the equilibrium condition,
9、income, output, Y,Eplannedexpenditure,45,The equilibrium value of income,income, output, Y,Eplannedexpenditure,E =Y,E =C +I +G,The Keynesian Crossmore details,10 of 32,11 of 32,3-1 The Composition of GDP,Consumption (C) refers to the goods and services purchased by consumers.Investment (I), sometime
10、s called fixed investment, is the purchase of capital goods. It is the sum of nonresidential investment and residential investment.Government Spending (G) refers to the purchases of goods and services by the federal, state, and local governments. It does not include government transfers, nor interes
11、t payments on the government debt.,12 of 32,3-1 The Composition of GDP,Imports (IM) are the purchases of foreign goods and services by consumers, business firms, and the U.S. government.Exports (X) are the purchases of U.S. goods and services by foreigners.,13 of 32,3-1 The Composition of GDP,Invent
12、ory investment is the difference between production and sales.,Net exports (X IM) is the difference between exports and imports, also called the trade balance.,14 of 32,3-2 The Demand for Goods,The total demand for goods is written as:,The symbol “” means that this equation is an identity, or defini
13、tion.,To determine Z, some simplifications must be made:Assume that all firms produce the same good, which can then be used by consumers for consumption, by firms for investment, or by the government.,15 of 32,3-2 The Demand for Goods,Assume that firms are willing to supply any amount of the good at
14、 a given price, P, and demand in that market.Assume that the economy is closed, that it does not trade with the rest of the world, then both exports and imports are zero.Under the assumption that the economy is closed, X = IM = 0, then:,16 of 32,3-2 The Demand for Goods,Disposable income, (YD), is t
15、he income that remains once consumers have paid taxes and received transfers from the government.,The function C(YD) is called the consumption function. It is a behavioral equation, that is, it captures the behavior of consumers.,Consumption (C),A more specific form of the consumption function is th
16、is linear relation:,17 of 32,3-2 The Demand for Goods,This function has two parameters, c0 and c1:c1 is called the (marginal) propensity to consume, or the effect of an additional dollar of disposable income on consumption.c0 is the intercept of the consumption function.Disposable income is given by
17、:,Consumption (C),18 of 32,3-2 The Demand for Goods,Consumption (C),Consumption increases with disposable income but less than one for one.,19 of 32,3-2 The Demand for Goods,Variables that depend on other variables within the model are called endogenous. Variables that are not explain within the mod
18、el are called exogenous. Investment here is taken as given, or treated as an exogenous variable:,Investment (I ),Government Spending (G),Government spending, G, together with taxes, T, describes fiscal policythe choice of taxes and spending by the government.,20 of 32,3-2 The Demand for Goods,We sha
19、ll assume that G and T are also exogenous for two reasons:Governments do not behave with the same regularity as consumers or firms.Macroeconomists must think about the implications of alternative spending and tax decisions of the government.,21 of 32,3-3 The Determination of Equilibrium Output,Assum
20、ing that exports and imports are both zero, the demand for goods is the sum of consumption, investment, and government spending:,Then:,22 of 32,Equilibrium in the goods market requires that production, Y, be equal to the demand for goods, Z:,Then:,The equilibrium condition is that, production, Y, be
21、 equal to demand. Demand, Z, in turn depends on income, Y, which itself is equal to production.,3-3 The Determination of Equilibrium Output,23 of 32,3-3 The Determination of Equilibrium Output,Macroeconomists always use these three tools:Algebra to make sure that the logic is correctGraphs to build
22、the intuitionWords to explain the results,24 of 32,3-3 The Determination of Equilibrium Output,Rewrite the equilibrium equation:,Using Algebra,Move to the left side and reorganize the right side:,Divide both sides by,25 of 32,The equilibrium equation can be manipulated to derive some important terms
23、:Autonomous spending and the multiplier:The term is that part of the demand for goods that does not depend on output, it is called autonomous spending. If the government ran a balanced budget, then T=G.Because the propensity to consume (c1) is between zero and one, is a number greater than one. For
24、this reason, this number is called the multiplier.,3-3 The Determination of Equilibrium Output,Using Algebra,26 of 32,3-3 The Determination of Equilibrium Output,First, plot production as a function of income.Second, plot demand as a function of income.In Equilibrium, production equals demand.,Equil
25、ibrium output is determined by the condition that production be equal to demand.,Using a Graph,27 of 32,Using a Graph,An increase in autonomous spending has a more than one- for-one effect on equilibrium output.,3-3 The Determination of Equilibrium Output,28 of 32,Using a Graph,The first-round incre
26、ase in demand, shown by the distance AB equals $1 billion.This first-round increase in demand leads to an equal increase in production, or $1 billion, which is also shown by the distance in AB.This first-round increase in production leads to an equal increase in income, shown by the distance in BC,
27、also equal to $1 billion.,3-3 The Determination of Equilibrium Output,29 of 32,Using a Graph,The second-round increase in demand, shown by the distance in CD, equals $1 billion times the propensity to consume.This second-round increase in demand leads to an equal increase in production, also shown b
28、y the distance DC, and thus an equal increase in income, shown by the distance DE.The third-round increase in demand equals $c1 billion, times c1, the marginal propensity to consume; it is equal to $c1 x c1 = $ c12billion.,3-3 The Determination of Equilibrium Output,30 of 32,Following this logic, th
29、e total increase in production after, say, n + 1 rounds, equals $1 billion multiplied by the sum:1 + c1 + c12 + + c1n Such a sum is called a geometric series.,3-3 The Determination of Equilibrium Output,Using a Graph,31 of 32,To summarize:An increase in demand leads to an increase in production and
30、a corresponding increase in income. The end result is an increase in output that is larger than the initial shift in demand, by a factor equal to the multiplier.To estimate the value of the multiplier, and more generally, to estimate behavioral equations and their parameters, economists use economet
31、ricsa set of statistical methods used in economics.,3-3 The Determination of Equilibrium Output,Using Words,32 of 32,Describing formally the adjustment of output over time is what economists call the dynamics of adjustment.Suppose that firms make decisions about their production levels at the beginn
32、ing of each quarter.Now suppose consumers decide to spend more, that they increase c0.Having observed an increase in demand, firms are likely to set a higher level of production in the following quarter.In response to an increase in consumer spending, output does not jump to the new equilibrium, but
33、 rather increases over time.,3-3 The Determination of Equilibrium Output,How Long Does It Take for Output to Adjust?,33 of 32,3-4 Investment Equals Saving: An Alternative Way of Thinking about Goods-Market Equilibrium,Saving is the sum of private plus public saving.Private saving (S), is saving by c
34、onsumers.,Public saving equals taxes minus government spending.If T G, the government is running a budget surpluspublic saving is positive.If T G, the government is running a budget deficitpublic saving is negative.,34 of 32,The equation above states that equilibrium in the goods market requires tha
35、t investment equals savingthe sum of private plus public saving.This equilibrium condition for the goods market is called the IS relation. What firms want to invest must be equal to what people and the government want to save.,3-4 Investment Equals Saving: An Alternative Way of Thinking about Goods-
36、Market Equilibrium,35 of 32,Consumption and saving decisions are one and the same.,The term (1c1) is called the propensity to save.,In equilibrium:,Rearranging terms, we get the same result as before:,Investment Equals Saving: An AlternativeWay of Thinking about Goods-Market Equilibrium,36 of 32,The
37、 Paradox of Saving,The paradox of saving (or the paradox of thrift) is that as people attempt to save more, the result is both a decline in output and unchanged saving.,37 of 32,3-5 Is the Government Omnipotent?A Warning,Changing government spending or taxes is not always easy.The responses of consu
38、mption, investment, imports, etc, are hard to assess with much certainty.Anticipations are likely to matter.Achieving a given level of output can come with unpleasant side effects.Budget deficits and public debt may have adverse implications in the long run.,38 of 32,Key Terms,Consumption (C)Investm
39、ent (I)Fixed investmentNonresidential investmentResidential investmentGovernment spending (G)Government transfersImports (IM)Exports (X)Net exports (X-IM)Trade balanceTrade surplusTrade deficitInventory investmentIdentityDisposable income (YD)Consumption functionBehavioral equationLinear relationPar
40、ameterPropensity to consume (c1)Endogenous variables,Exogenous variablesFiscal policyEquilibriumEquilibrium in the goods marketEquilibrium conditionAutonomous spendingBalanced budgetMultiplierGeometric seriesEconometricsDynamicsForecast errorConsumer confidence indexPrivate saving (S)Public saving (T-G)Budget surplusBudget deficitSavingIS relationPropensity to saveParadox of saving,
