Simple Macro Model

Econ 10

Holmes

Review

Y

IIYII

Y

CCYCC

ICD

SCY

DY

A

A

0),(

10),(

m)equilibriu(in

Circular Model

FirmsConsumers

C

I

Y (income) Y

DS

New setup

MultiplierY

C

I

S

-(SA)= CA

IA

DA

This guy is tricky. If S goes up then C must go down.

Sample Problem

Suppose MPC=.5, MPI=.25, and CA=100. Find•multiplier eq Y•total S, C, I

First compute multiplier. MPS=MPC+MPI=.5 + .25 = .75

Y D1 D20 0100 75 100

DA=25Y=100Y/ DA=4

1/(1-MPS)=1/(1-.75)=1/.25=1/(1/4)=4

Using the Chart

MultiplierY

C

I

S

-(SA)= CA

IA

DA

CA=100

100-(-100)

0

100

4

400

MPC=.5MPI=.25

400*.5200

400*(1-.5)200

400*.25100

total S=-100 + 200 = 100total C= 100 + 200 = 300total I= 0 + 100 = 100

AnotherMPSave=.2, MPI=.15. SA=-20, IA=20

MPS=.8+.15 = .95Multiplier = 1 / (1-.95) = 1 / .05 = 20

Y D1 D20 0100 95 100

100/5 = 20

.2 + .15 ? Want MPC, not MP Save...

Using the Chart

MultiplierY

C

I

S

-(SA)= CA

IA

DA

SA=-20IA=20

20-(-20)

20

40

20

800

MPC=.8MPI=.15

800*.8640

800*.2160

800*.15120

total S=-20 + 160 = 140total C= 20 + 640 = 660total I= 20 + 120 = 140

A Check

1. Total change in Y = total change in C + total change in I= 660 + 140 = 800

2. Total change in Y = total change in C + total change in S= 660 + 140 = 800

Fallacy of Composition

Suppose SA=100. MPC=.7, MPI=.2.Society is saving more. What happens in eq?

Mult = 1/(1-(.7+.2)) = 1 / .1 = 10

Using the Chart

MultiplierY

C

I

S

-(SA)= CA

IA

DA

SA=100

-100-(100)

0

-100

10

-1000

MPC=.7MPI=.2

-1000*.7-700

-1000*.3-300

-1000*.2-200

total S=100 + -300 = -200total C= -100 + -700 = -800total I= 0 + -200 = -200

So….

Society is saving more, but has repercussions that lead to a net decrease in saving.

“Paradox of Thrift”

Why? As people save money, less consumption. I spend $100 less, so the people at the grocery store get laid off, they spend less, etc….

One for the road

Suppose MPC=.7, MPI=.1. IA=-10.

Find•multiplierY•total S, C, IExplain intuitively why IA has the effect it does.