slide 1 diploma macro paper 2 monetary macroeconomics lecture 2 aggregate demand: consumption and...
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![Page 1: Slide 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 2 Aggregate demand: Consumption and the Keynesian Cross Mark Hayes](https://reader038.vdocuments.us/reader038/viewer/2022102814/5517fe55550346c6568b50d3/html5/thumbnails/1.jpg)
slide 1
Diploma Macro Paper 2
Monetary Macroeconomics
Lecture 2
Aggregate demand:
Consumption and the Keynesian Cross
Mark Hayes
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Outline
Introduction
Map of the AD-AS model
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Goods marketKX and IS
(Y, C, I)
Moneymarket (LM)
(i, Y)
IS-LM(i, Y, C, I)
AD
Labour market(P, Y)
ASAD-AS
(i, P, Y, C, I)
Foreign exchange market(NX, e)
AD*-AS(i, P, e, Y, C, I, NX)
Phillips Curve(,u)
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Short-run effects of an increase in demand
Y
P
AD1
In the short run when prices are sticky,…
…causes output to rise.
PSRAS
Y2Y1
AD2
…an increase in aggregate demand…
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Outline
Introduction
Map of the AD-AS model
This lecture, we begin explaining the AD curve
Step 1: Equilibrium with variable income and consumption - the Keynesian Cross
Various Multipliers
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The Circular Flow I
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The Circular Flow II
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Income in Classical model
Profit and Rent
Wages
Consumption
Consumption
Saving
Investment
Consumption
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First step to AD - the Keynesian Cross
A simple ‘closed economy’ model (NX exogenous) in which private consumption (C ) is the only element of demand which varies
Notation: I = expected investmentE = C + I + G = expected expenditureY = real GDP = value of output
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Elements of the Keynesian Cross
I I
,G G T T
Consumption function:
for now, investment is exogenous:
Expected expenditure:
equilibrium condition:
Government consumption and tax:
Value of output = expected expenditure
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Plotting the equilibrium condition
income, output, Y
E
expected
expenditure
E =Y
45º
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Plotting planned expenditure
income, output, Y
E
expected
expenditure
E =C +I +G
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The equilibrium value of income
income, output, Y
E
expected
expenditure
E =Y
E =C +I +G
Equilibrium income
c11
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An increase in autonomous consumption
Y
E
E =Y
E =C +I +G1
E1 = Y1
E =C +I +G2
E2 = Y2Y
G
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The spending multiplier
Definition: the change in income resulting from a (small) change in autonomous expenditure such as G or I.
(In the following slides MPC = c1 )
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The multiplier as a partial derivative
Y C I G
Y C I G
MPC Y G
C G
(1 MPC) Y G
1
1 MPC
Y G
equilibrium condition
in changes
because I exogenous
because C = MPC Y
Collect terms with Y on the left side of the equals sign:
Solve for Y :
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The spending multiplier
In this model, the spendingmultiplier equals
If MPC = 0.8
15
1 0.8
YG
An increase in G causes income to increase 5 times
as much!
An increase in G causes income to increase 5 times
as much!
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Why the multiplier is greater than 1
An increase in G represents an equal increase in Y: Y = G.
But Y C
further Y
further C
further Y So the final impact on income is much bigger
than the initial G. But not infinite, it converges.
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Conventional explanation of convergence
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The Phillips Machine, 1949
Invented by Bill Phillips at the LSE. A water-driven analogue computer used to demonstrate Keynesian economics
The flaw is that he used water, taking us back to a Classical corn model
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The Phillips Machine, 1949
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The Phillips Machine, 1949
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The Phillips Machine, 1949
www.sms.cam.ac.uk/media/1094078
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An increase in taxes
Y
E
E =C2 +I +G
E2 = Y2
E =C1 +I +G
E1 = Y1Y
C = MPC T
The tax increase reduces consumption, and therefore E:
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The tax multiplier
Definition: the change in income resulting from
a (small) change in T
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The tax multiplier as a partial derivative
Y C I G
MPC Y T
C
(1 MPC) MPC Y T
equilibrium condition in changes
I and G exogenous
Solving for Y :
MPC
1 MPC
Y TFinal result:
![Page 27: Slide 1 Diploma Macro Paper 2 Monetary Macroeconomics Lecture 2 Aggregate demand: Consumption and the Keynesian Cross Mark Hayes](https://reader038.vdocuments.us/reader038/viewer/2022102814/5517fe55550346c6568b50d3/html5/thumbnails/27.jpg)
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The tax multiplier
MPC
1 MPC
YT
0.8 0.84
1 0.8 0.2
YT
If MPC = 0.8, then the tax multiplier equals
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The tax multiplier
…is negative: A tax increase reduces C, which reduces income.
…is greater than one (in absolute value):
A change in taxes has a multiplier effect on income.
…is smaller than the spending multiplier: Consumers save the fraction (1 – MPC) of a tax cut, so the initial boost in spending from a tax cut is smaller than from an equal increase in G.
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The balanced budget multiplier
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YtTG
GTYtcY ])1[(1GYtGcYctY )()1( 11
GctctccY )1()1( 1111
11
1
1
1
c
c
G
Y
BB
By definition:
EquilibriumCondition:
The balanced budget multiplier
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Summary
Keynesian cross: equilibrium income determined with income and consumption variable
Shows how the direction of causation between saving and investment is reversed from the Classical model
The multiplier as comparative statics
– Spending, tax and balanced budget multipliers
– Comparing two equilibrium positions does not explain the dynamic process linking them
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slide 32
Next time
Step 2 of building the AD curve
Finding equilibrium when income, consumption and investment can all move
the IS-LM model