Chapter 10: Aggregate Demand I

Transcription

1 Context Chapte 0: 0 Chapte 9 intoduced the model of aggegate demand and aggegate supply. Long un pices flexible output detemined by factos of poduction & technology unemployment equals its natual ate Shot un pices fixed output detemined by aggegate demand unemployment negatively elated to output Context The Keynesian Coss This chapte develops the -LM model, the basis of the aggegate demand cuve. We focus on the shot un and assume the pice level is fixed (so, SRAS cuve is hoizontal). This chapte (and chapte ) focus on the closed-economy case. Chapte 2 pesents the open-economy case. A simple closed economy model in which income is detemined by expenditue. (due to J.M. Keynes) Notation: I = planned investment = C + I + G = planned expenditue = eal GD = actual expenditue Diffeence between actual & planned expenditue = unplanned inventoy investment 2 3 Elements of the Keynesian Coss Gaphing planned expenditue consumption function: govt policy vaiables: fo now, planned investment is exogenous: planned expenditue: C C( T ) G G, T T I I C ( T ) I G planned expenditue MC =C +I +G equilibium condition: actual expenditue = planned expenditue income, output, 4 5

2 Gaphing the equilibium condition The equilibium value of income planned expenditue = planned expenditue = =C +I +G 45º income, output, income, output, Equilibium income 6 7 An incease in govenment puchases Solving fo At, thee is now an unplanned dop in inventoy G =C +I +G 2 =C +I +G C I G C I G C G MC G equilibium condition in changes because I exogenous because C = MC so fims incease output, and income ises towad a new equilibium. = 2 = 2 Collect tems with on the left side of the equals sign: ( MC) G Solve fo : G MC 8 9 The govenment puchases multiplie Definition: the incease in income esulting fom a $ incease in G. In this model, the govt puchases multiplie equals G MC Example: If MC = 0.8, then G An incease in G causes income to incease 5 times as much! Why the multiplie is geate than Initially, the incease in G causes an equal incease in : = G. But C futhe futhe C futhe So the final impact on income is much bigge than the initial G. 0 2

3 An incease in taxes Initially, the tax incease educes consumption, and theefoe : C = MC T so fims educe output, and income falls towad a new equilibium 2 = 2 = =C +I +G =C 2 +I +G At, thee is now an unplanned inventoy buildup Solving fo C I G C MC T Solving fo : Final esult: eq m condition in changes I and G exogenous ( MC) MC T MC T MC 2 3 The tax multiplie def: the change in income esulting fom a $ incease in T : T MC MC If MC = 0.8, then the tax multiplie equals T The tax multiplie is negative: A tax incease educes C, which educes income. is geate than one (in absolute value): A change in taxes has a multiplie effect on income. is smalle than the govt spending multiplie: Consumes save the faction ( MC) of a tax cut, so the initial boost in spending fom a tax cut is smalle than fom an equal incease in G. 4 5 NOW OU TR: actice with the Keynesian Coss Use a gaph of the Keynesian coss to show the effects of an incease in planned investment on the equilibium level of income/output. The cuve def: a gaph of all combinations of and that esult in goods maket equilibium i.e. actual expenditue (output) = planned expenditue The equation fo the cuve is: C ( T) I( ) G 7 3

4 Deiving the cuve Why the cuve is negatively sloped I I = =C +I ( 2 )+G =C +I ( )+G 2 A fall in the inteest ate motivates fims to incease investment spending, which dives up total planned spending (). To estoe equilibium in the goods maket, output (a.k.a. ka actual expenditue, ) must incease The cuve and the loanable funds model (a) The L.F. model (b) The cuve S 2 S 2 2 Fiscal olicy and the cuve We can use the -LM model to see how fiscal policy (G and T) affects aggegate demand and output. Let s stat by using the Keynesian coss to see how fiscal policy shifts the cuve I ( ) S, I Shifting the cuve: G At any value of, G so the cuve shifts to the ight. = =C +I ( )+G 2 =C +I ( )+G NOW OU TR: Shifting the cuve: T Use the diagam of the Keynesian coss o loanable funds model to show how an incease in taxes shifts the cuve. The hoizontal distance of the shift equals G MC

5 The Theoy of Liquidity efeence Due to John Maynad Keynes. A simple theoy in which the inteest ate is detemined by money supply and money demand. Money supply The supply of eal money is fixed: s inteest ate s eal money Money demand Equilibium Demand fo eal money : d L ( ) inteest ate s The inteest ate adjusts to equate the supply and demand dfo money: inteest ate s L( ) L( ) L( ) eal money eal money How the Fed aises the inteest ate To incease, Fed educes M inteest ate 2 M 2 M L( ) eal money 28 CASE STUD: Monetay Tightening & Inteest Rates Late 970s: > 0% Oct 979: Fed Chaiman aul Volcke announces that monetay policy would aim to educe inflation Aug 979-Apil 980: Fed educes 8.0% Jan 983: = 3.7% How do you think this policy change would affect nominal inteest ates? 29 5

6 Monetay Tightening & Inteest Rates, cont. model pices pediction actual outcome The effects of a monetay tightening on nominal inteest ates shot un Liquidity pefeence (Keynesian) sticky i > 0 8/979: i = 0.4% 4/980: i = 5.8% long un Quantity theoy, Fishe effect (Classical) flexible i < 0 8/979: i = 0.4% /983: i = 8.2% The LM cuve Now let s put back into the money demand function: L(, ) The LM cuve is a gaph of all combinations of and that equate the supply and demand fo eal money. The equation fo the LM cuve is: d L(, ) 3 Deiving the LM cuve Why the LM cuve is upwad sloping (a) The maket fo eal money (b) The LM cuve LM An incease in income aises money demand. Since the supply of eal is fixed, thee is now excess demand in the money maket at the initial inteest ate. 2 L (, 2 ) L (, ) 2 The inteest ate must ise to estoe equilibium in the money maket. M How M shifts the LM cuve 2 (a) The maket fo eal money L (, ) 2 (b) The LM cuve LM 2 LM NOW OU TR: Shifting the LM cuve Suppose a wave of cedit cad faud causes consumes to use cash moe fequently in tansactions. Use the liquidity pefeence model to show how these events shift the LM cuve. M 2 M 34 6

7 The shot-un equilibium The Big ictue The shot-un equilibium is the combination of and that simultaneously satisfies the equilibium conditions in the goods & money makets: C ( T) I( ) G L(, ) Equilibium inteest ate LM Equilibium level of income Keynesian Coss Theoy of Liquidity efeence cuve LM cuve -LM model Agg. demand cuve Agg. supply cuve Explanation of shot-un fluctuations Model of Agg. Demand and Agg. Supply 36 eview of Chapte In Chapte, we will use the -LM model to analyze the impact of policies and shocks. lean how the aggegate demand cuve comes fom -LM. use the -LM and AD-AS models togethe to analyze the shot-un and long-un effects of shocks. use ou models to lean about the Geat Depession.. Keynesian coss Chapte Summay basic model of income detemination takes fiscal policy & investment as exogenous fiscal policy has a multiplie effect on income 2. cuve comes fom Keynesian coss when planned investment depends negatively on inteest ate shows all combinations of and that equate planned expenditue with actual expenditue on goods & sevices 38 Chapte Summay 3. Theoy of Liquidity efeence basic model of inteest ate detemination takes money supply & pice level as exogenous an incease in the money supply lowes the inteest ate 4. LM cuve comes fom liquidity pefeence theoy when money demand depends positively on income shows all combinations of and that equate demand fo eal money with supply Chapte Summay 5. -LM model Intesection of and LM cuves shows the unique point (, ) that satisfies equilibium in both the goods and money makets. 7