Transcript ECONOMICS - University of Maryland, College Park

CHAPTER
The Short-Run Macro Model
Chapter 11
1
Short-Run Macro Model
• Macroeconomic model that explains how
changes in spending can affect real GDP
in the short run.
• Short-run is month-to-month, quarter-to
quarter, year-to-year.
• Long-run model presented in chapter 8
covers multi-year time frame.
2
Start with Consumption Spending (C)
• Recall that C (personal household
consumption expenditure) is about 70% of
total spending on final goods and
services.
• Consumption spending increases when:
–
–
–
–
Disposable income (Y-T) rises
Wealth (W) rises
The interest rate (r) falls
Households become more optimistic
about the future - positive expectations
about the future
3
Disposable Income
• Disposable income
= Income − Tax payments + Transfers
received
= Income − (Taxes − Transfers)
= Income – Taxes + Transfers
= Income − Net taxes
= Y–T
• Transfers increase disposable income
4
Relationship Between Consumption and
Disposable Income
• A direct relationship meaning as
disposable income rises, consumption
spending rises
– is roughly linear
• We call this relationship the consumption
function.
5
Quarterly U.S. Consumption and Disposable
Income, 2000–2011: roughly linear
6
Quarterly U.S. Consumption and Disposable Income,
2000–2014
11000.0
C = 453.95 +0.8713(Y-T)
10500.0
R² = 0.9783
10000.0
9500.0
9000.0
8500.0
8000.0
8500.0
9000.0
9500.0
10000.0
10500.0
11000.0
11500.0
12000.0
7
Relationship Between Consumption and
Disposable Income
Notation: ∆ = change
∆ C = change in consumption
∆ Y = change in income
∆ (Y-T) = change in disposable income
8
Autonomous Consumption Spending
• The part of consumption spending that is
independent of income
– Measured by the vertical intercept of the
consumption function
9
Example: Hypothetical Data on Disposable Income and
Consumption
(C)
(Y – T)
NOTE: ∆ (Y-T) = 1000
∆ C = 600
10
Marginal propensity to consume (MPC)
• MPC is the slope of the consumption function
– the change in consumption divided by the
change in disposable income
∆C
MPC =
∆(Y−T)
• The amount by which consumption spending
rises when disposable income rises by one
dollar
∆C
600
• On the previous table MPC =
=
∆(Y−T) 1000
MPC = 0.60
11
The Marginal Propensity to Save
S
marginal propensity to save (MPS) 
Y
MPC + MPS = 1
The marginal propensity to consume (MPC) is the fraction
of an increase in disposable income that is consumed (or
the fraction of a decrease in income that comes out of
consumption).
The marginal propensity to save (MPS) is the fraction of an
increase in disposable income that is saved (or the fraction
of a decrease in income that comes out of saving).
The Consumption Function Graph
Real Consumption
Spending ($ billions)
MPC =
∆C
= 0.6
∆(Y−T)
8,000
7,000
Consumption
Function
The vertical intercept ($2,000 billion) is
autonomous consumption spending . . .
6,000
5,000
Consumption
Function
600
4,000
∆C
1,000
3,000
∆ (Y-T)
2,000
and the slope of the line (0.6)
is the marginal propensity to
consume (MPC).
1,000
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Real Disposable Income ($ billions)
13
Consumption and Disposable Income
• Formula for the straight line consumption function
C = a + b ˣ (Y - T)
– “a” is the vertical intercept of the consumption
function
• The theoretical level of consumption spending at
disposable income (Y-T) = 0
• Referred to as autonomous consumption spending
– “b” is the MPC, the slope of the consumption
function
– From the previous graph, what’s the equation?
C = (?) + (?) ˣ (Y –T)
14
Consumption and Income
• We can redefine the consumption function to
show the value of consumption spending at
each level of income (Y) rather than
disposable income(Y-T)
• Assumption
– T is a fixed dollar amount independent
of income
– this is referred to as a lump-sum tax.
15
The Relationship between Consumption and
Income
(C)
(Y-T)
(T)
(Y)
∆ (Y) = 1000
∆ (Y-T) = 1000 ∆ C = 600
16
Consumption and Income
• H&L call this the Consumption–income line.
• It is the same as the Consumption Function,
relating C to Y rather than C to (Y-T).
• I will refer to it as the Consumption Function
– A function showing aggregate consumption
spending (C) at each level of income (Y) or
real GDP
• It has the same slope - MPC!
17
Consumption and Income
• The only difference is the vertical
intercept. It becomes: (a − MPC × T)
• Here’s why:
Start with:
C = a + MPC ˣ (Y – T)
C = a + MPC ˣ Y – MPC ˣ T
C = (a – MPC ˣ T) + MPC ˣ Y
C = (2000 – 0.6 ˣ 2000) + 0.6 ˣ Y
C = 800 + 0.6 ˣ Y
18
Consumption and Income:
Real Consumption
Spending ($ billions)
5,600
B
5,000
4,000
A
2. The line has the same
slope as the consumption
function in Figure 2 . . .
3,000
Consumption
600
Function
1,000
2,000
∆ (Y)
1,000
800
∆C
3. but a different
vertical intercept.
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000
Real Income
1. To draw the consumption–income line, we measure real
($ billions)
income (instead of real disposable income) on the horizontal axis.
19
What happens if Income Changes?
• If income (Y) increases and net taxes (T)
remain unchanged
– Disposable income will rise
– Consumption spending will rise
– Movement rightward up along the
consumption function
MPC =
∆C
= 0.6
∆(Y)
• If income decreases and net taxes remain
unchanged – the opposite occurs
20
What happens if Taxes Change?
• With a decrease in T (net taxes)
– Disposable income (Y – T) will rise at
each level of income
– Consumption spending will rise at each
income level
– Shift upward of the consumption function
21
A Shift in the Consumption Function caused
by a reduction in T
Real Consumption
Spending ($ Billions)
6,000
5,000
Consumption function
when net taxes drop to
$500 billion
4,000
3,000
2,000
1,700
Consumption
Function
Consumption Function
when net taxes start at
$2,000 billion
1,000
800
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000
Real income ($ billions)
A decrease in T is caused by a reduction in taxes or and increase in
transfer payments.
22
Other factors that Shift the Consumption
Function
– Wealth (W), which is accumulated
household savings and investments
– Interest rates (r), which is the cost to
borrow.
– Expectations about the future
23
Other factors that Shift the Consumption
Function
• Increase in autonomous consumption
– Because of
• an increase in household wealth (W)
• a decrease in interest rates (r)
• households become more optimistic about
the future (
)
• Shift the consumption function upward
24
Upward Shift in the Consumption Function
Real Consumption
Spending ($ Billions)
6,000
W↑, r ↓, T ↓ ,
5,000
4,000
3,000
Consumption
Function
2,000
1,000
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000
Real income ($ billions)
25
Shift in the Consumption Function
• Decrease in autonomous consumption
– Because of
• a decrease in household wealth (W)
• an increase in interest rates (r)
• household became more pessimistic about
the future (
)
– Shift the consumption function downward
26
Downward Shift in the Consumption Function
Real Consumption
Spending ($ Billions)
6,000
5,000
4,000
3,000
Consumption
Function
W ↓, r ↑, T ↑,
2,000
1,000
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000
Real income ($ billions)
27
Movement Along Versus a Shift
• Move along the consumption function
– is caused by a change in income
• Shift of the consumption function
– is caused by a change in factors beside
income that cause consumption spending
to change (W, T, r, expectations)
28
Total Spending
• Components of total spending in the
economy
–
–
–
–
Consumption spending by households (C)
Planned investment spending (Ip)
Government purchases (G)
Net exports (NX)
• We Assume: Ip, G, and NX
– are determined outside of our analysis
– have fixed values
– called autonomous
29
Total Spending
• Planned Investment Spending (Ip)
– Plant and equipment purchases by
business firms and new home construction
– Remember Ip does not included
unplanned changes in inventories
• Government purchases
– All of the goods and services that
government agencies - federal, state, and
local - buy during the year
• Net exports (NX)
– Exports minus imports
30
We Call Total Spending
Aggregate Expenditure
• Aggregate Expenditure (AE)
– Sum of spending by households, business
firms, the government, and foreigners on
final goods and services produced in the
United States
AE = C +
P
I
+ G + NX
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The Relationship Between Income, Aggregate Expenditure
and Unplanned Change in Inventories
32
Inventories and Equilibrium GDP
• Change in inventories during any
period will always equal output minus
aggregate expenditure
Δ Inventories = GDP – AE
33
Equilibrium GDP in the Short-Run
• When AE < GDP
(total spending < what is produced)
– Output will decline in the future
• Thus, any level of output at which AE < GDP
cannot be the equilibrium GDP
• When AE > GDP
– Output will rise in the future
• Thus, any level of output at which AE > GDP
cannot be the equilibrium GDP
• Equilibrium GDP in the short run
– The level of output at which AE = GDP
34
35
Equilibrium GDP in the Short-Run
• The level of aggregate expenditure (AE) in
the economy determines the equilibrium
level of GDP in the short-run.
• The equilibrium level of GDP in the short-run
can be less than full employment.
• This is an important difference from the
long-run classical model, and its is because
of sticky prices! (Chapter 10)
36
The Aggregate Expenditure (AE) Line
and Equilibrium GDP
• AE line
– C, consumption at each level of income,
consumption function
– C+IP at each level of income
– C+IP+G at each level of income
– AE line: C+IP+G+NX at each level of
income
– Slope = MPC
37
Deriving the Aggregate Expenditure Line
Real Aggregate Expenditure
($ billions)
12,000
C + IP + G + NX
C + IP + G
5. to get the aggregate
expenditure line.
C + IP
C
10,000
8,000
Consumption
Function
4. and net exports (NX) . . .
6,000
4,000
3. government purchases (G) . . .
2,000
2. then add planned investment (Ip) . . .
2,000
1. Start with the
consumption–income line,
4,000
6,000
8,000
10,000
12,000
Real GDP ($ billions)
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38
The 45o Guide Line
• A 45° line = translator line
• It allows us to measure any
horizontal distance as a vertical
distance instead
39
Using a 45° Line to Translate Distances
A
Dollars
1. Using a 45° line . . .
Consumption
Function
3. into an equal vertical
distance (BA).
45°
0
B
Dollars
2. we can translate any horizontal
distance (such as 0B) . . .
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
40
Equilibrium GDP
• Any output level where
– AE line lies below the 45° line
• AE < GDP
• Inventories will increase (unplanned!)
• Output (GDP/Y) will decrease in the future
– AE line lies above the 45° line
• AE > GDP
• Inventories will decrease (unplanned!)
• output will increase in the future
41
At point E, where the
aggregate expenditure line
crosses the 45° line, the
economy is in short-run
Real AE ($ billions)
Increase in inventories
equilibrium. With real GDP
equal to $8,000 billion,
A
aggregate expenditure
C+IP+G+NX
12,000
equals real GDP.
Decrease in inventories
At higher levels of real
GDP—such as $12,000
10,000
H
billion—total production
E
exceeds aggregate
8,000
expenditures, and firms will
Consumption
be unable to sell all they
K
Function
Total
produce. Unplanned
6,000
Aggregate
Output
inventory increases equal to
Expenditure HA will lead them to reduce
4,000
production.
J Aggregate
At lower levels of real
Total
Expenditure
GDP—such as $4,000
2,000
Output
billion—aggregate
expenditure exceeds total
45°
production. Firms find their
Real GDP
2,000 4,000 6,000 8,00010,000 12,000
inventories falling, and they
($ billions)
will respond by increasing
production.
Determining Equilibrium Real GDP
42
Equilibrium GDP
• Equilibrium GDP is the output level at
which the AE line intersects the 45° line
– if firms produce this output level
• Their inventories will not change and they
continue producing the same level of output in
the future
• Equilibrium GDP Can Be Less than Full
Employment GDP. Prices are assumed
fixed in the short-run.
43
Equilibrium GDP and Employment
• It is possible to have a short-run equilibrium
and yet have abnormally high unemployment:
– Aggregate expenditure is too low to create
an intersection at full-employment output
– Cyclical unemployment is caused by
insufficient spending
– As long as spending remains low
• Production will remain low
• Unemployment will remain high
44
Equilibrium GDP Can Be Less than Full-Employment GDP
Aggregate Expenditure
($ billions)
When the aggregate
expenditure line is low . . .
F
0
$10,000 Consumption
Function
A
$8,000
Real GDP
($ billions)
Potential GDP
B
and equilibrium
employment is less
than full employment
Equilibrium output
($8,000) is less than
potential output,
$8,000 $10,000
Aggregate
Production
Function
cyclical
unemployment
= 50 million
AELOW
$10,000 Consumption
Function E
45°
Real GDP
($ billions)
0
100
Million
150
Million
Number
of workers
Full employment
45
Equilibrium GDP and Employment
• Short-run equilibrium
– Economy can overheat because spending
is too high
– As long as spending remains high
• Production will exceed potential output
• Unemployment will be unusually low
– Abnormally high employment
46
Equilibrium GDP can be greater than full-employment GDP
Aggregate Expenditure
($ billions)
When the aggregate
expenditure line is high . . .
E’
Real GDP
($ billions)
and equilibrium
employment is greater
than full employment
AEHIGH
F
$10,000 Consumption
Function
Aggregate
Production
Function
$12,000
H
$10,000 Consumption
Function
B
Equilibrium output
($12,000) is greater
than potential output,
45°
0
$10,000 $12,000
Potential GDP
Real GDP
($ billions)
0
150
Million
Full employment
200
Million
Number
of workers
47