Transcript Introduction to Macroeconomics

Introduction to Macroeconomics
Chapter 22. Keynesian Macroeconomics
Chapter 22. Keynesian Macroeconomics
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John Maynard Keynes
Consumption
Simple Equilibrium Model
Add Investment to the Model
Add Government Spending to the Model
Autonomous Spending Multiplier
Recessionary, Inflationary, and Output Gaps
Government Fiscal Policy
1. John Maynard Keynes
• General Theory… (1936)
• Objections to Classical Model
• Equilibrium with Unemployment
because of inadequate demand
• Advocated Activist Government
Fiscal Policy
• Short-run model of aggregate
demand only
1. John Maynard Keynes
Objections to Classical Model
• Interest rates, prices, and wages are
rigid (“sticky”)
• Savings (consumption) is a function
of income, not interest rate.
• Supply doesn’t create its own
demand, it responds to changes in
demand
AS
Equilibrium
– Sticky prices
– Interest rates
have only a long
run effect
– Long-run growth
factors can be
ignored in shortrun model
Full-employment output
• Horizontal
Aggregate
Supply Curve
Average Price Level
1. John Maynard Keynes
Equilibrium with Unemployment
Output
AD
1. John Maynard Keynes
Keynesian Activist Fiscal Policy
Average Price Level
– increase
government
spending
– reduce taxes
Full-employment output
• Equilibrium Output
less than fullemployment output
AS
AD
– Aggregate Demand
(AD) shifts to right
Output
1. John Maynard Keynes
Short-Run Model of Aggregate Demand Only
• Changes in Aggregate Supply have no
effect on spending (contrary to Say’s
Law)
• Aggregate Supply responds to changes
in demand
• Economy can be modeled by looking at
Aggregate Demand only
2. Consumption
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•
•
Consumption Function
Graph Consumption Function
Autonomous Consumption
Marginal Propensity to Consume
• Savings
• Marginal Propensity to Save
• Average Propensity to Consume
Average Propensity to Save
2. Consumption
Consumption Function
C = C0 + b • Y
C = desired consumption
C0 = autonomous consumption
b = marginal propensity to consume
0<b<1
Y = income
2. Consumption
Graph Consumption Function
Desired Consumption
60
C = C0 + b • Y
50
40
30
Slope = b
20
10
Intercept = C0
0
0
15
30
Income
45
60
2. Consumptioon
Autonomous Consumption
• Autonomous consumption = C0
• Level of consumption at zero income
• Consumption independent of the
level of income
• “Subsistence” level of income
2. Consumption
Marginal Propensity to Consume (MPC)
• The change in consumption that
results from a $1 change in income
• MPC = dC / dY
• Slope of the consumption function (b)
2. Consumption
Marginal Propensity to Consume (MPC)
Desired Consumption, C
60
MPC = dC / dY
= 10 / 15
= 0.667
50
40
dC = 10
dY = 15
dC = 10
30
dY = 15
dC = 10
20
dY = 15
dC = 10
10
dY = 15
0
0
15
30
Income
45
60
3. Simple Equilibrium Model
Aggregate Expenditures:
AE = C + I + G + NX
Assume:
– No government, G = 0
– No investment, I = 0
– No international trade, NX = 0
AE = C
3. Simple Equilibrium Model
Aggregate Expenditures
Aggregate Expenditures
60
AE = C
= C0 + MPC • Y
50
40
30
Slope = MPC
20
10
Intercept = C0
0
0
15
30
Income
45
60
3. Simple Equilibrium Model
Equilibrium - the 45o Line
60
Aggregate Expenditures
• The 45o line:
all points that
represent
potential
equilibrium
(aggregate
expenditures =
income)
70
50
40
30
20
10
45o
0
0
15
30
45
Income
60
70
3. Simple Equilibrium Model
Aggregate Expenditures and the 45o Line
Aggregate Expenditures
70
45o Line
60
AE
50
40
30
20
Equilibrium
10
0
0
15
30
Income
45
60
3. Simple Equilibrium Model
Disequilibrium
Aggregate Expenditures
70
Income > Spending
Undesired Inventory Build
60
45o Line
AE
50
Income < Spending
Undesired Inventory Decline
40
30
20
10
0
0
15
30
Income
45
60
3. Simple Equilibrium Model
Autonomous Consumption Multiplier
• Shift in AE - if autonomous consumption
increases by $1, how much does national
income increase by?
• National income increases by the Multiplier
times the change in autonomous
consumption
3. Simple Equilibrium Model
Shift in Autonomous Consumption
Aggregate Expenditures
70
Slope = MPC = 0.67
60
dC0 = ± 5
50
40
30
20
dY = ± 15
10
0
0
15
30
Income
45
60
3. Simple Equilibrium Model
Autonomous Consumption Multiplier
Person Income
Spending
1
-
+ $5.00
2
$5.00
$5 x 0.67 = $3.33
3
$3.33
$3.33 x 0.67 = $2.22
4
$2.22
$2.22 x 0.67 = $1.48
5
$1.48
$1.48 x 0.67 = $0.99
…
Totals
…
$15.00
…
$15.00
Spending = Income x Marginal Propensity to Consume
4. Add Investment to Model
• I = I0
= Autonomous Investment
Investment independent of the level of income
• AE = Consumption + Investment
=C+I
= C0 + MPC • Y + I0
4. Add Investment to Model
Aggregate Expenditures
Aggregate Expenditures
70
AE = C + I
= C0 + MPC • Y + I0
60
AE = C + I
C
50
Slope = MPC
40
30
20
I0 = 10
10
C0 = 10
0
0
15
30
Income
45
60
Aggregate Expenditures
4. Add Investment to Model
Aggregate Expenditures and Equilibrium
45o Line
90
80
AE = C + I
Equilibrium
C
70
60
50
40
30
I0 = 10
C0 = 10
20
10
0
0
15
30
45
Income
60
75
90
5. Add Government Spending to Model
• G = G0
= Autonomous Government Spending
Spending independent of the level of income
• AE = C + I + G
= C0 + MPC • Y + I0 + G0
Aggregate Expenditures
5. Add Government Spending
Aggregate Expenditures with Equilibrium
Equilibrium
100
G0 = 10
I0 = 10
C0 = 10
45o Line
80
AE = C + I + G
C+I
C
60
40
20
0
0
15
30
45
60
Income
75
90
105
6. Autonomous Spending Multiplier
Autonomous Spending: Spending that is
independent of any other variable (e.g.,
income, prices, interest rate)
• C0 = Autonomous Consumption
• I0 = Autonomous Investment
• G0 = Autonomous Government Spending
Autonomous (adj.) - self-governing
6. Autonomous Spending Multiplier
The Multiplier
Multiplier = ___1___
1 - MPC
If MPC = 0.9, Multiplier = 10
A $1 increase in autonomous spending leads to a
$10 increase in national income
If MPC = 0.8, Multiplier = 5
A $1 increase in autonomous spending leads to a
$5 increase in national income
6. Autonomous Spending Multiplier
Change in Autonomous Spending
45o Line
5,000
AE1
4,000
C
AE0
D
3,000
A
B
2,000
1,000
0
0
1,000
2,000
3,000
4,000
5,000
Change in Automous Spending = CD
Change in National Income = AB
Marginal Propensity to Consume = Slope = BD / AB
6. Autonomous Spending Multiplier
Graphical Derivation of Spending Multiplier
Multiplier =
Change in National Income___
Change in Autonomous Spending
= AB / CD
= AB / (BC - BD)
= AB / (AB - BD)
where BC = AB for 45o triangle
=
(AB / AB)______
(AB / AB) - (BD / AB)
=
1_____
1 - (BD / AB)
where MPC = BD / AB
Multiplier =
1_ __
1 - MPC
6. Autonomous Spending Multiplier
Algebraic Derivation of Spending Multiplier
AE = C + I + G
= C0 + MPC • Y + I0 + G0
In equilibrium:
Y = AE
Y = C0 + MPC • Y + I0 + G0
Y - MPC • Y = C0 + I0 + G0
(1 - MPC) • Y = C0 + I0 + G0
Y = ___1___ • (C0 + I0 + G0)
1 - MPC
7. Gaps
• Recessionary Gap
– output in equilibrium less than full-employment
output
• Inflationary Gap
– output in equilibrium greater than fullemployment output
• Output Gap
– difference between actual output and fullemployment output
7. Gaps
Gaps and the Keynsian Cross
45o Line
Inflationary
Gap
50
AE
40
Recessionary
Gap
20
10
Full-employment
30
Output
Aggregate Expenditures
60
Output Gap
0
0
15
Output Gap
30
Income
45
60
8. Government Fiscal Policy
• Lump Sum Tax
• Lump Sum Tax Multiplier
• Balanced Budget Multiplier
8. Government Fiscal Policy
Lump Sum Tax
• Consumption = C0 + MPC • Yd
Yd = disposable income
= total income (Y) - lump sum tax (T0)
• Consumption = C0 + MPC • (Y - T0)
= C0 + MPC • Y - MPC • T0
• Multiplier = - MPC_
1 - MPC
8. Government Fiscal Policy
Derivation of Lump Sum Tax Multiplier
AE = C + I + G + NX
AE = C0 + MPC • Y - MPC • T0 + I0 + G0
In equilibrium:
Y = AE
Therefore:
Y = C0 + MPC • Y - MPC • T0 + I0 + G0
Y - MPC • Y = C0 - MPC • T0 + I0 + G0
(1 - MPC) • Y = (C0+ I0 + G0) - MPC • T0
Y=
1___ • (C0+ I0 + G0) - MPC_ • T0
1 - MPC
1 - MPC
8. Government Fiscal Policy
Balanced Budget Multiplier
Multiplier
Autonomous Government
Spending
___1___
1 - MPC
Lump Sum Tax
- _MPC_
1 - MPC
$1 Spending - $1 Tax
1