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# 25 - ECON NOTES Accounting of GDP Spending multiplier GDP=...

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ECON NOTES GDP= C+I+G+X-M Consumption Largest component (70%)- Usually stable Investment is smallest (9%)- VOLATILE; changes a lot Government spending (20%)-based on government needs; exogenous Government expenditures NX is -7% Exports depend on income of foreign countries; X=f (Y Foreign countries) Imports= f ( Y u.s.a.) Transfer payments NOT part of G; changing hands; not productive activity C= f(income(y), wealth(w)) Changes in stock of inventories- Rising stock inventories is a sign of recession ; because businesses aren’t able to sell what they need to sell MAJOR Oil price increase in 1972, 73; made us better nation Keynesian Consumption Function C= Co+ C1 Y Co= autonomous consumption; independent of income C=100+ (.8)Y (.8)Y is MPC- Marginal Propensity to Consume MPSave=.20 MPC=.80

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Spending Multiplier Income Spending 1 .80 .80 .64 .64 .50 .50 .40 Spending multiplier= 1/ (1-MPC) 1/(.2) =5 so that \$1 generates \$ 5 income MPC=.8 = 5 MPC=.9 = 10 MPC=.5 = 2 Households Firms Government International Spending multiplier= 5 (From previous example) C=100 + .8Y GDP= Y = 500 C= 500 S = 0 I = 0 BD = 0
C= 100+ .8Y I= 200 100 200 300 300 X 5= 1500 GDP=Y=1500 C= 1300 S = 200 I= 200 BD= 0 C= 100 + .8Y I=200 G=300 600 x 5= 3000 Y=3000 C= 2500 S= 500 I= 200 BD= 300 Private saving= 500 Public saving= - 300 ------------------- National saving= 200 Tax Multiplier= - (Spending multiplier – 1) 3/27/08

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Test Review Main Principles: 1. AD/AS Model 2. Classical and Keynesian 3. Oil Prices and AD/AS 4. Money/inflation prices 5. Growth Model, Classical, Neo-Classical 6. Solow’s 1/3 Rule Three Goods Markets: Goods, Financial, and Labor markets Main objective of every economy: Full employment - When full employment is reached, no governmental policy is necessary Yp = Potential GDP – The amount of production necessary to employ everyone Recessionary Gap – The gap between real GDP and potential GDP Keynesian Economics advocates monetary and fiscal policy – they assume an active role in the government – Fiscal – taxes and spending (to expand the economy, cut the taxes, or increase spending) Monetary – Policy of the Fed (central bank) Both Fiscal and monetary expansionary policy shift the AD curve to the right Expansionary policy is utilized in the presence of a recessionary gap Consumer Confidence – AD shifter to the right Expansionary monetary policy lowers interest rate, but fiscal policy and consumer confidence increases it i (nominal interest rate) = real interest rate + inflation Demand Pull Inflation – Increased inflation that results as a result of increased aggregate demand Cost-Push Inflation – Increase in interest resulting from higher prices AS shifters – Oil prices – Increase in oil prices signifies an increased price for energy in
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25 - ECON NOTES Accounting of GDP Spending multiplier GDP=...

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