Econ 002
Kyle and Wissink sections should understand this handout.
Understand this simple model and expand it by adding more terms into the AE
Scenario 1:
Assume a simple Keynesian model
Y = C + I
where
C = a + bY
C = 190 + 0.9Y
and I = 50
In this model
if C = 190 + 0.9Y , then S = 190 + 0.1Y
And
Y = C + S = 190 + 0.9Y 190 + 0.1Y = Y
Define AE = C + I
Y = AE
Solve for Y using Y = 190 + 0.9Y + 50
Calculate S.
Compare S to the value to I
S is called a leakage and I is called an injection.
Change I from I = 50 to I = 51
Solve for Y using Y = 190 + 0.9Y + 51
Calculate S.
Compare the levels of S and I
You will find that $1 change in I has lead to $10 change in Y.
The spending multiplier is 10
Scenario II:
Assume a more interesting Keynesian model
Ignore NX;
let NX = 0
Y = C + I
+ G
where C = a + b(YT)
C = 190 + 0.9(Y – 100);
G = 100;
T = 100, and I = 50
In this model
if C = 190 + 0.9(Y100) , then S = 190 + 0.1(Y100)
And
Y = C + S + 100 = 190 + 0.9(Y –100)  190 + 0.1(Y100)
+ 100 = Y
Or
(Y – 100) =
190 + 0.9(Y –100)  190 + 0.1(Y100)
=
(Y100) = C + S
Y = C + S + T
Solve for Y using Y = 190 + 0.9(Y100) + 100 + 50
Calculate S. Compare the levels of
(S+T )
and
(I + G)
(S+T) are called leakages and (I+G) are called injections
Change I from I = 50 to I = 51
Solve for Y using Y = 190 + 0.9(Y100) + 100 + 51
Calculate S.
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 Spring '06
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 Macroeconomics, Monetary Policy, Keynesian economics

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