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# 11-12-07 - -suppose price decreases to p3-when price...

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Real GDP Y C I G AE 0 0 1 1 2 1 .5 1 1 2.5 2 1 1 1 3 3 1.5 1 1 2.5 4 2 1 1 4 5 2.5 1 1 4.5 6 3 1 1 5 Y=(C+I+G) (C+I+G)=expenditures=AE Y=income AE=aggregate expenditures -expenditures are in equilibrium when Y=AE -in our example Y=AE=4 Keynesian multipliers G increases .5 Y C I G AE 0 0 1 1.5 2.5 1 .5 1 1.5 3 2 1 1 1.5 3.5 3 1.5 1 1.5 4 4 2 1 1.5 4.5 5 2.5 1 1.5 5 6 3 1 1.5 5.5 -now Y=AE=5 -note: govt increased spending by 0.5 but the economy grew by 1 -growth of economy is 2 times growth in govt expenditures -so Keynesian multiplier is 2 -horizontal in Y is larger than vertical increase in G Keynesian Math 1) C+I+G=Y 2) C=A+BY Plug (2) into (1)… (A + BY) + I + G=Y Solve for Y Y= (1/1-B)(A+I+G) 1/1-b=multiplier -So 1/1-b is multiplier -recall b=MPC -Multiplier=1/1-MPC

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-1/1-.5=2 -in sum, when g increases economy grows at (1/1-MPC) times the increase in G -suppose begin at AE, and P1 -now suppose price level increase to p2 -when price increases, you buy less in “real terms” so AE decreases to AE2
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Unformatted text preview: -suppose price decreases to p3-when price decreases, you buy more stuff, AE increases to AE3-connect the dots on bottom graph and get AD-consider very short run all prices are sticky-suppose G increases-this increase AE to AE2-then AD increases to AD2-but in SR, prices can adjust (wages sticky)-SR equilibrium is where AD=SRAS-so in SR, prices go up a little.-but when price increases, AE decreases to AE3-in LR, wage can adjust-when G increase, AE increase, to AE2-and AD to AD2-in SR, Price increase, AE decreases to AE3-in LR, wages increase, SRAS decreases to SRAS2 then Price increases, AE decreases to AE,-in LR, Govt has no effect on real GDP-only effect is higher prices...
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