Lecture Notes 5

# Lecture Notes 5 - AE = C I G intercepts the 45 degree line...

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13/04/11 AE = C + I + G – intercepts the 45 degree line at GDP* Full employment level it not at that intercept – GDP(fe) > GDP* - the economy is in recession, there is a recessionary gap Two option – increase G, or decreae taxes, to move the AE function upwards and move the intercept to GDP (fe) If GDP(fe) was less than GDP*, inflation would be increasing – cut government spending, or increase taxes This is from a Keynsian policy model Suppose GDP* = 1000, GDP(fe) = 1200 Consumption function = 50 + .8Y(d) Change in G to get to full employment? o Multiplier = 1/(1-MPC) = 1/.2 = 5 o Change in Government expenditure should be 40 Restriction on government expenditure – what change in tax policy will accomplish the same goal? o Tax multiplier: 4 (MPC/MPS) o Cut taxes by 50 Smaller change in Government expenditure is needed versus a tax cut What is both changes were to occur? Requirement to balance budget o Government decided to increase expenditure by 40 dollars o At the same time, there has to be an increase in taxes that accounts for the increase in taxes

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## This note was uploaded on 09/08/2011 for the course ECON 101 taught by Professor Gulati during the Spring '11 term at Columbia.

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Lecture Notes 5 - AE = C I G intercepts the 45 degree line...

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