Econ1102_Week_5

# Econ1102_Week_5 - Week 5 Lectures 9 10 Spending and Output...

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W e e k 5 L e c t u r e s 9 1 0 Spending and Output in the Short-Run (continued) Reference: Bernanke, Olekalns and Frank - Chapter 7 Key Issues 45-degree diagram Equilibrium and disequilibrium Injections and withdrawals Multiplier

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2 Review In Week 4 we developed a simple algebraic model of output. It consists of: An equilibrium condition: PAE Y = output that equals planned aggregate expenditure A definition of PAE: NX G I C PAE P + + + = An economic model for consumption: ) ( T Y c C C + =
3 Two Sector Model Assumptions (simplifying): no government sector no foreign sector (i.e. a closed economy) Planned aggregate expenditure P I C PAE + = Consumption function (no taxes, so consumption depends on total, not disposable income) cY C C + = Planned investment is exogenous

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4 A Diagram Showing Consumption and Investment C, I cY C C + = P I Y
5 Planned Aggregate Expenditure cY I C I C PAE P P + + = + = P I C PAE + = C, I, PAE cY C C + = P I Y

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6 45-Degree Diagram How can we represent equilibrium diagrammatically? Equilibrium is where PAE Y = PAE 2 0 1 0 1 0 2 0 Y
7 PAE Y = for all points on the 45-degree line PAE Y = P A E 1 PAE 0 45 1 Y Y

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8 Equilibrium GDP in the 2-Sector Model 45-degree line P A E PAE C P I e Y Y
9 Equilibrium GDP in the 2-Sector Model: The Algebra Equilibrium Condition PAE Y = Definition of PAE P I C PAE + = Consumption Function cY C C + = (Substitution) P I cY C Y + + = (Collect terms in Y ) P I C c Y + = ) 1 ( Equilibrium GDP ] [ 1 1 P e I C c Y + =

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10 Injections and Withdrawals There is an alternative way to look at the equilibrium condition for GDP. PAE Y = P I C Y + = Now subtract C from both sides P I C Y = or P I S = S = Withdrawals (WD): Part of income not consumed P I = Injections ( P INJ ): All exogenous spending
11 Short-Run Equilibrium Condition WD INJ P = Planned Injections equals Withdrawals Saving Function P I C Y = cY C C + = P I cY C Y = P I Y c C = + ) 1 ( P I S = so Y c C S ) 1 ( + =

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