Notes_ECO202_02 - Macroeconomics Theory and Policy...

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Unformatted text preview: Macroeconomics Theory and Policy Classical vs. Keynesian Views: . Classical View: - Quantity - Price P S S’ - Supply side is perfectly inelastic, given the available resources in the economy - Any increase in demand leads to higher price level - To increase D’ D Y (GDP) Masoud Anjomshoa Classical vs. Keynesian Views: 1 . Keynesian View: - Quantity - Price - Supply - Increase P Keynesian view is more relevant in short run. S D’ D Classical view is more relevant In medium/long run. Y (GDP) Masoud Anjomshoa Masoud Anjomshoa 2 1 Macroeconomics Theory and Policy Short Run vs. Long Run: . Y Short/Medium Run Output (GDP) Y Actual Output, Y Y - Full Employment Output - Natural Level of Output Long Run Y Time (quarters) Masoud Anjomshoa 3 Short Run (Keynesian Model): . 1- Assumptions about the behavior of the economy in the Short Run: Y Y Short/Medium Run 2- Capital, K, and labor, L, are fixed, so output capacity, Y, is fixed: YFK,L 3- Actual output, Y, can freely go above (below) output capacity, Y , by over-utilization (underutilization) of resources (capital and labor). Recession: Boom: Masoud Anjomshoa Masoud Anjomshoa 4 2 Macroeconomics Theory and Policy Goods Market: IS Curve Masoud Anjomshoa 5 Goods Market in Short Run: . Demand = Z = C + I + G + NX + Δinv Suppose: - Economy is closed: NX = 0 - No change in inventory levels: Δinv = 0 Demand = Z = C + I + G For now: Exogenous I= Ī Endogenous Behavioral function Masoud Anjomshoa Masoud Anjomshoa Exogenous Policy variable set by government 6 3 Macroeconomics Theory and Policy Keynesian Consumption Function: . Disposable Income: Yd = Y – T T: Income tax, a policy variable, set by government. C = co + c1 . Yd C = co + c1 (Y - T) Marginal Propensity to Consume (MPC): Autonomous consumption: - Example: MPC = 0.8 For every extra dollar disposable income, consumption goes up by ¢80, saving goes up by ¢20. Monthly indexes: - Consumer Sentiment - Consumer Confidence - Consumer Confidence Masoud Anjomshoa 7 Goods Market in Short Run: C = 200 + 0.8 (Y – T), I = 100, Balanced Budget: T = 200, G = 200 Z=C+G+I= All variables are in real term Z, C I, G 340 Z = 340 + 0.8 Y Slope = 0.8 C = 200 + 0.8 (Y-200) 200 G=200 100 I=100 40 Masoud Anjomshoa Masoud Anjomshoa Income, Y 8 4 Macroeconomics Theory and Policy Short Run Equilibrium in Goods Market: Demand: Z = 340 + 0.8 Y Supply: Z=Y Z=Y Z = 340 + 0.8 Y E Z, C I, G C = 200 + 0.8 (Y-200) 340 200 G=200 100 I=100 40 Y*=1700 Masoud Anjomshoa Income, Y 9 Disequilibrium in Goods Market:. Z, C I, G Z=Y S E If Y = 1500 Y↑ D Z = 340 + 0.8 Y D S 340 If Y = 1900 Y↓ 45o Y=1500 Y=1900 Y*=1700 Anjomshoa Masoud Masoud Anjomshoa Income, Y 10 5 Macroeconomics Theory and Policy Recession/Boom . Y* Y Z=Y Z, C I, G E’ E Z = 340 + 0.8 Y Demand should be increased: Expansionary Fiscal Policies: 340 200 G=200 45o Y*=1700 Y 1800 Masoud Anjomshoa Income, Y Recession/Boom . Z, C I, G Y* Y Recession Demand should be increased: Z=Y E’ E 11 Z = 340 + 0.8 Y Expansionary Fiscal Policies: 340 C = 200 + 0.8 (Y-200) 200 40 Or trying to increase consumer/investor confidence. 45o Y*=1700 Y 1800 Masoud Anjomshoa Masoud Anjomshoa Income, Y 12 6 Macroeconomics Theory and Policy Fiscal Policies & Multipliers: . Z co c1 (Y T) I G Y co c1 (Y T) I G Z Y Y c1Y co c1T I G Y 1 Y 1 c G 1 c1 Y T 1 c1 1 co c1T I G 1 c1 G-multiplier: If c1 = 0.8 ΔY = 5 ΔG If ΔY= 100 T-multiplier: If c1 = 0.8 ΔY = -4 ΔT If ΔY= 100 Masoud Anjomshoa G-Multiplier: c1 Z 13 . YG Y Z=Y If c1 0.8 Z’ E’ Z ΔG ΔG ΔC E ΔC c1 45° Masoud Anjomshoa $0.512 . . . 1 $5 1 c1 Masoud Anjomshoa $1 $0.8 $0.64 ΔC ΔY Y $1 Y -----------------------ΔY 1/(1-c1) $5 14 7 Macroeconomics Theory and Policy National Saving: . Demand Approach: Y = C + G + I Income Approach: Y = C + T + S C+G+I =C+T+S I = S + (T – G) Investment Masoud Anjomshoa 15 Investment Function: . I = I (Y , i ) I Given i I = I (Y , i’) I = I (Y , i ) + – Investors have two sources for investment: 1Negatively related to interest rate. 2Positively related to income. if i ↓: i’ < i Y Masoud Anjomshoa Masoud Anjomshoa 16 8 Macroeconomics Theory and Policy Short Run Equilibrium in Goods Market:. Z = co + c1 (Y – T) + I (Y , i ) + G + – Z=Y Z C I G If i falls A new equilibrium for any given Z =Y interest rate. Z’ E’ Z = co + c1 (Y-T) + I(Y, i) + G E C = co + c1 (Y-T) I’ = I (Y , i’ ) I = I (Y , i ) G 45o Y* Z =Y Z C I G Y Y** Masoud Anjomshoa 17 Z2 = co + c1 (Y-T) + I2(Y, i2) + G + – E2 Z1 = co + c1 (Y-T) + I1(Y, i1) + G + – E1 I2= I (Y , i2 ) + – I1 = I (Y , i1 ) + – 45o Y1 Y Y2 IS curve is the geometric location of all (i , Y) that bring the goods market to equilibrium. i i1 E1 i2 E2 Y1 Masoud Anjomshoa IS Y2 Y Masoud Anjomshoa 18 9 Macroeconomics Theory and Policy Equilibrium in Goods Market (IS Curve): Z = co + c1 (Y – T) + I (Y , i ) + G + – Z=Y IS Curve Y = co + c1 (Y – T) + I (Y , i ) + G + – The IS Curve is downward sloping, i.e. in goods market the relation between interest rate and output is negative: i i1 E1 i2 E2 Y1 IS Y2 Y Lower interest rate, i Masoud Anjomshoa Z’2 = co + c1 (Y-T) + I2(Y, i2) + G’ + – Z2 = co + c1 (Y-T) + I2(Y, i2) + G E’2 Z C I G 19 + – Z’1 = co + c1 (Y-T) + I1(Y, i1) + G’ + – E2 Z1 = co + c1 (Y-T) + I1(Y, i1) + G + – E’1 E1 If G increases: 45o Y1 Y’1 Y2 Y’2 Y If T decreases: i i1 E’1 E1 Consumer optimism: E’2 i2 E2 Y1 Y’1 Masoud Anjomshoa Y2 Y’2 IS IS’Y Masoud Anjomshoa 20 10 ...
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This note was uploaded on 10/08/2011 for the course ECO 202 taught by Professor Anjomshoa during the Fall '08 term at University of Toronto.

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