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Lecture7 - Chapter 10 Aggregate Expenditures Ryan W Herzog...

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Chapter 10: Aggregate Expenditures Ryan W. Herzog February 25, 2014 Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 1 / 43
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Outline 1 Introduction 2 Keynesian Model Menu Costs 3 Planned Aggregate Expenditures Investment Consumption Consumption, PAE, and Output 4 Short-Run Equilibrium Planned Spending and the Output Gap Multiplier Mathematical Solution 5 Stabilizing Planned Spending: Fiscal Policy 6 Endogenous Taxes and Imports Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 2 / 43
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Introduction Introduction This chapter begins our analysis of short-term fluctuations in the economy. Like microeconomics, macroeconomics is also concerned with demand and supply, the primary difference is macroeconomics looks at demand and supply in the aggregate. Aggregate supply is determined by the collective behavior of firms and workers. Aggregate demand is determined by the total expenditures of households, firms, government, and the rest of the world. In this section we will analyze the factors that make up aggregate demand. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 3 / 43
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Keynes Introduction Prior to the Great Depression, the consensus of the day was markets were quick to adjust. The self correcting tendency of the economy would ensure prices and wages would adjust quickly keeping the labor and goods markets in equilibrium. During the Great Depression, John Maynard Keynes, pointed out an economy operating with unemployment rates in excess of 20% could not be in equilibrium. Keynes argued wages and prices were slow to adjust, the result was disequilibrium in both the goods and labor markets. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 4 / 43
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Keynes Assumptions Instead of assuming prices and wages adjust quickly, Keynes assumed firms met demand at preset prices. It was easier for firms to layoff workers than adjust prices and wages. During recessions in was common to observe an excess supply of goods and workers. Firms would responds to decreases in demand by cutting production or increases in demand by expanding production. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 5 / 43
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Keynes Menu Costs Menu Costs Keynes argued it was costly to change prices. Firms need to estimate the optimal prices which took time and proved to be costly. Firms wanted to be sure the change in demand was permanent. Workers disliked wage cuts. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 6 / 43
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PAE Introduction In the Keynesian model firms respond to changes in demand through production, which meant the primary determinant of output is spending. The more spending that occurs results in greater production and vice versa. Planned aggregate expenditures (PAE) is total planned spending on final goods and services. (PAE) include household consumption (C), investment (I), government spending (G), and net exports (NX).
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