Lecture7

# This will occur at points to the right of equilibrium

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Unformatted text preview: ccur at points to the right of equilibrium. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 28 / 43 Short-Run Equilibrium Planned Spending and the Output Gap Planned Spending and the Output Gap Even when the economy is in equilibrium, this does not necessarily imply the economy is at potential. For now suppose Y ∗ = 11, 000 which also equals actual output. What happens when autonomous consumption and investment fall by \$500? If we decrease investment by \$500, then PAE = 1700 + 0.8Y . If we set Y = PAE , Y = 8, 500. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 29 / 43 Short-Run Equilibrium Planned Spending and the Output Gap A Decrease in Investment (Figure 10.9) Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 30 / 43 Short-Run Equilibrium Planned Spending and the Output Gap Return to Potential Now the economy is operating below potential of Y ∗ = 11, 000. What can we do to increase output? The easiest way to think about this is through the intercept term. When autonomous spending declined by \$500, the intercept declined by \$500. To increase output we need the intercept to shift up by \$500. The easiest way to do this is through the increasing government spending or decreasing taxes by the amount autonomous spending declined by (\$500). For every dollar we decrease taxes, autonomous spending will increase by MPC × ∆T or 0.8 × 1 = 0.8. If we want spending to increase by \$100, then taxes must be cut by \$100/0.8 = 125. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 31 / 43 Short-Run Equilibrium Multiplier Multiplier When autonomous spending declined by \$500, output declined by \$2500, why? This is because of the income-expenditure multiplier (also called autonomous expenditure multiplier). 1 2 3 4 5 6 7 I and C falls by \$500 Remember Y = C + I + G + NX , so Y falls by \$500. Remember C = C + MPC (Y − T...
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## This document was uploaded on 03/18/2014 for the course ECON 202 at Gonzaga.

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