Therefore NX0 We will drop this assumption in week 3 38 2016 faculty

# Therefore nx0 we will drop this assumption in week 3

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› Therefore: NX=0! › We will drop this assumption in week 3! 38

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| Date 14-11-2016 faculty of economics and business The model Assuming that exports and imports are both zero, the demand for goods and services is the sum of consumption, investment and government spending: › Inserting all behavioral relationships gives : 39 Z C I G + + ( ) 0 1 Z c c Y -T I G = + + +
| Date 14-11-2016 faculty of economics and business Equilibrium (1) › Equilibrium in the goods market requires that the supply /production of goods, Y , be equal to the demand for goods, Z : › The equilibrium condition is that, production, Y , be equal to demand. Demand, Z , in turn depends on income, Y , which itself is equal to production. Hence : 40 Y Z = 0 1 ( ) Y c c Y T I G = + + +

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| Date 14-11-2016 faculty of economics and business The equilibrium (2) 41 › Solving the model gives: › A.k.a. The Keynesian cross. 0 1 1 1 1 Y c I G cT c = + +
| Date 14-11-2016 faculty of economics and business Fiscal policy (1) What will happen in the economy if the government wants to stimulate output? For example, what is the effect of an increase in government spending ( ∆𝐺𝐺 )? The equilibrium condition shows that Y will increase with: 1 1−𝑐𝑐 1 ∆𝐺𝐺 The more than one-to-one increase in output is called the multiplier effect. 42

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| Date 14-11-2016 faculty of economics and business Fiscal policy (2) 43
| Date 14-11-2016 faculty of economics and business 44

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| Date 14-11-2016 faculty of economics and business Fiscal multipliers are small, but not that small 45
| Date 14-11-2016 faculty of economics and business Fiscal policy - recap In the closed economy model for the short run: The government can use fiscal policy (G and/or T) to influence aggregate output. Expansive fiscal policy of magnitude X, will affect output with more than X. This is because of the multiplier effect. The magnitude of the multiplier effect depends on the marginal propensity to consume 46

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| Date 14-11-2016 faculty of economics and business Exam Question (2014) Consider the goods market for a closed economy in which consumption C depends on disposable income Y − T and in which taxes T depend on income Y : T = t 0 + t 1 Y . Note that t 0 is the autonomous component of taxes. Furthermore, investment I and government spending G are exogenous. The marginal propensity to consume is denoted as c , and c and t 1 are positive numbers which are smaller than 1. The government spending multiplier in this economy equals A) 1/(1– c ct 1 ). B) 1/[1– c (1− t 1 )]. C) 1/(1– c + t 1 ). D) none of the above. 47

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| Date 14-11-2016 faculty of economics and business An alternative interpretation of the goods market If households do not consume, they save If governments do not spend all taxes, they save as well: Total saving in the economy, therefore is: 𝑆𝑆 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 = 𝑆𝑆 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑡𝑡𝑡𝑡𝑝𝑝 + 𝑆𝑆 𝑝𝑝𝑝𝑝𝑝𝑝𝑡𝑡𝑝𝑝𝑐𝑐 = 𝑌𝑌 − 𝐶𝐶 − 𝑇𝑇 + (

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