The Keynesian Cross and the equilibrium level of output Ch'3

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The Keynesian Cross and the equilibrium level of
output (Ch.3)

• The Goods Market
• The composition of the GDP (the demand of goods)
• The Keynesian consumption function
• The Keynesian Cross and the equilibrium level
  of output
• The multiplier
• Fiscal policy an increase in G

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The Composition of GDP
The Components of Aggregate Production (GDP)

• C -- Consumption
• Goods and services purchased by consumers (70 of
  GDP)
• I -- Fixed Investment
• Nonresidential investment (firms) (we also have
  residential investment) (overall 10/15 of GDP)

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The Composition of GDP
The Components of Aggregate Production (GDP)

• G -- Government Spending
• Purchases by the central state, and local
  governments. Excludes transfer payments (20 of
  GDP)
• IS -- Inventory Investment
• Production - sales (1 of GDP)

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The Composition of GDP
The Components of Aggregate Production (GDP)

• X - IM -- Net Exports
• Exports (X) (10-20 of GDP) - Imports (Q) (10-20
  of GDP)
• X gt IM -- trade surplus
• X lt IM trade deficit

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The Demand for Goods
Total Demand
It represents the amount that the four actors of
our economy plan to spend on goods and services.
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The Demand for Goods
Consumption (C)

• The main determinant of C is disposable income
• YD Y T
• T Net taxes Taxes - Transfers

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The Demand for Goods
Consumption (C)

• The consumption function
• C f(YD) C0 C1YD
• ()
• C0 minimal consumption (subsistence)
• C1 propensity to consume
• Change in C from a dollar change in income
• 0 lt C1 lt 1

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Consumption and Disposable Income
Consumption function C c0 C1YD
Consumption, c
Slope c1
Disposable Income,YD
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The Demand for Goods

• Endogenous Variables
• Variables that depend on other variables in the
  model
• C is endogenous because it responds to
  productionIncome (Y)
• C C0 C1 (Y T)

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The Determination ofEquilibrium Output
Demand for Goods (Z)

• .

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The Determination ofEquilibrium Output
Equilibrium

• The difference between actual and planned
  expenditures is unplanned inventory investment Is
• If firms do not hold inventories, then
• Y supply of goods (actual expenditures)

Equilibrium occurs when

• Supply of goods (Y) Demand for goods (Z) or
  planned expenditures

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The Determination ofEquilibrium Output
The Model and Equation Types

• Identity Equations
• Behavioral Equations
• Equilibrium Equations

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The Determination ofEquilibrium Output
The Algebra
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The Determination ofEquilibrium Output
The Algebra

• Subtracting C1Y from both sides gives

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The Determination ofEquilibrium Output

• Dividing both sides by (1 - C1) gives

The Algebra
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The Determination ofEquilibrium Output
The Algebra YZ
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The Determination ofEquilibrium Output
Example

• C0 increases by 1 billion
• C1 0.6

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The Determination ofEquilibrium Output

• Change Y change C0 x multiplier
• 1 billion x
• 1 billion x
• 1 billion x 2.5
• 2.5 billion

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Equilibrium in the Goods Market
45o line
Production
Demand (Z), Production (Y)
Slope 1
Y1
Income,Y
Y1
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Equilibrium in the Goods Market
45o line
Production
ZZ
Demand (Z), Production (Y)
Demand
Income,Y
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Equilibrium in the Goods Market
45o line
Production
Slope 1
ZZ
A
Demand (Z), Production (Y)
Demand
Equilibrium point Y Z
Autonomous spending
Income,Y
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Equilibrium in the Goods Market
45o line
ZZ
Demand (Z), Production (Y)
Income,Y
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Effect of an increase in G (increase in
autonomous spending)
45o line
.
ZZCIG
GgtG
A
ZZCIG
Demand (Z), Production (Y)
A
Y
Income,Y
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Fiscal Policy
Government Spending (G)

• G T describe the fiscal policy (governments
  decisions about spending and taxes)

Stabilization Policy

• Governt actions to try to keep output close to
  its potential level

Budget Deficit and National Debt

• DeficitG-T (a flow) is when government outlays
  exceed government receipts. While the National
  Debt is the stock of outstanding government debt
  (it the result of accumulation of past deficits)