Intermediate Macroeconomics

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Intermediate Macroeconomics

• Chapter 5
• The Keynesian Model

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The Keynesian Model

1. Simple Keynesian model
2. Aggregate expenditures
3. Equilibrium
4. Consumption function
5. Autonomous spending
6. Autonomous spending multiplier
7. Government fiscal policy
8. Automatic stabilizers

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1. Simple Keynesian Model

• Macroeconomics in a recession
• Classical macro theory
• Prices will fall thereby stimulating demand.
• Interest rates will fall thereby stimulating
  investment.
• Keynesian macro theory
• Prices, wages and interest rate are fixed.
• Government fiscal policy stimulus needed.

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2. Aggregate Expenditures

• AE C I G NX
• C Consumption
• I Private Domestic Investment
• G Government Spending
• NX Net Exports (Exports - Imports)

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3. Equilibrium

• Y AE
• Undesired Inventory Build Y gt AE
• Undesired Inventory Draw Y lt AE
• where, Y National Income
• AE Aggregate Expenditures

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4. Consumption Function

• C C0 c ? Y
• Co Autonomous consumption
• c Marginal propensity to consume
• out of income (MPC)
• Y Income

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4. Consumption Function
C C0 c ? Y
2500
2500
Saving
Dissaving
C0 500
c MPC slope of consumption function
(2500 - 500) / (2500 - 0)
0.8
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5. Autonomous Spending

• Spending that is independent of any other
  variable (e.g., income, prices, interest rate)
• C0 Autonomous Consumption
• I0 Autonomous Investment
• G0 Autonomous Government Spending
• Autonomous (adj.) - self-governing

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Autonomous Spending MultiplierEquilibrium model
solution

• Step 1. Restate aggregate expenditures
• Step 2. State the equilibrium condition
• Step 3. Substitute aggregate expenditures from
  Step 1 into equilibrium condition in Step 2
• Step 4. Solve for Y (national income)

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Autonomous Spending MultiplierStep 1. Aggregate
expenditures restated

• Given
• AE C I G NX
• C C0 c ? Y
• I I0
• G G0
• NX 0
• Step 1. Substitute into equation for aggregate
  expenditures
• AE C0 c ? Y I0 G0

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Autonomous Spending MultiplierAggregate
expenditures curve
AE (C0 I0 G0) c ? Y
AE
C
5000
5000
45o Line (AE Y) all possible equilibria
C0 I0 G0 NX 1000 MPC slope of
consumption line slope aggregate
expenditure line (5000 - 1000) / (5000
- 0) 0.8
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Autonomous spending multiplierSteps 2 and 3

• Step 2. State the Equilibrium Condition
• Y AE
• Step 3. Substitute AE from Step 1 into Step 2
• Y C0 c ? Y I0 G0
• or
• Y (C0 I0 G0) c ? Y

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Autonomous spending multiplierStep 4. Solve for
National Income (Y)

• Y (C0 I0 G0) c ? Y
• Y - c ? Y C0 I0 G0
• (1 - c) ? Y C0 I0 G0
• Y 1 ? (C0 I0 G0)
• 1 - c

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6. Autonomous Spending Multiplier

• Change in Y Multiplier ? Change in C0, I0,or G0
• Equilibrium model solution
• Y 1 ? (C0 I0 G0)
• 1 - c
• Autonomous Spending Multiplier
• 1 or 1
• 1 - c 1 - MPC

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Government Fiscal Policy

• Given Equations
• AE C I G NX
• C C0 c ? YD
• I I0, G G0, NX 0
• YD Y - t ? Y - T0 TR
• YD disposable income
• t ? Y income tax revenues
• T0 lump sum tax
• TR govt transfer payments

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Government Fiscal PolicyStep 1. Restate
aggregate expenditures

• AE C I G NX
• C0 c ? YD I0 G0
• C0 c ? (Y - t ? Y - T0 TR) I0 G0
• C0 I0 G0
• c ? Y - c ? t ? Y - c ? T0 c ? TR

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Government Fiscal PolicySteps 2 and 3

• Step 2. State the Equilibrium Condition
• Y AE
• Step 3. Substitute AE from Step 1 into Step 2
• Y C0 I0 G0
• c ? Y - c ? t ? Y - c ? T0 c ? TR

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Government Fiscal PolicyStep 4. Solve for
National Income (Y)

• Y C0 I0 G0 c ? Y - c ? t ? Y - c ? T0 c
  ? TR
• Y C0 I0 G0 - c ? T0 c ? TR (c - c ? t)?
  Y
• Y C0 I0 G0 - c ? T0 c ? TR c ? (1 - t)?
  Y
• Y - c ? (1 - t )? Y C0 I0 G0 c ? (TR -
  T0)
• 1 - c ? (1 - t ) ? Y C0 I0 G0 c ? (TR -
  T0)
• Y 1 ? C0 I0 G0 c ? (TR
  - T0)
• 1 - c ? (1 - t )

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Government Fiscal PolicyMultipliers
Assume c (marginal propensity to consume) 0.8
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Government Fiscal PolicyBalanced budget
multiplier

• 1 increase in government spending
• matched by
• 1 increase in lump sum taxes

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Government Fiscal PolicyBalanced budget
multiplier

• Spending multiplier (assume no income tax)
• 1  
• 1 c
• Lump Sum tax multiplier
• - c  
• 1 - c
• Balanced budget multiplier
• spending multiplier lump sum tax
  multiplier
• 1   - c    1 c 1
• 1 c 1 c 1 - c

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Government Fiscal PolicyBalanced Budget
Multiplier

• From Step 4 (assume t 0)
• Y 1 ? C0 I0 G0 c ? (TR - T0)
• 1 - c
• Multiplier (assume ?C0 ?I0 ?TR 0)
• ?Y 1 ? ( ? G0 - c ? ? T0)
• 1 - c
• Balanced Budget (? G0 ? T0)
• ?Y 1 ? ( ? G0 - c ? ? G0)
• 1 - c
• 1 ? ( 1 c) ? ? G0
• 1 - c
• 1 ? ? G0
• Multiplier 1

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8. Automatic Stabilizers