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150807_UWIN-PIE11-s49-Rev
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Bachelor in Economics (S.E): Manajemen
Course : Pengantar Ilmu Ekonomi (1508PIE11)
online.uwin.ac.id
Session Topic : Adding Government &
Trade to the Simple Macro Model
Course: Pengantar Ilmu Ekonomi
By Tovan Krisdianto, S.E., M.M.
UWIN eLearning Program
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Content
Part 1 Desired Investment Expenditure
Part 2 Equilibrium National Income
Part 3 Desired Government Expenditure
Part 4 Desired Foreign Trade
Part1: Desired Investment Expenditure
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Investment Expenditures: Definition
Recall: Investment refers to purchases of
a. Capital stock (plant & equipment)
b. Residential building
c. Business inventories
Investment expenditure is the most volatile component of GDP:
changes in investment expenditure are ..strongly associated with short-run fluctuations
3 important determinants of aggregate investment expenditure are:
a. The real interest rate
b. Changes in the level of sales
c. Business confidence
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Investment Expenditures: Komposisi Investasi
Bangunan
Transportasi
Permesinan & Peralatan
Lain2
1009080
70
60
50403020
10
0
Sumber: BPS & perhitungan staf Bank Dunia
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Investment Expenditures: The Real Interest Rate
The real interest rate is the opportunity cost for:
Investment in,
a. New plants & equipment
b. Inventories
c. Residential construction
Thus,
all 3 components of desired investment expenditure are negatively related to the real interest rate, other things being equal.
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Investment Expenditures: Changes in Sales & Business Confidence
Changes in Sales
The higher the level of production & sales, the larger the desired stock of inventories: changes in the rate of sales cause temporary bouts of
investment in inventories
Business Confidence
When business confidence improves, firms want to invest now so as to reap future profits. Business confidence & consumer confidence may feed off of one
another.
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Investment Expenditures: The Investment Function
Desired investment
Defn: Treated as entirely autonomous
Completely unrelated to the current level of Y
We can write I = I Were I is determined by:a. Real interest rates
b. Expectations (confidence)
c. Changes in sales
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Investment Expenditures: The Investment Function (Picture)D
esi
red Invest
ment
I
Actual National Income
Y
I
0
200
150
100
I
I
Interest rate falls
Expectations improve or Sales increase
Interest rate rises
Expectations worsen or Sales decrease
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Investment Expenditures: Our Story
Our Story- A simplified version (no Government, no Trade)
We will now start to tell our story (assemble our macroeconomic model).
Our story has 2 key purposes:1. To explain what determines the level of aggregate economic
activity (the size of the GDP or Y)
2. To understand,
What might cause GDP (Y) to,
a. increase &
b. decrease?
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Aggregate Expenditure: Definition
The Aggregate Expenditure Function
>The AE function:
Relates desired aggregate expenditure to actual national income
In the absence of government & international trade,
desired aggregate expenditure is:
AE = C + I
This is called a closed economy with no government
no Government, no Trade AE = C + I + G + NX
A Lou Dobbs economy (or perhaps the Fox Network economy).
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Aggregate Expenditure: A Closed Economy with No Government
Domestic Households
Domestic Firms
Factor income:
wages, rents profits
YD = Y
Revenue from
sales of final G & S= C + I
Savings
Investment
ConsumptionFinancial
markets
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Aggregate Expenditure: Level
The aggregate expenditure function,
relates the level of desired aggregate expenditure to the level of actual national income. But how? Through actual national incomes influence on C
AE = C + I
But,
C = a + bYD (the consumption function) & YD = Y (no government no taxes)
Therefore AE = a + bY + I
AE = a + I + bY
Note: Distinction between desired aggregate expenditure & actual
national income
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Aggregate Expenditure: Level (Cont.)
Since AE = C + I
implies that AE = a + I + bY
What Indonesian economic agents desire (intend or plan),
to spend on final goods & services in this period depends on... the level of actual national income (Y) this period.
Consider the following example:
a. The consumption function is: C = 30 + (0.8)Y
b. The investment function is: I = 75
The AE function is then given by:
AE = C + I
AE = 30 + (0.8)Y + 75
AE = 105 + (0.8)Y
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National
Income
(Y)
Desired
Consumption
Expenditure
(C=30+0.8 x Y)
Desired
Investment
Expenditure
(I=75)
Desired
Aggregate
Expenditure
(AE = C + I)
30 54 75 129
150 150 75 225
300 270 75 345
450 390 75 465
525 450 75 525
600 510 75 585
900 750 75 825
Aggregate Expenditure: Function
The slope of the AE function is the marginal propensity to spend:
in this simple model, it is just MPC
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Aggregate Expenditure: The Slope of AE Function
The slope of the AE function is the marginal propensity to spend..
In the simplest model with no taxes & no international trade, this is just the MPC
Y C I AE
30 54 75 129
120 126 75 201
150 150 75 225
300 270 75 345
450 390 75 465
525 450 75 525
600 510 75 585
900 750 75 825
600
300
105
105 300 600
AE =C + I
Actual National IncomeD
esi
red
Aggre
ga
te
Exp
end
iture
75
30
C
I75 75
270
345 510
585
Actual Desired
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Aggregate Expenditure: Summary
a. The AE function combines the spending plans of households &
firms.
It shows, that for any level of actual national income, the level of desired aggregate spending.
What happens to AE if the,
b. consumption function shifts up or down?
c. slope of the consumption function increases or decrease?
d. investment function shifts up or down?
e. slope of the investment function increases or decrease?
(We will assume that it is always zero?)
Part2: Equilibrium National Income
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Equilibrium: Desired Aggregate Expenditure
Equilibrium National Income
Recall:
> Desired aggregate expenditure. Defn:
What buyers want to buy during the period (C + I in our simple model)
>Actual output. Defn:
What firms actually produce during the period (Y or GDP)
If desired aggregate expenditure,
a. exceeds actual output:
what is happening to inventories? falling there is pressure for output to riseb. is less than actual output:
what is happening to inventories? rising there is pressure for output to fall
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Equilibrium: Desired Aggregate Expenditure
What happens if desired AE (C+I) is,
1. less than output (actual Y or
GDP)?
AE < Y (GDP)
a. Firms cannot sell all that they are
producing this period
b. Inventories build up (this is
unintended I, it is not desired)
c. This is the firms signal that a
decrease in output is necessary
d. Firms decrease output until AE = Y
2. greater than output (actual GDP,
Y)?
AE > Y (GDP)
a. Firms are selling more than they
are producing this period
b. Inventories are being run down
(this is an unintended decrease in I)
c. This is the firms signal that an
increase in output is necessary
d. Firms increase output until AE = Y
How the Economy Gets to Equilibrium - Inventory Adjustment Mechanism
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Equilibrium: National Income Table
Actual
National
Income
(Y)
Desired
Aggregate
Expenditure
(AE = C+I)
Effect
30 129
Inventories are falling;
firms increase output
150 225
300 345
450 465
525 525 Equilibrium income
600 585 Inventories are rising;
firms reduce output900 825
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Equilibrium: Demand Determined
In this model, output is said to be
demand determined.
The equilibrium condition is:
Y = AE(Y)
In words:
Equilibrium national income is,
that level of national income where
desired aggregate expenditure equals actual national income.
600
300
105
300 600
900
900
AE
Actual National IncomeD
esi
red A
.E.
45 line
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Equilibrium: 2 Types
2 types of shifts can occur with the AE function:
The,
a. AE function can shift parallel to itself
b. Slope of the AE function can change
(should not really be called a shift but a rotation)
e
1
Y0 Y1
e0
AE0
Y0 Y1
AE1
AE0
AE1e1
AE = Y
E1
E0
E1
E0 e0
e2
AE = Y
Y Y
AEAE
Changes in Equilibrium National Income
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Equilibrium: The Multiplier
The Multiplier
Defn: A measure of the size of the change in equilibrium Y that results
from a change in autonomous expenditure.
In our simplest of macro models, the multiplier exceeds one.
Simple multiplier =Y
A=
1
1-z
Where z is,
the marginal propensity to spend out of national income & A is the change in autonomous expenditure.
e
1
Y0 Y1
e0
AE0
AE1e1
AE =Y
E1
E0
A
Y
Y
AE
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Equilibrium: AE
The,
larger is z, steeper is the AE curve & larger is the simple multiplier.
Y0 Y1
AE0
AE1
AE =Y
E1
E0
A
Y
Y0 Y1
AE0
AE1
AE =Y
E1
E0A
Y
AE AE
Y Y
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Equilibrium: What Might Cause GDP to Increase from Y0?
Q: What if interest rates fall?
A:
Consumers borrow more (or save less) & buy more now
Investors borrow to buy more plant, equipment, new housing.
AE shifts up (both C & I have shifted up)
Firms produce more (hire more workers, buy more resources,
generate more profits) GDP (Y)
increases
Same outcome for a positive change in expectations, increase in wealth,
increase in sales
Y0 Y1
AE0
AE1
AE =Y
E1
Y
AE
E0
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Equilibrium: What Might Cause GDP to Decrease from Y0?
Q: What if interest rates rise?
A:
Consumers borrow less (or save more) & buy less now
Investors borrow less & buy less plant, equipment, new housing.
AE shifts down (both C & I have shifted down)
Firms produce less (hirer fewer workers, buy more resources,
generate more profits) GDP (Y)
increases
Same outcome for a negative change in expectations, decrease in
wealth, decrease in sales
AE0
Y1 Y0
AE1
AE =Y
E0
Y
AE
E1
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Equilibrium: Economic Fluctuations
Economic Fluctuations as Self-Fulfilling Prophecies
Households & firms,
base their desired investment & consumption partly on their expectations of the future:changes in expectations can lead to real changes in the current state
of the economy
Example:
Imagine that firms feel optimistic about the futureThis increases,
their desired investment, shifting up the AE curve Y, justifying the initial optimism
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Equilibrium: Opposite Scenario
Now imagine the opposite scenario.
It should be clear that if firms & households are pessimistic about the future in large numbers,
the ensuing change in their behaviour will lead to a self-fulfilling prophecy of reduced national
income.
Could the Prime Minister (or the Governor of the
Bank of Canada),
ever announce to the country that they might have made a big mistake?
For example:
suppose that government analysts report to the Prime Minister
that having signed the Kyoto Accord might result in a recession.
Part3: Desired Government Expenditure
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No. NegaraGDP/ kapita
(USD, 2010)
Lama di (sd 2010 (thn)) Pertumbuhan
Income rata2
2000-10 (%)
KetMI UMI
1 Uruguay 10.934 112 15 3.3 UMIT
2 Polandia 10.731 50 11 3.9
3 Malaysia 10.567 27 15 2.6 UMIT
4 Venezuela 9.662 60 23 1.4 UMIT
5 Thailand 9.143 28 7 3.6
6 Suriah 8.717 46 15 1.7 UMIT
7 Saudi Arabia 8.396 32 20 0.9 UMIT
8 Turki 8.123 51 6 2.3
9 RR China 8.019 17 2 8.9
10 Meksiko 7.763 53 8 0.7
11 Panama 7.146 56 - 2.4 LMIT
12 Iran 6.789 52 - 3.4 LMIT
13 Brazil 6.737 53 - 2.0 LMIT
14 Colombia 6.542 61 - 2.6 LMIT
15 Jordania 5.752 55 - 3.5 LMIT
16 Peru 5.733 61 - 4.2 LMIT
17 Indonesia 4.790 25 - 3.9 LMIT
18 India 3.407 9 - 6.1
19 Vietnam 3.262 9 - 6.1
20 Filipina 3.054 34 - 2.5 LMIT
Aggregate Expenditure: Tabel III-Ringkasan Posisi Negara Berpendapatan Menengah
Terperangkap dalam
UMIT : Upper Middle Income Trap
LMIT : Lower Middle Income Trap
Sumber: ADB(2010)
Batas lepas LMIT: USD 7250
Butuh: 28 tahun Minimal
pertumbuhan:
4.7% per tahun
(rata2)
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Aggregate Expenditure: The Circular Flow of Expenditure & Income
Here we consider all
of
the economic agents who might
buy
final goods &services from
Indonesian firms
C + I + G + (X - IM)
= Desired Aggregate Expenditure
IM
C
I
G
X
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Introducing Government: Purchases & Net Tax
Government Purchases
>>Government purchases of goods & services (G) are,
part of desired aggregate expenditures excluding transfer payments (BLT, BOS, Subsidi) WHY?
Net Tax Revenues
>>Net taxes (T). Defn:
Total tax revenues net of transfer payments.
Q: Why net-of-transfer payments?
A: We assume net taxes are given by:
T = tY
where t is the net tax rate.
Example:
if t = 0.3 & Y = 600 then T = 0.3(600) = 180Implies that all taxes are related to the level of income.
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Introducing Government: Budget Balance
The Budget Balance
The budget balance is the difference between G & T.*
if G < T: a budget surplus if G > T: a budget deficit
Government Expenditure Function
Desired government expenditure is,
treated as autonomous completely unrelated to the current level of Y
We write G = G
Were G is determined by,
1. What governments do!
2. The budget process!
3. Election cycles!
Mostly just the provision of goods & services (general government, health,
education, public safety, transportation)
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Introducing Government: Government Expenditure Function
Government Expenditure Function (what does it look like?)D
esi
red G
overn
ment
Expenditure
s
G
Actual National IncomeY
G
0
200
150
100
G
G
Shift up,
implies a Government spending increases
Shift down,
implies a Government spending cuts
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Introducing Government: Government Net Tax Function
T
Y0
200
150
100
T = tY
-150
-100
Governments set,
the tax rate (t) but Y determines the total
taxes paid (T)
Y1
T0 = tY0
T1 = tY1
Y0Desi
red N
et Taxes
Actual National Income
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Introducing Government: Changes in Taxes (the Tax Rate t)
T
Y
T = tY
0
200
100
T = tY
Net tax increases
Net tax decrease
-150
-100
T = tY
Note: t > t > t
Y0
T0T0
T0
Desi
red N
et Taxes
Actual National Income
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Introducing Government: The Public Saving Function
Public Saving. Defn:
defined as T G Net tax revenue which the government does not
spend
As national income rises,
the budget surplus (public saving) increases.
The slope of the public saving function is
equal to the net tax rate.
T - G
Public
Savin
g
0 300 600 900
Actual National Income
*
Y G T=0.1xY T-G
150 51 15 -36
300 51 30 -21
525 51 52.5 1.5
600 51 60 9
900 51 90 39
Part4: Desired Foreign Trade
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Foreign Trade: Net Exports
Net Exports
We make 2central assumptions:
Indonesians
1. Exports are autonomous with respect to Indonesian GDP
2. Imports rise as Indonesian GDP rises
a. For imports, we assume:
IM = mY
where m is the marginal propensity to import.
b. Thus, net exports are given by:
NX = X - mY
Example:
if X = 300, m = 0.4 & Y = 400
Then NX = 300 0.4(400) = 300 160 = 140
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Foreign Trade: Ceteris Paribus
Ceteris Paribus
Changes in domestic GDP lead to changes in net exports:
a. as Y rises, NX falls
b. as Y falls, NX rises
The relationship between Y & NX is shown by the net export
function.
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Foreign Trade: Net Exports
The NX function is drawn holding
constant:
1. Foreign GDP
2. Domestic and foreign prices
3. The exchange rate
Y X IM=0.1xY NX
0 72 0 72
300 72 30 42
600 72 60 12
720 72 72 0
900 72 90 -18
72
48
24
0 300 600 900
96IM = 0.1Y
X = 72
72
48
24
0 300 600 900
-24
Import
s &
Export
sN
et Export
s
NX = 72 - 0.1Y
Y
Y
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Foreign Trade: Net Export
Shifts in the Net Export Function
1. An increase in foreign income leads to more foreign demand
for Indonesian goods:
increases X & shifts NX function upward
2. A rise in Indonesian prices (holding foreign prices constant):
decreases X IM function rotates up as Indonesian switch toward foreign
goods
NX function shifts down & gets steeper
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Foreign Trade: Illustration
Illustration of,
a rise in Indonesia prices relative to
foreign prices.
This could be caused by:
1. exchange rate2. price levels
Import
s &
Export
sN
et Export
s
IM
X
(X - IM)
X
IM
(X - IM)
Actual National Income
Actual National Income
XX
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Foreign Trade: Shifts in the Net Export Function
Summary
1. Foreign Income
An increase in foreign income results in an increase in Indonesian exports
NX function shifts up. (& the reverse)
2. Relative International Prices
A rise in Indonesian prices relative to foreign prices reduces Indonesian exports (X shifts down).
The IM function also rotates up since Indonesians now spend a higher fraction of income on foreign goods.
The NX (=X-IM) function shifts down & also gets steeper. (& the reverse)
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Foreign Trade: Shifts in the Net Export Function (Cont.)
3. Appreciation of the Indonesian Rupiah
A rise in the value of the Indonesian Rupiah reduces Indonesian exports (X shifts down).
The IM function also rotates up since Indonesians now spend a higher fraction of income on foreign goods.
The NX (=X-IM) function shifts down & also gets steeper. (& the reverse)
4. Other considerations:
a. Barriers to trade Tariffs, quotas, regulations.
Mad cow disease, lead paint on toys.
b. Taste trade promotion, buy Indonesian
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Reference
Ragan, Christopher T.S. & Lipsey, Richard G. (2010). Macroeconomics, Thirteenth Canadian
Edition. MyEconLab.
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online.uwin.ac.id
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