C+I+G+net X C+IC

45o means Y=C+I+G+net X

equilibrium

a

=b= marginal propensity to consume

income

Expenditure

45o

C+I+G+net X

New C+I+G+net X

$10 billionMoreGovtExpenditure

Old equilibrium

New equilibrium

income

Expenditure

HOW MUCH DOESINCOME RISE?

45o

C+I+G+net X

New C+I+G+net X

$10 b.More Expend-iture

Means $10 b.More income

$10 b. More income Means $9 b. more Expend

Means $9 b.More income

Etc.Etc.

income

Expenditure

INCOME RISES BY$100 BILLION.

45o means Y=C+I+G+net X

C+I+G+net X C+IC

New C+I+G+net X

$10 billionMoreGovtExpenditure

Old equilibrium

New equilibrium

Shifts of the Consumption Function

• In the function C = a + bYD a change in either of the values of a or b will change the dimensions of the function.

Shifts of the Consumption Function

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)

Increased confidence

0

a2

a1

C = a2 + bYD

C = a1 + bYD

Shifts of the Consumption Function

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)0

a2

a1

C = a2 + bYD

C = a1 + bYD Increased confidence==>increased consumptionof $100 billion

Shifts of the Consumption Function

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)0

a2

a1

C = a2 + bYD

C = a1 + bYD

Increased consumptionof $100 billion==>Increased income of $100 billion

Shifts of the Consumption Function

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)0

a2

a1

C = a2 + bYD

C = a1 + bYD

ASSUME MPC=.8Increased incomeof $100 billion==>Increased consumption of $80 billion

Shifts of the Consumption Function

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)0

a2

a1

C = a2 + bYD

C = a1 + bYD

Increased consumptionof $80 billion==>Increased income of $80 billion

Shifts of the Consumption Function

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)0

a2

a1

C = a2 + bYD

C = a1 + bYD

ASSUME MPC=.8Increased incomeof $80 billion==>Increased consumption of $64 billion

Shifts of the Consumption Function

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)0

a2

a1

C = a2 + bYD

C = a1 + bYD

Increased incomeof $64 billion==>Increased income of $64 billion

ULTIMATELY IS 5 TIMESGREATER THAN INITIAL SHIFT

CONS

UMPT

ION

(C) (

dolla

rs p

er y

ear)

DISPOSABLE INCOME(dollars per year)0

a2

a1

C = a2 + bYD

C = a1 + bYD +51.2... +64

+80

100

500

THE MULTIPLIER

100 *___1___1-MPC

=100 *___1___1- 0.80

=500

Shifts vs. MovementsCO

NSUM

PTIO

N(b

illion

s of

dol

lars

per

yea

r)

DISPOSABLE INCOME (billions of dollars per year)0 Y2 Y1

a2

a1

Ch

Cg

Cf

ShiftMovementg

h

f

C = a2 + bYD

C = a1 + bYD

NO FOREIGN SECTOR, NO GOVERNMENTStructural Equations:Z=C+I+G IdentityYd= C + S Capital letters are endogenous

Y=Z EquilibriumC=co + c1 *Yd BehavioralI=Io ExogenousReduced Form Equations:Y = 1/(1-c1) * {co +Io}S= Y-C

GOVERNMENT BUT NO FOREIGN SECTOR

Structural Equations:Z=C+I+G IdentityYd= C + SY=Z EquilibriumC=co + c1 *Yd Behavioral =co + c1 *(Y-T)I=IoG=Go ExogenousT=ToReduced Form Equations:Y = 1/(1-c1) * {co - c1 *To +Io +Go}S= Y-T-C

Structural Equations:Z=C+I+G IdentityYd= C + SY=Z EquilibriumC=co + c1 *Yd Behavioral =co + c1 *(Y-To- t*Y)I=Io ParameterG=Go ExogenousT=To+ t*YReduced Form Equations:Y = 1/(1-c1 +t*c1) * {co +Io +Go-c1To}S= Y-T-C

GOVERNMENT w/ INCOME TAX BUT NO FOREIGN SECTOR

Structural Equations:Z=C+I+G+X-IM IdentityYd= C + SY=Z EquilibriumC=co + c1 *Yd Behavioral =co + c1 *(Y- t*Y)I=Io ParameterG=Go ExogenousT=To+t*Y, IM=q*YReduced Form Equations:Y = 1/(1-c1 +t*c1+q) * {co +Io +Go+To}S= Y-T-C

GOVERNMENT w/ INCOME TAX and FOREIGN SECTOR

MACROECONOMIC SCHOOLS OF THOUGHT

Classical Economics:1920s Keynes’ General Theory: 1930s

Keynesian Cross: 1940s

IS-LM & Phillips Curve:1950s

New Keynesian Economics: 1980s

Monetarism: 1960s

New Classical Economics:1970s

Post Keynesian Economics: 1950s-1990s

Lower Price Higher Price

LowerOutput

HigherOutput

Leftward (downward)

Shift of Demand

Rightward(upward)

Shift of Demand

Rightward(downward)

Shift ofSupply

Leftward(upward)Shift of Supply

Breakdown all shifts into their output and price vectors

Lower Price (deflation) Higher Price (inflation)Lower

Output (slow

Growth)

HigherOutput

(fastGrowth)

RECESSION/DEPRESSIONLeftward

(downward) Shift of Aggregate

Demand: less injections,

or more leakages

HIGH GROWTH-HIGH INFLATIONRightward (upward) Shift of Demand: mor injections, or less leakages

HIGH GROWTH-LOW INFLATIONRightward(downward)Shift ofSupply : More factors or lower factor prices

STAGFLATIONLeftward(upward)Shift of Aggregate Supply: Less factors or higher factor prices

Breakdown all shifts into their output and price vectors

Lower Price Higher Price

LowerOutput

HigherOutput

Leftward (downward)

Shift of Demand

Rightward(upward)

Shift of Demand

Rightward(downward)

Shift ofSupply

Leftward(upward)Shift of Supply

Breakdown all shifts into their output and price vectors

More incomeMore tastes for goodMore buyersMore complementHigher priuce for substitutesBuyer expectations about future shortages

less incomeless tastes for goodless buyersless complementlower priuce for substitutesBuyer expectations about future shortages

Less productivity (technological change)Higher price of resourcesSeller expectations of future surplusesLess number of sellers

More productivity (technological change)Lower price of resourcesSeller expectations of future shortagesMore number of sellers