1 Use along with H/O 1 and formative worksheetsMacroeconomics (1) G12 Use along with H/O 1 and formative worksheets
2 AD/AS Model
3 Fill in the answer blanks or cross out the incorrect word/phrase in italicsa) The gap is deflationary (recessionary)/ inflationary gap (Choose one) and there will therefore be shortages (bottlenecks and unfilled job vacancies)/ large scale unemployment (Choose one) Is the level of unemployment at Ye higher OR lower than at Y* ? ____________________ c) One way to eliminate the gap is through a change in market conditions to let the economy automatically adjust (New Classical Economics) (i) to achieve this shift, prices of inputs, interest rates and wages should be allowed to rise/fall (ii) What might cause this required change in “prices”? (iii) show diagrammatically by drawing a new curve on the diagram (iv) Therefore, theoretically, in the LONG RUN, the economy will automatically return to …………… Group III
4 But …..Will the automatic adjustment happen?
5 New Classical View (from H/O Page 1)Theoretically, the determination of long-run equilibrium happens automatically and occurs at the full employment level of output (potential Y). While there may be short-term fluctuations in output, the economy will always return to the full employment level of output in the long run, through a change in factor prices (including wages and interest rates) (ie due to MARKETS). (There can be changes in the long-run equilibrium as potential output changes (LRAS shifts))
6 Reminder Equilibrium definition 1) If in equilibrium, ………………………….2) If in disequilibrium, will …………………….
7 Where is Ye? How is it determined?............. REVIEW group VI BUT ……….supposing market adjustment (new classical view) does not occur or suppose it takes too long……….. Need to know: Where is Ye? How is it determined? Will it equal Yp in the long run?..... If not, can govt. take precise measures to get it there? - KEYNESIAN THEORY of NATIONAL INCOME DETERMINATION
8 KEYNESIAN AD/AS MODEL Where is Ye? …………………………….Will it equal Yp in the long run? …………………… Handout 1+ exercises Make sure that you work through the exercises on Pages 4) and 5) in order to derive the formula. Carry out the review of understanding on Page 6) Work through the formative worksheets on pages 7)-12) Then you will have mastered the multiplier!
9 Extending the model to four sectors Suppose: out of every extra dollar of income, people pay 5 c in tax, and spend 90 c on goods, of which 10 c is imported goods. 1) How much do they save? 2) What is the mpc? mpw? Suppose: Exports of Honda cars drop by $100 3) What happens to the incomes of Honda’s workers and owners? 4) Then what happens? what is k? WS (1) Part 2 Q1Q6 Move to rest of Formative worksheet.
10 Assumptions: Government spends $100M in an economy. 20% of all additional income goes to taxes, 10% is saved and 10% is used to buy imports. The remaining income of 60% is spent on domestic goods and services marginal propensity to consume = …………………. Given this information, what is the total spending of the economy from the initial spending of $100M? next slide
11 Numerical example (continued)Initial spending by government M 2nd round of spending=60% of $100M = 60M 3rd round of spending=60% of $60M = M 4th round of spending=60% of 36M = M And so on…. 20th round of spending = M Total spending including the initial spending by government = M The final addition to national income, when all the income has been spent and re-spent amounts to…………. $250M = times the original government spending of $100M. NOTE : Any injection into the circular flow of this economy would contribute (2.5x its amount) to national income WHILE a fall in an injection (of, for example, 200 million) would……….
12 Flows of National Income
13 The Multiplier Effect
14 Formulas mpw = MPS + MPM + MPT (or MRT)MPC is the proportion of any increase in income used for domestic consumption. MPC= change in C/change in Y= ∆𝐶 ∆𝑌 mpw is the proportion of a change in income which does not return to the system in the form of consumption mpw = MPS + MPM + MPT (or MRT) MPS= change in savings/change in Y MPM=change in imports/change in Y MRT or MPT=change in taxes/change in Y mpw + mpc= ?
15 Δ Y = k . Δ J k= 1 1−𝑚𝑝𝑐 = 1 𝑚𝑝𝑤 Formulas (continued)(J = an injection) k= 1 1−𝑚𝑝𝑐 = 1 𝑚𝑝𝑤
16 More practice Calculate the multiplier for an economy where the mpc is 0.75 By how much will national income increase in total if there is an investment of $50,000. Answer: Multiplier is 4 = 1/0.25=4 National income increases by $200,000 (4x$50,000)
17 More practice Any change in any of the withdrawals from the circular flow will change the multiplier. If taxation rate increases, multiplier …………. If mpm falls, multiplier……………... If mps falls, what happens to the multiplier?
18 But……………………. Sunday, May 29, JAPAN TIMES Kan government struggles to raise reconstruction funds John Maynard Keynes , the British economist who advocated government intervention to regulate financial health, has lately been cited in the Japanese press in reference to the current administration's plan to raise the consumption tax . When he held the post of finance minister for five months right before becoming prime minister in June of last year, Naoto Kan famously remarked that he didn't understand Keynes, who believed in the multiplying effect of stimulus: If you inject spending into the economy, either through subsidies or tax cuts, people will spend that money and the economy will expand in many ways. Before the March 11 earthquake and tsunami, the consumption tax argument was centered on public welfare — more exactly, how to take care of Japan's rapidly aging society. Now the argument is doubly urgent, since funds are desperately needed for reconstruction. Kan has already proposed issuing new bonds and raising the consumption tax from 5 percent to 8 percent for three years. The bond proposal has received mixed reactions since it would increase Japanese debt, which is already the highest in the world, thus further undermining international confidence in Japan. But the main discussion in the media is about taxes. Would an increase do more harm than good? On the TV Asahi talk show "Morning Bird," several economists discussed the wisdom of a hypothetical ¥10 trillion tax cut. Based on the Keynesian model, such a reduction could be expected to grow the economy by ¥1.2 trillion, which would be great. However, a tax cut means the government takes in less money and the debt would also grow. Moreover, the Japanese public has been skittish about spending, especially when the general psychological mood tends toward uncertainty about the future, a situation exacerbated by the disaster. There's no guarantee that people wouldn't just take the tax cut and stash it away
19 END HERE Go to the powerpoint on Macroeconomic policies (2) and then to Monetary policy ppt(following slides are using statistics from the OECD)
20 In the real world which components of AD are most volatile? Do the predictions of the AS/AD model apply in the real world? THREE main variables……………………………………
21 Consumption
22 Investment
23 Exports
24 Do statisticians and economists measure POTENTIAL INCOME (GDP)?
25 Output Gap (Actual – Potential Output)
26 Are UNEMPLOYMENT and GDP growthNEGATIVELY CORRELATED?
27 GDP Growth When did the financial crisis happen?How and why could it affect our AD and/or AS?
28 Unemployment Rate
29 Was the recession (fall in GDP) of 2008 caused by AD shifting left or by AS shifting left?
30 Inflation Rate Headline inflation rate – unlike core inflation rate (underlying, long run inflation rate) includes the price changes of food and energy
31 Imports
32 Net Exports
33 Japan and US are both “Net Borrowers” or “Budget Deficit” They are issuing Gov Bonds (IOUs)The value of the government bonds are determined by the ability of the government to pay back the bonds…depends on GDP, tax schemes, G and T, actual and potential output levels, etc. Evaluated by the S&P, Wall Street, Investment Banks Analysts
34 Corporate Tax Rates
35 Consumption Tax Rates
36 Personal Income Tax (varies by level of income)