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Macroeconomics by yurtgc548

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									  Macroeconomics

        Lecture 3
The Keynesian Cross Model
      Outline of this lecture

• The national accounting identity.
• Planned and unplanned expenditure.
• Demand-side equilibrium in the
  Keynesian Cross model.
• The Keynesian Multiplier.
• How to pay for the War?
                               DAD-SAS
                                (R,,Y)

               Labour market
                   (AS)
Goods market
                                AD-AS
 Keynesian
                                (R,P,Y)
 Cross (IS)
                  IS-LM
                  (R, Y)
                    AD
 Financial
markets (LM)
                  Foreign
                                   AD*
                 exchange
                               (R*,Y,e, CA)
                  markets
  The national accounting identity

     Y  C  I G X Z
Total income
                     Total expenditure

What guarantees this?
Investments may include an undesired component.

                   I I
                     P       U

           Planned               Unplanned
                   Example
Suppose there is a boycott of exports.

Before: Y  AE0  Y  AE0  0
After: gap  Y  AE1  X
For unchanged spending plans and taxes,
the gap is filled by firms being forced to invest
in the form of unplanned inventory build-up

           Y  AE1  I U
     Demand-side equilibrium
An equilibrium is a situation in which no agent
would want to change behavior and the behavior
of all agents is consistent.
The economy is at equilibrium when there are
no unplanned expenditures (investments), that is
when

 Planned expenditure

 =
 Actual expenditure    =   Income (output)
                               Only holds in equilibrium!



Actual                    Income Y =     Planned expenditure
expenditure              = Output
C                                        C
Consumption                               Consumption
+ Ip                                      + Ip
Planned investment                        Planned investment
+ IU
Unplanned investment

+G                                        +G
Government expenditure                    Government expenditure
+ X-Z                                     + X-Z
net exports                               net exports
             Income determination
          Assume that all prices (P, R, e) are fixed
          (and that P=e=P*=1).
(1) Y  C  I  G  X  Z
(2) C  c0  c1 (1  t )Y  T 
(3) I P  i0  i1 R                 Planned demand
(4) Z  z0  z1Y                   Behavioral relations
(5) X   0  1Y f

(6) G  G, T  T , 0  t  1       Government behavior
Planned aggregate expenditure
  AE  C  I P  G  X  Z

        c0  c1 (1  t )Y  T   i0  i1R   G
         0  1Y f   z0  z1Y 


        c1 (1  t )  z1 Y  A

  A  G  i0  i1R  0  0Yf  z0  c0  c1T 
                                   AE  c1 (1  t )  z1 Y  A
Planned expenditure, AE




                                                                      AE
                              (1-t)      c1(1-t)
                          1
                                  z1            C                          Flat if
                                                                           • z1 large
                                                                           • c1 small
                                                   c1 (1  t )  z1        • t large
                              B
                                                                       slope less than 1
                                       £1
           A
                                                                                income
                                                                                output, Y
AE         Equilibrium: Y*=AE(Y*)

                                  Actual Expenditure=Y
AEa
        Expenditure
       exceeds output                            AE
AE 0
AE1                                           I 0
                                                u

AE 2
AE *                Output exceeds
                     expenditure
 A

               *                                         income
           Y            Y2   Y1       Y0                 output, Y
   Equilibrating mechanism
Actual demand > planned demand
       Unplanned inventory build up
       Firms want to change their production
       plans to avoid this

       Reduction in output and income (actual demand)

       Reduction in planned demand, but

       Gap between planned and actual reduced.
                   Equilibrium
    Y  AE c1 (1  t )  z1 Y  A
                        1
          Y   *
                                      A
              1  c1 (1  t )  z1 

                       The Keynesian
Autonomous               multiplier
expenditures
    The Keynesian Multiplier
     The effect on an endogenous variable of
   a one unit change in an exogenous variable
              CETERIS PARIBUS

   The change in equilibrium income (Y*) when
   autonomous expenditure (A) increases by £1
            (keeping all prices fixed)

Why is this important?
         • Determines the impact of economic policy
         • Determines the impact of shocks
                                         Import leakage
Initial impact

                                              z1
   Planned
 expenditure
                                   Y

          Large multiplier                       Tax
          if leakages are small          t     leakage


   C                              Yd
                         c1
                 Savings leakage
z1=0

    A             Yd                  C                      Y
1   1                                                             1

2                1 t               c1 (1  t )            c1 (1  t )

3          c1 (1  t )       2
                                   c1 (1  t ) 2
                                    2
                                                           c (1  t )
                                                              2
                                                              1
                                                                           2



4          c1 (1  t ) 3
            2
                                    c1 (1  t ) 3 c1 (1  t ) 3
                                     3             3


       

     Y
    i 1
            i    1  c1 (1  t )  c1 (1  t ) 2  c1 (1  t ) 3  ....
                                     2               3



                   1
                            1           for   c1 (1  t )  1
             1  c1 (1  t )
AE                        Actual expenditure=Y


                                    AE1

                          A        AE0

                                   A
                          1  c1 (1  t )  z1 
                                                  Y
A1
     A
                Y
A0


          Y0   Y2                            income
                     Y1                      output, Y
           How large is it?
                       1
        MP 
             1  c1 (1  t )  z1 

“Back of the envelope”      Empirical estimates

z1=0.22
t=0.3      MP=2.7               MP=1.5-3
c1=0.8-0.9
          How to Pay for the War?
                             (Keynes, 1940)

Question: How can Great Britain meet the economic efforts required by
          the Second World War without generating inflation?

   Y1938  £5520
                                 Y  £825
    Y  £6345
  How much can government spending be raised?     G  £825????
                G               z1  0       c1    C
                                                            4380
                                                                     0.79
 Y                                                 Y       5520

       1  c1 (1  t )  z1    tT 
                                   Y
                                          770
                                          5520    0.14
                G
825                                      G  £265
      1  0.79 (1  0.14 ) 
              What is next?

• Fiscal policy in the Keynesian model
  – The balanced budget
  – Automatic stabilisers


• Comparison between Classical and Keynesian
  model

• The IS curve
                                          Leakages

              Y                    Y T                Y T  S  C         CZ
                    Taxes                                 imports
                                      Savings

                  Government




                                                          Rest of the
Income                         T               S                        X
                    sector




                                                            world
Expenditure                    G               I                        Z



              Government
                                     Investments         Exports
              expenditure
              C  I G X  Z      CI  X Z          C X Z              CZ
                                          Injections

								
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