EC202 1nd Edition Lecture 25Outline of Last Lecture I. Finish lesson 6Outline of Current Lecture II. Modeling fluctuationsIII. Planned aggregate expenditureIV. Unplanned investmentV. Consumption Current Lecture-John Maynard Keynes-most influential economist of the 20th century-published The General Theory of Employment, Interest, and Money in 1936-Keynes’ main ideas -a decline in aggregate spending may cause output to fall below potential output for long periods of time-stabilization policy could be used to reduce or eliminate the output gap-government spending increases and tax reduction could increase planned expenditures to restore full employment-modeling fluctuations-goal is to develop a model of how recessions and expansions may arise from fluctuations in planned spending -the basic Keynesian model will be the focus-spending is determined by income-short-run model: prices presetThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.-output, not prices, respond to spending changes in the short-run -planned expenditures are induced-total planned expenditures change with GDP-in the short run firms meet the demand for their products at preset prices-do not respond by changing their prices-set a price for some period and satisfy the quantity demanded at that price-produce just enough to meet their customers’ orders-prices preset in the short-run-in the short-run stores post prices and sell product at those prices-changing prices is costly so it is infrequent-menu costs: the costs of changing prices-printing a new menu-remarking merchandise-in the short-run changing prices may not significantly influence quantity demanded-other factors may be more important-expectations of future purchasing power-prior spending imbalances-planned aggregate expenditure-Planned Aggregate Expenditure (PAE)-total planned spending on final goods and services-planned C, G, and NX are assumed equal to actual C, G, and NX-four components of PAE -consumer expenditure (C)-planned Investment (Ip)-government purchases (G)-net exports (NX)-aggregate planned expenditure -planned may differ from actual for firms-when a firm sells either less or more of its product than expectedI = Ip + IuI is actual investment, Iu is unexpected or unplanned investmentIu is the unplanned change in business inventories-for households, governments, and foreign purchasers we can reasonably assumethat actual equals planned-unplanned investment-suppose a firm’s actual sales are less then expected-warehouses fill up-actual investment is greater than planned investment-the extra inventory becomes part of actual investmentI > Ip since Iu is positive Ip is planned investmentI is actual investment, Iu is unplanned investment-if a firm sells more than expectedI < Ip since Iu is negative-the firm planned on increasing inventories more than it actually did, or the decline in inventories is larger than planned-planned aggregate expenditure equals the economy’s total planned spendingPAE = C + Ip + G + NX where PAE is planned expenditure and Ip is planned investment-consumption (C)-C is nearly 2/3 of PAE-many determinants of consumption spending-examples: prices, incomes, tastes, etc.-disposable income-after-tax income is particularly important-income (Y) minus net taxes (T)-consumption is induced-as income rises, consumption (C)
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