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OU ECON 1113 - Keynesian Cross Model

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ECON 1113 1st Edition Lecture 11Outline of Last Lecture I. The Keynesian Consumption FunctionA. NumericallyB. GraphicallyC. MathematicallyD. Shifts in the Consumption FunctionE. Case StudyII. Stock Market Crash of 1987Outline of Current Lecture I. Review of Previous LecturesII. Keynesian Cross ModelCurrent LectureI. Review of Previous LecturesA. Inflation: increase in the cost of money and effectsB. Planned TE reflects the entire economy1. Determinants of Planned TE are summarized in the equation: consumer spending + investment spending + government spending + (export spending – import spending) or Planned TE = C + I + G + (X – M)C. Consumption Function (C-Ftn) Model1. The x-axis represents disposable spending (Yd) and the y-axis represents consumer spending (C)2. A reference line forms a 45 degree angle from the origin of the graph3. The C-Ftn does not slope as quickly as reference line and does not begin at the originII. Keynesian Cross ModelA. Planned Total Expenditure (PTE) Diagram1. The y-axis is defined by PTE = C + I + G + (X – M); however, I, G, X, and M remain constant for the purpose of this graph, while C may change2. Keynesian Aggregate Supply: denoted by the ASK line, which begins at the origin and continues at a 45 degree angle upwarda. A form of the supply curve in this diagramb. Represents the amount of goods and services suppliers are willing to produceThese 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.3. Planned Total Expenditure: denoted by the PTE and its equation line, which begins above the origin on the y-axis and does not retain as steep of a slopea. A form of the demand curve in the diagramb. Represents the amount of goods and services buyers are willing toconsume4. Inventory Adjustment Mechanism: the movement of a disequilibrium in the market balancing itself and reaching the equilibrium level of nominal GDP in this instance0 2 4 6 8 10 12 14 160246810121416Planned Total Expenditure (PTE) GraphAS k PTE = C + I + G + (X - M)Y (meaning nominal GDP) ( in dollars)PTE = C + I + G + (X - M) (in dollars)5. If the nominal GDP is below equilibrium, a shortage will occur6. If the nominal GDP is above equilibrium, a surplus will occurB. Y*: national target income for nominal GDP1. Non-inflationary, full employment level of GDP2. Two possibilitiesa. Fiscal Policy: fixes macro economic problems through government expenditure (G) policy and taxation (T) policyb. Ye (equilibrium nominal GDP) < Y*i. Unemployment results, so the policy recommendation is to increase the PTEii. To increase the PTE, increase the determinants as components of PTEiii. As G increases, PTE increasesiv. As T decreases, disposable income (Yd) increases, thus consumer spending increasesc. Ye > Y*i. Inflation results, so the policy recommendation is to decrease the PTEii. To decrease the PTE, decrease the determinants as components of PTEiii. As G decreases, PTE decreasesiv. As T increases, Yd decreases, thus consumer spending decreasesC. Further Explanation1. An increase in the PTE line displays as increase in incomes, which acts with a ripple effect2. The Multiplier Concept (a ratio)a. Government Multiplier (mG) = the change in nominal GDP divided by the change in government spending, or the subsequent equation in which MPC is the marginal propensity to consumeb. ∆ Y∆ G=11− MPCc. Examplei. MPC = 0.8ii. 1/(1-0.8) = 5iii. This means that when G increases by $1, PTE, or the nominal GDP, increases by $5iv.∆ Y∆ G=5,thus when ∆ Y = $ 100 billion , ∆ G= $ 20 billion, or 1/5 of the PTEd. Taxation Multiplier (mT) = the change in nominal GDP divided by the change in taxation, or the subsequent equation in which MPC is the marginal propensity to consumee. ∆ Y∆ T=−MPC1− MPCf. Examplei. MPC = 0.8ii. -0.8/(1-0.8) = -4iii. This means that when T decreases by $1, PTE, or the nominal GDP, decreases by $4iv.∆ Y∆ T=5,thus when ∆ Y = $ 100 billion , ∆ T =−$ 25 billion, or 1/4 of the


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