- Office hours: Wednesday 9:30-11:40 & 2:30-4 in 7416 Social ScienceThursday 5-6:30 in 6203 Social Science- Keynesian Crosso Consider 2 scenariosY = AEAEAEYYeBoomIf you produce Yfe inventory ↓ & Y↑AEY = AEAEYfeYeYLow unemploymentIf you produce Yfe inventory ↑ & Y↓RecessionAEY = AEAEYeYfeYHigh unemploymento Can be in equilibrium but be producing the “wrong” level of output for unemployment (but the economy will always move toward equilibrium)- Keynesian insighto *If the economy’s Ye does not equal Yfe it is possible to engage in activist policy to get the economy to Yfe- Illustration of activist policy and multipliero ΔY = multiplier*(Δ government spending)o OR ΔY = tax multiplier*(Δ taxes)o ΔG or ΔT fiscal policy If Ye < Yfe recession- Not enough spending- Need to increase spending- ↑G and/or ↓T If Ye > Yfe boom- Too much spending- Need to lower spending- ↓G and/or ↑To Simple multiplier = 1/(1-b) Used when Δa, ΔG, ΔI, or Δ(X-M)o Tax multiplier = (-b)/(1-b) Used when ΔTo E.g. Suppose MPC = 0.8 and that the government spends $100 at business A The owner of business A receives $100 and spends 80%, $80 at business B The owner of business B receives $80 and spends 80%, $64 at business C The owner of business C receives $64 and spends 80%, etc. multiplier effect: when the economy is injected with $ the people who receive it will continue to spend portions of it o Numeric e.g. Given: C = 10 + 0.8(Y – (T – TR)), T – TR = 20, G = 20, I = 10, (X – M) = 10, Ye = 170,Yfe = 200AEAE’Y = AEAEΔGYeYfeYΔYAEY = AEAE170200YYfeYe ΔY = Yfe – Ye = 200 – 170- ΔY = 30- ΔY = (multiplier)*(ΔG)- 30 = (1/(1-b))*(ΔG)- 30 = (1/(1-0.8))*(ΔG)- ΔG = 6 OR ΔY = (tax multiplier)*(ΔT)- 30 = (-b/(1-b))*(ΔT)- 30 = (-0.8/(1-0.8))*( ΔT)- ΔT = -7.5- Lower (T – TR) by7.5 to 12.5 In equilibrium, Y’ = AE- Y’ = C + I + G + (X – M)- Y’ = 10 + 0.8(Y’ – 12.5) + 10 + 20 + 10- Y’ = 50 + 0.8Y’ – 10- 0.2Y’ = 40- Y’ = Ye’ = 200 = Yfe’ You can either increase G by 6 or decrease taxes by 7.5 changing G is cheaperbecause the multiplier is largero Balanced Budget Amendment When increasing G, T must also be increased so that ΔG = ΔT to finance the spending by the government This sounds good in principle but most economists are against it It is a very expensive way to stimulate the economy:- ΔY = (multiplier)*(ΔG) + (tax multiplier)*(ΔT)- ΔY = (1/(1-b))*(ΔG) + (-b/(1-b))*(ΔT)- ΔY = (1/(1-b))*(ΔG) + (-b/(1-b))*(ΔG)- ΔY = [(1/(1-b)) + (-b/(1-b))]*( ΔG)- ΔY = [(1-b)/(1-b)]*( ΔG)- ΔY = ΔG- ΔG must = 30 to stimulate the economy enough very expensive!- Points of the Keynesian modelo Can alter the level of output and therefore the level of employment through fiscal policyo There are expensive and less expensive ways to do fiscal policyo (Although we have not proved it in lecture) in equilibrium leakages = injectionso We have created a simple model that can help us understand SR business cycle fluctuations- Fiscal crisis of 2008o Real estate market bubble burst Houses worth less less spending because people felt poorer Financial market uncertainty less spending More unemployment less spending Less confidence less spending & more savingo Paradox of thrift: lack of adequate spending makes a recession worse (even though it is smart on the individual
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