Classical Model when businesses make too much and cant sell:● In equilibrium Y=AE● In case of insufficient AE○ Leakages >injections○ S>i (intended)● Consumption= What households spend○ C=c+mpc YY=Income C=autonomous consumptionMPC= Marginal propensity to consume= # of additional dollars of consumption for everyadditional dollar of income typically 0-1 also delta C/Delta Y● MPS= marginal propensity to save - # of additional dollars saved for each additionaldollar of income typicalhy 0-1 delta S/delta Y● For every dollar ppl get they spend or svae so mpc + mps m=1S=Y-C =Y -(c+mpcY)=-c+(1-mpc)Y or S=-c +1-mpc)YOr S=-c=mpsYAE= consumption+investmentInvestment= additions to stocks of non-financial assets, generally by businesses. It is thepurchases of optimism or pessimism that investors feel about the economy or animal spiritsmaybe slightly affected b y other things (interest rates)● Not determined by incomeEquilibrium- output = income● AE=Y● I=S● This may be equilibrium but it may not be what is best for economy, unemployment etc● Might haver to jump investment upSavings are a leakage (households do not spend income)Investment is an injection (firms borrow from households and spend)When there is not enough aggregate demand leakages> injections S>iMultiplier- change in income is larger than the change in investment spending that caused it● Total Delta Y/ Delta I● Multiplier = 1/(1-mpc)Paradox of thrift- the phenomenon that an increase in intended savings can lead through adecline in equilibrium outcome to total lower savings● S goes up and AE goes down. Unintended increases in inventories● Business responds by cutting back on production so income goes down and savingsgoes downKeyes: People will not invest when they feel they need to save so the gov has to do it for themMore realistic model: Adding government to the model● Fiscal Policy● Gov spending- component of GDP that represents spending goods and services byfederal, state or local governments.● Determine outside of the models by politics● Sometimes we use fiscal policy to “fix” economy, other times its argued we need to leavethe economy aloneAE=C+I now we have to add government - AE= C+ I + GMultipliers are exactly the same.Delta Y= (1/(1-MPC) Delta IDelta Y= (1/(1-MPC) Delta GTaxesDisposable income Yd= Y-T+TRSame as Y=Yd+T-TRConsumption as a function of disposable incomeC =C (bar) +