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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 Y Y Income C autonomous consumption MPC Marginal propensity to consume of additional dollars of consumption for every additional dollar of income typically 0 1 also delta C Delta Y MPS marginal propensity to save of additional dollars saved for each additional dollar of income typicalhy 0 1 delta S delta Y For every dollar ppl get they spend or svae so mpc mps m 1 S Y C Y c mpcY c 1 mpc Y or S c 1 mpc Y Or S c mpsY AE consumption investment Investment additions to stocks of non financial assets generally by businesses It is the purchases of optimism or pessimism that investors feel about the economy or animal spirits maybe slightly affected b y other things interest rates Not determined by income Equilibrium 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 up Savings 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 i Multiplier 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 a decline 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 savings goes down Keyes People will not invest when they feel they need to save so the gov has to do it for them More realistic model Adding government to the model Fiscal Policy Gov spending component of GDP that represents spending goods and services by federal 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 leave the economy alone AE C I now we have to add government AE C I G Multipliers are exactly the same Delta Y 1 1 MPC Delta I Delta Y 1 1 MPC Delta G Taxes Disposable income Yd Y T TR Same as Y Yd T TR Consumption as a function of disposable income C C bar mpc

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ADELPHI EC 151 - Classical Model

Course: Ec 151-
Pages: 2
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