MACROECONOMIE PART 2
Week 3 college 3 + week 4 college 3
HOOFDSTUK 11 – Macroeconomic equilibrium in the short run
How can we explain cyclical deviations (business cycles) around long term trend?
What can we do to try and reduce them?
General macroeconomic equilibrium on the goods and money market
Goods market: income influences demand for money à money market
Ø Equilibrium on goods market: IS curve
Money market: Interest rates affect aggregate demand à goods market
Ø Equilibrium on the money market: TR curve
Keynesian assumptions
CLASSICS (LONG RUN)
- Assumption of flexible prices (money neutrality principle)
- Aggregate supply (K,L,A) determines income
à Prices adjust à aggregate demand = supply
KEYNES (SHORT RUN) _
- Assumption of sticky prices p = p
- Aggregate demand determines output of firms
à Prices cannot adjust à aggregate demand is not equal to supply
à supply adjusts to demand
In reality, prices do not change often the short run (once a year)
Aggregate demand
Y = C + I + G + NX (we only at the closed economy this chapter)
<--------------
Aggregate supply: total volume of goods and services brought to the market
by producers (Y)
Aggregate demand: sum of consumption, investment, government purchases
(plus net exports) of goods and services (C + I +G)
Prices sticky in short run so supply adapts to demand
Determinants of demand
- G (government spending): is assumed for now (with tax receipts T) as
_ _
exogenous with value G (and T)
- I (investment): was shown to depend positively on the Tobin’s q and
negatively on the real interest rate i.
Ø Investment function: I = I(q,i) (+,-)
- C (consumption): depends positively on wealth Ω and positively on
_
disposable income Yd = (Y – T) _
Ø Consumption function: C = C(Ω, Y – T) (+,+)
,For now: let’s simplify and assume that consumption depends only on disposable
income: C = c0 + c1 (Y – T)
> c1 = marginal propensity to consume: the effect of an additional euro
of disposable income on consumption (fraction of income)
> c0 = the intercept of the consumption function (autonomous consumption)
(consumption if you don’t have an income)
Equilibrium output
- Equilibrium in the goods market: supply = demand
- Supply in equilibrium is simply aggregate production Y
- Demand depends on income, which itself is equal to production
Equilibrium requires that demand is equal to the production (= income) that
generates this demand.
Y = c0 + c1 (Y – T) + I + G
Desired demand
_ _
DD = C(Ω, Y – T) + I(q,i) + G
(+, +) (+, -)
DD = desired demand or planned expenditure
- Amount economic agents would like to spend given their income Y
Ø Only consumption depends on Y
- Desired = depends on certain endogenous variables in the model
Y = actual income or actual output
- Actual production and supply of goods
DD can be different from Y!
Equilibrium: Y = DD
> Actual income = planned expenditure
,The Keynesian cross
Equilibrium of demand and supply
Supply should equal output/income
> Supply adjusts to demand (short run: prices are fixed)
à Keynesian Cross: Y = DD
A: equilibrium
Supply > Demand Supply < demand
What happens if Y and DD are different?
Y > DD
- Firms did not sell as much as they expected at the given price level.
- At the end of the year, they have to buy the rest of their products
à Unplanned increase of investment in inventory
- Actual I > planned I (actual expenditure > planned expenditure)
Y < DD
- Households buy more than was expected by the firms
à Unplanned drop of inventory
Actual I < planned I
, If planned expenditure (DD) is not equal to Y: unplanned I will adjust so that
aggregate demand always equals aggregate supply
Ø Following year: firms will adapt their production: Y adapts to DD
Summary
1. What is the formal equation describing DD line?
DD = C + I + G = c0 + c1 (Y – T) + I + G
2. Why is DD flatter than 1?
c1 is the slope: c1 < 1, because of consumption
smoothing
3. To what corresponds the intercept of the DD line?
c0 + I + G
4. Why is the slope of supply equal to 1?
Output = supply = income
Week 3 college 3 + week 4 college 3
HOOFDSTUK 11 – Macroeconomic equilibrium in the short run
How can we explain cyclical deviations (business cycles) around long term trend?
What can we do to try and reduce them?
General macroeconomic equilibrium on the goods and money market
Goods market: income influences demand for money à money market
Ø Equilibrium on goods market: IS curve
Money market: Interest rates affect aggregate demand à goods market
Ø Equilibrium on the money market: TR curve
Keynesian assumptions
CLASSICS (LONG RUN)
- Assumption of flexible prices (money neutrality principle)
- Aggregate supply (K,L,A) determines income
à Prices adjust à aggregate demand = supply
KEYNES (SHORT RUN) _
- Assumption of sticky prices p = p
- Aggregate demand determines output of firms
à Prices cannot adjust à aggregate demand is not equal to supply
à supply adjusts to demand
In reality, prices do not change often the short run (once a year)
Aggregate demand
Y = C + I + G + NX (we only at the closed economy this chapter)
<--------------
Aggregate supply: total volume of goods and services brought to the market
by producers (Y)
Aggregate demand: sum of consumption, investment, government purchases
(plus net exports) of goods and services (C + I +G)
Prices sticky in short run so supply adapts to demand
Determinants of demand
- G (government spending): is assumed for now (with tax receipts T) as
_ _
exogenous with value G (and T)
- I (investment): was shown to depend positively on the Tobin’s q and
negatively on the real interest rate i.
Ø Investment function: I = I(q,i) (+,-)
- C (consumption): depends positively on wealth Ω and positively on
_
disposable income Yd = (Y – T) _
Ø Consumption function: C = C(Ω, Y – T) (+,+)
,For now: let’s simplify and assume that consumption depends only on disposable
income: C = c0 + c1 (Y – T)
> c1 = marginal propensity to consume: the effect of an additional euro
of disposable income on consumption (fraction of income)
> c0 = the intercept of the consumption function (autonomous consumption)
(consumption if you don’t have an income)
Equilibrium output
- Equilibrium in the goods market: supply = demand
- Supply in equilibrium is simply aggregate production Y
- Demand depends on income, which itself is equal to production
Equilibrium requires that demand is equal to the production (= income) that
generates this demand.
Y = c0 + c1 (Y – T) + I + G
Desired demand
_ _
DD = C(Ω, Y – T) + I(q,i) + G
(+, +) (+, -)
DD = desired demand or planned expenditure
- Amount economic agents would like to spend given their income Y
Ø Only consumption depends on Y
- Desired = depends on certain endogenous variables in the model
Y = actual income or actual output
- Actual production and supply of goods
DD can be different from Y!
Equilibrium: Y = DD
> Actual income = planned expenditure
,The Keynesian cross
Equilibrium of demand and supply
Supply should equal output/income
> Supply adjusts to demand (short run: prices are fixed)
à Keynesian Cross: Y = DD
A: equilibrium
Supply > Demand Supply < demand
What happens if Y and DD are different?
Y > DD
- Firms did not sell as much as they expected at the given price level.
- At the end of the year, they have to buy the rest of their products
à Unplanned increase of investment in inventory
- Actual I > planned I (actual expenditure > planned expenditure)
Y < DD
- Households buy more than was expected by the firms
à Unplanned drop of inventory
Actual I < planned I
, If planned expenditure (DD) is not equal to Y: unplanned I will adjust so that
aggregate demand always equals aggregate supply
Ø Following year: firms will adapt their production: Y adapts to DD
Summary
1. What is the formal equation describing DD line?
DD = C + I + G = c0 + c1 (Y – T) + I + G
2. Why is DD flatter than 1?
c1 is the slope: c1 < 1, because of consumption
smoothing
3. To what corresponds the intercept of the DD line?
c0 + I + G
4. Why is the slope of supply equal to 1?
Output = supply = income
