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大学生考试网 让学习变简单

大学生考试网 让学习变简单

Chapter 3: The Product Market Analysis

Gang Gong March 4, 2002

Copyright Notes:This electronic file is only used as a lecture notes for the student in this class. It is not allowed to be used for presentation anywhere else without the permission from the author.

Introduction

? The aim of this chapter is to study how output is determined in Keynesian framework. The analysis in this chapter is often named multiplier analysis.

Introduction

? The key assumption of multiplier analysis is on “the demand determined,” this is “output is purely determined by demand.” There is no restriction in the supply side of the economy. The capacity to supply the output as demanded is always available. The firms are able and willing to supply any level of output as demanded (at given price?).

Introduction

? In macroeconomics, aggregate demand (AD) can be defined as the sum of consumption (C), gross investment (I), government expenditure (G) and net export (E-M).

AD = C+I+G+E-M This is indeed the GDP minus inventory change (V)

Introduction

? It is more difficult to define the aggregate supply. Generally one simply believes that aggregate supply is a function of economic resources (labor, capital stock, technology among others).

Output in a Private-Closed Economy

? In this case, the aggregate demand is equal to consumption plus investment: AD = C + I

Output in a Private-Closed Economy

? In the followed analysis, we simply assume that V is equal to 0, indicating all output is demanded, so that we should allow GDP = C + I

Output in a Private-Closed Economy

? According to income approach, GDP is also reflected as income (Y) so that we have Y=C+I

Output in a Private-Closed Economy

? Consumption Determination: Consumption can be divided into two parts. One is income-related consumption and the other is non-income related consumption (often called autonomous consumption). Therefore the consumption function can be written as C = A + c· Y

Output in a Private-Closed Economy

? Consumption Determination: C = A + c· Y where A can be regarded as autonomous consumption and c· Y as the income-related consumption. Note that 1 > c > 0. This indicates that when income increases, the consumption will also increase, but with less amount (see figure presented in class)

Output in a Private-Closed Economy

? Saving Determination: Saving (S) is the income that is not used for consumption. Therefore S=Y-C = Y - (A + cY) = -A + (1-c)Y (see the figure presented in class)

Output in a Private-Closed Economy

? Some Definitions:

– An autonomous demand is the demand that is not related to income. – Average propensity to consumption (APC)

APC = C/Y

– Average propensity to save (APS)

APS = S/Y

Output in a Private-Closed Economy

? Some Definitions:

– Marginal propensity to consumption (MPC)

MPC = ?C/?Y

– Marginal propensity to saving (MPS)

MPS = ?S/?Y

Output in a Private-Closed Economy

? Nonlinear and Linear Consumption Function: If the consumption function is linear as presented before, then APC = MPC = c APS = MPS = 1-c.

Output in a Private-Closed Economy

? Nonlinear and Linear Consumption Function : Perhaps, a more reasonable consumption function is nonlinear (see the figure presented in class). In this case, MPC is declining. This is indeed suggested by Keynes in his General Theory. How about APC and APS in this nonlinear case?

Output in a Private-Closed Economy

? Given the consumption function as presented, the determination of output (Y) is simply given by

1 Y? (A? I) 1? c

(see the figure in class for the graphic presentation of this determination)

Output in a Private-Closed Economy

? Investment-Saving (IS) Relation: Note that the above analysis indicates that investment equals saving. Therefore the previous equation is sometime also called IS curve. It represents the equilibrium condition in product market, given the autonomous demand A and I.

Why multiplier?

? Consider now a change in investment denoted as ?I. It will cause the output increased by ? I/(1-c):

1 ?Y ? ?I 1? c

Therefore, a change in investment will cause the change in output by a multiplier 1/(1-c).

Why Multiplier?

? How can this Multiplier Occur? Initial Change in Investment = ?I

First Change in Consumption = MPC × ?I

Second Change in Consumption = MPC × ?I

2

: ?Y = (1+ MPC+ MPC + MPC +...) × ?I

2 3

Why Multiplier?

? Assume MPC = c. We thus have

1 ?Y ? ?I 1? c

Why Multiplier?

? Definition: The multiplier process is the income and output generation process starting with the injection of an autonomous demand such as ?I with the total generated output or income ?Y to be satisfied with

1 ?Y ? ?I 1? c

Output in a Closed Economy

? In this case, the aggregate demand is equal to consumption plus investment and government expenditure: AD = C + I + G

Output in a Closed Economy

? On the other hand, the income that the household can use for consumption, denoted as disposable income (Yd), can be written as

Yd ? Y ? T

where T is the tax.

Output in a Closed Economy

? The consumption function should become

C ? A ? c ? Yd

? Finally, assume that the tax is a proportion of income T=t· Y where t is the tax rate.

Output in a Closed Economy

? We thus have the model that includes

AD = C + I + G Y = AD

Yd ? Y ? T

C ? A ? c ? Yd

T=t· Y

Output in a Closed Economy

? The solution of output Y is thus given by

1 Y? ( A ? I ? G) 1 ? c(1 ? t )

(see the figure presented in class for the graphic analysis) ? Is the multiplier process still applied here? If it is, then what is the value of multiplier?

Output in an Open Economy

? In this case the model should include

AD = C + I + G + E-M Y = AD

Yd ? Y ? T

C ? A ? c ? Yd

T=t· Y

Output in an Open Economy

? The solution of output Y is thus given by

1 Y? (A? I ? G ? E ? M ) 1 ? c(1 ? t )

(see the figure presented in class for the graphic analysis)