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    Spending and Output in The Short Run: Part 2: MB MC

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    This document discusses short-run equilibrium output and the role of fiscal policy. It introduces the Keynesian cross model which shows that equilibrium output is determined by the intersection of planned aggregate expenditure and real GDP. A decline in autonomous spending can cause a recession by shifting the expenditure line down, while an increase in government purchases can boost aggregate demand and spending to eliminate a recessionary gap. The income-expenditure multiplier measures how a change in autonomous spending affects equilibrium output. Fiscal policy tools like government spending, taxation, and transfers can be used as countercyclical stabilization policies.

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    Spending and Output in The Short Run: Part 2: MB MC

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    scribd225
    58 views23 pages
    This document discusses short-run equilibrium output and the role of fiscal policy. It introduces the Keynesian cross model which shows that equilibrium output is determined by the intersection of planned aggregate expenditure and real GDP. A decline in autonomous spending can cause a recession by shifting the expenditure line down, while an increase in government purchases can boost aggregate demand and spending to eliminate a recessionary gap. The income-expenditure multiplier measures how a change in autonomous spending affects equilibrium output. Fiscal policy tools like government spending, taxation, and transfers can be used as countercyclical stabilization policies.

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    MBA Lecture 5

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    This document discusses short-run equilibrium output and the role of fiscal policy. It introduces the Keynesian cross model which shows that equilibrium output is determined by the intersection of planned aggregate expenditure and real GDP. A decline in autonomous spending can cause a recession by shifting the expenditure line down, while an increase in government purchases can boost aggregate demand and spending to eliminate a recessionary gap. The income-expenditure multiplier measures how a change in autonomous spending affects equilibrium output. Fiscal policy tools like government spending, taxation, and transfers can be used as countercyclical stabilization policies.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    58 views23 pages

    Spending and Output in The Short Run: Part 2: MB MC

    Uploaded by

    scribd225
    This document discusses short-run equilibrium output and the role of fiscal policy. It introduces the Keynesian cross model which shows that equilibrium output is determined by the intersection of planned aggregate expenditure and real GDP. A decline in autonomous spending can cause a recession by shifting the expenditure line down, while an increase in government purchases can boost aggregate demand and spending to eliminate a recessionary gap. The income-expenditure multiplier measures how a change in autonomous spending affects equilibrium output. Fiscal policy tools like government spending, taxation, and transfers can be used as countercyclical stabilization policies.

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    You are on page 1of 23

    Spending and

    Output in the
    Short Run: Part 2

    MB MC

    Lecture 4
    MB MC

    Contents

     1. Short-Run Equilibrium Output


    (Keynesian Cross)
     2. Income-Expenditure Multiplier
     3. Stabilizing Planned Spending
     4. Role of Fiscal Policy

    MBA Lecture 4 Slide 2


    MB MC

    Short-run equilibrium

     Keynesian Assumption

    Producers meet demand at preset


    prices in the short-run
    Short-run equilibrium: Y = PAE

    MBA Lecture 4 Slide 3


    MB MC

    Short-run equilibrium

     Short-run Equilibrium Output


     The level of output at which output
    (Y ) equals planned aggregate
    expenditure (PAE)
    Short-run equilibrium output is the
    level of output that prevails during
    the period in which prices are
    predetermined

    MBA Lecture 4 Slide 4


    MB MC
    Determination of Short-Run
    Equilibrium Output (Keynesian Cross)
    Y = PAE
    Planned aggregate expenditure PAE

    Expenditure line
    PAE = 960 + 0.8Y

    Slope = 0.8
    Equilibrium
    • PAE intersects the 45o line @ 4,800
    Disequilibrium
    960 • < 4,800, PAE > Y
    • > 4,800, PAE < Y

    45o
    4,800
    Output Y

    MBA Lecture 4 Slide 5


    MB MC
    A Decline In Planned
    Spending Leads To A Recession
    Y = PAE
    Expenditure line
    Planned aggregate expenditure PAE
    PAE = 960 + 0.8Y

    Expenditure line
    PAE = 950 + 0.8Y
    E

    A decline in autonomous
    F aggregate expenditure (C)
    shifts the expenditure line
    960 down
    950

    Recessionary gap
    45o
    4,750 4,800
    Y* Output Y

    MBA Lecture 4 Slide 6


    MB MC

    Planned Aggregate Expenditure

     Observations
     Other factors remaining constant, a
    decline in autonomous spending
    causes short-run equilibrium output to
    fall and creates a recessionary gap.
     A decrease in autonomous spending
    can be caused by a reduction in C, IP, G,
    and/or NX.

    MBA Lecture 4 Slide 7


    MB MC

    Planned Aggregate Expenditure

     Observations
     Other factors remaining constant, an
    increase in autonomous spending causes
    short-run equilibrium output to rise and
    creates an expansionary gap.
     An increase in autonomous spending can
    be caused by an increase in C, IP, G,
    and/or NX.

    MBA Lecture 4 Slide 8


    MB MC

    Planned Aggregate Expenditure

     Income-Expenditure Multiplier
     The effect of a 1-unit increase in autonomous
    expenditure on short-run equilibrium output,
    or
     Change in the equilibrium level of output for
    one unit change in autonomous expenditure
     For example, a multiplier of 5 means that a 10-
    unit decrease in autonomous expenditure
    reduces short-run equilibrium output by 50
    units

    MBA Lecture 4 Slide 9


    MB MC

    Income-Expenditure Multiplier

     The Multiplier
     Recall
    PAE = 960 + 0.8Y, equilibrium Y = 4,800
    C fell by 10

    PAE = 950 + 0.8Y, equilibrium Y = 4,750#

    The Multiplier: 1/ (1 - MPC)

    MBA Lecture 4 Slide 10


    MB MC

    Income-Expenditure Multiplier

     The Multiplier Effect


     The decrease in the equilibrium Y was
    5 times the fall in C.
     The income-expenditure multiplier
    equaled 5.
     The size of the multiplier is influenced
    by the MPC.
     The Multiplier: 1/ (1 - MPC)

    MBA Lecture 4 Slide 11


    MB MC

    Stabilizing Planned Spending

     In the Keynesian Model:


    Recessionary and expansionary
    gaps are caused by inadequate or
    excessive spending, respectively.
    Stabilization policies are used to
    affect planned aggregate
    expenditures to eliminate output
    gaps.

    MBA Lecture 4 Slide 12


    MB MC

    Stabilizing Planned Spending

     Stabilization Policies

    Government policies that are used


    to affect planned aggregate
    expenditure, with the objective of
    eliminating output gaps

    MBA Lecture 4 Slide 13


    MB MC

    Stabilizing Planned Spending

     Expansionary Policies
     Government policy actions intended to
    increase planned spending and output

     Contractionary Policies
     Government policy actions designed to
    reduce planned spending and output

    MBA Lecture 4 Slide 14


    MB MC

    Stabilizing Planned Spending

     Tools of Stabilization Policy

     Fiscal
    policy
     Monetary policy

    MBA Lecture 4 Slide 15


    MB MC
    Stabilizing Planned Spending:
    The Role of Fiscal Policy

     Tools of fiscal policy


     Government spending
    Direct effect on PAE

     Taxation
    Indirect effect on PAE

     Transfer payments
    Indirect effect on PAE

    MBA Lecture 4 Slide 16


    MB MC
    Stabilizing Planned Spending:
    The Role of Fiscal Policy
     Tools of fiscal policy

     Government spending
    We saw that 10 units decrease in
    autonomous spending resulted a 50
    units decline in short-run equilibrium
    output (multiplier effect).

    MBA Lecture 4 Slide 17


    MB MC
    Stabilizing Planned Spending:
    The Role of Fiscal Policy
     Tools of fiscal policy
     Government spending
    Thus, to cover that 50 units fall in output
    govt. can increase its expenditure by ten
    units (e.g., military expenditure).
    Govt. expenditure is a part of autonomous
    expenditure.
    Autonomous expenditure as well as output
    then will return to its original level.

    MBA Lecture 4 Slide 18


    An Increase In Government
    MB MC

    Purchases Eliminates A Recessionary Gap


    Y = PAE
    Expenditure line
    Planned aggregate expenditure PAE
    PAE = 960 + 0.8Y
    Expenditure line
    PAE = 950 + 0.8Y

    An increase in G shifts the


    F expenditure line upward
    960
    950

    Recessionary gap
    45o
    4,750 4,800
    Output Y
    Y*
    MBA Lecture 4 Slide 19
    MB MC
    Stabilizing Planned Spending:
    The Role of Fiscal Policy

     Taxes, Transfers, and Aggregate


    Spending
     Taxes and transfers affect PAE indirectly
     Example
     Using a tax cut to close a recessionary
    gap

    MBA Lecture 4 Slide 20


    MB MC
    Stabilizing Planned Spending:
    The Role of Fiscal Policy
     Example
     Assume
    Recessionary gap = 50
    MPC = 0.8, multiplier = 5
     Use a tax cut to eliminate the gap
    The tax cut must increase PAE by 10
    For every dollar reduction in taxes,
    consumption will increase by 80
    cents (MPC = 0.8)

    MBA Lecture 4 Slide 21


    MB MC
    Stabilizing Planned Spending:
    The Role of Fiscal Policy
     Example: Assume
    Recessionary gap = 50
    MPC = 0.8, multiplier = 5
     Use a tax cut to eliminate the gap
     Change in spending (10) = tax cut x MPC
    (0.8)
     Tax cut = change in spending / MPC = 10/0.8
    = 12.5
     A tax cut of 12.5 will raise PAE by 10 (12.5 x
    0.8) = 10

    MBA Lecture 4 Slide 22


    MB MC
    Stabilizing Planned Spending:
    The Role of Fiscal Policy

     The same results could be obtained by


    increasing transfer payments by 12.5
    units.
     80% of 12.5 ( = 10) will be consumed.
     Consumption expenditure will increase
    and, therefore, PAE will be increased by
    10.

    MBA Lecture 4 Slide 23

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