Short-Run Macro Economic Equilibrium

Short-run Macroeconomic
Equilibrium
Short-run Macroeconomic Equilibrium
Background to the
Theory
A simplified circular flow of income model
Cd
Incomes Cd
Incomes Cd
W=S+T+M
J=I+G+X
Incomes Cd
W=S+T+M
BACKGROUND TO THE THEORY
• Defining aggregate demand and national

income
• The 45° line diagram
– the significance of the 45° line
The 45° line
Cd, W, J
Cd + W (=Y)
£100bn
O £100bn Y

income
• Consumption

income
• Consumption
– the consumption function
– the mpc
The consumption function
120
Y
C
100
Consumption (£bn)
∆C = 8
80
∆Y = 10
60
mpc = ∆C / ∆Y
50
= 8/10
40
= 0.8
20
0
0 20 40 50 60 80 100 120 140
Y (£bn)
Different consumption functions (a)
120
Y
100 C1
Consumption (£bn)
80
60
40
20
0
0 20 40 60 80 100 120 140
Y (£bn)
Different consumption functions (b)
120
Y
100
Consumption (£bn)
80 C2
60
40
20
0
0 20 40 60 80 100 120 140
Y (£bn)
Different consumption functions (c)
120
Y
C3
100
Consumption (£bn)
80
60
40
20
0
0 20 40 60 80 100 120 140
Y (£bn)
Different consumption functions (d)
120
Y
100
C4
Consumption (£bn)
80
60
40
20
0
0 20 40 60 80 100 120 140
Y (£bn)

income
• Consumption
– the mpc
– other determinants of consumption

income
• Consumption
– the mpc
– short-run and long-run consumption functions
Long-run and short-run consumption functions
120
Y
100
Consumption (£bn)
80 C10 years’ time

C5 years’ time
60 Cnow
40
20
0
0 20 40 60 80 100 120 140
Y (£bn)
Long-run and short-run consumption functions
120
Y
100
Clong run
Consumption (£bn)
80 C10 years’ time

C5 years’ time
60 Cnow
40
20
0
0 20 40 60 80 100 120 140
Y (£bn)

income
• Consumption
– the mpc
– short-run and long-run consumption functions
– the consumption of domestically produced goods
The consumption of domestic product
120
Y
C
100
Consumption (£bn)
80
Cd
60
40
20
0
0 20 40 60 80 100 120 140
Y (£bn)
• Withdrawals
– net saving: the saving function
• the mps
• determinants of saving
£m UK consumption and saving
180
170
160
150
140
130
120 Disposable income
110
100
90
80
70
60
50
40
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
180
170
160
150
140
130
110
100
90
80
70
60
50
40
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
180
170
160 Saving
150
140
130
110
100 Consumer expenditure
90
80
70
60
50
40
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Household saving as % of personal disposable income
Source:
• Withdrawals
• the mps
– net taxes: tax functions
• Withdrawals
• the mps
• the tax rate and the mpt
• Withdrawals
• the mps
• expenditure taxes and Cd
• Withdrawals
• the mps
– imports: import functions
• Withdrawals
• the mps
• the mpm
• Withdrawals
• the mps
• the mpm
• effect of imports on Cd
• Withdrawals
• the mps
• the mpm
– the withdrawals function
• Withdrawals
• the mps
• the mpm
– the withdrawals function
• the mpw
Cd, W
The W and Cd functions
Cd + W (=Y)
100 Cd
70
30
O 100 Y
• Injections
– investment
• increased consumer demand
• expectations
• cost and efficiency of capital
• rate of interest
– government expenditure
– exports
– the injections function
The injections and withdrawals functions
Cd, W, J
O
Y
Determination of
National Income
DETERMINATION OF NATIONAL INCOME
• Equilibrium national income

– withdrawals equal injections
Cd, W, J
Deriving equilibrium national income
O
Y
Cd, W, J
a
J
b
O Y1 Y
Cd, W, J
W
c
d J
O Y2 Y
Cd, W, J
x
J
O
Ye Y

– income equals expenditure

Cd, W, J
Y = Cd + W
O
Y
Cd, W, J
Y = Cd + W
E = Cd + J
Cd
J
O
Y
Cd, W, J
Y = Cd + W
E = Cd + J
Cd
e
W
f
O Y1 Y
Cd, W, J
Y = Cd + W
g E = Cd + J
h Cd
O Y2 Y
Cd, W, J
Y = Cd + W
E = Cd + J
Cd
z
x
J
O
Ye Y

• The multiplier: introduction



– the circular flow of income and effects of
changes in injections
J=I+G+X
Incomes Cd
W=S+T+M


– the circular flow of income and effects of
changes in injections
– definition of the multiplier: ∆Y/∆J

• The multiplier: the withdrawals and

injections approach
– graphical analysis: shift in the J line
The multiplier: (a) a shift in injections
W, J
a
J1
O
Ye1 Y
W, J
W
b
J2
a
J1
O
Ye1 Ye2 Y

injections approach
– the formula: 1 / mpw
or: 1 / (1 – mpcd )
W, J
Multiplier = ∆Y / ∆
J
= ∆Y / ∆W
= c− a / b− c
W
b
J2 J2
∆J a ∆W
J1 J1
c
O
Ye1 ∆Y Ye2 Y
W, J
Multiplier = ∆Y / ∆
J
= ∆Y / ∆W
= c− a / b− c
= 1/mpw
W
b
J2 J2
∆J a ∆W
J1 J1
c
O
Ye1 ∆Y Ye2 Y

injections approach
or: 1 / (1 – mpcd )
– numerical illustration

injections approach
or: 1 / (1 – mpcd )
– the withdrawals multiplier
The multiplier: (b) a shift in withdrawals
W, J
W1
a
J
O
Ye1 Y
W, J
W1
W2
a c
J
O
Ye1 Ye2 Y
W, J
Multiplier = ∆Y / ∆W
= c −a / a − b
W1
W2
a c
J
∆W b
O
Ye1 ∆Y Ye2 Y

injections approach
or: 1 / (1 – mpcd )
• The multiplier: the income and
expenditure approach

injections approach
or: 1 / (1 – mpcd )
– graphical analysis
The multiplier: (c) a shift in the expenditure curve
E, W, J
E1
O Ye1 Y
E, W, J
Y
E2
E1
O Ye1 Ye2 Y
E, W, J
Multiplier = ∆Y / ∆ J Y
E2
= c− a / b− a
E1
c
∆Y
b
∆J
a
O Ye1 Ye2 Y

injections approach
or: 1 / (1 – mpcd )
– graphical analysis
• The multiplier: some qualifications
– deriving the mpcd from the mpc
– effects of changes in one injection or

withdrawal on other ones
• Relationship between the 45° line

diagram and the AD and AS diagram
Showing the multiplier effect on the 45o line and AD/AS diagrams
Y
Cd, W, J
E1
O Y
Y
P
AS
AD1
O Y
Y
Cd, W, J
E1
O Y
Y
P
AS
AD1
O Y
Y E2
Cd, W, J
E1
O Y
Y Y
P
AS
AD1 AD2
O Y
Y E2
Cd, W, J
E1
O Y
Y Y
Simple Keynesian Analysis

of Unemployment and
Inflation
UNEMPLOYMENT AND INFLATION
• The deflationary gap

– withdrawals and injections approach
The deflationary gap
W, J
J
O
Ye Y
W, J
Deflationary gap
W
c
d J
O YF
Ye Y

– income and expenditure approach

W, J, E
O YF
Ye Y
W, J, E
E
a
Deflationary gap
O YF
Ye Y
W, J, E
E
a
Deflationary gap
W
c
d J
O YF
Ye Y

• The inflationary gap



The inflationary gap
W, J
W
J
O Ye Y
W, J
W
J
O YF Ye Y
W, J
Inflationary gap
W
g
J
h
O YF Ye Y



W, J, E
Y
E
O Ye Y
W, J, E
Y
E
O Ye Y
W, J, E
Y
E
Inflationary gap f
O YF Ye Y
W, J, E
Y
E
Inflationary gap f
W
g
J
h
O YF Ye Y
• Inflation and unemployment at the same

time
– inflationary pressures before the
full-employment level of income
– implications for shape of AS curve

Unemployment and inflation
AS1
Price level
O YF Y
Unemployment and inflation
AS2 AS1
Price level
O YF Y
• Inflation and unemployment at the same

time
– inflationary pressures before the
full-employment level of income
– implications for shape of AS curve
– relationship between 45° line diagram and

the AD & AS diagram
Allowing for inflation in the 45° line and AD / AS diagrams
P
AS
P1
AD1
Y
Y1
Cd, W, J, E
Y
P
AS
P1
AD1
Y
Cd, W, J, E Y
E1
Y
Y
P
AS
P2
P1
AD2
AD1
Y
Cd, W, J, E Y
E2
E1
Y
Y Y
P
AS
P2
P1
AD2
AD1
Y
Cd, W, J, E Y
E2
E3
E1
Y
Y Y Y
Keynesian Analysis of
the Business Cycle
KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE
• The accelerator
– changes in national income and induced

investment
The accelerator effect
• The accelerator

investment
– the accelerator coefficient

• The accelerator

investment
– the instability of investment

Indicator of industrial confidence in the EU
EU Euro area
Balances (%)
Source: European Economy Business and Consumer Surveys (Commission of the European Communities)
Indicator of level of capacity utilisation (%) in the EU
02
Source: European Economy Business and Consumer Surveys (Commission of the European Communities)
• The accelerator

investment
• The multiplier / accelerator interaction

Fluctuations in UK real GDP and investment: 1978-2002
20
18
16
14
GDP, Investment (% annual change)
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
-12
-14
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
20
18
16
14
12
10
8
6
4
2 GDP
0
-2
-4
-6
-8
-10
-12
-14
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
20
18
16 Investment
14
12
10
8
6
4
2 GDP
0
-2
-4
-6
-8
-10
-12
-14
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
• The accelerator

investment
• The multiplier / accelerator interaction
• Fluctuations in stocks
• Analysing the phases of the business

cycle
– causes of the upturn
– causes of the expansion
– causes of the peaking out
– causes of the recession
• Conclusions
– why do booms and recessions persist?
– why do booms and recessions come to an
end?

Short-Run Macro Economic Equilibrium

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Short-Run Macro Economic Equilibrium

Uploaded by

Copyright:

Available Formats

Short-run Macroeconomic

• Defining aggregate demand and national

• Defining aggregate demand and national

• Defining aggregate demand and national

• Defining aggregate demand and national

• Defining aggregate demand and national

80 C10 years’ time

80 C10 years’ time

• Defining aggregate demand and national

• Equilibrium national income

• Equilibrium national income

– income equals expenditure

• Equilibrium national income

– income equals expenditure

• The multiplier: introduction

• Equilibrium national income

– income equals expenditure

• The multiplier: introduction

• Equilibrium national income

– income equals expenditure

• The multiplier: introduction

– definition of the multiplier: ∆Y/∆J

• The multiplier: the withdrawals and

• The multiplier: the withdrawals and

• The multiplier: the withdrawals and

• The multiplier: the withdrawals and

• The multiplier: the withdrawals and

• The multiplier: the withdrawals and

• The multiplier: the withdrawals and

• The multiplier: some qualifications

– deriving the mpcd from the mpc

– effects of changes in one injection or

• Relationship between the 45° line

Simple Keynesian Analysis

• The deflationary gap

• The deflationary gap

– income and expenditure approach

• The deflationary gap

– income and expenditure approach

• The inflationary gap

• The deflationary gap

– income and expenditure approach

• The inflationary gap

• The deflationary gap

– income and expenditure approach

• The inflationary gap

– income and expenditure approach

• Inflation and unemployment at the same

– implications for shape of AS curve

• Inflation and unemployment at the same

– implications for shape of AS curve

– relationship between 45° line diagram and

– changes in national income and induced

– changes in national income and induced

– the accelerator coefficient

– changes in national income and induced

– the accelerator coefficient

– the instability of investment

– changes in national income and induced

– the accelerator coefficient

– the instability of investment

• The multiplier / accelerator interaction

– changes in national income and induced