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demandGDP
inventory investment

assumption in short run
 price is fixed
 ie. firms are willing to supply any amount of goods

Consumption is a function of...
disposable income

Why are G&T exogenous?
Governments do not behave with the same regularity as consumers or firms.
Macroeconomists must think about the implications of alternative spending and tax decisions of the government.

Difference btw GDP and total demand for goods
Inventory investment; because it is not consumed it is not part of the demand

*Components in GDP, eg. C and IM may offset each other and result in no net change in GDP

Autonomous spending is positive when...negative when...
 Government is running a balanced budget or having budget deficit;
 very large budget surplus

Formula of Z
Z=(autonomous spending)+c1Y

*Any change in autonomous spending will change output by more than one for one

The multiplier effect/amplification effect comes from
 demand Z↑
 production Y↑
 income↑
 consumption↑
 hence Y↑>initial shift in demand

Y=income/production;
Z=...
 Demand
 expenditure
 spending

Interpreting the multiplier
The sum of all successive increase in production

How Long Does It Take for Output to Adjust?
assume production responds to demand instantaneously!
assume consumption responds to changes in disposable income instantaneously.

Deriving IS relationships
 no govt
 Y=Z
 Y=C+Saving
 Z=C+I
 I=Saving
 verify I=saving
 with govt
 Y=C+I+G
 I=YCG
 private saving=YTC
 public saving=TG
 national saving=YCG
 hence I=national saving

private saving equation
S=c0+MPS(YT)

Equilibrium IS equation
I=c0+(1c1)(YT)+(TG)(ie the public saving)

Explain how diseqm leads to inventory investment
Originally the firm produces 100 units and it is the equilibrium output, now it decides to produce 200 units, according to Z=c1Y+autonomous spending, change in demand equals c1(0.5)*100=50, total demand=150, 50 units becomes inventory investment

what is the paradox of saving
as people attempt to save more, the result is both a decline in output and unchanged saving IN THE SHORT RUN

mechanism behind paradox of savingI=S perspective
 s=c0+MPS(disposable income)
 when consumer wants to save more, c0 ↓
 1)c0 ↑, s ↑
 2)consumption ↓, Z ↓, by eqm, Y↓, S↓

The government is not omnipotent because
 Changing government spending or taxes is not always easy .
 The responses of consumption, investment, imports, etc, are hard to assess with much certainty.
 Anticipations are likely to matter .
 Achieving a given level of output can come with unpleasant side effects.
 Budget deficits and public debt may have adverse implications in the long run.

mechanism behind paradox of savingY=Z perspective
 S=YTC
 Y=C+I+G(Y=Z)
 hence S=I+GT
 consumer's decision to save more cannot affect I, G, T
 S does not change

how to calculate GDP deflator
nominal GDP/real GDP(specific base year)

calculate inflation rate
 Pt: GDP deflator of t
 P(t1): GDP deflator of t1
 inflation rate=P_{t}P_{t1}/P_{t1}

under what condition will chained type GDP and fixed based year GDP give different numbers
 produce more than one good
 otherwise due to the different weights of goods, the estimate is not accurate

problems with fixed based year
 overest. growth of years after base year and underest growth of years before base year
 frequent revisions

how to calculate real GDP for 2001 in chained dollars
 matrix: base years dollars as column; years'productions as row
 use column results: production growth rate for both years
 avg production growth rate
 2000 index:1; 2001 index=1+avg rate
 2001 GDP in chained=nominal GDP in 2000*2001 index

how to calculate eqm output and demand
 Y, Yd, C, multiplier, autonomous spending
 output: mutliplier
 demand: C+I+G

why is tax called automatic stabilizer when T=t0+t1Y
 multiplier=(1c1+c1t1)
 autonomous spending↑, Y↑, T↑, lessen the ↑in Y
 economy responds less to changes in autonomous spending than in the case where T is independent of Y

suppose t depends on Y, if autonomous spending ↓, why is balanced budget requirement destabilizing?
 Y↓ and T↓
 to balance budget, ↓G
 Y further ↓

suppose I=b0+b1Y, if b0 ↑, what is the ↑ in investment?
(b0↑)+ b1*Y↑

if investment is exogenous(given), saving is
unchanged

variables which affect demand for money
NOMINAL income $Y, +
i, ()

why Interest rate has a negative effect on money demand
 as interest rate increase,
 return of bonds increase,
 people put more wealth on bonds instead of money

equilibrium condition in the financial market(LM relation) and explain
MS=$Y L(i)

What does M(money supply) depends on
monetary policy of the central bank

shifting variables of demand for money
$Y

effect of buying bonds on bond price and interest rate and implications
 decrease interest rate,
 increase bond price

effect of changing the RRR
increase M

a decision of the central bank to lower the interest rate is equivalent to...
increasing money supply

monetary policy instruments for the central bank to change the money supply
interest rate(federal funds rate, discount rate)
required reserve ratio
open market operations

shifting variables of LM curve
M

deriving the LM curve
 increase Y
 Md curve shifts right
 eqm interest rate increase
 (one point of LM)

investment depends on
level of sales(Y, +)
interest rate(i, )

why investment depends on Y
 as output changes,
 demand changes,
 firms change investment in order to keep up capacity with demand

why ↓M changes output
i↑, investment↓, demand↓, output↓

why interest rate has a negative effect on investment
 high interest rate,
 cost of borrowing money increase
 investment decrease

what are the measures of fiscal expansion
 cut tax
 increase government spending

why is Z an increasing function of Y?
 Y increase,
 C and I increase,
 demand for goods increase

why is ZZ flatter than 45deg line?
 increase in the output will not lead to an oneforone increase in demand
 (by a factor of MPC)

shifting variables of IS curve
ZZ(demand for goods)

Deriving the IS curve
 increase I
 ZZ curve shift down(through decrease in investment)
 eqm output decrease
 (obtain one point on IS curve)

exogenous variables in the ISLM model
fiscal policy and monetary policy

how fiscal expansion change ISLM model
increases the demand in goods market
shift IS curve to the right

how monetary expansion change ISLM model
increase the money supply
shift LM curve to the right

is monetary expansion more investment friendly than fiscal expansion?
Yes
fiscal expansion:Y&I increase
monetary expansion: Y increase and i decrease

changes in autonomous spending has what effect on I
ambiguous

if investment is independent of interest rate
 IS curve is a vertical line
 fixed ouput

Decrease in money demand has equivalent effect as
Increase in money supply

factors that shift money demand
Use of atm: left
Worry about bank failure: right
decrease in price level: right

Looking at the effect of deficit reduction on investment from investmentsaving relationship
I=S+(TG)
TG↑, I↑
S=YTC
Y&C↓, Y↓>C↓(MPC), S↓
ambiguous

If Y is a variable in C and I
Z is an increasing function of Y

Let M/P=d1Yd2i, slope of the LM curve…
D1/d2

direct effect(of output on demand) of the multiplier
captured by c1+b1
horizontal shift of the IS curve

indirect effect of the multiplier
captured by b2d1/d

what is crowding out and its implication
increase in output due to shift in IS curveeqm output
effect of fiscal policy on interest rate limits the ability of fiscal policy to influence output

larger multiplier mean the sensitivity of consumption and investment to output is
larger

Effectiveness of fiscal policy depends on
Multiplier

crowing out(con’t)why and how the slope of LM curve affect effectiveness of fiscal policy(interest rate)
 G increase,
 Y increase
 money demand increase
 interest rate increase
amount of increase in interest rate depends on slope of LM curve
 d1/d2 is smaller
 the flatter LM curve
 the less increase in interest rate
 less crowding out

Implication of balanced budget change
follow the direction of G because the effect of G is always greater than that of T

if there is fiscal contraction, what variables must change?
Y, C&i

if consumer confidence change, what variables must change?
C, Y, i

if money supply change, what variables must change?
 i, I, Y, C
 (no change if investment is independent on interest rate)

definition of real money supply
stock of money measured in terms of goods

dynamic assumption of ISLM model...
based on the assumption, changing M will lead to... and changing fiscal policy will lead to...
 economy always on LM, only moves slowly to IS
 immediate change in i and no initial change in Y
 gradual change in i and gradual change in Y

with IS↑ and LM↓, under what condition will I be ambiguous?
 i must ↑
 if output ↓, I is lower
 output↑, I is ambiguous

slope and intercept of the IS curve
 (1c1b1)/b2;
 c0c1T+b0+G

investment is very sensitive to interest rate
 a flatter IS slope
 a less effective fiscal policy(small multiplier)

increasing M in higher MPC countries leads to...
 since flatter IS
 larger increase in output and smaller decrease in i

eqm Y ISLM combined: multliplier
1c1b1+b2d1/d2

eqm Y ISLM combined: autonomous spending
c0c1T+b0+b2/d2(M/P)+G

why banks keep reserve?
 subject to requirements
 people withdraw money
 depositors write checks

calculate RRR
bank reserves/checkable deposits

how banks create checkable deposits
making loans on credit

US 2001 recession
cause: ↓ in I
policy: ficsal and monetary expansion
outcome: offset part of the ↓ in Y

arguements for PRC to cut RRR
 affirm:
 encourage banks to lend to small enterprise after credit crisis
 retain investment(western counterpart)
 high i and high RRR, a lot of room
 boost property price
 against:
 labour market holding up
 inflation

