macroeconomics 17 dec
TRANSCRIPT
December 17 2011
Macroeconomics
2
Aggregate Demand and Supply
Aggregate Demand and Aggregate Supply
3
»Some countries are rich and some are not!
»Aggregate Demand and Aggregate Supply
answer questions about equilibriums in
goods, money market, unemployment, GDP
levels etc
»Provides a “big picture” view of the
economy
»Describes the overall relationship between
overall price level and output
Aggregate Demand and Aggregate Supply
4
»Aggregate Supply (AS) curve describes, for
each given price level, the quantity of
output firms are willing to supply
»Aggregate Demand (AD) curve shows the
combinations of the price level and level of
output at which the goods and money
markets are simultaneously in equilibrium
Aggregate Demand and Aggregate Supply
5
»Difference in the micro and macro economic
concepts of demand and supply
»Equilibrium state of AS and AD
»Shift in AD curve
»Shift in AS curve
Aggregate Supply curve
6
»Classical Supply curve:
»Vertical – indicating that the same
amount of goods will be supplied
whatever be the price level
»Assumption: Labor market equilibrium
»Long term possibility
»Why should supply curve be vertical in
long run? Recall how it was in
microeconomics!
Aggregate Supply curve
7
»Classical Supply curve:
»Potential GDP
»Shift of vertical AS curve
»Does potential GDP grow over time?
»Changes in potential GDP do not depend
on the price level
»Potential GDP changes very little over
time
Aggregate Supply curve
8
»Keynesian Supply curve:
»Horizontal– indicating that firms will supply
whatever amount of goods is demanded at
the existing price level
»Assumption: Unemployment
»Why should supply curve be horizontal in the
short run?
»Short-run price stickiness
»Price level does not depend on GDP - inflation
Aggregate Demand curve
9
»AD curve shows the combination of the
price level and level of output at which the
goods and money markets are
simultaneously in equilibrium
»Expansionary policies’ effects?
»Do consumer and investor confidence have
an effect on AD?
»Depends on real money supply
»AD curve slopes downwards and shifts
AD in Alternative Supply assumptions
10
»Equilibrium under Keynesian case
»Given perfectly elastic supply, shifting
AD to the right will increase output but
leave the equilibrium price level
unchanged
»Equilibrium under Classical case
»Given perfectly inelastic supply, shifting
AD to the right results in an increase in
the price level but no change in output
Supply side economics
11
»Some supply-side policies:
»Removing regulations, maintaining an
efficient legal system, technological
progress
»What is the effect of cutting tax rates?
»Does it have an effect on AD or AS?
»Only supply-side policies permanently
increase output
»AS and AD in the long run
12
Income, Spending, Multiplier
Introduction
13
»Attempt to answer the most fundamental
question of – Why does output fluctuate?
»Uneven growth observed
»Relationship between output and spending
»Spending Output and Income
Spending
»Spending and output feedback leads to an
increase in Aggregate Demand
AD and Equilibrium Output
14
»Aggregate Demand is the total amount of
goods demanded in the economy
»AD = C + I + G + NX
»Output at its equilibrium level is when Y =
AD
»What happens when Y is > or < than AD at
any point in time?
»Concept of unplanned inventory investment
or disinvestment
Consumption function and AD
15
»Major part of AD is Consumption
»Other components of AD?
»Link between consumption and income
»Assumption to start with – No G or NX
»Relationship between consumption and
income is described by the consumption
function and denoted by
»C = C + cY−
Consumption function, Saving and AD
16
»What do C, C and c mean?
»What is Marginal Propensity to Consume?
»Increase in consumption per unit increase in
income ~ out of a Re. 1 increase in income,
a fraction of it goes towards consumption
»If only a fraction of it spent on consumption,
what happens to the remaining?
Mathematical notation?
−
Consumption function, Saving and AD
17
»Budget Constraint?
»S ≡ Y – C
»Relationship between Consumption, Income,
Saving and Aggregate Demand
»S ≡ −C + (1-c)Y
»How would you interpret the role of MPC
and MPS here?
»Saving is an increasing function of income
(Example)
−
Consumption, AD and Autonomous Spending
18
»Removing the assumption in the real world
scenario!
»Another assumption of all other components
being autonomous. How will the Y curve be
denoted?
»Concept of Disposable Income and its role in
the consumption function (YD = Y – TA + TR)
»What will be the new consumption function
and AD?
Equilibrium Income and Output
19
»Aggregate demand schedule is a vertical
addition of all components
»The equilibrium level of income is such that
aggregate demand equals output, which in
turn equals income
»Refer to the 45◦ line and where it intersects
the A and C curve
»At that level of output, planned spending
precisely matches production
− −
Formula for equilibrium output
20
»Y = AD
»Substituting for AD with Autonomous
spending?
»Equilibrium level of income and output
equation:
»Y0 = A/(1-c)
»From the equation, what are the things that
would equilibrium output higher?
−
Savings and Investment
21
»In equilibrium, planned investment equals
saving, assuming that there is no G or NX
»What do the distances between the curves
in the graph signify?
»What uses is income put to?
»Y = C + S and Y = C + I
»Including G and NX; Y = C + TA – TR
»I = S + (TA – TR – G) - NX
Multiplier
22
»By how much does a Re. 1 increase in A
raise the equilibrium level of output and
income?
»The Multiplier table
»∆ AD = ∆ A / (1-c)
»Multiplier indicates how much would be the
amount spent on demand/consumption for
every Re. 1 the autonomous spending rises
~ 1/(1-c)
−
Multiplier
23
»The 3 most critical observations from a
multiplier effect
»An increase in autonomous demand (A)
leads to an increase in equilibrium
income
»The increase in income is a multiple of
the increase in A
»The larger the MPC, the larger the
multiplier
−
−
Government Sector
24
»What are people’s expectations from the
Government during booms and troughs?
»What is the primary source of income for
the Government?
»Government purchases of goods and
services is a critical part of AD
»Taxes and transfers – R’ship amongst
output, income and Disposable Income (YD)
Government Sector
25
»Fiscal policy is the government’s policy
regarding the level of government
purchases, level of transfers and the tax
structure (recall budget surplus)
»Assumptions regarding G and TR
»How can we substitute in our consumption
function?
»MPC for income and MPC for YD – Difference
»AD function with Disposable Income
Equilibrium Income and Taxes
26
»Equilibrium Income with YD:
»Y0 = A/1-c(1-t)
»Effect of taxes on the multiplier
»Automatic Stabilizers
»Any mechanism in the economy that
automatically controls the change in
output to a change in autonomous
demand – Examples?
−
Government Sector - Recap
27
»Government Purchases and transfer
payments act like increases in autonomous
spending in their effects on income
»Role of proportional income tax and its
impact on Disposable Income
»Automatic stabilizers
»A reduction in transfers lowers output
»What do you think is the role of fiscal
policy?
Budget
28
»Is there a reason to fear government
budget deficit?
»Budget surplus is the excess of the
government’s revenues, taxes over its total
expenditures, consisting of purchasing
goods and services and transfer payments
»Define budget deficit
»How does fiscal policy impact budgets?
Some key terms to recall
29
» Aggregate
Demand
» Automatic
stabilizer
» Budget constraint
» Budget
surplus/deficit
» Consumption
function
» Disposable
Income
» Fiscal policy
» MPC
» MPS
» Multiplier
30
Case Discussion – Should Energy be Subsidized?
Case Analysis
31
»What are subsidies?
»Financial assistance given to energy
companies
»Direct Assistance – Grants, Tax breaks/
exemptions (have a direct impact on
price)
»Indirect Assistance – R&D support,
Government encouragement for
innovations
Case Analysis
32
»Reasons
»Primary: Access to poorer sections of the
society
»Secondary: Keeping the prices under
control
»Variants of Energy Subsidies
»Cash transfer, Reduced rate loans,
quotas, trade restrictions, preferential
tax treatment
Case Analysis – Effects/Impacts of subsidies
33
»Short-term and long-term impacts:
»Cost Angle:
»Per unit cost of generating energy was
higher for renewable resource
»Social cost of removing subsidies is high
»Social Angle:
»Pollution costs/Climate change
»Greenhouse effect
Case Analysis – Some statistics
34
Year Amount Countries/Economies
1992 $ 230 bn Global
1997 $ 58 bnUS and 20 largest
countries outside OECD
1999 $95 bn8 of the largest
developing economies
2001 €17.2 bn EU
2005 $250 bn Non-OECD countries
Case Analysis – Arguments FOR subsidies
35
»Essential for all economic activities
(subsidized kerosene, LPG, electricity…)
»Direct impact on inflation
»If prices of fuel increase, cost of
transporting vegetables goes up!
»Politics – think vote bank!
»Cross subsidies
Case Analysis – Arguments AGAINST subsidies
36
»Leads to increased consumption
»Irresponsible usage of energy
»Leads to faster depletion of a precious
resource
»Distorted costs and prices
»Failure in determining actual cost of
production of non-renewable resource
»Environmental damage
Case Analysis – Arguments AGAINST subsidies
37
»Majority of the subsidies flows into nuclear
power
»High cost of insurance coverage
»Nuclear waste disposal costs
»Hampers growth of renewable resources
»Discourages research and innovation
»Does it actually benefit the
underprivileged? Can it be diverted?
Subsidies – Renewable Resource
38
»Social Costs will
come down
»Cleaner fuel
»Reduced health
care costs
»Tariff arrangements
FOR AGAINST
»Capital costs of
establishing
renewable resource
plants
»A few types may
have adverse
ecological impact
Points for discussion
39
»Impact of subsidies on economy
»Who are the beneficiaries and who pays for
them?
»Are subsidies essential?
»Does renewable/non-renewable make a
difference?
»Would developing/developed countries
make a difference?
»Should renewable energy be promoted?
Questions???
Have a happy Sunday!