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Short-run Macroeconomic Equilibrium

Background to the Theory

A simplified circular flow of income model

A simplified circular flow of income model

Cd

A simplified circular flow of income model

Incomes

Cd

A simplified circular flow of income model

Incomes

Cd

W=S+T+M

A simplified circular flow of income model

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

Cd, W, J

**The 45° line
**

Cd + W (=Y)

£100bn

O

£100bn

Y

**BACKGROUND TO THE THEORY
**

• Defining aggregate demand and national income • The 45° line diagram

– the significance of the 45° line

• Consumption

**BACKGROUND TO THE THEORY
**

• Defining aggregate demand and national income • The 45° line diagram

– the significance of the 45° line

• Consumption

– the consumption function – the mpc

120

**The consumption function
**

Y C

∆C = 8 ∆Y = 10

100

Consumption (£bn)

80

60

50

40

mpc = ∆C / ∆Y = 8/10 = 0.8

20

0 0 20 40

50 60

80

100

120

140

Y (£bn)

**Different consumption functions (a)
**

120

Y C1

100

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 C4

100

Consumption (£bn)

80

60

40

20

0 0 20 40 60 80 100 120 140

Y (£bn)

**BACKGROUND TO THE THEORY
**

• Defining aggregate demand and national income • The 45° line diagram

– the significance of the 45° line

• Consumption

– the consumption function – the mpc – other determinants of consumption

**BACKGROUND TO THE THEORY
**

• Defining aggregate demand and national income • The 45° line diagram

– the significance of the 45° line

• Consumption

– the consumption function – the mpc – other determinants of consumption – short-run and long-run consumption functions

120

**Long-run and short-run consumption functions
**

Y

100

Consumption (£bn)

80

C10 years’ time C5 years’ time Cnow

60

40

20

0 0 20 40 60 80 100 120 140

Y (£bn)

120

**Long-run and short-run consumption functions
**

Y Clong run C10 years’ time C5 years’ time Cnow

100

Consumption (£bn)

80

60

40

20

0 0 20 40 60 80 100 120 140

Y (£bn)

**BACKGROUND TO THE THEORY
**

• Defining aggregate demand and national income • The 45° line diagram

– the significance of the 45° line

• Consumption

– the consumption function – the mpc – other determinants of consumption – 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)

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

£m

180 170 160 150 140 130 120 110 100 90 80 70 60 50 40

UK consumption and saving

Disposable income

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

£m

180 170 160 150 140 130 120 110 100 90 80 70 60 50 40

UK consumption and saving

Disposable income

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

£m

180 170 160 150 140 130 120 110 100 90 80 70 60 50 40

UK consumption and saving

Saving

Disposable income Consumer expenditure

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Household saving as % of personal disposable income

Source:

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

– net taxes: tax functions

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

**– net taxes: tax functions
**

• the tax rate and the mpt

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

**– net taxes: tax functions
**

• the tax rate and the mpt • expenditure taxes and Cd

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

**– net taxes: tax functions
**

• the tax rate and the mpt • expenditure taxes and Cd

– imports: import functions

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

**– net taxes: tax functions
**

• the tax rate and the mpt • expenditure taxes and Cd

**– imports: import functions
**

• the mpm

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

**– net taxes: tax functions
**

• the tax rate and the mpt • expenditure taxes and Cd

**– imports: import functions
**

• the mpm • effect of imports on Cd

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

**– net taxes: tax functions
**

• the tax rate and the mpt • expenditure taxes and Cd

**– imports: import functions
**

• the mpm • effect of imports on Cd

– the withdrawals function

**BACKGROUND TO THE THEORY • Withdrawals
**

– net saving: the saving function

• the mps • determinants of saving

**– net taxes: tax functions
**

• the tax rate and the mpt • expenditure taxes and Cd

**– imports: import functions
**

• the mpm • effect of imports on Cd

**– the withdrawals function
**

• the mpw

Cd, W

**The W and Cd functions
**

Cd + W (=Y)

100

Cd

70

W

30

O

100

Y

**BACKGROUND TO THE THEORY • Injections
**

– investment

• increased consumer demand • expectations • cost and efficiency of capital • rate of interest

– government expenditure – exports – the injections function

Cd, W, J

The injections and withdrawals functions

W

J

O

Y

Short-run Macroeconomic Equilibrium

Determination of National Income

**DETERMINATION OF NATIONAL INCOME • Equilibrium national income
**

– withdrawals equal injections

Cd, W, J

Deriving equilibrium national income

W

O

Y

Cd, W, J

Deriving equilibrium national income

W a b

O Y1

J

Y

Cd, W, J

Deriving equilibrium national income

W c d

O Y2

J

Y

Cd, W, J

Deriving equilibrium national income

W

x

J

Y

O

Ye

**DETERMINATION OF NATIONAL INCOME • Equilibrium national income
**

– withdrawals equal injections – income equals expenditure

Cd, W, J

**Deriving equilibrium national income
**

Y = Cd + W

W

J

O

Y

Cd, W, J

**Deriving equilibrium national income
**

Y = Cd + W E = Cd + J Cd J

W

J

O

Y

Cd, W, J

**Deriving equilibrium national income
**

Y = Cd + W E = Cd + J Cd

e f W

J

O Y1

Y

Cd, W, J

**Deriving equilibrium national income
**

Y = Cd + W E = Cd + J g h Cd

W

J

O Y2

Y

Cd, W, J

**Deriving equilibrium national income
**

Y = Cd + W E = Cd + J Cd z

W

x

J

Y

O

Ye

**DETERMINATION OF NATIONAL INCOME • Equilibrium national income
**

– withdrawals equal injections – income equals expenditure

• The multiplier: introduction

**DETERMINATION OF NATIONAL INCOME • Equilibrium national income
**

– withdrawals equal injections – income equals expenditure

**• The multiplier: introduction
**

– the circular flow of income and effects of changes in injections

A simplified circular flow of income model

J=I+G+X

Incomes

Cd

W=S+T+M

**DETERMINATION OF NATIONAL INCOME • Equilibrium national income
**

– withdrawals equal injections – income equals expenditure

**• The multiplier: introduction
**

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

**DETERMINATION OF NATIONAL INCOME • The multiplier: the withdrawals and injections approach
**

– graphical analysis: shift in the J line

W, J

The multiplier: (a) a shift in injections

W

a O

J1

Y

Ye1

W, J

The multiplier: (a) a shift in injections

b a O

W J2 J1

Ye1

Ye2

Y

**DETERMINATION OF NATIONAL INCOME • The multiplier: the withdrawals and injections approach
**

– graphical analysis: shift in the J line – the formula: 1 / mpw or: 1 / (1 – mpcd )

W, J

The multiplier: (a) a shift in injections

Multiplier = ∆Y / ∆ J = ∆Y / ∆W = c− a / b− c

J2 J1 O

b ∆J a c Ye1 ∆Y Ye2 ∆W

W J2 J1

Y

W, J

The multiplier: (a) a shift in injections

Multiplier = ∆Y / ∆ J = ∆Y / ∆W = c− a / b− c = 1/mpw

J2 J1 O

b ∆J a c Ye1 ∆Y Ye2 ∆W

W J2 J1

Y

**DETERMINATION OF NATIONAL INCOME • The multiplier: the withdrawals and injections approach
**

– graphical analysis: shift in the J line – the formula: 1 / mpw or: 1 / (1 – mpcd ) – numerical illustration

**DETERMINATION OF NATIONAL INCOME • The multiplier: the withdrawals and injections approach
**

– graphical analysis: shift in the J line – the formula: 1 / mpw or: 1 / (1 – mpcd ) – numerical illustration – the withdrawals multiplier

W, J

The multiplier: (b) a shift in withdrawals

W1

a O

J

Y

Ye1

W, J

The multiplier: (b) a shift in withdrawals

W1 W2

a O c

J

Y

Ye1

Ye2

W, J

The multiplier: (b) a shift in withdrawals

Multiplier = ∆Y / ∆W = c −a / a − b

W1 W2

a ∆W b O Ye1 ∆Y Ye2 c

J

Y

**DETERMINATION OF NATIONAL INCOME • The multiplier: the withdrawals and injections approach
**

– graphical analysis: shift in the J line – the formula: 1 / mpw or: 1 / (1 – mpcd ) – numerical illustration – the withdrawals multiplier

• The multiplier: the income and expenditure approach

**DETERMINATION OF NATIONAL INCOME • The multiplier: the withdrawals and injections approach
**

– graphical analysis: shift in the J line – the formula: 1 / mpw or: 1 / (1 – mpcd ) – numerical illustration – the withdrawals multiplier

**• The multiplier: the income and expenditure approach
**

– graphical analysis

E, W, J

**The multiplier: (c) a shift in the expenditure curve
**

Y E1

O

Ye1

Y

E, W, J

**The multiplier: (c) a shift in the expenditure curve
**

Y E2 E1

O

Ye1

Ye2

Y

E, W, J

**The multiplier: (c) a shift in the expenditure curve
**

Multiplier = ∆Y / ∆ J = c− a / b− a c

Y

E2 E1

∆Y b ∆J a

O

Ye1

Ye2

Y

**DETERMINATION OF NATIONAL INCOME • The multiplier: the withdrawals and injections approach
**

– graphical analysis: shift in the J line – the formula: 1 / mpw or: 1 / (1 – mpcd ) – numerical illustration – the withdrawals multiplier

**• The multiplier: the income and expenditure approach
**

– graphical analysis – numerical illustration

**DETERMINATION OF NATIONAL INCOME • 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

Cd, W, J

Y E1

O

Y

Y

**Showing the multiplier effect on the 45o line and AD/AS diagrams
**

P

AS

O Cd, W, J

AD1 Y E1

Y

O

Y

Y

**Showing the multiplier effect on the 45o line and AD/AS diagrams
**

P

AS

O Cd, W, J

AD1 Y E2 E1

Y

O

Y

Y

Y

**Showing the multiplier effect on the 45o line and AD/AS diagrams
**

P

AS

O Cd, W, J

AD1 Y

AD2 E2 E1

Y

O

Y

Y

Y

Short-run Macroeconomic Equilibrium

Simple Keynesian Analysis of Unemployment and Inflation

**UNEMPLOYMENT AND INFLATION • The deflationary gap
**

– withdrawals and injections approach

W, J

The deflationary gap

W J

O Ye

Y

W, J

The deflationary gap

Deflationary gap

W

c d O Ye YF

J

Y

**UNEMPLOYMENT AND INFLATION • The deflationary gap
**

– withdrawals and injections approach – income and expenditure approach

W, J, E

**The deflationary gap
**

Y E

O

Ye

YF

Y

W, J, E

**The deflationary gap
**

Y E

a b Deflationary gap

O

Ye

YF

Y

W, J, E

**The deflationary gap
**

Y E

a b Deflationary gap

W

c d O Ye YF

J

Y

**UNEMPLOYMENT AND INFLATION • The deflationary gap
**

– withdrawals and injections approach – income and expenditure approach

• The inflationary gap

**UNEMPLOYMENT AND INFLATION • The deflationary gap
**

– withdrawals and injections approach – income and expenditure approach

**• The inflationary gap
**

– withdrawals and injections approach

W, J

The inflationary gap

W J

O

Ye

Y

W, J

The inflationary gap

W J

O

YF

Ye

Y

W, J

The inflationary gap

Inflationary gap

g h O YF Ye

W J

Y

**UNEMPLOYMENT AND INFLATION • The deflationary gap
**

– withdrawals and injections approach – income and expenditure approach

**• The inflationary gap
**

– withdrawals and injections approach – income and expenditure approach

W, J, E

**The inflationary gap
**

Y E

O

Ye

Y

W, J, E

**The inflationary gap
**

Y E

O

Ye

Y

W, J, E

**The inflationary gap
**

Y E

e Inflationary gap f

O

YF

Ye

Y

W, J, E

**The inflationary gap
**

Y E

e Inflationary gap f

g h O YF Ye

W J

Y

**UNEMPLOYMENT AND INFLATION • 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

**UNEMPLOYMENT AND INFLATION • 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 Cd, W, J, E Y1 Y

Y

**Allowing for inflation in the 45° line and AD / AS diagrams
**

P AS

P1 AD1 Cd, W, J, E Y E1 Y

Y

Y

**Allowing for inflation in the 45° line and AD / AS diagrams
**

P AS

P2 P1 AD1 Cd, W, J, E AD2 Y Y E2 E1

Y

Y

Y

**Allowing for inflation in the 45° line and AD / AS diagrams
**

P AS

P2 P1 AD1 Cd, W, J, E AD2 Y Y E2 E3 E1

Y

Y Y

Y

Short-run Macroeconomic Equilibrium

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 effect

The accelerator effect

The accelerator effect

The accelerator effect

KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator

– changes in national income and induced investment – the accelerator coefficient

KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator

– changes in national income and induced investment – the accelerator coefficient – 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)

KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator

– changes in national income and induced investment – the accelerator coefficient – the instability of investment

• The multiplier / accelerator interaction

**Fluctuations in UK real GDP and investment: 1978-2002
**

20 18 16 14 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

GDP, Investment (% annual change)

**Fluctuations in UK real GDP and investment: 1978-2002
**

20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996

GDP, Investment (% annual change)

GDP

1998

2000

2002

**Fluctuations in UK real GDP and investment: 1978-2002
**

20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14

1978 1980 1982 1984 1986 1988 1990 1992 1994

Investment

GDP, Investment (% annual change)

GDP

1996

1998

2000

2002

KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator

– changes in national income and induced investment – the accelerator coefficient – the instability of investment

• The multiplier / accelerator interaction • Fluctuations in stocks

KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

**• 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?

- Market Structures
- Market Structure 2
- Market Structure 1
- Isoquant Analysis
- Imperfect Competition
- Government, The Firm and the Market
- Economies of Scale
- Costs
- Costs of Production
- Business Economics
- Alternative Theories of the Firm
- Sources of Finance for Development - Full Version
- Models of Development - Full Version
- Inequality and the Redistribution of Income
- Inequality - Full Version
- Indicators of Economic Development - Full Version
- Income and Wealth Distribution - Full Version
- Economic Problems of Developing Countries 2
- Economic Problems of Developing Countries
- Economic Growth - Full Version
- Development Strategies - Full Version
- Long-Term Economic Growth and Supply-Side Policies
- Investment and the Employment of Capital
- Aggregate Supply, Unemployment and Inflation

AD and AS

AD and AS

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- Restatement of quantity theory of money
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- 11071_1945-1949
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- Macroeconomics, Consumption and Saving
- nipa_scb031979
- Determination of Income and Employment
- Consumption
- 61421_1985-1989
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- Ch 5
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- Consumption Function
- Consumption Hypotheses
- 45796_1960-1964
- 10817_2000-2004
- 32106_2000-2004
- Short-Run Macro Economic Equilibrium

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