Week 8.

Building Aggregate Demand side of the model.

Tools to help understand, policy.

What impact of those policy are.

The first Multiplier Model.

What is aggregate demand.

Basically output and GDP.

A lot of GDP. Decompose into 4 components.

Consumption, Investment, Government, Net Exports.

If we have any fluctuations consumption 70% and investment greater than 10%. It will fluctuate
aggregate demand (GDP).

In the very early stages, government are relatively small.

It moves around quiet a lot.

Multiplier Process,

What exactly is multiplier, if we want to give you money, you going to spend up the money, receive
some income. You guys spend up money. Effect multpier process. Affect of changing in aggregate
output.

Multiply process, circular flow. Income to income for someone else. Demerit presentation of
magnitude of this change. Monetary and fiscal policy can control the ecnonomy.

Consumption Function. What we do now. We have to understand. How changes in consumption can
affect the economy. Consumption is written:

C=C0 +C1 Y.

How you actually interpret the equation

Consumption = C

C0 = constant. Not part in Income.

C1 = slope.

C1 = the part of consumption Y is income. Affected by your income.

This is very natural. We simplified it

What we have here, autonomous consumption = very much depend of level income (Induced
consumption)

What that mean is if increase income by 1 dollar, it going to increase 0.6

There is C1 = marginal propensity to consume.

The slope. Equal to MPC.

All of this is telling you.

Change in consumption, given the level of income.

Larger responses to increase income of there a steeper consumption.

Consisted with smoothing consumption.

Someone give you money, for future use.

That also smoothing the consumption over time.

What do we do

We explore the MPC.

MOC itself, is something how you respond when there is increase in income.

What drives is?

1. Credit , if you want to borrow per se. you force to consume by siginicat income.
For rich family, if you are poor family, by definition your are poor.
If your are rich, even you got 3 million dollar, you are have lifestyle, because the change is
not large.
Appreciate, MPC how wealthy you are, what is your expectation for the future.
To what I expect there will be increase or decrease in Income. Given family.
SO, how all this come together, consumption is pretty much based.
How do they change in consumption affect the GDP.
How it does it began to affect the GDP.
45* Degree line.
Output equal to Consumption.
Equilibrium fo the economy.
AD= C+I+G+(X-M)
Combination of ouptu equals aggreagete demand,
Representative of circular flow.
Production.
3 definition of GDP
1. Spending
2. Production
3. Income
Economy is must on the line, where should be .

Low output. High unemployment.

We then need to understand, what actually drive the consumption.

Two parts of consumption.

Independent of income, we also can say. Want to maintain kind of lifestyle.

Define wealt.

Really, all of your assets minus debt, give you net wort. Most valuable to you.

Broad Wealth = broad assets – debt.

Ability to earn. This is expected future earning.

Target broad wealth.

Okay, what we gonna then do. What would happen if this component affected.

Consider the case, target wealth is above the expected wealth.

What are you going to do.

In this case you haven’t reached the target.

Saving.

By Saing you are going to reduce the consumption

If above you actual

You reduce the consumption.

Affect the consumption behaviour.

HOUSEHOLD.

Housing market. Hot topic in Australia.

Housing market has a very propoert market. Very significal proportion.

What happen if there is a changed in actual price of housing.

Direct change of household wwealth.

What would happen if you bank, less to lend. Value of portperty come off. Reduce in value.

Change in credit constraints.

Reduce consumption, you hard to consume today.

Consumption smoothing,

Is reflected in aggreagete demand curve.

By C1.

AD Curve. Y = C + I + G + NX.

C = C0 + C1Y.

Investment,

Treted as autonomous, not depending on income.

AD = Y = C0 + C1Y + I

Equilibrium is intersect with 45 degrees line.

Multiplier process

Fall in investment =

Agregate demand comes off

Lower ouput and income

Further fall in demand and income

New Equlibrium.

Neet way to see this.

AD = C0 + Ci Y + I

It initially fall agreagte demand fals.

AD fall

Y Fall

A sequaence.

S1 = A reduction in I

Reduction in I in output, in the next period, become Ci I in the next output, Ci square times I + Ci
cube times I.

Reduce in economy is sum all of this.

There is a reason. This is a sequaence.

C1Si = CI + CI2 I + Ci4I + …….. (2)

1-2

S – C1S1 = I – CI n+1(I)

S1 = I/ 1-c

What this also means, Equilibrium, is set. Y = AD = C+I

Same expression. Two R are identical.

What is the most interesting about investment.

Grwoth in demand relatively small. Investment move quiet a lot. Growth in investment related
industrial investment

Manager of a firm, basically an owner.

What that mean is, gain more some cash.

Simply said, separated entity, into save money. Interest rate paid.

It could be capacity in another country or home country.

Investment in general, is broad to calculate in I.

Investment at home.

GDP from another country.

Number 4 is to definition of incetment.

What is incentives of this, if you are owner of the firm, you could consume now, save it.

Preference to consume now, is a discount.

How about investment, Generate profit.

3 different measure. Probably, high discount rate, interest rate, expect profit rate.

You choose to say, We actually look,

IF THERE IS DECREASE IN INTEREST RATE< INVESTMENT INCREASE.

Downward sloping associate it with it.

If there are no opportunity.

Choose not to invest it.

There are other major factor.

If you have expectation.

Expected way of profit. It lifts it up.

The whole thing is going to shift up.

Unsurprisingly increase the investment.

Higher forecast demand for firms output, increase in investment.

The other 2 factors.

The rest of model.

Government and export.

Government general speaking, quiet autonomous.

A shift in the innocent.

I=I

Import =X – mY

Marginal propensity to import.

Multiplier model one =

Disposable income Co new + C1 (1-t)Y