Please enable JavaScript.
Coggle requires JavaScript to display documents.
Week 3: Spending and output in the short run (Short- run equilibrium…
Week 3: Spending and output in the short run
Prices (and inflation)
In short period: prices are not fully flexible
Set prices for short time
Sustained changes in demand will make firms change their prices eventually
Menu costs
Aggregate expenditure
Planned aggregate expenditure:
AE = C + I + G + NX
Assume that all imports are purchased by households:
AE = C^d + I + G + X
C = C^d + M
(where C^d is domestically consumption and M is the imports)
Planned vs Actual expenditure
Differ due to: inventory investment because
actual investment = planned inventory investment + unplanned inventory investment
I^p = planned investment and I = actual investment
If sales were less than expected => I > I^p
If sales were more than expected => I < I^p
Planned aggregate spending
PAE = C^d + I^P + G + X
Consumer spending and the economy
Consumption function:
C^d = C^(-) + c(Y- T)
C^(-) is
exogenous consumption
: a variable whose value is determined from
outside
of the model (example: desired consumption, more optimistic)
Y - T = income after tax
c: amount by which consumption rises when disposal income rises by one dollar (0< c < 1). It is a
Marginal Propensity to Consume
parameter c:
slope
of the consumption function
Planned aggregate expenditure and output
Exogenous expenditure
: the portion of planned aggregate expenditure that is
independent
of output
Example: PAE = 980 + 0.8Y => 980 is the exogenous expenditure
Induced expenditure
: the portion of planned aggregate expenditure that
depends
on output
Example: PAE = 980 + 0.8Y => 0.8Y is the induced expenditure (
Y represents income or output
)
Short- run equilibrium output
during the short- run period in which prices are preset => firms produce an amount that is equal to planned aggregate expenditure =>
Y = PAE
Injections (INJ^p) = I^p + G + X
spending on domestic output that does not come from households' consumption expenditure (
exogenous expenditure
in the
economy
)
Withdrawals (W) = Saving (S) + Tax (T) + Imports (M)
part of income not used for consumption purposes
Equilibrium:
INJ^p = WD
Circular flow of income
: economy's national income which can be
equivalently measured
using the production, expenditure or income approaches
Disequilibrium:
PAE is differ from Y and INJ^p is differ from WD
PAE > Y or INJ^p > WD
PAE < Y or INJ^p < WD
Consumption and investment in the two- sector model
two- sector economy consisting of households and firms
households consumption function:
C = C^(-) + cY
(tax = 0 because no government sector)
savings in the two- sector model:
S = Y - C = -C^(-) + (1-c)Y
=> if no income =>
S = -C^(-)
=> funds to finance this consumption would come from reducing saving
Consumption + saving functions
graph
are in page 149
Investment
is regarded as
exogenous
determined by 2 factors:
Real interest rate
: represents the opportunity cost of the funds used to finance investment
Entrepreneur's expectations
: about the future profitability of proposed investment projects
The
horizontal investment function
reflects the assumption that investment does not change when GDP varies
The 45- degree diagram
The 45- degree line traces all the economy's points of equilibrium where planned aggregate expenditure equals GDP (
PAE = Y
)
Details in page 151
In two- sector economy:
PAE = C + I^p