1. Keynesian Cross Add G and NX 1

2. What we have so far: AE = C + I = C auto + MPC x Y D = a + bY + I = (a + I) + bY But recall, Y = C + I + G + NX Government: o Does whatever it wants to o Assume the simplest: discretionary G o Remember, purchases not transfers! o Financing government: o Taxes T = tY o Net tax rate o Marginal propensity to tax o T is ALL net taxes o Taxes net of transfers o Taxes by all levels of government Disposable: o Y D = Y – T = Y – tY = (1 – t)Y 2

3. Net Export NX = X – IM How would what the foreigners buy depend on our income? X is autonomous How would IM depend on Y? IM = mY o Marginal propensity to import NX = X – mY o Graphically Shifts in NX o Foreign income => shift X => shift NX o Relative prices Shift X Rotate IM (Shift + rotate) NX Exchange rate and relative prices 3

4. Equilibrium Y Y = C + I + G + NX o C = a + bY D = a + b(1 – t)Y o I = I o G = G o NX = X – IM = X – mY AE = C + I + G + NX = (a + I + G + X) + [b(1 – t) – m]Y o Marginal propensity to spend z = b(1 – t) – m < b Equilibrium Y, graphically 4

5. Multiplier without trade and without government o Multiplier = 1/(1 – MPC) o Because MPC = slope of AE With trade and government o Slope of AE = b(1 – t) – m = MPC(1 – t) – m 5

6. Shifting curves: o Change in (autonomous) X o Change in NX o Fiscal policy o Manipulating G and/or T o Stabilization policy o Potential GDP and fiscal stabilization policy, graphically o Changes in G o Shift in AE o Changes in t o Rotate AE o Because b(1 – t) – m No talk about production One says this model shows GDP as demand- determined 6