1. Aggregate Expenditures: The Multiplier, Net Exports, and Government CHAPTER TEN

2. CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 20 I g0 430 450 470 490 510 Equilibrium GDP at I g0 level of investment S (C + I g ) 0

3. CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 20 I g0 430 450 470 490 510 Equilibrium GDP at I g0 level of investment S (C + I g ) 0 If I g increases...

4. CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o (C + I g ) 1 Real domestic product, GDP (billions of dollars) 510490470450430 20 I g0 I g1 430 450 470 490 510 Equilibrium GDP at I g1 level of investment S (C + I g ) 0

5. Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 20 I g0 430 450 470 490 510 Equilibrium GDP at I g0 level of investment (C + I g ) 0 S CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER If I g decreases...

6. Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o (C + I g ) 2 Real domestic product, GDP (billions of dollars) 510490470450430 20 I g0 I g2 430 450 470 490 510 Equilibrium GDP at I g2 level of investment (C + I g ) 0 S CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER

7. THE MULTIPLIER EFFECT Multiplier = change in real GDP initial change in spending OR Change in GDP = Multiplier x initial change in spending Rationale - $ spent in the economy is earned by others as income. Others go and spend part of their income and so on, and so on…

8. Change in GDP = Multiplier x initial change in spending and the marginal propensities.... Inverse relationship between Multiplier & MPS SimplifiedMultiplier = OR 1 MPS1 1 - MPC THE MULTIPLIER EFFECT How much will a dollar spent, not saved have an impact on the economy?

9. The Multiplier Effect The multiplier helps us understand that spending changes are magnified when applied to the economy. This is especially important for fiscal policy considerations! The complex multiplier current being applied by the President is 2. Remember the simple multiplier only takes into effect the leakage of savings. Complex takes into effect taxes and imports.

10. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT NET EXPORTS

11. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT NET EXPORTS Positive if exports > imports

12. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT NET EXPORTS Positive if exports > imports Negative if imports > exports

13. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT NET EXPORTS Positive if exports > imports Negative if imports > exports Now C + I + (x-m) or C + I + X n g g

14. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 +5-5 430 450 470 490 510 C + I g Equilibrium GDP at net export = 0 level

15. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 +5-5 430 450 470 490 510 C + I g Equilibrium GDP at net export = 0 level Toillustrate positive net exports

16. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 +5-5 430 450 470 490 510 C + I g Equilibrium GDP at positive net export level X n1 X n1 C + I g + X n1

17. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 +5-5 430 450 470 490 510 C + I g Equilibrium GDP at net export = 0 level Toillustrate negative net exports

18. INTERNATIONAL TRADE EQUILIBRIUM OUTPUT Private spending (billions of dollars) Saving and investment (billions of dollars) o o 45 o Real domestic product, GDP (billions of dollars) 510490470450430 +5-5 430 450 470 490 510 C + I g X n2 Equilibrium GDP at negative net export level X n2 C + I g + X n2

19. International Economic Linkages…These shift the net export curve. International Economic Linkages…These shift the net export curve. Prosperity Abroad Prosperity Abroad The more prosperous our trading partners are we will likely see an increase in exports.

20. International Economic Linkages... Prosperity Abroad Prosperity Abroad Tariffs Tariffs Prosperity Abroad Prosperity Abroad Tariffs Tariffs Tariffs imposed by other countries on our products will reduce our Exports.

21. International Economic Linkages... Linkages... Prosperity Abroad Prosperity Abroad TariffsTariffs Exchange Rates Exchange Rates Prosperity Abroad Prosperity Abroad TariffsTariffs Exchange Rates Exchange Rates Depreciation of the $ will cause exports to increase. We also Won’t buy as many imports as they will be more expensive.

22. ADDING THE PUBLIC SECTOR o 45 o Real domestic product, GDP (billions of dollars) 5030 0 470 510 550 C + I g + X n Real domestic product, GDP (billions of dollars) 470 510 550 C I g + X S+M C + I g + X n + G (billions of dollars) S a +M+T, I g + X + G (billions of dollars) Show the effect of government spending

23. ADDING THE PUBLIC SECTOR o 45 o Real domestic product, GDP (billions of dollars) 5030 0 470 510 550 C + I g + X n + G Equilibrium GDP after $20 billion government spending C + I g + X n Real domestic product, GDP (billions of dollars) 470 510 550 C I g + X I g + X + G S+M Government spending $20 billion Government spending $20 billion C + I g + X n + G (billions of dollars) S a +M+T, I g + X + G (billions of dollars)

24. C + I g + X n + G (billions of dollars) S a +M+T, I g + X + G (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 5030 0 490 550 490 550 C + I g + X n + G Impact of taxes on equilibrium GDP Real domestic product, GDP (billions of dollars) I g + X I g + X + G S+M $15 billion decrease in consumption 490 550 490 550 $20 billion increase in taxes ADDING THE PUBLIC SECTOR

25. C + I g + X n + G (billions of dollars) S a +M+T, I g + X + G (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 5030 0 490 550 490 550 C + I g + X n + G Impact of taxes on equilibrium GDP Real domestic product, GDP (billions of dollars) I g + X I g + X + G S+M $15 billion decrease in consumption 490 550 490 550 $20 billion increase in taxes ADDING THE PUBLIC SECTOR To illustrate a $20 billion tax increase To illustrate a $20 billion tax increase Lump-Sum Taxes

26. C + I g + X n + G (billions of dollars) S a +M+T, I g + X + G (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 5030 0 490 550 490 550 C + I g + X n + G Impact of taxes on equilibrium GDP Real domestic product, GDP (billions of dollars) I g + X I g + X + G S+M $15 billion decrease in consumption $5 billion decrease in saving 490 550 490 550 S a +M S a +M+T C a + I g + X n + G $20 billion increase in taxes ADDING THE PUBLIC SECTOR

27. C + I g + X n + G (billions of dollars) S a +M+T, I g + X + G (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 5030 0 490 550 490 550 C + I g + X n + G Impact of taxes on equilibrium GDP Real domestic product, GDP (billions of dollars) I g + X I g + X + G S+M $15 billion decrease in consumption $5 billion decrease in saving 490 550 490 550 S a +M S a +M+T C a + I g + X n + G $20 billion increase in taxes ADDING THE PUBLIC SECTOR BalancedBudgetMultiplier

28. Real GDP (billions of dollars) o 45 o 490 510 530 (C + I g + X n + G) 0 Full Employment Private and government spending (billions of dollars) Recessionary gap - When aggregate expenditures are inadequate to bring about full employment Recessionary gap - When aggregate expenditures are inadequate to bring about full employment ADDING THE PUBLIC SECTOR

29. Real GDP (billions of dollars) (C + I g + X n + G) 1 o 45 o 490 510 530 (C + I g + X n + G) 0 Full Employment } Recessionary Gap = $5 billion Private and government spending (billions of dollars) Recessionary gap - When aggregate expenditures are inadequate to bring about full employment Recessionary gap - When aggregate expenditures are inadequate to bring about full employment ADDING THE PUBLIC SECTOR

30. Real GDP (billions of dollars) o 45 o 490 510 530 Full Employment Private and government spending (billions of dollars) ADDING THE PUBLIC SECTOR Inflationary gap - When aggregate expenditures are greater than the full employment level causing demand-pull inflation Inflationary gap - When aggregate expenditures are greater than the full employment level causing demand-pull inflation (C + I g + X n + G) 0

31. Real GDP (billions of dollars) o 45 o 490 510 530 (C + I g + X n + G) 0 Full Employment Private and government spending (billions of dollars) ADDING THE PUBLIC SECTOR (C + I g + X n + G) 1 { Inflationary Gap = $5 billion Inflationary Gap = $5 billion Inflationary gap - When aggregate expenditures are greater than the full employment level causing demand-pull inflation Inflationary gap - When aggregate expenditures are greater than the full employment level causing demand-pull inflation

32. Historical Applications... Great Depression Great Depression

33. Historical Applications... Great Depression Great Depression Overcapacity & Business Indebtedness Overcapacity & Business Indebtedness

34. Historical Applications... Great Depression Great Depression Overcapacity & Business Indebtedness Overcapacity & Business Indebtedness Decline in Residential Construction Decline in Residential Construction

35. Historical Applications... Great Depression Great Depression Overcapacity & Business Indebtedness Overcapacity & Business Indebtedness Decline in Residential Construction Decline in Residential Construction Stock Market Crash Stock Market Crash

36. Historical Applications... Great Depression Great Depression Overcapacity & Business Indebtedness Overcapacity & Business Indebtedness Decline in Residential Construction Decline in Residential Construction Stock Market Crash Stock Market Crash Shrinking Money Supply Shrinking Money Supply

37. Historical Applications... Great Depression Great Depression Overcapacity & Business Indebtedness Overcapacity & Business Indebtedness Decline in Residential Construction Decline in Residential Construction Stock Market Crash Stock Market Crash Shrinking Money Supply Shrinking Money Supply Vietnam War Inflation Vietnam War Inflation

39. Recessionary gapRecessionary gap Inflationary gapInflationary gap Multipliers: Simple, Tax, and balanced-budget multiplierMultipliers: Simple, Tax, and balanced-budget multiplier Lump-sum taxLump-sum tax Recessionary gapRecessionary gap Inflationary gapInflationary gap Multipliers: Simple, Tax, and balanced-budget multiplierMultipliers: Simple, Tax, and balanced-budget multiplier Lump-sum taxLump-sum tax

40. Coming Next: AGGREGATE DEMAND AND AGGREGATE SUPPLY AGGREGATE DEMAND AND AGGREGATE SUPPLY CHAPTER 11