macroeconomics National Income – a Simple Equilibrium Model 1

 Think a “regular” market  There are curves (demand, supply), or functions  And there is equilibrium  GDP we talked about last time is equilibrium  Call it ACTUAL  We can think about FUNCTIONS of national income  Call it DESIRED, or PLANNED  Y a = C a + I a + G a + Nx a  Desired aggregate expenditure AE = C + I + G + NX 2

 We are going to split all expenditures into two parts  Autonomous, E = f(Y)  Induced  Assume very simple economy  No trade  No government  AE = C + I 3

 Consumption function  C = C(Y) = C auto + MPC x Y D  Empirics  Reasoning  Keynesian consumption theory  Permanent-income theory 4

 Average propensity to consume  APC = C/Y D  Marginal propensity to consume  MPC = ΔC/ΔY D  ΔC = MPC x ΔY D  But then, what we do not consume we save  Macro definition of savings, S = Y - C  Average propensity to save  APS = S/Y D  Marginal propensity to save  MPS = ΔS/ΔY D  APC + APS = 1  MPC + MPS = 1 5

 Shifts in AE function:  Household wealth  Interest rates  Expectations  Other stuff 6

 Shifts in C function:  Household wealth  Interest rates  Expectations  Other stuff  They are also shifts in AE function!!! 7

 Equilibrium:  AE = Y a  Keynesian Cross 8

 Investment function  I = I(r, exp, …) 9

 AE = AE(Y) = C + I = (C auto + I) + MPC x Y D  Equilibrium: AE = Y  Shifts in AE and determination of Y a  A multiplier:  A (change in equilibrium Y)/(autonomous change in AE)  (simple) Multiplier = ΔY/ΔAE = 1/(1 – MPC)  Canadian multiplier 10