1. L EAKAGES VS. I NJECTIONS &T HE M ULTIPLIER IN A CTION Ch. 10 Instability or Self Adjustment

2. P REDICTIONS OF M ACRO F AILURE ( UNEMPLOYMENT, OUTPUT AND PRICES DON ’ T MEET GOALS ) In short run—they WILL occur In long run—they WILL persist In short run—they MAY occur In long run—they WON’T persist KeynesClassical Economists

3. I DEAL W ORLD : A T FULL EMPLOYMENT GDP, SUFFICIENT INCOME TO BUY ALL GOODS PRODUCED Leakages : Output that is lost to the circular flow Injections : Additions of spending to the circular flow Leakages and injections balance each other out. PROBLEM! Imbalances between income and output Instability where economic goals are met briefly

4. T HE R OOT OF F AILURES : I MBALANCES & I NSTABILITY Output that is lost to the circular flow Consumer / Business Saving Personal / Business Taxes Imports Additions of spending to the circular flow Investment Government Spending Exports LeakagesInjections

5. T HE C IRCULAR F LOW The focus of macro concern is whether desired injections will offset desired leakage at full employment. Full employment GDP is the value of total output (real GDP) produced at full employment. LO1

6. L EAKAGES AND I NJECTIONS Business taxes Household taxes Imports Saving Gross Business Saving (Dep. & Ret Earnings) INJECTIONS Exports Government spending Investment LEAKAGES Product market Factor market Business Firms Households (disposable income) LO1

7. C ONSUMER S AVING Saving is a primary leakage from the circular flow. Saving represents income not directly returned to the product markets. Paradox of Thrift: Impossible to save your way out of recession—dollars saved represent further consumption forgone, recession worsens LO1

8. S ELF A DJUSTMENT OR I NSTABILITY Self Adjustment (Classical) Injections =Leakages Full Employment GDP Flexible Interest Rates Savings won’t sit around long Flexible Price Levels Suppliers can lower prices to encourage spending again Instability (Keynes) Injections = Leakages No Full Employment GDP DESPITE Flexible Rates Lower Consumption hurts business expectations (why invest if no one is buying) DESPITE New Price Levels Expectations still stall investment

9. T HE M ULTIPLIER E FFECT “No holiday season”

10. “N O HOLIDAY SEASON ” Divide into 7 groups Each group assigned a short skit (1-3 minutes) 10 minutes to prepare Perform skits in sequence Describe each step in sequence on organizer Complete debriefing questions with group 5 minutes to complete 5 minutes for class discussion

11. D ISCUSSION Q UESTIONS Define the multiplier effect in your own words. What does the multiplier effect tell us about the chances for self-adjustment? Where do we see the multiplier effect today?

12. T HE M ULTIPLIER Multiple by which an initial change in spending will alter total spending as it moves through the circular flow of economic activity ad infinitum Multiplier=___1___ 1—MPC A “snowball effect”

13. T HE M ULTIPLIER LO2

14. T HE M ULTIPLIER P ROCESS 1. $100 billion in unsold goods appear 3. Income reduced by $100 billion4. Consumption reduced by $75 billion 5. Sales fall $75 billion 6. Further cutbacks in employment or wages 7. Income reduced by $75 billion more 8. Consumption reduced by $56.25 billion more Factor markets Product markets Business firms Households 9. And so on 2. Cutbacks in employment or wages LO2

15. T HE M ULTIPLIER C YCLES LO2

16. M ULTIPLIER C AVEATS … 1/1-MPC is OVERSIMPLIFIED U.S. MPC estimated at around 0.9 Should mean a multiplier of 10! REALITY: Multiplier is less than 2 What reduces the multiplier? Imports (as GDP grows, so do imports—a leakage) Inflation (change price levels) Income taxes(higher taxes  lower multiplier)

17. K EYNESIAN A DJUSTMENT IN A CTION LO2 1 st Action If leakages > injections Then producers reduce output & lay off workers 2 nd Step If Income falls Then consumer spending falls 3 rd Step If consumer spending falls Then producers will further reduce output & lay off more workers Why? The multiplier effect!

18. M ULTIPLIER E FFECTS Real Output (in billions of dollars per year) Price Level (average price) Q F = 3000 m a P0P0 26002900 AD 2 c  I = $100 billion  C = $300 billion b d AD 1 AS AD 0 LO2

19. C HECK FOR U NDERSTANDING If the MPC is 0.8 and investors have reduced planned investment by $100, by how much will the AD shift? How much of the shift is induced by the multiplier (not the original) Graph the recessionary gap

20. P RICE AND O UTPUT E FFECTS The impact of a shift in aggregate demand is reflected in both output and price changes. LO3

21. R ECESSIONARY GDP G AP The Multiplier’s overall scope is REDUCED by changes in price level As long as the aggregate supply curve is upward- sloping, the shock of any AD shift will be spread across output and prices. LO3

22. R ECESSIONARY GDP G AP The recessionary GDP gap is the amount by which equilibrium GDP falls short of full- employment GDP. The recessionary GDP gap equals the difference between equilibrium real GDP (Q E ) and full-employment real GDP (Q F ). Result=Cyclical Unemployment LO3

23. R ECESSIONARY GDP G AP REAL OUTPUT(in billions of dollars per year) PRICE LEVEL (average price) QEQE QFQF P0P0 PEPE AD 0 AD 2 AS c m a Recessionary GDP gap LO3

24. C LOSING THE G AP Trade-off unemployment reductions for inflation increases Explains why full employment is not the same as zero unemployment

25. C HECK FOR U NDERSTANDING Describe how the multiplier would work for an INCREASE in autonomous spending? MPC =0.75 Increase=Stimulus check of $250 What is the full shift of AD? What is induced? Graph the Inflationary Gap

26. N EXT S TEPS … Complete Unit 3 Study Guide Take Quia Quizzes on Chapters 8-10 Chapter 8 http://www.quia.com/quiz/2661735.html Chapters 9 & 10 http://www.quia.com/quiz/2681803.html I will use the best of the two scores TOMORROW: Test!