AGREGATE DEMAND AND BUSINESS CYCLES dr. Aleksandar Kešeljević Faculty of Economics University of Ljubljana Assistant professor.

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AGREGATE DEMAND AND BUSINESS CYCLES dr. Aleksandar Kešeljević Faculty of Economics University of Ljubljana Assistant professor

THREE MAIN TOPICS A.AD, CONSUMPTION AND INVESTMENT (Ch. 21) B. BUSINESS CYCLES AND AGGREGATE DEMAND (Ch. 22) C. TODAY’S CRISIS

A. AGREGATE DEMAND 1. CONSUMPTION (C) 2. INVESTMENT (I) 3. GOVERNMENT EXPENDITURES (G) 4. NET EXPORTS (NX)

1. CONSUMPTION AD= C+I+G+NX Y= C + S → C = f (Y) C = 55% GDP Family budget expenditures (P) Consumption function (P) Marginal propensity to consume (MPC) (P) MPC + MPS = 1 Hypothesis (classical, Friedman, Modigliani) Determinants of consumption (DI, weath, live cycle,…)

P: Family budget expenditures

P: Consumption function

P: MPC

Saving Y= C + S The saving function (P4) MPS = 1 – MPC Paradoks of saving (S ↑ →C ↓ →AD ↓ → Y ↓ → S ↓) S = f (Y, i, T, social security system, financial markets, inflation…..)

P: The saving function

2. INVESTMENT Double role of I (AD= C+I+G+NX; AS) The investment demand curve (P) Determinants of investments (revenues, costs, expectations) (P) Investments and saving S= I

P: The investment demand curve

P: Determinants of ivestments

3. GOVERNMENT EXPENDITURES AD= C + I + G + NX Comparasion: G/BDP, T/BDP (P7) G T

P: Governement spending

P: Governement taxation

Functions of the governement (improving economic efficiency, reducing economic inequality, stabilizing through macroeconomic policies, international economic policy) Social state and governement expenditures → no such a thing as a free lunch! Governement expenditures (state, local) Today’s crisis and the role of the government

4. NET EXPORTS AD= C + I + G +NX EX- IM =NX X = f (Y F, e) M = f (Y D, e) e = exchange rate (mechanism,…)

P: AD = C + I + G + NX

B. BUSINESS CYCLES AND AGGREGATE DEMAND 1.BUSINESS CYCLES 2.ANTICYCLICAL POLICY 3.THE MULTIPLIER MODEL

1. BUSINESS CYCLES Business cycles are fluctuations in output, income, employment, inventiries usually lasting 2 to 10 years Four phases (peak, contraction or recession, trough, expansion) (P) Recession occurs when real GDP has declined for two consecutive calendar quaters

P: Four phases of business cycle

P: Business activity since 1919

Internal theories (multiplicator theory, monetary theory, political theories, real cycle theory,….) External reasons (wars, oil shocks, revolutions, elections, gold expeditions, migrations, new world,.....)

2. ANTICYCLICAL POLICY Business cycles forecasting Discretionary policy versus rules Anti-cyclical policy Automatic (or built in) stabilizers EU, EMU

3. THE MULTIPLIER MODEL How output is determined in the short run? How changes in spending (AD) get translated into changes in output and employment? ∆ GDP = m * ∆ AD Three approaches: AS-AD, I=S, Keynesian cross Advantages/disadavantages

Multiplier: I ↑ → GDP ↑

AS-AD APPROACH: AD ↓ → GDP ↓

KEYNESIAN CROSS APPROACH

NUMERICAL ANALYSIS ∆ GDP = m * ∆ AD GDP = C +I+G+NX; I, G, NX=0 → ∆ GDP= ∆C ∆Y=1000 (Y=C+S) 1000+666+444+296+……= 3000 1 + r + r2 +...= 1 ∕ (1-r) = 1 ∕ (1- MNP)= 1∕MPS ∆GDP = 1 ∕ (1-MPC) * ∆ AD = (1 / MPS) * ∆ AD

MULTIPLIERS Investment multiplier Government expenditures multiplier Tax multiplier

Investment and government expenditures multipliers ∆ GDP = 1/MPS * ∆I investment multiplier ∆ GDP = 1/MPS * ∆G government expenditure multiplier

Tax multiplier T ↑ → AD ↓ → GDP ↓ T↓ → AD ↑ → GDP ↑ ∆ GDP = MPC/MPS * ∆T tax multiplier

Tax multiplier

FISCAL POLICY IN THE MULTIPLIER MODEL ∆ GDP = 1/MPS * ∆G r ∆ GDP = MPC/MPS * ∆T mt = mg * MPC mt < mg Tax mupliplier= MPC * expenditure multiplier Consequences for fiscal policy and its affect on output

AD vs. AS -Supply side economics -AS (not AD) in the center of interest -Laffer curve -Privatization, deregulation, liberalisation -USA, GB in the 1980’s -Effect of moving AS curve

C. TODAY’S CRISIS Crisis is like pretty woman: Hard to define but recognizable when encountered (Goldsmith) Crisis: financial, economic, social, political, sistemic aspect

Main reasons too expansive monetary policy fast liberalization of capital markets and inovative financial instruments booms and baloons bad regulation in the financial sector (grey banking) structural reasons (w/GDB↓) bad corporate governance

WALL STREET-MAIN STREET (“We are 99”)

SOLUTIONS AND COSTS Screenplay for the movie Apokalipsa Restoring the confidence and trust among population and banks (government guarantees of bank deposits, recapitalization of banks,…) Coordinated action of CB ( ↓ i, liquidity trap, QE3) Fiscal policy stimulus packages Fiscal measures: government debt guarantees, injection of capital, purchases of assets, take-overs by the government (state ownership), Funding: IMF, WB, the role of rising China ESFS, EFSM (2013), ESM (2013→) Fiscal deficits and public debt (P)

P: Public debt/GDP (%) 20072011 Germany64,982,4 Irland25,0112,0 France63,984,7 Italy103,6120,3 Belgium84,297,0 Greece105,4158 Spain36,168,1 Slovenia23,142,8 Czech Republik29,041,3 Croatia33,240,4 EMU-1766,287,8 EU2759,082,3

Not every country in the same position (crisis on crisis, free rider) Different approaches: In EU not enough manoeuvring space for economic policy, EU is not a federal state as USA, EU27 more modest (3% GDP) than USA (different ES), differences regarding FED and ECB American elections (Obama, Romney)

Dilemmas Dilemma 1: to much from taxpayers viewpoint or to little to solve the problem (P) Dilemma 2: moral solution and deep recession or vice versa Dilemma 3: exit or relying on others (PIGS) Dilemma 4: market or the state Dilema 5: socialist instruments or more market Dilemma 6: austerity measures or higher spending. Are austerity measures effective?

Implications for the Capitalism? Is capitalism dead, We are 99 Enormous creation of well being until today by capitalism (1980-2008 GDP↑ 145%, 3,4% annually) Is socialism an alternative? (not hamper the markets, not all regulation will be wise) Capitalism will not be the same afterwards → today market the only game and enemy in town Regulation: Institutional reforms, corporate responsibility, business ethics, corporate governance, living within the personal limits,…

Better days It is not as bad, as it sounds… (M. Twain)

Gini Coefficient World 2011

HDI World in 2011

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