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Lecture 3: Basic Aggregate Demand Model

Lecture 3: Basic Aggregate Demand Model. Goal: Determine equilibrium output Short-run A bit more complex than standard micro demand and supply Feedback Shortcuts (isolate one effect). First Model: The Goods Market. Production. Income. Demand. Demand Determined Output.

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Lecture 3: Basic Aggregate Demand Model

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  1. Lecture 3: Basic Aggregate Demand Model • Goal: Determine equilibrium output • Short-run • A bit more complex than standard micro demand and supply • Feedback • Shortcuts (isolate one effect)

  2. First Model: The Goods Market Production Income Demand

  3. Demand Determined Output • Aggregate demand (Z): • Z = C + I + G + (X-Q) • Aggregate supply: • fixed P • as much as needed to satisfy demand • Model: • behavioral equations • equilibrium conditions

  4. Behavioral Equations • X-Q = 0 (for now) • G and I: constant • C = c0 + c1*YD; c0>0 ; 0<c1<1 • YD = Y - T, T constant Z = (c0 - c1*T + I + G) + c1*Y

  5. Equilibrium Z(Y) = Y $ c1 c0+I+G-c1*T 45 Y* Y Y* = (1/ (1-c1)) * (c0-c1*T+I+G) multiplier autonomous spending

  6. Comparative Statics Fiscal contraction; consumption boom (stock market) $ c1 c0+I+G-c1*T 45 Y* Y Y* = (1/ (1-c1)) * (c0-c1*T+I+G)

  7. Consumer Confidence c0’<c0 $ c0+I+G-c1*T c0’+I+G-c1*T 45 Y1 Y0 Y(t+1) = Z(t) => (inventories) Other: C(t) = c0+0.5*c1* (Y(t)+Y(t-1)) Macroeconomic policy is tricky… lags and leads

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