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Spending and Output in the Short Run

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shanae
72 diapositives · 919 Views · Sep 13, 2014

This overview explores the Keynesian model of economics, focusing on the relationship between spending and output in the short run. It discusses how inadequate aggregate spending can lead to recessionary gaps and highlights the crucial assumption that firms meet demand at preset prices due to factors like menu costs. By examining planned aggregate expenditure, including consumption, investment, government purchases, and net exports, the document illustrates how output is determined in the short run and the differences between planned and actual expenditures.

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  1. Spending and Output in the Short Run

  2. Introduction • Observations • Spending, in the short run, may not be sufficient to support a normal level of output. • Therefore, recessionary gaps are caused by insufficient aggregate spending. Chapter 13: Spending and Output in the Short Run

  3. Introduction • John Maynard Keynes • Economist, diplomat, financier, journalist, and patron of the arts • Publications include: • The Economic Consequences of the Peace • The General Theory of Employment, Interest, and Money Chapter 13: Spending and Output in the Short Run

  4. Introduction • John Maynard Keynes • The General Theory: • Revolutionized economic policy • Predicted that a decrease in aggregate spending could create a recessionary gap • Suggests that government policy could be used to restore full employment Chapter 13: Spending and Output in the Short Run

  5. The Keynesian Model’s Crucial Assumption: Firms Meet Demand at Preset Prices • In the short run, firms meet the demand for their products at preset prices. • Firms do not respond to every change in the demand for their products by changing their prices. • Instead, they typically set a price for some period, then meet the demand at that price. Chapter 13: Spending and Output in the Short Run

  6. The Keynesian Model’s Crucial Assumption: Firms Meet Demand at Preset Prices • In the short run, firms meet the demand for their products at preset prices. • By “meeting the demand,” we mean that firms produce just enough to satisfy their customers at the prices that have been set. Chapter 13: Spending and Output in the Short Run

  7. The Keynesian Model’s Crucial Assumption: Firms Meet Demand at Preset Prices • Meeting Demand at Preset Prices: • Is a logical management decision because of menu costs. • Menu costs – the costs of changing prices • Prices should be changed only if the benefit exceeds the menu cost. • In the long run firms will change prices. Chapter 13: Spending and Output in the Short Run

  8. The Keynesian Model’s Crucial Assumption: Firms Meet Demand at Preset Prices • Economic Naturalist • Will new technologies eliminate menu costs? • Keynesian theory assumes that menu cost prevent firms from changing prices. • Many new technologies (bar codes) have reduced menu cost and increased price flexibility. Chapter 13: Spending and Output in the Short Run

  9. The Keynesian Model’s Crucial Assumption: Firms Meet Demand at Preset Prices • Economic Naturalist • Will new technologies eliminate menu costs? • Pricing decisions also require market analysis, strategic considerations, and cost analysis. • These factors are a component of menu costs. Chapter 13: Spending and Output in the Short Run

  10. Planned Aggregate Expenditure • Planned Aggregate Expenditure • Total planned spending on final goods and services Chapter 13: Spending and Output in the Short Run

  11. Planned Aggregate Expenditure • The Components of Planned Aggregate Expenditure • Consumer expenditure or Consumption (C) • Household spending on durables, nondurables, and services Chapter 13: Spending and Output in the Short Run

  12. Planned Aggregate Expenditure • The Components of Planned Aggregate Expenditure • Investment (I) • New capital goods spending • New residential spending • Increases in inventories Chapter 13: Spending and Output in the Short Run

  13. Planned Aggregate Expenditure • The Components of Planned Aggregate Expenditure • Government purchases • Federal, state, and local spending on goods and services Chapter 13: Spending and Output in the Short Run

  14. Planned Aggregate Expenditure • The Components of Planned Aggregate Expenditure • Net exports • Exports - Imports Chapter 13: Spending and Output in the Short Run

  15. Planned Aggregate Expenditure • Planned Spending Versus Actual Spending • In the Keynesian model, output is determined by PAE. • Actual expenditures may not equal PAE. • If inventories are larger than expected: • I > planned investment (IP) • If inventories are smaller than expected: • I < IP Chapter 13: Spending and Output in the Short Run

  16. Planned Aggregate Expenditure • Example • Actual and planned investment • Fly-by-Night Kite Co. produces $5 million of kites per year. • Expected sales = $4.8 million and planned inventory = $200,000 • Capital expenditure = $1 million Chapter 13: Spending and Output in the Short Run

  17. Planned Aggregate Expenditure • Example • If actual sales are: • $4,600,000 instead of $4,800,000 • IP = $1,000,000 + $200,000 = $1,200,000 • I = $1,200,000 + $200,000 = $1,400,000 • I > IP • $4,800,000 • IP = $1.2 m. = I Chapter 13: Spending and Output in the Short Run

  18. Planned Aggregate Expenditure • Example • If actual sales are: • $5,000,000 • IP = $1,000,000 + $200,000 = $1,200,000 • I = $1,200,000 - $200,000 = $1,000,000 • I < IP Chapter 13: Spending and Output in the Short Run

  19. Planned Aggregate Expenditure • Planned Aggregate Expenditure Chapter 13: Spending and Output in the Short Run

  20. Planned Aggregate Expenditure • Hey Big Spender! Consumer Spending and the Economy • Consumption (C) accounts for two thirds of total spending • The primary determinant of C is disposable income or Y - T Chapter 13: Spending and Output in the Short Run

  21. Planned Aggregate Expenditure • Consumption Function • The relationship between consumption spending and its determinants, in particular, disposable (after-tax) income Chapter 13: Spending and Output in the Short Run

  22. Planned Aggregate Expenditure • Relating Consumption to Income and Other Determinants • The consumption function: • C = a constant; represents the non income determinants of C • Consumer optimism • Wealth • Real interest rates Chapter 13: Spending and Output in the Short Run

  23. Planned Aggregate Expenditure • Economic Naturalist • What effect did the 2000-2002 decline in the U.S. stock market values have on consumption spending? • From March 2000 to March 2002 the S&P 500 fell 49%. • Households lost $6.5 trillion of wealth in two years Chapter 13: Spending and Output in the Short Run

  24. Planned Aggregate Expenditure • Economic Naturalist • What effect did the 2000-2002 decline in the U.S. stock market values have on consumption spending? • $1 decrease in wealth reduces C by 3 to 7 cents/year • The $6.5 trillion loss could reduce C between $195 and $455 billion Chapter 13: Spending and Output in the Short Run

  25. Planned Aggregate Expenditure • Economic Naturalist • What effect did the 2000-2002 decline in the U.S. stock market values have on consumption spending? • C rose from 2000-2002 • Higher housing prices (greater wealth) • Lower interest rates • Increase in disposable income (Y – T) Chapter 13: Spending and Output in the Short Run

  26. Planned Aggregate Expenditure • Consumption Function • mpc = marginal propensity to consume • mpc = the amount by which consumption rises when disposable income rises by $1; 0 < mpc < 1 Chapter 13: Spending and Output in the Short Run

  27. Consumption function Slope = mpc C A Consumption Function Consumption spending C Disposable income Y-T Chapter 13: Spending and Output in the Short Run

  28. The U.S. Consumption Function, 1960-2004 Chapter 13: Spending and Output in the Short Run

  29. Planned Aggregate Expenditure • Planned Aggregate Expenditure and Output • The relationship between changes in production and income and PAE • C is a large part of PAE • C depends on Y • PAE depends on Y Chapter 13: Spending and Output in the Short Run

  30. Planned Aggregate Expenditure • Example • PAE = C + IP + G + NX • C = C + mpc(Y – T) • PAE = C + mpc(Y – T) + IP + G + NX • C = 620; mpc = 0.8; T = 250; IP= 220; G = 330; NX = 20 Chapter 13: Spending and Output in the Short Run

  31. Planned Aggregate Expenditure • Example • Then: Chapter 13: Spending and Output in the Short Run

  32. Planned Aggregate Expenditure • Example • If Y increases by $1, C will increase by 80 cents (mpc = 0.80) • C is part of PAE • PAE increases by 80 cents ($1 X 0.80) Chapter 13: Spending and Output in the Short Run

  33. Planned Aggregate Expenditure • Example • There are two parts to PAE: • Autonomous expenditure (960) • Is independent of output • Does not vary when output changes • Induced expenditure (0.8Y) • Depends on output (Y) Chapter 13: Spending and Output in the Short Run

  34. Planned Aggregate Expenditure • Example • PAE = autonomous expenditure + induced expenditure Chapter 13: Spending and Output in the Short Run

  35. Planned Aggregate Expenditure • Short-run Equilibrium Output • The level of output at which output Y equals planned aggregate expenditure PAE • The level of output that prevails during the period in which prices are predetermined Chapter 13: Spending and Output in the Short Run

  36. Planned Aggregate Expenditure • Short-run Equilibrium Output • Keynesian Assumption • Producers meet demand at preset prices in the short-run • Short-run equilibrium: Y = PAE Chapter 13: Spending and Output in the Short Run

  37. Planned Aggregate Expenditure • Short-run Equilibrium Output • Three ways to find short-run equilibrium output: • Table to compute Y – PAE = 0 • The Keynesian Cross • Algebra Chapter 13: Spending and Output in the Short Run

  38. (1) Output Y (2) Planned aggregate expenditure PAE = 960 + 0.8Y (3) Y - PAE (4) Y = PAE? 4,000 4,160 -160 No 4,200 4,320 -120 No 4,400 4,480 -80 No 4,600 4,640 -40 No 4,800 4,800 0 Yes 5,000 4,960 40 No 5,200 5,120 80 No Numerical Determination of Short-Run Equilibrium Output • Equilibrium: Y = PAE; Y (4,800) = PAE (4,800) • If Y = 4,000 < PAE = 960 + .8(4000) = 4,160 • If Y = 5,000 > PAE = 960 + .8(5,000) = 4,960 Chapter 13: Spending and Output in the Short Run

  39. Y = PAE Expenditure line PAE = 960 + 0.8Y Slope = 0.8 • Equilibrium • PAE intersects the 45o line @ 4,800 • Disequilibrium • < 4,800, PAE > Y • > 4,800, PAE < Y 960 45o 4,800 Determination of Short-Run Equilibrium Output (Keynesian Cross) Planned aggregate expenditure PAE Output Y Chapter 13: Spending and Output in the Short Run

  40. Y = PAE Expenditure line PAE = 960 + 0.8Y Slope = 0.8 • Equilibrium Algebraically • At equilibrium: PAE = C + Ip + G + NX • PAE = 960 + 0.8Y • 0.2Y = 960 • Y = 960/0.2 = 4,800 = equilibrium 960 45o 4,800 Determination of Short-Run Equilibrium Output (Keynesian Cross) Planned aggregate expenditure PAE Output Y Chapter 13: Spending and Output in the Short Run

  41. Y = PAE Expenditure line PAE = 960 + 0.8Y Expenditure line PAE = 950 + 0.8Y E A decline in autonomous aggregate expenditure (C) shifts the expenditure line down F 960 950 Recessionary gap 45o 4,750 4,800 Y* A Decline In Planned Spending Leads to a Recession Planned aggregate expenditure PAE Output Y Chapter 13: Spending and Output in the Short Run

  42. (1) Output Y (2) Planned aggregate expenditure PAE = 960 + 0.8Y (3) Y - PAE (4) Y – PAE? 4,600 4,630 -30 No 4,650 4,670 -20 No 4,700 4,710 -10 No 4,750 4,750 0 Yes 4,800 4,790 10 No 4,850 4,830 20 No 4,900 4,870 30 No 4,950 4,910 40 No 5,000 4,950 50 No Determination of Short-Run Equilibrium Output After a Fall In Spending • If Y = 4,800 > PAE = 4,790 • Y = PAE @ 4,750 • Output Gap: Y* (4,800) > Y (4,750) Chapter 13: Spending and Output in the Short Run

  43. Planned Aggregate Expenditure • Observations • Other factors remaining constant, a decline in autonomous spending causes short-run equilibrium output to fall and creates a recessionary gap. • A decrease in autonomous spending can be caused by a reduction in C, IP, G, and/or NX. Chapter 13: Spending and Output in the Short Run

  44. Planned Aggregate Expenditure • Economic Naturalist • Why was the deep Japanese recession of the 1990s bad news for the rest of East Asia? • Recession in Japan reduced Japanese imports • The decline in East Asian exports to Japan reduced domestic spending in non-export sectors Chapter 13: Spending and Output in the Short Run

  45. Planned Aggregate Expenditure • Economic Naturalist • What caused the 2001 recession in the United States? • Reduction in investment spending Chapter 13: Spending and Output in the Short Run

  46. Planned Aggregate Expenditure • Income-Expenditure Multiplier • The effect of a 1-unit increase in autonomous expenditure on short-run equilibrium output • For example, a multiplier of 5 means that a 10-unit decrease in autonomous expenditure reduces short-run equilibrium output by 50 units Chapter 13: Spending and Output in the Short Run

  47. Planned Aggregate Expenditure • The Multiplier • Recall • PAE = 960 + 0.8Y, equilibrium Y = 4,800 • C fell by 10 • PAE = 950 + 0.8Y, equilibrium Y = 4,750 Chapter 13: Spending and Output in the Short Run

  48. Planned Aggregate Expenditure • The Multiplier Effect • The decrease in the equilibrium Y was 5 times the fall in C. • The income-expenditure multiplier equaled 5. • The size of the multiplier is influenced by the mpc. Chapter 13: Spending and Output in the Short Run

  49. Planned Aggregate Expenditure • What Do You Think? • Why is the change in equilibrium Y a multiple of the change in autonomous spending? Chapter 13: Spending and Output in the Short Run

  50. Stabilizing Planned Spending: The Role of Fiscal Policy • In the Keynesian Model: • Recessionary and expansionary gaps are caused by inadequate or excessive spending, respectively. • Stabilization policies are used to affect planned aggregate expenditures to eliminate output gaps. Chapter 13: Spending and Output in the Short Run