So increasing G, even if it is totally funded by T, will increase Y. The effect of G is always larger than that of T because G expands by the multiplier, which is always > 1, while T is multiplied by MPC, which never exceeds 1. With taxation, the consumption function becomes the following: C = a + m p c × ( Y d - T ) We must realize, however, that some government spending comes from taxes, which consumers view as a reduction in income. Government spending (G) also increases Y. Likewise, an increase in imports over exports (a decrease in NX) will decrease Y by the decrease in NX times the multiplier. An increase in exports over imports will increase aggregate output Y by the increase in NX times the expenditure multiplier. To make the model more realistic, we can easily add NX to the equation. We know that because investment fell and the marginal propensity to consume was > 0, so the fall was more than $194 billion, as expressed by the equation Y = (a + I) × 1/(1 − mpc). What happened to aggregate output? How do you know?Īggregate output fell by more than $232 billion − $38 billion = $194 billion. Practice calculating aggregate output in Exercise 2.ĭuring the Great Depression, investment (I) fell from $232 billion to $38 billion (in 2000 USD). 25, by contrast, would flatten Y ad and lead to a lower equilibrium: Y = 800 × 1 /. Y = 800 × 1/.25 = 800 × 4 = $3,200 billion because Y ad would have a much steeper slope.
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If the marginal propensity to consume were to increase to. If I increases to 600 billion, Y = 800 × 2 = $1,600 billion. So if a is 200 billion, I is 400 billion, and mpc is. This is called the expenditure multiplier and it is summed up by the following equation: Y = ( a + I ) × 1 / ( 1 - m p c ) Due to the upward slope of Y ad, aggregate output will increase more than the increase in I. We can now predict changes in aggregate output given changes in the level of I and C and the marginal propensity to consume (the slope of the C component of Y ad). If Y < Y ad, inventories will shrink below desired levels and firms will increase production. If Y > Y ad, inventory levels will be higher than firms want, so they’ll cut production. Equilibrium is reached via inventories (part of I).
WHAT DOES MPC 2 STAND FOR AND MULTPLIER 2 PLUS
The other line, the aggregate demand function, is the consumption function line plus planned investment spending I. The 45-degree line simply represents the equilibrium Y = Y ad. Mpc = marginal propensity to consume (change in consumer expenditure from an extra dollar of income or “disposable income ” it is a constant bounded by 0 and 1) Y d = disposable income, all that income above aĪ = autonomous consumer expenditure (food, clothing, shelter, and other necessaries) Keynes further explained that C = a + (mpc × Y d) I = investment (on new physical capital like computers and factories, and planned inventory)
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en./wiki/John_Hicks It begins with John Maynard Keynes’s recognition that Y = Y a d = C + I + G + N X What is the Keynesian cross diagram and what does it help us to do?ĭeveloped in 1937 by economist and Keynes disciple John Hicks, the IS-LM model is still used today to model aggregate output (gross domestic product, gross national product, etc.) and interest rates in the short run.What is the equation for C and why is it important?.What does this equation mean: Y = Y ad = C + I + G + NX?.