Shortrun Macroeconomic

1
Short-run Macroeconomic Equilibrium
2
Short-run Macroeconomic Equilibrium

• Background to the Theory

3
A simplified circular flow of income model
4
A simplified circular flow of income model
Cd
5
A simplified circular flow of income model
Cd
Incomes
6
A simplified circular flow of income model
Cd
Incomes
W S T M
7
A simplified circular flow of income model
J I G X
Cd
Incomes
W S T M
8
BACKGROUND TO THE THEORY

• Defining aggregate demand and national income
• The 45 line diagram
• the significance of the 45 line

9
The 45 line
Cd, W, J
Cd W (Y)
O
Y
10
BACKGROUND TO THE THEORY

• Defining aggregate demand and national income
• The 45 line diagram
• the significance of the 45 line
• Consumption

11
BACKGROUND TO THE THEORY

• Defining aggregate demand and national income
• The 45 line diagram
• the significance of the 45 line
• Consumption
• the consumption function
• the mpc

12
The consumption function
Y
C
Consumption (bn)
50
50
Y (bn)
13
Different consumption functions (a)
Y
C1
Consumption (bn)
Y (bn)
14
Different consumption functions (b)
Y
C2
Consumption (bn)
Y (bn)
15
Different consumption functions (c)
Y
C3
Consumption (bn)
Y (bn)
16
Different consumption functions (d)
Y
C4
Consumption (bn)
Y (bn)
17
BACKGROUND TO THE THEORY

• Defining aggregate demand and national income
• The 45 line diagram
• the significance of the 45 line
• Consumption
• the consumption function
• the mpc
• other determinants of consumption

18
BACKGROUND TO THE THEORY

• Defining aggregate demand and national income
• The 45 line diagram
• the significance of the 45 line
• Consumption
• the consumption function
• the mpc
• other determinants of consumption
• short-run and long-run consumption functions

19
Long-run and short-run consumption functions
Y
Consumption (bn)
Y (bn)
20
Long-run and short-run consumption functions
Y
Clong run
C10 years time
C5 years time
Cnow
Consumption (bn)
Y (bn)
21
BACKGROUND TO THE THEORY

• Defining aggregate demand and national income
• The 45 line diagram
• the significance of the 45 line
• Consumption
• the consumption function
• the mpc
• other determinants of consumption
• short-run and long-run consumption functions
• the consumption of domestically produced goods

22
The consumption of domestic product
Y
C
Cd
Consumption (bn)
Y (bn)
23
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving

24
UK consumption and saving
m
Disposable income
25
UK consumption and saving
m
Disposable income
26
UK consumption and saving
m
Disposable income
Consumer expenditure
27
Household saving as of personal disposable
income
Source Datastream
28
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions

29
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions
• the tax rate and the mpt

30
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions
• the tax rate and the mpt
• expenditure taxes and Cd

31
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions
• the tax rate and the mpt
• expenditure taxes and Cd
• imports import functions

32
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions
• the tax rate and the mpt
• expenditure taxes and Cd
• imports import functions
• the mpm

33
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions
• the tax rate and the mpt
• expenditure taxes and Cd
• imports import functions
• the mpm
• effect of imports on Cd

34
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions
• the tax rate and the mpt
• expenditure taxes and Cd
• imports import functions
• the mpm
• effect of imports on Cd
• the withdrawals function

35
BACKGROUND TO THE THEORY

• Withdrawals
• net saving the saving function
• the mps
• determinants of saving
• net taxes tax functions
• the tax rate and the mpt
• expenditure taxes and Cd
• imports import functions
• the mpm
• effect of imports on Cd
• the withdrawals function
• the mpw

36
The W and Cd functions
Cd, W
O
Y
37
BACKGROUND TO THE THEORY

• Injections
• investment
• increased consumer demand
• expectations
• cost and efficiency of capital
• rate of interest
• government expenditure
• exports
• the injections function

38
The injections and withdrawals functions
Cd, W, J
W
J
O
Y
39
Short-run Macroeconomic Equilibrium

• Determination of National Income

40
DETERMINATION OF NATIONAL INCOME

• Equilibrium national income
• withdrawals equal injections

41
Deriving equilibrium national income
Cd, W, J
O
Y
42
Deriving equilibrium national income
Cd, W, J
O
Y1
Y
43
Deriving equilibrium national income
Cd, W, J
W
J
O
Y
44
Deriving equilibrium national income
Cd, W, J
W
J
O
Ye
Y
45
DETERMINATION OF NATIONAL INCOME

• Equilibrium national income
• withdrawals equal injections
• income equals expenditure

46
Deriving equilibrium national income
Cd, W, J
W
J
O
Y
47
Deriving equilibrium national income
Cd, W, J
Y Cd W
W
J
O
Y
48
Deriving equilibrium national income
Cd, W, J
Y Cd W
E Cd J
Cd
W
J
O
Y1
Y
49
Deriving equilibrium national income
Cd, W, J
Y Cd W
E Cd J
Cd
W
J
O
Y2
Y
50
Deriving equilibrium national income
Cd, W, J
Y Cd W
E Cd J
Cd
W
J
O
Ye
Y
51
DETERMINATION OF NATIONAL INCOME

• Equilibrium national income
• withdrawals equal injections
• income equals expenditure
• The multiplier introduction

52
DETERMINATION OF NATIONAL INCOME

• Equilibrium national income
• withdrawals equal injections
• income equals expenditure
• The multiplier introduction
• the circular flow of income and effects of
  changes in injections

53
A simplified circular flow of income model
J I G X
Cd
Incomes
W S T M
54
DETERMINATION OF NATIONAL INCOME

• Equilibrium national income
• withdrawals equal injections
• income equals expenditure
• The multiplier introduction
• the circular flow of income and effects of
  changes in injections
• definition of the multiplier ?Y/?J

55
DETERMINATION OF NATIONAL INCOME

• The multiplier the withdrawals and injections
  approach
• graphical analysis shift in the J line

56
The multiplier (a) a shift in injections
W, J
W
J1
O
Y
57
The multiplier (a) a shift in injections
W, J
W
J2
a
J1
O
Ye1
Y
58
DETERMINATION OF NATIONAL INCOME

• The multiplier the withdrawals and injections
  approach
• graphical analysis shift in the J line
• the formula 1 / mpw or 1 / (1 mpcd )

59
The multiplier (a) a shift in injections
W, J
W
b
J2
J2
a
J1
J1
O
Ye1
Ye2
Y
60
The multiplier (a) a shift in injections
W, J
W
b
J2
J2
a
J1
J1
O
Ye1
Ye2
Y
61
DETERMINATION OF NATIONAL INCOME

• The multiplier the withdrawals and injections
  approach
• graphical analysis shift in the J line
• the formula 1 / mpw or 1 / (1 mpcd )
• numerical illustration

62
DETERMINATION OF NATIONAL INCOME

• The multiplier the withdrawals and injections
  approach
• graphical analysis shift in the J line
• the formula 1 / mpw or 1 / (1 mpcd )
• numerical illustration
• the withdrawals multiplier

63
The multiplier (b) a shift in withdrawals
W, J
W1
a
J
O
Ye1
Y
64
The multiplier (b) a shift in withdrawals
W, J
W1
W2
a
J
O
Ye1
Y
65
The multiplier (b) a shift in withdrawals
W, J
W1
W2
a
c
J
O
Ye1
Y
Ye2
66
DETERMINATION OF NATIONAL INCOME

• The multiplier the withdrawals and injections
  approach
• graphical analysis shift in the J line
• the formula 1 / mpw or 1 / (1 mpcd )
• numerical illustration
• the withdrawals multiplier
• The multiplier the income and expenditure
  approach

67
DETERMINATION OF NATIONAL INCOME

• The multiplier the withdrawals and injections
  approach
• graphical analysis shift in the J line
• the formula 1 / mpw or 1 / (1 mpcd )
• numerical illustration
• the withdrawals multiplier
• The multiplier the income and expenditure
  approach
• graphical analysis

68
The multiplier (c) a shift in the expenditure
curve
E, W, J
Y
E1
O
Y
69
The multiplier (c) a shift in the expenditure
curve
E, W, J
Y
E2
E1
O
Ye1
Ye2
Y
70
The multiplier (c) a shift in the expenditure
curve
E, W, J
Y
E2
E1
a
O
Ye1
Ye2
Y
71
DETERMINATION OF NATIONAL INCOME

• The multiplier the withdrawals and injections
  approach
• graphical analysis shift in the J line
• the formula 1 / mpw or 1 / (1 mpcd )
• numerical illustration
• the withdrawals multiplier
• The multiplier the income and expenditure
  approach
• graphical analysis
• numerical illustration

72
DETERMINATION OF NATIONAL INCOME

• The multiplier some qualifications
• deriving the mpcd from the mpc
• effects of changes in one injection or withdrawal
  on other ones
• Relationship between the 45 line diagram and the
  AD and AS diagram

73
Showing the multiplier effect on the 45o line and
AD/AS diagrams
Y
Cd, W, J
O
Y
Ye1
74
Showing the multiplier effect on the 45o line and
AD/AS diagrams
P
Y
O
Y
Cd, W, J
E1
O
Y
Ye1
75
Showing the multiplier effect on the 45o line and
AD/AS diagrams
P
AS
AD1
Y
O
Y
E2
Cd, W, J
E1
O
Y
Ye2
Ye1
76
Showing the multiplier effect on the 45o line and
AD/AS diagrams
P
AS
AD1
Y
O
Y
E2
Cd, W, J
E1
O
Y
Ye2
Ye1
77
Short-run Macroeconomic Equilibrium

• Simple Keynesian Analysis of Unemployment and
  Inflation

78
UNEMPLOYMENT AND INFLATION

• The deflationary gap
• withdrawals and injections approach

79
The deflationary gap
W, J
W
J
O
Ye
Y
80
The deflationary gap
W, J
W
J
O
Ye
YF
Y
81
UNEMPLOYMENT AND INFLATION

• The deflationary gap
• withdrawals and injections approach
• income and expenditure approach

82
The deflationary gap
W, J, E
Y
E
O
Ye
YF
Y
83
The deflationary gap
W, J, E
Y
E
O
Ye
YF
Y
84
The deflationary gap
W, J, E
Y
E
a
b
Deflationary gap
W
c
J
d
O
Ye
YF
Y
85
UNEMPLOYMENT AND INFLATION

• The deflationary gap
• withdrawals and injections approach
• income and expenditure approach
• The inflationary gap

86
UNEMPLOYMENT AND INFLATION

• The deflationary gap
• withdrawals and injections approach
• income and expenditure approach
• The inflationary gap
• withdrawals and injections approach

87
The inflationary gap
W, J
W
J
O
Ye
Y
88
The inflationary gap
W, J
W
J
O
Ye
YF
Y
89
The inflationary gap
W, J
W
J
O
Ye
YF
Y
90
UNEMPLOYMENT AND INFLATION

• The deflationary gap
• withdrawals and injections approach
• income and expenditure approach
• The inflationary gap
• withdrawals and injections approach
• income and expenditure approach

91
The inflationary gap
W, J, E
Y
E
O
Ye
Y
92
The inflationary gap
W, J, E
Y
E
O
Ye
Y
93
The inflationary gap
W, J, E
Y
E
O
Ye
YF
Y
94
The inflationary gap
W, J, E
Y
E
e
f
Inflationary gap
W
g
J
h
O
Ye
YF
Y
95
UNEMPLOYMENT AND INFLATION

• Inflation and unemployment at the same time
• inflationary pressures before the
  full-employment level of income
• implications for shape of AS curve

96
Unemployment and inflation
Price level
O
YF
Y
97
Unemployment and inflation
AS2
AS1
Price level
O
YF
Y
98
UNEMPLOYMENT AND INFLATION

• Inflation and unemployment at the same time
• inflationary pressures before the
  full-employment level of income
• implications for shape of AS curve
• relationship between 45 line diagram and the AD
  AS diagram

99
Allowing for inflation in the 45 line and AD /
AS diagrams
P
AS
AD1
Y
Cd, W, J, E
Y
100
Allowing for inflation in the 45 line and AD /
AS diagrams
P
AS
P1
AD1
Y
Y
Cd, W, J, E
Y
101
Allowing for inflation in the 45 line and AD /
AS diagrams
P
AS
P1
AD1
Y
Y
Cd, W, J, E
E2
E1
Y
Y1
102
Allowing for inflation in the 45 line and AD /
AS diagrams
P
AS
P2
P1
AD2
AD1
Y
Y
Cd, W, J, E
E2
E1
Y
Y1
Y2
Y3
103
Short-run Macroeconomic Equilibrium

• Keynesian Analysis of the Business Cycle

104
KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator
• changes in national income and induced investment

105
The accelerator effect
106
The accelerator effect
107
The accelerator effect
108
The accelerator effect
109
The accelerator effect
110
KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator
• changes in national income and induced investment
• the accelerator coefficient

111
KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator
• changes in national income and induced investment
• the accelerator coefficient
• the instability of investment

112
Indicator of industrial confidence in the EU
EU Euro area
Balances ()
Source European Economy Business and Consumer
Surveys (Commission of the European Communities)
113
Indicator of level of capacity utilisation () in
the EU

02
Source European Economy Business and Consumer
Surveys (Commission of the European Communities)
114
KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator
• changes in national income and induced investment
• the accelerator coefficient
• the instability of investment
• The multiplier / accelerator interaction

115
Fluctuations in UK real GDP and investment
1978-2002
116
Fluctuations in UK real GDP and investment
1978-2002
GDP
117
Fluctuations in UK real GDP and investment
1978-2002
Investment
GDP
118
KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• The accelerator
• changes in national income and induced investment
• the accelerator coefficient
• the instability of investment
• The multiplier / accelerator interaction
• Fluctuations in stocks

119
KEYNESIAN ANALYSIS OF THE BUSINESS CYCLE

• Analysing the phases of the business cycle
• causes of the upturn
• causes of the expansion
• causes of the peaking out
• causes of the recession
• Conclusions
• why do booms and recessions persist?
• why do booms and recessions come to an end?