Macro4
- 1. INTRO TO MACROECONOMICS Tutorial 4 Raj.Chande@bristol.ac.uk
- 2. EQUILIBRIUM: GET USED TO THE CONCEPT Economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the (equilibrium) values of economic variables will not change (Wikipedia). Many questions will follow this format: Equilibrium > Disturbance > Transition > New Equilibrium Explain the transition and describe the differences between the two equilibria
- 3. Q)1) Start at an equilibrium. How do we know it is an equilibrium? Because Z = Y Disturbance? An increase in G is the best example of a disturbance. Why?
- 4. OK... SO NOW WHAT? TRANSITION A 1 unit increase in G leads to a 1 unit increase in Y, the extra unit on government production has to be received by someone as income But a 1 unit increase in Y leads to an increase in C by c1 (c1 x 1 unit) which means Y has increased by c1, which means C will increase by c1 x c1 and so on and so on. Each increase in Y is smaller than the last, so we converge to a new equilibrium level of Y The ultimate increase in Y as a result of a 1 unit increase in G is 1/(1-c1) In this case, 1/(1-c1) is the Keynesian Multiplier
- 5. JUST TO REPEAT EQUILIBRIUM: Z0 = Y0 DISTURBANCE: ΔG TRANSITION: Δ Y > Δ C > smaller Δ Y... NEW EQUILIBRIUM: Z1 = Y1 (Y1-Y0) = Δ G / (1-c1)
- 6. 2) GENERALLY GOOD Write the equation each time, dull but necessary iii) Δ Y = Δ G / (1-c1) So if Δ Y = 100, then 100 = Δ G / (1-0.75) Δ G = 25 Tax equivalent? Δ Y = -c1(Δ T)/(1-c1) Δ T = -33.33
- 7. 2)IV) Now taxes are: T = 80 + 0.25Y Note that T=f(Y) Equilibrium income (Y = Z) is now: Y = 60 + 0.75(Y – 80 – 0.25Y) + G + I So now each increase in C leads to a smaller increase in Y. Y = 250/0.4375 = 571.43
- 8. KM IS NOT ALWAYS THE MPC In the second case, T=f(Y) If Y increases, there is less Y left for C after taxes, i.e. Yd is lower than it would have been before The new multiplier is actually 2.29, lower than before