150803_UWIN-PIE11-s49

Bachelor in Economics (S.E): Manajemen

Course : Pengantar Ilmu Ekonomi (1508PIE11)

online.uwin.ac.id

Session Topic : Adding Government &

Trade to the Simple Macro Model

Course: Pengantar Ilmu Ekonomi

By Tovan Krisdianto, S.E., M.M.

UWIN eLearning Program

Powered by HarukaEdu.com - 1508PIE11- S.3

Content

Part 1 Desired Investment Expenditure

Part 2 Equilibrium National Income

Part 3 Desired Aggregate Expenditure

Part 4 Introducing Foreign Trade

Part1: Desired Investment Expenditure


Investment Expenditures: Definition

Recall: Investment refers to purchases of

a. Capital stock (plant & equipment)

b. Residential building

c. Business inventories

Investment expenditure is the most volatile component of GDP:

changes in investment expenditure are ..strongly associated with short-run fluctuations

3 important determinants of aggregate investment expenditure are:

a. The real interest rate

b. Changes in the level of sales

c. Business confidence


Investment Expenditures: Komposisi Investasi

Bangunan

Transportasi

Permesinan & Peralatan

Lain2

1009080

70

60

50403020

10

0

Sumber: BPS & perhitungan staf Bank Dunia


Investment Expenditures: The Real Interest Rate

The real interest rate is the opportunity cost for:

Investment in,

a. New plants & equipment

b. Inventories

c. Residential construction

Thus,

all 3 components of desired investment expenditure are negatively related to the real interest rate, other things being equal.


Investment Expenditures: Changes in Sales & Business Confidence

Changes in Sales

The higher the level of production & sales, the larger the desired stock of inventories: changes in the rate of sales cause temporary bouts of

investment in inventories

Business Confidence

When business confidence improves, firms want to invest now so as to reap future profits. Business confidence & consumer confidence may feed off of one

another.


Investment Expenditures: The Investment Function

Desired investment

Defn: Treated as entirely autonomous

Completely unrelated to the current level of Y

We can write I = I Were I is determined by:a. Real interest rates

b. Expectations (confidence)

c. Changes in sales


Investment Expenditures: The Investment Function (Picture)D

esi

red Invest

ment

I

Actual National Income

Y

I

0

200

150

100

I

I

Interest rate falls

Expectations improve or Sales increase

Interest rate rises

Expectations worsen or Sales decrease


Investment Expenditures: Our Story

Our Story- A simplified version (no Government, no Trade)

We will now start to tell our story (assemble our macroeconomic model).

Our story has 2 key purposes:1. To explain what determines the level of aggregate economic

activity (the size of the GDP or Y)

2. To understand,

What might cause GDP (Y) to,

a. increase &

b. decrease?


Aggregate Expenditure: Definition

The Aggregate Expenditure Function

>The AE function:

Relates desired aggregate expenditure to actual national income

In the absence of government & international trade,

desired aggregate expenditure is:

AE = C + I

This is called a closed economy with no government

no Government, no Trade AE = C + I + G + NX

A Lou Dobbs economy (or perhaps the Fox Network economy).


Aggregate Expenditure: A Closed Economy with No Government

Domestic Households

Domestic Firms

Factor income:

wages, rents profits

YD = Y

Revenue from

sales of final G & S= C + I

Savings

Investment

ConsumptionFinancial

markets


Aggregate Expenditure: Level

The aggregate expenditure function,

relates the level of desired aggregate expenditure to the level of actual national income. But how? Through actual national incomes influence on C

AE = C + I

But,

C = a + bYD (the consumption function) & YD = Y (no government no taxes)

Therefore AE = a + bY + I

AE = a + I + bY

Note: Distinction between desired aggregate expenditure & actual

national income


Aggregate Expenditure: Level (Cont.)

Since AE = C + I

implies that AE = a + I + bY

What Indonesian economic agents desire (intend or plan),

to spend on final goods & services in this period depends on... the level of actual national income (Y) this period.

Consider the following example:

a. The consumption function is: C = 30 + (0.8)Y

b. The investment function is: I = 75

The AE function is then given by:

AE = C + I

AE = 30 + (0.8)Y + 75

AE = 105 + (0.8)Y


National

Income

(Y)

Desired

Consumption

Expenditure

(C=30+0.8 x Y)

Desired

Investment

Expenditure

(I=75)

Desired

Aggregate

Expenditure

(AE = C + I)

30 54 75 129

150 150 75 225

300 270 75 345

450 390 75 465

525 450 75 525

600 510 75 585

900 750 75 825

Aggregate Expenditure: Function

The slope of the AE function is the marginal propensity to spend:

in this simple model, it is just MPC


Aggregate Expenditure: The Slope of AE Function

The slope of the AE function is the marginal propensity to spend..

In the simplest model with no taxes & no international trade, this is just the MPC

Y C I AE

30 54 75 129

120 126 75 201

150 150 75 225

300 270 75 345

450 390 75 465

525 450 75 525

600 510 75 585

900 750 75 825

600

300

105

105 300 600

AE =C + I

Actual National IncomeD

esi

red

Aggre

ga

te

Exp

end

iture

75

30

C

I75 75

270

345 510

585

Actual Desired


Aggregate Expenditure: Summary

a. The AE function combines the spending plans of households &

firms.

It shows, that for any level of actual national income, the level of desired aggregate spending.

What happens to AE if the,

b. consumption function shifts up or down?

c. slope of the consumption function increases or decrease?

d. investment function shifts up or down?

e. slope of the investment function increases or decrease?

(We will assume that it is always zero?)

Part2: Equilibrium National Income


Equilibrium: Desired Aggregate Expenditure

Equilibrium National Income

Recall:

> Desired aggregate expenditure. Defn:

What buyers want to buy during the period (C + I in our simple model)

>Actual output. Defn:

What firms actually produce during the period (Y or GDP)

If desired aggregate expenditure,

a. exceeds actual output:

what is happening to inventories? falling there is pressure for output to riseb. is less than actual output:

what is happening to inventories? rising there is pressure for output to fall


Equilibrium: Desired Aggregate Expenditure

What happens if desired AE (C+I) is,

1. less than output (actual Y or

GDP)?

AE < Y (GDP)

a. Firms cannot sell all that they are

producing this period

b. Inventories build up (this is

unintended I, it is not desired)

c. This is the firms signal that a

decrease in output is necessary

d. Firms decrease output until AE = Y

2. greater than output (actual GDP,

Y)?

AE > Y (GDP)

a. Firms are selling more than they

are producing this period

b. Inventories are being run down

(this is an unintended decrease in I)

c. This is the firms signal that an

increase in output is necessary

d. Firms increase output until AE = Y

How the Economy Gets to Equilibrium - Inventory Adjustment Mechanism


Equilibrium: National Income Table

Actual

National

Income

(Y)

Desired

Aggregate

Expenditure

(AE = C+I)

Effect

30 129

Inventories are falling;

firms increase output

150 225

300 345

450 465

525 525 Equilibrium income

600 585 Inventories are rising;

firms reduce output900 825


Equilibrium: Demand Determined

In this model, output is said to be

demand determined.

The equilibrium condition is:

Y = AE(Y)

In words:

Equilibrium national income is,

that level of national income where

desired aggregate expenditure equals actual national income.

600

300

105

300 600

900

900

AE

Actual National IncomeD

esi

red A

.E.

45 line


Equilibrium: 2 Types

2 types of shifts can occur with the AE function:

The,

a. AE function can shift parallel to itself

b. Slope of the AE function can change

(should not really be called a shift but a rotation)

e

1

Y0 Y1

e0

AE0

Y0 Y1

AE1

AE0

AE1e1

AE = Y

E1

E0

E1

E0 e0

e2

AE = Y

Y Y

AEAE

Changes in Equilibrium National Income


Equilibrium: The Multiplier

The Multiplier

Defn: A measure of the size of the change in equilibrium Y that results

from a change in autonomous expenditure.

In our simplest of macro models, the multiplier exceeds one.

Simple multiplier =Y

A=

1

1-z

Where z is,

the marginal propensity to spend out of national income & A is the change in autonomous expenditure.

e

1

Y0 Y1

e0

AE0

AE1e1

AE =Y

E1

E0

A

Y

Y

AE


Equilibrium: AE

The,

larger is z, steeper is the AE curve & larger is the simple multiplier.

Y0 Y1

AE0

AE1

AE =Y

E1

E0

A

Y

Y0 Y1

AE0

AE1

AE =Y

E1

E0A

Y

AE AE

Y Y


Equilibrium: What Might Cause GDP to Increase from Y0?

Q: What if interest rates fall?

A:

Consumers borrow more (or save less) & buy more now

Investors borrow to buy more plant, equipment, new housing.

AE shifts up (both C & I have shifted up)

Firms produce more (hire more workers, buy more resources,

generate more profits) GDP (Y)

increases

Same outcome for a positive change in expectations, increase in wealth,

increase in sales

Y0 Y1

AE0

AE1

AE =Y

E1

Y

AE

E0


Equilibrium: What Might Cause GDP to Decrease from Y0?

Q: What if interest rates rise?

A:

Consumers borrow less (or save more) & buy less now

Investors borrow less & buy less plant, equipment, new housing.

AE shifts down (both C & I have shifted down)

Firms produce less (hirer fewer workers, buy more resources,

generate more profits) GDP (Y)

increases

Same outcome for a negative change in expectations, decrease in

wealth, decrease in sales

AE0

Y1 Y0

AE1

AE =Y

E0

Y

AE

E1


Equilibrium: Economic Fluctuations

Economic Fluctuations as Self-Fulfilling Prophecies

Households & firms,

base their desired investment & consumption partly on their expectations of the future:changes in expectations can lead to real changes in the current state

of the economy

Example:

Imagine that firms feel optimistic about the futureThis increases,

their desired investment, shifting up the AE curve Y, justifying the initial optimism


Equilibrium: Opposite Scenario

Now imagine the opposite scenario.

It should be clear that if firms & households are pessimistic about the future in large numbers,

the ensuing change in their behaviour will lead to a self-fulfilling prophecy of reduced national

income.

Could the Prime Minister (or the Governor of the

Bank of Canada),

ever announce to the country that they might have made a big mistake?

For example:

suppose that government analysts report to the Prime Minister

that having signed the Kyoto Accord might result in a recession.

Part3: Desired Aggregate Expenditure


No. NegaraGDP/ kapita

(USD, 2010)

Lama di (sd 2010 (thn)) Pertumbuhan

Income rata2

2000-10 (%)

KetMI UMI

1 Uruguay 10.934 112 15 3.3 UMIT

2 Polandia 10.731 50 11 3.9

3 Malaysia 10.567 27 15 2.6 UMIT

4 Venezuela 9.662 60 23 1.4 UMIT

5 Thailand 9.143 28 7 3.6

6 Suriah 8.717 46 15 1.7 UMIT

7 Saudi Arabia 8.396 32 20 0.9 UMIT

8 Turki 8.123 51 6 2.3

9 RR China 8.019 17 2 8.9

10 Meksiko 7.763 53 8 0.7

11 Panama 7.146 56 - 2.4 LMIT

12 Iran 6.789 52 - 3.4 LMIT

13 Brazil 6.737 53 - 2.0 LMIT

14 Colombia 6.542 61 - 2.6 LMIT

15 Jordania 5.752 55 - 3.5 LMIT

16 Peru 5.733 61 - 4.2 LMIT

17 Indonesia 4.790 25 - 3.9 LMIT

18 India 3.407 9 - 6.1

19 Vietnam 3.262 9 - 6.1

20 Filipina 3.054 34 - 2.5 LMIT

Aggregate Expenditure: Tabel III-Ringkasan Posisi Negara Berpendapatan Menengah

Terperangkap dalam

UMIT : Upper Middle Income Trap

LMIT : Lower Middle Income Trap

Sumber: ADB(2010)

Batas lepas LMIT: USD 7250

Butuh: 28 tahun Minimal

pertumbuhan:

4.7% per tahun

(rata2)


Aggregate Expenditure: The Circular Flow of Expenditure & Income

Here we consider all

of

the economic agents who might

buy

final goods &services from

Indonesian firms

C + I + G + (X - IM)

= Desired Aggregate Expenditure

IM

C

I

G

X


Introducing Government: Purchases & Net Tax

Government Purchases

>>Government purchases of goods & services (G) are,

part of desired aggregate expenditures excluding transfer payments (BLT, BOS, Subsidi) WHY?

Net Tax Revenues

>>Net taxes (T). Defn:

Total tax revenues net of transfer payments.

Q: Why net-of-transfer payments?

A: We assume net taxes are given by:

T = tY

where t is the net tax rate.

Example:

if t = 0.3 & Y = 600 then T = 0.3(600) = 180Implies that all taxes are related to the level of income.


Introducing Government: Budget Balance

The Budget Balance

The budget balance is the difference between G & T.*

if G < T: a budget surplus if G > T: a budget deficit

Government Expenditure Function

Desired government expenditure is,

treated as autonomous completely unrelated to the current level of Y

We write G = G

Were G is determined by,

1. What governments do!

2. The budget process!

3. Election cycles!

Mostly just the provision of goods & services (general government, health,

education, public safety, transportation)


Introducing Government: Government Expenditure Function

Government Expenditure Function (what does it look like?)D

esi

red G

overn

ment

Expenditure

s

G

Actual National IncomeY

G

0

200

150

100

G

G

Shift up,

implies a Government spending increases

Shift down,

implies a Government spending cuts


Introducing Government: Government Net Tax Function

T

Y0

200

150

100

T = tY

-150

-100

Governments set,

the tax rate (t) but Y determines the total

taxes paid (T)

Y1

T0 = tY0

T1 = tY1

Y0Desi

red N

et Taxes



Introducing Government: Changes in Taxes (the Tax Rate t)

T

Y

T = tY

0

200

100

T = tY

Net tax increases

Net tax decrease

-150

-100

T = tY

Note: t > t > t

Y0

T0T0

T0

Desi

red N

et Taxes



Introducing Government: The Public Saving Function

Public Saving. Defn:

defined as T G Net tax revenue which the government does not

spend

As national income rises,

the budget surplus (public saving) increases.

The slope of the public saving function is

equal to the net tax rate.

T - G

Public

Savin

g

0 300 600 900


*

Y G T=0.1xY T-G

150 51 15 -36

300 51 30 -21

525 51 52.5 1.5

600 51 60 9

900 51 90 39

Part4: Introducing Foreign Trade


Foreign Trade: Net Exports

Net Exports

We make 2central assumptions:

Indonesians

1. Exports are autonomous with respect to Indonesian GDP

2. Imports rise as Indonesian GDP rises

a. For imports, we assume:

IM = mY

where m is the marginal propensity to import.

b. Thus, net exports are given by:

NX = X - mY

Example:

if X = 300, m = 0.4 & Y = 400

Then NX = 300 0.4(400) = 300 160 = 140


Foreign Trade: Ceteris Paribus

Ceteris Paribus

Changes in domestic GDP lead to changes in net exports:

a. as Y rises, NX falls

b. as Y falls, NX rises

The relationship between Y & NX is shown by the net export

function.


Foreign Trade: Net Exports

The NX function is drawn holding

constant:

1. Foreign GDP

2. Domestic and foreign prices

3. The exchange rate

Y X IM=0.1xY NX

0 72 0 72

300 72 30 42

600 72 60 12

720 72 72 0

900 72 90 -18

72

48

24

0 300 600 900

96IM = 0.1Y

X = 72

72

48

24

0 300 600 900

-24

Import

s &

Export

sN

et Export

s

NX = 72 - 0.1Y

Y

Y


Foreign Trade: Net Export

Shifts in the Net Export Function

1. An increase in foreign income leads to more foreign demand

for Indonesian goods:

increases X & shifts NX function upward

2. A rise in Indonesian prices (holding foreign prices constant):

decreases X IM function rotates up as Indonesian switch toward foreign

goods

NX function shifts down & gets steeper


Foreign Trade: Illustration

Illustration of,

a rise in Indonesia prices relative to

foreign prices.

This could be caused by:

1. exchange rate2. price levels

Import

s &

Export

sN

et Export

s

IM

X

(X - IM)

X

IM

(X - IM)



XX


Foreign Trade: Shifts in the Net Export Function

Summary

1. Foreign Income

An increase in foreign income results in an increase in Indonesian exports

NX function shifts up. (& the reverse)

2. Relative International Prices

A rise in Indonesian prices relative to foreign prices reduces Indonesian exports (X shifts down).

The IM function also rotates up since Indonesians now spend a higher fraction of income on foreign goods.

The NX (=X-IM) function shifts down & also gets steeper. (& the reverse)


Foreign Trade: Shifts in the Net Export Function (Cont.)

3. Appreciation of the Indonesian Rupiah

A rise in the value of the Indonesian Rupiah reduces Indonesian exports (X shifts down).

The IM function also rotates up since Indonesians now spend a higher fraction of income on foreign goods.

The NX (=X-IM) function shifts down & also gets steeper. (& the reverse)

4. Other considerations:

a. Barriers to trade Tariffs, quotas, regulations.

Mad cow disease, lead paint on toys.

b. Taste trade promotion, buy Indonesian


Reference

Ragan, Christopher T.S. & Lipsey, Richard G. (2010). Macroeconomics, Thirteenth Canadian

Edition. MyEconLab.


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150803_UWIN-PIE11-s49