Summary of unit 14 Core Economy.
Topics covered:
Role of Government
Aggregate demand function
Multiplier model
Household wealth
Investment spending
Stabilising the economy
• GOP fluctuates due to consumption & investment decisions
• government intervention can stabilise an economy
• Great moderation- Period of low volatility in aggregate output in advanced economies between
the 1980s and the 2008 financial crisis
• Exogenous factors: government spending, exports
• Consumption: household’s MPC is out of disposable income (1-t)Y
• Investment: depends on the interest rate and after-tax rate of profit
• Imports: The amount of imports depends on domestic income.
• Marginal propensity to import = The fraction of each additional unit of income that is spent on
imports
• Primary budget deficit = G –T
• pro-cyclical
• the government must borrow to cover the gap between spending and revenue, by issuing bonds
Government debt = sum of all the bonds sold over time to finance budget deficit – matured bonds
(repaid debt).
Sovereign debt crisis = a situation in which government bonds come to be considered risky
(default risk).
Debt-to-GDP ratio = The level of indebtedness of a government is measured relative to the size of
the economy
Indebtedness can fall
• if the primary budget balance is positive
• if GDP is growing faster than government debt
• if in ation is high (real value of debt falls)
AGGREGATE DEMAND FUNCTION
- aggregate consumption function (total consumption spending)
- Aggregate demand: The total of the components of spending in the economy, added to
get GDP: Y = C + I + G + X – M. It is the total amount of demand for (or expenditure
on) goods and services produced in the economy.
- Assumption: firms are willing to supply any amount of the goods demanded by those
making purchases in the economy; they are not operating at full capacity utilisation.
- Capacity utilisation rate - A measure of the extent to which a firm, industry, or entire
economy is producing as much as the stock of its capital goods and current knowledge
would allow.
fl
, -There
are only two components to aggregate spending:
• Consumption : C = Co + C1Y
• Investment : Does not depend on income therefore Co
1. Autonomous Consumption (Co)
- the fixed amount spent, independent of Income
- even if income = 0 (still consumption)
• savings, credit facilities borrowing
2 . Consumption dependent on income (C1)
- proportional to current income
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