These notes will help you pass your exam. Macroeconomics is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and government spending to regulate an economy’s growth and stability. Notes con...
(2022 notes + Relevant past exams + applicable solutions)
GOODS MARKET MODEL
• Endogenous variables - depends on other variables within the model
• consumption depends on income >> endogenous
• exogenous variables - constant, not explained within the model, taken as a given
The full model will consist of four sectors: households, firms, the government, and the foreign sector. Households earn
income from firms, which they spend on private consumptions and savings. Firms produce goods sold on the goods
market, and pay the revenue to households for factors of production. The government collects taxes which finance
transfers and public consumption. Goods are also exported to and imported from the foreign sector. The first version of
the model, however, is simplified as far as possible. It contains only the household- and firm sectors. It is closed in the
sense of having no trade with the rest of the world, and private in the sense of having no government. According to the
system of national accounts, GDP, denoted by Y, can be alternatively expressed in terms of production, expenditure, or
income. The national account balance identity define GDP from the expenditure approach. It states that firm production,
Y, will be used for either household consumption, C, or investments, I.
Y=C+I
Total Demand for Goods, (Z) (total = aggregate)
The total amount of goods and services demanded in the goods market. This total demand for goods and services
determines the level of income and output in the economy.
Total amount of goods: (total = aggregate)
All goods and services produced even if they replace depreciated or worn out products.
Gross domestic expenditure (GDE)
The total value of spending within the borders of a country including imports but excluding exports, since spending on
exports takes place outside the borders of the country.
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,Consumption Function
This is the spending by private firms and households. Households are assumed to consume a fixed proportion of their
income. Since income is equal to production (Y), this simple rule can be expressed by the following consumption
function:
C = co+ cYd
co- autonomous consumption, which is the consumption independent of income level and is the intercept or vertical
component of the consumption curve
- is the induced consumption, the spending which is directly linked to income level; disposable income (Yd) - income
remaining after paying taxes, receiving gov't transfers
The parameter c, called the marginal propensity to consume (MPC), specifies how much is consumed out of an income
increase. It is assumed to be constant and known, and to lie in the interval 0 < b < 1. It is the slope of the consumption
curve
Investment
Investments I are assumed to be constant, in the sense of being independent of production (or income).
I=Ī
Placing a bar above the ‘I’ in investment, refers to the investment as a given, and does not respond to changes in income.
Real investment:
Spending on capital stock such as machinery, buildings, inventories etc. with the hope of a making a future profit. This increases
the production capacity.
Government spending, (G)
Money spent by the government to stimulate the economy – like books for schools, personnel costs, bridges, roads etc.
The combination of Government spending (G) and Taxes (T) forms the fiscal policy.
The reason for assuming G and T to be exogenous variables is different to the reasons for I. The reasons for treating
Government and Taxes as exogenous variables is based on two distinct arguments:
Governments do not behave with the same consistency as consumers or firms, so there is no reliable rule for G and T to
which a formula can be written as was done with consumption. However there are certain predictable behavioral
concepts in G and T.
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,One of the tasks of the most important tasks in macroeconomics is to think about the implications of alternative spending
(G) and tax (T) decisions, and what implications these decisions would have.
Exports are treated as autonomous
Imports are composed of induced and autonomous components as done is ECS1601
Equilibrium
NB: at equilibrium the following condition is held: Total spending in the economy= Total Income in the economy
IMPACT OF FISCAL POLICY TO EQUILIBRIUM
Fiscal policy is the government's policy in respect of the nature, level and composition of government spending, taxation
and borrowing, aimed at pursuing particular economic goals. The main instrument of fiscal policy is the budget, and the
main policy variables are government spending and taxation.
Expansionary Fiscal Policy
An expansionary fiscal policy is used to stimulate or expand economic activity by increasing the demand for goods. For
fiscal policy to be expansionary it must increase the demand for goods which then increases production and income.
This can be achieved by increasing government spending and/or by reducing taxation.
Effect of increasing G
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, We first consider the impact of increased government spending. An increase in government spending implies that
government buys more goods from firms in the economy, for instance more text books for schools, medicines for
hospitals, cement for buildings, etc. Firms respond by increasing their production of goods and services, to which end
they employ more factors of production and households’ income increases, with the result that they increase their
consumption spending, thus increasing demand further, which stimulates the production of goods and services so that
households’ income increases further.
The multiplier process is in operation and the increase in government spending stimulates production and income in the
economy.
Using a chain of events the impact of an increase in government spending can be describe as follows:
G↑ → Z↑ → Y↑
(The opposite is true in the case of contractionary fiscal policy e.g. decrease in government spending.)
Effect of reducing T
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