Lecture 11
The MULTIPLIER
1. Full-employment GDP
- Is u = 0 at full employment? Good heavens, no! Why not?
- Actual GDP vs. Potential GDP
- Actual unemployment (u) vs. natural rate of unemployment (u*)
1.1 Recessionary gap
- Actual GDP is less than Potential GDP
1.2 Inflationary gap
- Actual GDP is greater than Potential GDP
- Yikes! How is this possible?
2. Change in exogenous spending
Multiplier = Change in GDP / Change in exogenous spending
2.1 Model #1
- Exogenous variables: I, G, X-IM, T
- Suppose I increases
- The AE-line shifts up (by how much?)
- Eqbm GDP increases (by how much)
2.2 Computing the multiplier
Investment Multiplier = Change in Y / Change in I
2.3 More about the multiplier
- The multiplier is greater than 1 (why?)
- Multiplier = 1/(1-MPC) in the base model (Model #1)
- Suppose firms had decreased their spending. Is the multiplier any different?
3. A first look at fiscal policy
- If the economy is in a recessionary gap, what can the govt do?
- Increase G, or
- Decrease T
- Effect on aggregate expenditure?
- Effect on GDP and unemployment?
3.1 Questions
- Compute the government spending multiplier. Show that it equals 1/MPS in the base model (Model #1)
- Compute the tax multiplier.
- Why is the government spending multiplier greater than the tax multiplier?
4. Transfer payments
- If the govt increases transfer payments, what happens to GDP?
- Hint: Begin with the consumption line in the income-expenditure diagram
5. International trade
5.1 Changes in the exchange rate
- If the dollar depreciates, AE will increase (why?)
- Effect on eqbm GDP?
5.2 Change in foreign GDP
- How will a decrease in Canada's GDP affect the U.S. economy?
- Hint: Look at the (X-IM) component of aggregate expenditure on U.S. goods and services
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