[00:17] Okay, let's uh let's start. Um
[00:21] So, what you have there in that picture
[00:22] is uh is the result of a survey to a
[00:26] bunch of economists
[00:27] on which are asked to assess the
[00:30] probability that there is a recession
[00:31] within the next 12 months.
[00:34] Recession means essentially a decline in
[00:37] aggregate output.
[00:38] Um and well, the first thing to notice
[00:41] here is that you know, it's not very
[00:43] good news. There is a very high chances
[00:45] at at least according to
[00:48] this expert that that the US enters a
[00:50] recession within the next 12 months or
[00:53] so. Pretty high probability.
[00:55] You can see that that number typically
[00:57] is very very low and it goes very high
[00:59] sort of real next to recessions.
[01:01] And now we're not in a recession, but
[01:03] but there is a sort of very high per se
[01:05] probability that we may
[01:08] go into recession in the near future.
[01:10] So, how is that these people come up
[01:12] with this forecast? Well,
[01:15] at some level, either explicitly or
[01:17] implicitly, they must have some model
[01:20] uh
[01:21] that of the determination of equilibrium
[01:23] output. I mean, you know, they need to
[01:24] understand
[01:26] they need to see certain things that
[01:28] suggest
[01:29] when you go through a model that output
[01:32] will decline.
[01:34] Um so, that's what we're going to start
[01:36] doing today. And
[01:38] and in fact, that's what we're going to
[01:40] do
[01:40] throughout this course. It's we're going
[01:42] to try to find ever more complex perhaps
[01:46] or or richer models of
[01:49] uh output determination, aggregate
[01:51] output determination. So, that's
[01:53] essentially what this course is about.
[01:55] Uh
[01:56] and so, and understanding sort of we're
[01:58] going to try to understand what is it
[01:59] that drives that equilibrium output and
[02:01] how is it that we get to one specific
[02:03] level of output.
[02:05] That's what it means to find the
[02:06] equilibrium level of output.
[02:08] Um and we're going to do it sort of in
[02:10] three stages.
[02:11] In the first part of the course, that is
[02:13] up to quiz one,
[02:15] uh we're going to focus on on on the
[02:17] very short run. How output is determined
[02:19] in the very short run, say within a year
[02:22] or so.
[02:23] Uh
[02:24] uh
[02:25] well, a little more even, but but that
[02:27] type of frame time frame.
[02:29] Then we're going to focus on the medium
[02:31] run. That's sort of is
[02:34] at the beginning of
[02:35] of of the second part of the course.
[02:38] Uh
[02:38] and by the medium run, simply we're
[02:40] going to mean by the time in which
[02:41] prices begin to adjust sufficiently.
[02:44] Okay? Before that, is most of the action
[02:47] happens in in quantities. There is
[02:49] little movement in goods prices. There's
[02:52] lots of movement in asset prices, but
[02:53] little movement in goods prices.
[02:55] And in the last part of the course,
[02:57] we're going to look at how output is
[02:59] determined over the long run, which is
[03:00] quite different from how output is
[03:02] determined in the short run.
[03:04] The determination of output in the short
[03:06] run is what we mostly mean by business
[03:08] cycle analysis. Okay? And short or
[03:11] medium run, the way we're going to
[03:12] define it here, is what we mean by
[03:14] business cycle. The country's in a
[03:15] recession, it's in a boom, it's an
[03:17] expansion. Those are all terminologies
[03:19] of the short run
[03:20] or short or medium run.
[03:23] The determination of equilibrium output
[03:24] in the long run is when we think about
[03:26] growth. When we talk about why is it
[03:29] China grows faster than the US today?
[03:31] Well, that's a that's a question not
[03:32] about the business cycle. It's a
[03:34] question about the long-run determinants
[03:37] of output growth. Okay? And and they're
[03:40] even different class of models.
[03:42] In more advanced models, if you were
[03:44] doing a PhD, those things are a lot
[03:46] closer to each other and and and but but
[03:48] in this course, they're going to be very
[03:50] different type of models. It's easier to
[03:52] analyze these things with different type
[03:54] of models than trying to integrate all
[03:56] in one big machine. Okay? But let's
[03:59] start with the the simple part. In the
[04:01] short run,
[04:02] the key mechanism, something that will
[04:04] will keep showing up uh in all the
[04:08] models and sub models we analyze
[04:10] uh
[04:11] in the first eight lectures or so or
[04:13] seven lectures of the next seven
[04:15] lectures or so, is this mechanism. In
[04:17] the very short run,
[04:19] output, that is equilibrium output, the
[04:21] thing that these economists are
[04:23] forecasting that will decline in the
[04:25] next 12 within the next 12 months,
[04:27] is determined primarily
[04:30] by act what we call demand.
[04:32] Okay?
[04:33] So, demand will determine output. That's
[04:35] the change in demand that will change
[04:37] production.
[04:39] But when production changes, that will
[04:41] also change income. That you know from
[04:43] national accounts. Remember we said that
[04:44] we could measure output from the
[04:47] production side, but we also could
[04:49] measure the income side. And they're
[04:50] exactly the same. More production,
[04:52] somebody has to receive the proceeds of
[04:54] that. Workers and owners, capital
[04:57] owners, the government, whatever.
[04:59] But so, changes in in So, the second
[05:02] step we're going to make is those
[05:02] changes in production that were brought
[05:04] about by the changes in demand will lead
[05:07] to a change in income.
[05:08] But when income changes, that will
[05:10] change demand again.
[05:11] And so on and so forth. Okay? So, that's
[05:14] essentially that's quintessential
[05:16] short-run macro. It's to to try to
[05:18] understand this
[05:19] aggregate demand, because that's the
[05:21] main driver, and then how it gets
[05:23] multiplied
[05:24] uh in the short run. Okay? And
[05:27] in this lecture, we're going to talk
[05:28] about just about that.
[05:30] You know, primarily about that. Okay?
[05:31] But that's that's when So, when I mean
[05:33] short-run macro, that's the structure I
[05:35] have in mind and that's the structure
[05:36] most people have in mind. Something
[05:38] where aggregate demand will determine
[05:39] that. That's the reason why in the short
[05:41] run you worry a lot about whether
[05:42] consumer confidence is high or low.
[05:45] That's demand. If consumers are very
[05:46] depressed, they tend to reduce demand.
[05:48] If consumers are very bullish, that will
[05:50] tend to increase
[05:52] demand. And since in the short run
[05:54] output is determined by demand, the
[05:56] business cycle, whether we have got a
[05:58] recession or not, depends on about how
[06:00] demand feels. So, if somebody's
[06:02] forecasting a recession within the next
[06:03] 12 months, he's forecasting really that
[06:07] demand will decline within the next 12
[06:09] months. Okay?
[06:12] Why they're forecasting that, that's
[06:14] something we're going to learn in the
[06:15] steps
[06:16] uh as we go through the course. What
[06:17] what are the kind of things that they
[06:19] may be thinking about? What are the
[06:20] drugs on aggregate demand that are
[06:22] likely to depress demand?
[06:25] Uh and so on and so forth. But that
[06:26] we'll we'll get there. Okay?
[06:30] Anyways, first let me tell you about the
[06:31] components of aggregate demand.
[06:34] Uh
[06:35] the first and one of the and the largest
[06:37] component of aggregate demand is
[06:39] consumption. Okay? And when I mean
[06:41] aggregate demand, okay,
[06:43] I'll be
[06:45] I'll pause for a for a slide. Let me let
[06:47] me go over the definition. Consumption,
[06:49] we're going to denote by C,
[06:51] is the goods and services purchased by
[06:53] consumers. Okay? Households and so on.
[06:57] Investment, which we're going to denote
[06:59] by I,
[07:00] is the sum of non-residential and
[07:02] residential investment. So, equipment
[07:05] and establish and and and you know,
[07:08] factories
[07:09] on one side, and then residential
[07:11] investment is houses.
[07:12] Stuff like that, apartment buildings and
[07:14] so on.
[07:15] Which is also these are goods and
[07:17] services as well. They're just capital
[07:19] goods and so on, but they're also goods
[07:21] and services.
[07:22] Government spending, that's what we're
[07:24] going to denote by G, are purchases of
[07:26] goods and services by the federal,
[07:28] state, and local government. Okay?
[07:31] Excluding, and that's important,
[07:32] government transfers.
[07:35] What is a government transfer? Many of
[07:36] you may have received that during COVID.
[07:38] You know, the government sent you a
[07:39] check, for example. Okay?
[07:42] Well, that check that is not part of
[07:43] government expenditure. That check is
[07:45] like a
[07:46] it's a negative tax and it's going to
[07:48] enter somewhere else.
[07:50] When we mean government
[07:51] expenditure is is things the government
[07:54] purchases, services the government
[07:57] acquires and so on. Okay?
[08:00] Um
[08:01] then exports, X, which will play no role
[08:05] until seven lectures or eight lectures
[08:07] from now, or actually 10 lectures from
[08:09] now probably,
[08:10] is purchases of US goods and services,
[08:13] that is goods produced by US factories,
[08:17] uh
[08:18] uh
[08:19] by foreigners. Okay?
[08:24] I am is the other side of the story.
[08:26] Imports is the purchase of foreign goods
[08:30] and services by US consumers, US firms,
[08:32] US government. Okay? So, when you buy
[08:35] something that is produced in Germany,
[08:36] well, that's an import. When the Germans
[08:39] buy something that is produced in the
[08:40] US, that's an export. Okay?
[08:42] And then the last component is something
[08:44] we're going to going to pay any
[08:45] attention whatsoever in this course,
[08:47] which is inventory investment. Inventory
[08:49] investment is certainly
[08:51] it's almost accidental. There is some
[08:53] planning on it, but but there is a lot
[08:54] of it's just from the difference between
[08:56] sales and production. And over the very
[08:58] short run, there's lots of difference. I
[09:00] mean, you're not
[09:02] producing unless you're in a bakery, you
[09:03] know, you're not producing and selling
[09:05] immediately. There is there is certain
[09:07] certain lags.
[09:08] That's a small thing. It it's volatile,
[09:10] but it's a small thing, so we're going
[09:11] to ignore it
[09:13] for this this course. We're going to
[09:15] assume actually, unless we explicitly
[09:17] say the contrary, and that could show up
[09:18] in a piece that it would never show in a
[09:20] quiz,
[09:21] because it's not that important, we're
[09:23] going to assume that this inventory
[09:24] investment is equal to zero.
[09:26] Also, for this part of the course, until
[09:29] further notice, we're going to assume
[09:30] that exports and imports are equal to
[09:32] zero as well.
[09:34] That's not realistic, but it's easier to
[09:36] analyze what we call a closed economy.
[09:39] Okay? An economy that is not interacting
[09:41] with the rest of the world. In the in
[09:44] again, 10 lectures from now, we're going
[09:45] to open the economy to the rest of the
[09:47] world, and then we're going to have to
[09:48] talk about
[09:49] things like import, export, exchange
[09:51] rates, things of that kind. But for now,
[09:53] let's keep it simple. Okay?
[09:55] So, now you So, you get a sense this is
[09:57] for 2018, but I I mean the the totals
[10:00] change, but the composition doesn't
[10:02] change very much
[10:03] of GDP.
[10:05] Okay.
[10:08] Of of GDP
[10:11] output
[10:12] aggregate demand they're all the same
[10:16] in equilibrium, but we'll get there.
[10:19] GDP you see that consumption accounts
[10:21] for a big chunk close to 70% of
[10:24] aggregate demand. That's the reason
[10:26] people worry so much about consumer
[10:28] sentiment and so on. The
[10:30] University of Michigan
[10:32] has many claims to fame, but one of them
[10:34] is they produce this index of consumer
[10:35] sentiment, and everyone is watching that
[10:37] thing. Anyone that worries about macro
[10:39] or finance is watching that thing
[10:41] because it tells you a lot about one of
[10:43] the main drivers of output equilibrium
[10:47] output. Then you see investment is
[10:49] substantially smaller, but it's large in
[10:52] particular non-residential investment.
[10:55] Government expenditure is a big
[10:56] component of aggregate demand. And then
[11:00] I'm not going to worry too much about
[11:01] for a country like the US the open
[11:04] openness part is is relatively small.
[11:07] If you go to uh you know
[11:11] small a small economy typically will
[11:14] have sort of very large exports relative
[11:16] to GDP and so on. But that's not the
[11:18] case of the US.
[11:21] And there you see why we're going to set
[11:23] in inventory investment to zero. It's a
[11:25] small thing. It it moves a lot more than
[11:27] than its size, so it can account for for
[11:30] fluctuations in in
[11:32] sort of the monthly level of GDP, but
[11:34] it's not that important
[11:36] in a slightly longer periods of time.
[11:39] Okay. So, that's more or less the story.
[11:41] So, now this is the this is the model.
[11:44] Please stop me say if you Is there
[11:47] anything here you don't understand
[11:48] because any everything that we'll build
[11:50] from here to
[11:51] quiz one
[11:53] will build on understanding this what
[11:56] I'm about to say. Very simple, but if
[11:58] you miss a step here everything is going
[12:00] to be confusing in the next few
[12:01] lectures. So,
[12:02] and you're not supposed to understand it
[12:04] in the first run. So, so it's okay that
[12:05] you ask me. But let's make sure that you
[12:07] understand what's going on here.
[12:10] Okay. So, that's aggregate demand. First
[12:12] definitions. We're going to denote
[12:14] aggregate demand by this Z, okay? Letter
[12:17] Z.
[12:18] And aggregate demand is going to be When
[12:21] we say aggregate demand, remember what
[12:23] what what is the exercise we're trying
[12:25] to do. Ultimately, what we want to
[12:27] determine is the output the production
[12:30] of the US economy, say.
[12:32] So, when we mean when we talk about
[12:34] aggregate demand, we're trying to
[12:35] determine the demand for domestically
[12:38] produced goods for goods produced in the
[12:39] US.
[12:41] That's what we're trying to pin down.
[12:43] And so,
[12:44] that's the reason aggregate demand looks
[12:46] like that. It's well, consumers.
[12:48] Consumers are going to demand goods.
[12:50] Investment
[12:52] G plus exports. If foreign demand US
[12:55] goods, that's also increases US
[12:56] production.
[12:57] Minus imports because imports is
[13:01] uh goods and services that consumers,
[13:04] firms, and governments sort of buy from
[13:06] foreigners, but they're not produced by
[13:08] by US companies. So, they are not affect
[13:10] the determination of equilibrium output
[13:12] in the US. Okay? That's the reason you
[13:14] subtract it. Now, that distinction is
[13:17] not going to matter
[13:19] uh until 10 lectures from now because
[13:21] we're going to set X and IM equal to
[13:23] zero from the point of view of modeling.
[13:25] So, all demand is demand for
[13:27] domestically produced goods in this part
[13:29] of the course. Okay? So, aggregate
[13:31] demand for us will be this C plus I plus
[13:34] G. So, we need to understand what
[13:36] determines C plus I plus G.
[13:39] And at least initially, we're going to
[13:41] keep it very very simple. We're not
[13:43] going to think too much about what
[13:44] determines investment. In fact, we're
[13:46] going to assume it's a constant is
[13:48] given. So, it's determined somewhere
[13:49] else not in the model I'm about to
[13:51] solve.
[13:53] Government expenditure
[13:55] the same. I'm going to assume you know,
[13:56] it's determined by some other
[13:58] priorities, you know, green agendas and
[14:00] stuff like that. It has very little to
[14:01] do with with with what we're doing here.
[14:05] And then taxes is something that doesn't
[14:07] show up there, but it will show up very
[14:08] shortly. We're also going to assume that
[14:10] they're being determined somewhere else.
[14:12] In pieces and later on in the course
[14:14] we're going to endogenize all that, but
[14:16] not now. Let's assume I'm trying to come
[14:19] up with a the simplest possible model of
[14:21] aggregate demand.
[14:22] And I'm making two of these terms
[14:24] trivial just constants. Okay? And I'm
[14:27] going to focus all my effort here in
[14:30] this component here, which I already
[14:31] told you is the most important component
[14:34] of aggregate demand, which is
[14:35] consumption. Okay?
[14:37] So, we're going to assume here we're
[14:39] going to have a function. Something has
[14:41] to move so for the model to be
[14:42] interesting. So, this this this we're
[14:44] going to assume that consumption
[14:47] is an increasing function of disposable
[14:49] income. I'm about to define what
[14:51] disposable income is, but you can
[14:52] imagine what it is. It's something you
[14:53] can use to consume and so on. So, very
[14:56] naturally, if you have a higher
[14:58] disposable income, you're going to
[14:59] consume more. That's what this says.
[15:01] Okay?
[15:03] In reality, that consumption function is
[15:05] a lot more complex. There are lots of
[15:07] things that enter there that that we're
[15:09] not modeling for now. But let's
[15:11] start from the basics. Okay? So, that's
[15:14] going to be the only behavioral
[15:15] assumption we're going to make for a
[15:17] while.
[15:18] That that the consumers consume more
[15:21] when they have more disposable income.
[15:24] Okay.
[15:27] And I'm going to make it even simpler.
[15:29] I'm going to assume that consumption is
[15:31] a linear function of disposable income.
[15:34] Okay? So, there's going to be some
[15:36] constant C0, which captures lots of
[15:38] things that we're not modeling here. For
[15:40] example, the fact that for any given
[15:42] level of disposable income,
[15:44] if you know, if you if you
[15:47] if you're richer, suppose you have some
[15:48] shares and now the shares double in
[15:51] value, you probably are going to consume
[15:52] more as well.
[15:53] Okay? There are lots of other things
[15:55] that affect
[15:56] consumption, which are different from
[15:58] aside from your disposable income.
[16:01] But we're not going to model that. So,
[16:02] that's we're going to call it
[16:03] autonomous. Autonomous in the sense that
[16:05] we're not going to determine it here.
[16:07] We're going to take it as a parameter
[16:08] that comes from somewhere else. We may
[16:10] do some experiments moving that variable
[16:12] around, but it's not going to
[16:15] be part of what we model.
[16:17] C1 is a more interesting parameter for
[16:19] this part of the course, and it's what
[16:21] we call the marginal propensity to
[16:23] consume
[16:25] out of disposable income in this case.
[16:27] That is C1 tells you the share if you
[16:30] get an extra dollar of disposable
[16:32] income, how much of that do you spend in
[16:34] consumption? Okay? So, say you get an
[16:37] extra dollar of income, if you spend
[16:41] 60 cents in in the things you normally
[16:44] consume of that extra dollar, well, then
[16:47] your C1 is .6. Okay? That's the marginal
[16:49] propensity to consume.
[16:51] And that's what gives us our increasing
[16:52] function. You get an extra dollar,
[16:54] you're going to do you're going to save
[16:55] part, but some of it you're going to
[16:56] spend. That part you're going to spend
[16:58] is the C1 that we have there. Okay?
[17:02] Good.
[17:04] Uh
[17:07] And I
[17:08] Now, let me tell you what how we define
[17:10] disposable income. Disposable income is
[17:12] just equal to income, which is equal to
[17:14] production, you
[17:16] minus taxes. That's disposable income.
[17:18] Okay? It's whatever you earn as a either
[17:20] as a worker as a capital owner,
[17:24] well, then the government takes its
[17:25] something out of it. That's your
[17:27] disposable income, and that's where you
[17:29] have to decide how much to save and how
[17:31] much to consume.
[17:32] Okay?
[17:34] That's
[17:35] So, so that means that our consumption
[17:37] function is
[17:38] can be written that way
[17:40] after all these assumptions I made, you
[17:43] know, equal to this autonomous component
[17:45] plus C1 the marginal propensity to
[17:47] consume times
[17:49] uh income output minus taxes.
[17:56] Is it clear?
[17:59] Yes?
[18:00] So, all these are assumptions. Now,
[18:01] they're not crazy assumptions in the
[18:03] sense that you know, that we know that
[18:04] that there is a relationship between
[18:06] these two things. Again,
[18:07] the consumption function in practice is
[18:09] much richer than that.
[18:11] And there is lots of randomness random
[18:13] terms around and so on, but that's not
[18:15] what we're about here.
[18:17] But that's if you want to start with a
[18:18] consumption function, this is a pretty
[18:20] reasonable one to start with. Okay?
[18:24] Okay. So, that's going to look in the
[18:25] space of disposable income or income. I
[18:28] could have put income there not
[18:30] disposable income. So, it's going to
[18:31] look like that.
[18:33] Okay?
[18:34] So, C0 is that autonomous consumption is
[18:37] some something you're going to consume
[18:39] regardless of your level of disposable
[18:40] income. I mean, there is a minimum
[18:41] consumption you have to have. You know,
[18:43] say. And then
[18:46] and then
[18:47] the slope of that is is the marginal
[18:50] propensity to consume, which is C1,
[18:52] which is a number between zero and one.
[18:57] Okay. So, let's let's determine
[18:59] equilibrium output.
[19:02] So, we have aggregate demand, which is C
[19:04] plus I plus G. Okay?
[19:07] There we are.
[19:09] That's that was our definition of
[19:11] aggregate demand.
[19:12] Uh I'm going to stick in now the
[19:14] functional forms. Well, these guys are
[19:16] very boring. They're constants. And I'm
[19:18] plugging in here the the consumption the
[19:20] consumption function. Okay? So, what we
[19:23] have here is that aggregate demand
[19:27] is an increasing function of output or
[19:29] income. Okay?
[19:32] It's also a function of taxes,
[19:33] investment, and so on, but but it's an
[19:35] increasing function of output. And And
[19:37] this is important because I'm Remember,
[19:39] the the goal of this is to find
[19:42] equilibrium output.
[19:44] So, here I have on the right hand side
[19:46] of my aggregate demand
[19:48] output. That's good. I have one equation
[19:51] in which output shows up.
[19:53] Okay? Now, I cannot find equilibrium
[19:55] output just from this equation. Why is
[19:57] that?
[20:00] So, I'm Remember, we're trying to build
[20:02] a model
[20:03] to find
[20:05] equilibrium output.
[20:07] That's our goal. That's what will tell
[20:09] us whether we're in a recession or not.
[20:11] Output is low, recession. Output is
[20:13] high, we're in a boom.
[20:15] Obviously, I cannot solve it from this.
[20:17] I have two unknowns.
[20:19] What are my two unknowns?
[20:23] Two unknowns, one equation.
[20:25] What is my second unknown there?
[20:37] Aggregate demand, of course. We have to
[20:39] determine Z and Y.
[20:41] Okay?
[20:42] So, how are we going to do that?
[20:45] Well,
[20:46] using a second equation, which is the
[20:48] equilibrium condition. It's not a
[20:50] function. This is a function. This is
[20:52] not a function. This is an equilibrium
[20:53] condition. It says, "In equilibrium, not
[20:56] outside equilibrium. In equilibrium,
[20:59] output is equal to aggregate demand."
[21:02] Okay?
[21:03] That's what this
[21:05] equilibrium condition tells us. Off
[21:07] equilibrium, this doesn't hold. That's
[21:08] the reason this is not a function. This
[21:10] holds everywhere. It's a function.
[21:12] This is an equilibrium condition. It
[21:14] says, "At equilibrium, aggregate demand
[21:16] is equal to output."
[21:18] So, now we're done because we have two
[21:19] equations with two unknowns. Okay?
[21:24] Good.
[21:25] And the reason I post on this is that I
[21:27] see that mistake made often.
[21:29] Okay?
[21:30] That this is interpreted as a function.
[21:32] It's not. It's an equilibrium condition.
[21:34] At equilibrium, it holds. And that you
[21:36] can see, actually, I'm going to
[21:38] illustrate the same point in in the
[21:40] diagram. So, this is the
[21:42] Let me Let me keep going. So, this is
[21:44] clear, no? So, this is This is just a
[21:46] summary of what we had in the previous
[21:48] slides. It's
[21:50] And this is the new thing here, which is
[21:53] in equilibrium, output is equal to
[21:55] aggregate demand.
[21:56] And and and the and the
[22:00] And again, that's what makes
[22:02] this a really a short
[22:04] short-run model. You see, I'm saying
[22:07] output in the short run is whatever
[22:08] demand wants it to be.
[22:12] Which is different from from from
[22:15] the long run that says, "No, no. Hold on
[22:17] a second. I mean, but you
[22:18] How much output you can produce is a
[22:20] function of the capital you have, of the
[22:21] workers you have." Yeah, yeah, that's
[22:23] true in the long run. But in the short
[22:24] run, you have lots of flexibility
[22:26] because you have lots of unused capacity
[22:27] and so on.
[22:29] Okay? So, this is pretty It's a big
[22:31] assumption, and there is schools of
[22:33] thoughts within microeconomy that split
[22:35] by this assumption, whether you believe
[22:37] that that that in the short run, output
[22:40] is aggregate demand determined or not.
[22:43] At MIT, we tend to believe that in the
[22:45] short run. The long run, no. But in the
[22:47] short run, that's what it does.
[22:48] Now, sometimes the long run gets to you
[22:51] very quickly. And at this point, we're
[22:53] in a situation like that. That's the
[22:54] reason we're seeing inflation and so on,
[22:55] but that's something you'll understand
[22:57] later on.
[22:58] Okay? But but but for now, so this is
[23:01] this is important. We're going to We're
[23:03] saying here
[23:04] output I don't need another equation. I
[23:06] could have done aggregate demand like
[23:07] this, and then output a function of
[23:08] capital, labor, lots of things.
[23:11] I'm not going to even do that. I'm going
[23:12] to say, "No, no. Output will be whatever
[23:14] demand wants it to be." Okay?
[23:17] And that means in equilibrium, they have
[23:18] to be equal.
[23:20] Good.
[23:21] You had a question.
[23:28] No, they are the same for us.
[23:31] That's our definition. GDP for us is
[23:33] output.
[23:35] So, when I say aggregate output, I mean
[23:38] GDP.
[23:39] Remember? Real GDP. We're talking all
[23:41] about real GDP. Okay?
[23:43] Uh
[23:44] And it's also equal to income. Not
[23:46] disposable, but it's equal to income.
[23:47] Remember when we did those little tables
[23:49] where we look on our
[23:50] the three different ways of doing it?
[23:52] Well, the first two were output.
[23:55] And the last one was income, and they
[23:56] had to be the same.
[23:58] Okay?
[23:59] So, why is real GDP for us?
[24:04] That's real GDP.
[24:07] What happens in the table I show you,
[24:11] I already used the fact that real GDP is
[24:13] equal to aggregate demand, and that's
[24:14] the reason I show you the different
[24:15] components of Z.
[24:17] I show you that, that, and that.
[24:20] Okay? But in equilibrium, they're equal.
[24:28] There's really a figure that that will
[24:30] clarify, I think, a lot of that. But
[24:32] let's Let me keep solving this. So,
[24:34] we have that And so, what I'm going to
[24:36] do next is just solve it. So, we have
[24:38] this equilibrium condition. I'm going to
[24:39] plug in my aggregate demand function
[24:42] here,
[24:43] and so I can solve out for equilibrium
[24:45] output. And here we have the first for
[24:47] the first time in this course, an
[24:48] equation for equilibrium output.
[24:50] There you are. That's your equilibrium
[24:52] output in this economy.
[24:56] Okay?
[24:58] Now, this guy here
[25:01] is very famous,
[25:02] and is very macro.
[25:04] Doesn't happen in micro. It happens in
[25:06] macro only. Okay? This guy here.
[25:11] Another guy there is called the
[25:13] multiplier.
[25:16] Okay?
[25:19] And it's a very important macro concept.
[25:20] A huge concept in macro.
[25:24] Now, why do you think it's called a
[25:26] multiplier?
[25:28] Well, obviously, it multiplies
[25:29] something, but a multiplier sounds like,
[25:32] you know,
[25:34] that multiplies that makes something
[25:36] bigger, no?
[25:39] So, what happens if C1 is
[25:42] uh greater than zero?
[25:48] Is What happens if C1 is greater than
[25:50] zero? Remember, it's between zero and
[25:51] one. But what happens if it's greater
[25:53] than zero? What happened with that
[25:54] number there, one over one minus C1?
[26:02] It's greater than one. That's what this
[26:04] is. It multiplies. Okay? So, that's the
[26:06] reason we call it a multiplier. There's
[26:07] not nothing deep there. Uh okay? So,
[26:09] this thing here is sort of autonomous
[26:11] stuff, you know? It's what the
[26:12] government spends, what firms are
[26:14] spending, capital.
[26:15] This is autonomous consumption. Uh
[26:19] And this Actually, this is a typo there.
[26:21] There should be a C1 in front of that.
[26:24] Typo.
[26:25] It comes from there. C1 times
[26:28] T.
[26:29] So, fix that typo, please. I I'm going
[26:31] to upload the slides again with with the
[26:33] typo fixed. Okay?
[26:36] I'm just It comes from here. C1 times T.
[26:40] Okay, so that's what this does. It
[26:42] multiplies. So, whatever it is that that
[26:44] is happening here, whatever it is that
[26:45] the government is spending or whatever,
[26:47] this term multiplies it. And that's a
[26:49] huge thing. Uh There was a big debate uh
[26:53] almost always when you're trying to get
[26:55] out of a recession and the governments
[26:57] are spending, a big question is, "Well,
[26:58] how big is the multiplier?" If the
[27:00] multiplier is small, you're going to
[27:02] have to spend a lot to get the economy
[27:03] out of the recession. If the multiplier
[27:05] is large,
[27:07] then then uh
[27:09] you you're going to have have to spend
[27:11] very little, and then the multiplier
[27:13] will take you away from from that
[27:14] recession.
[27:16] So, what is it that makes the multiplier
[27:18] large or small?
[27:23] Well, mechanically, when is it that
[27:25] multiplier large?
[27:27] When C1 is closer to one. So, when when
[27:30] people are spending more of their income
[27:31] on Exactly. When C1 is large.
[27:34] And that that gives you the logic, and
[27:35] that's very important in macro. It's
[27:38] Why is it that a big multiplier? Well,
[27:40] because think what happens in macro. If
[27:42] the government spends,
[27:45] that increases output.
[27:47] But now, output increases income. And if
[27:49] consumers spend a big share of their
[27:51] extra income
[27:52] in output and consumption again, then
[27:55] that increases output again, which
[27:57] increases income again, and
[27:59] you keep going.
[28:00] Okay?
[28:01] So, that's the sequence. On the
[28:03] contrary, if consumers are very scared,
[28:04] they don't want to spend any extra
[28:06] dollar they receive, anything of the
[28:07] extra dollar they receive, then you
[28:09] don't get any multiplier because this
[28:11] initial increase in output that comes
[28:13] from the government expansion, that does
[28:16] lead to increase in income, but if
[28:17] consumers don't spend it, it doesn't
[28:19] recirculate into the economy, and then
[28:20] you don't get a multiplier. Okay? So,
[28:22] that's that's the reason we call it the
[28:24] multiplier.
[28:27] So, that diagram is is an important
[28:29] diagram. I'm just
[28:32] uh
[28:34] doing this, actually. In that diagram,
[28:37] I'm plotting the aggregate demand
[28:39] function,
[28:40] and then this equilibrium condition,
[28:42] output equal to aggregate demand,
[28:44] in the space
[28:46] of
[28:47] uh
[28:48] aggregate demand and output, production,
[28:51] and income here. But remember, income is
[28:53] equal to production. Okay?
[28:55] So, there's your aggregate demand,
[28:58] and that's your 45 degree line because
[29:01] this output equal to So, whatever is in
[29:03] this axis is equal to that axis. That's
[29:05] the 45 degree line.
[29:07] Okay? That's your equilibrium condition.
[29:09] It says, "At equilibrium, this guy here,
[29:12] aggregate demand Z, will have to be
[29:13] equal to Y." Those are That's straight
[29:16] there.
[29:17] This is aggregate demand.
[29:20] Why is this line flatter than that?
[29:25] Why is aggregate demand flatter than
[29:30] Uh because people don't spend their
[29:32] entire dollar on Exactly. Because C1 is
[29:34] less than one.
[29:36] So, the slope of the aggregate demand in
[29:38] this space is C1.
[29:40] It's the marginal propensity to consume.
[29:42] How much more they demand if they get an
[29:44] extra dollar? Well, And don't get They
[29:46] don't demand one one extra unit they
[29:48] demand C1 unit and C1 is less than one.
[29:51] Okay, that's the reason this.
[29:53] So, if C1 is very small,
[29:56] this line is going to be very flat.
[29:58] If C1 is very large, very high marginal
[29:59] propensity to consume, this is going to
[30:01] be very steep,
[30:02] the red line.
[30:03] The other one doesn't change, the 45°
[30:05] line.
[30:06] Okay? And what I said is that
[30:09] at equilibrium So, you see if I take an
[30:11] off-equilibrium level of output, say
[30:13] this,
[30:14] aggregate demand is different from
[30:15] output.
[30:16] It's only at equilibrium that these two
[30:19] things will hold.
[30:22] Okay?
[30:23] This function I can plot it everywhere.
[30:27] But this one will hold only at
[30:28] equilibrium.
[30:30] Okay?
[30:31] That's when these two things are equal.
[30:35] So, what I solve here,
[30:39] here I just found this point.
[30:41] Okay?
[30:42] So, parameters here are C0,
[30:46] uh
[30:46] C1 * T, and G. They all shifters of this
[30:50] aggregate demand up and down.
[30:53] Okay?
[30:55] And and that point here
[30:59] is exactly that. And those all those
[31:01] things are parameters in my aggregate
[31:03] demand.
[31:11] I really want you to internalize this
[31:12] diagram.
[31:15] Any questions about
[31:19] Just stare at this little bit because
[31:21] it's going to show up repeatedly.
[31:24] And and later on it's not going to show
[31:25] up, but whenever you get confused, the
[31:28] way to get yourself out of that
[31:29] confusion is going to be to go back to
[31:31] the diagram.
[31:32] You'll see. I'll remind you when when
[31:34] when that's likely to happen.
[31:37] Okay? So, so you better understand
[31:39] this diagram. Play with it. Move
[31:42] Here the only thing you can move around
[31:44] is the ZZ, the the the aggregate demand
[31:46] curve. Okay?
[31:48] The other thing is our equilibrium
[31:49] condition. You can't move that that 45°
[31:52] line. But ZZ you can move it around. So,
[31:55] let's do a a few exercises. Well, one,
[31:58] the most obvious.
[32:00] Suppose that C0 increases by 1 billion.
[32:05] Okay? So, autonomous consumption, that
[32:06] is that level of consumption which is
[32:07] independent of income, goes up by 1
[32:09] billion.
[32:10] And that could be, you know, we're all
[32:12] in a better mood. You know, okay,
[32:14] disposable income is whatever it is
[32:16] today, but you know, there's great
[32:18] expectation that that in the that the
[32:20] economy will enter a boom next year.
[32:24] And so, then you feel richer and so on,
[32:26] and you may decide to consume not wait
[32:28] until next year, you may decide to
[32:29] consume more today. That kind of thought
[32:31] experiment can be captured by a C0 type
[32:34] shift, go up. And that's when you I talk
[32:36] about consumer sentiment. Well, consumer
[32:38] sentiment is about a lot about C0. For
[32:41] any given level of income, will
[32:42] consumers are likely to to to consume
[32:45] more than they would otherwise or or
[32:47] less.
[32:48] And that's what C0 captures.
[32:50] So, let's go
[32:52] everything in this model, there's no
[32:53] dynamics
[32:54] in this simple model, so we immediately
[32:57] but we know is if just were to solve the
[32:59] equation,
[33:00] and I tell you what happens to if output
[33:03] what happens to output if C0 goes up by
[33:05] 1 billion,
[33:07] you know that output will rise by how
[33:09] much?
[33:12] Let's keep it simple.
[33:14] I
[33:15] just staring at that equation. If I tell
[33:17] you autonomous consumption goes up by 1
[33:19] billion,
[33:20] what happens to equilibrium output? Goes
[33:22] up by more or less than 1 billion?
[33:25] Or or exactly 1 billion?
[33:33] Exactly. And the multiplier is greater
[33:35] than one. So, we know that the output
[33:37] will increase by more than 1 billion.
[33:40] Will increase by 1 billion times the
[33:41] multiplier.
[33:43] If C1 is .5, then it will increase by 2
[33:46] billion dollars equilibrium output.
[33:49] Now, I'm going to get you to from the 1
[33:51] billion to the 2 billion in a steps
[33:54] using the diagram. That's what I intend
[33:55] to do next.
[33:58] Okay? So,
[34:00] this shift here, so we're starting from
[34:02] this equilibrium output here.
[34:04] This shift here,
[34:06] boom,
[34:08] is increasing C0. That's a 1 billion.
[34:10] So, distance A to B is 1 billion. That's
[34:14] it will be because what I did is for any
[34:16] given level of output I shift this
[34:17] aggregate demand up by 1 billion. That's
[34:20] autonomous consumption up.
[34:22] Okay?
[34:23] Well,
[34:24] because output is whatever demand wants,
[34:27] that immediately increases output
[34:30] by 1 billion. So, B, the distance
[34:32] between B and C is also 1 billion.
[34:35] Okay?
[34:36] Demand increase by 1 billion, boom,
[34:38] output immediately catches up.
[34:41] So, output increases by 1 billion.
[34:45] But if output increases by 1 billion,
[34:48] what has happened to income?
[34:56] It also increased by 1 billion. Income
[34:58] is the same as output.
[35:01] So,
[35:02] income has increased by 1 billion.
[35:04] Well, if income has increased by 1
[35:05] billion and C1 is different from zero,
[35:09] that means part of that extra billion is
[35:11] going to be spent
[35:12] in consumption, second round.
[35:15] So, say C1 is .5, then now you get 500
[35:18] million dollars more of expenditure.
[35:21] But if it's of consumption, and if
[35:22] there's 500 dollars that's that's a C
[35:25] CD.
[35:26] Shift, that's 500 million.
[35:29] Obviously, this C1 here is is less than
[35:31] .5 because otherwise
[35:33] you know, this would be half of that,
[35:35] but but it's not. Anyway,
[35:37] you get 500 million more.
[35:39] But if you if now there's 500 million
[35:41] more of demand, since output does
[35:43] whatever production does whatever demand
[35:45] wants, then you get 500 more of
[35:47] production.
[35:49] And if you have 500 more million dollars
[35:51] more of production, then you have 500
[35:52] million more of income.
[35:54] And if you have 500 more of income and
[35:56] so your C1 is greater than zero,
[35:57] say .5, you're going to spend 250
[36:00] million more.
[36:02] But 250 million more will generate 250
[36:05] million dollars of production, which
[36:06] also will generate 250 million dollars
[36:09] more
[36:10] of
[36:11] income,
[36:13] which will generate 125 million more
[36:16] of consumption, and blah blah blah blah
[36:17] blah. You you you get your Okay?
[36:20] So, that's and that's what is happening
[36:22] here.
[36:24] Boom.
[36:25] Yeah.
[36:29] From C
[36:30] to D. Okay. So, this is initial
[36:34] shift in aggregate demand up, 1 billion.
[36:38] That
[36:39] lead to leads to
[36:41] uh
[36:42] 1 billion more of production as well,
[36:45] which means 1 billion more of income.
[36:48] Okay? But now these consumers not only
[36:50] have this C0 1 billion higher in C0, but
[36:53] they also have 1
[36:55] uh billion more of income.
[36:57] And since they have 1 billion income and
[36:59] they're going to spend part of it, C1
[37:01] times that, and I assume C1 was .5,
[37:03] that's what gives me CD.
[37:06] That's the the extra five 500 million
[37:09] dollars.
[37:10] And then this that thing here there is
[37:12] also 500 million dollars, and then there
[37:13] was 250 million, 250 million, 125, 125,
[37:18] 62 and a half, blah blah blah.
[37:20] That's that's the way you get there.
[37:24] There's an alternative way of
[37:26] finding equilibrium output, which is
[37:28] entirely equivalent. And it's the way it
[37:30] was initially done, by the way.
[37:32] Uh and and and you'll see later on a
[37:34] very important curve in this course will
[37:37] be
[37:38] the IS curve, which is a curve that
[37:40] describes all the equilibrium in goods
[37:43] markets. We'll get there.
[37:45] But but the reason it's called IS is
[37:47] because of this alternative way of
[37:48] deriving the same I have derived,
[37:50] which is
[37:52] through you you can arrive to the same
[37:54] equilibrium by saying, "Look,
[37:55] equilibrium output is that output at
[37:58] which investment is equal to saving."
[38:01] That's the reason that curve is going to
[38:03] be called IS, investment equal to
[38:05] saving, S.
[38:07] So, let me very quickly do it for you
[38:08] and and then make a point and connect
[38:10] the two things.
[38:11] So, say private saving is, you know,
[38:14] what con- sumers do and so on,
[38:16] and firms, is just disposable income
[38:19] minus consumption. That's your saving.
[38:21] Okay?
[38:22] So, it's equal to Y minus T, that's
[38:24] disposable income, minus C.
[38:27] Government saving is taxes minus
[38:31] government expenditure. So, if the
[38:32] government has a deficit, that thing is
[38:34] negative. Governments often have
[38:36] negative saving. Okay? If you have a
[38:38] surplus, then taxes are greater than G,
[38:42] then you have a fiscal surplus. Again,
[38:45] rarely happens in the US
[38:47] or in the Americas in general. Okay?
[38:49] Happens a lot in Asia, but not doesn't
[38:51] happen very much in this part of the
[38:53] world.
[38:54] But there we are. So, in equilibrium,
[38:57] investment, I,
[39:00] has to be equal to saving. So, that's
[39:02] what you are going to use the saving
[39:03] for, to invest. Okay?
[39:06] So, investment is equal to the sum of
[39:08] savings.
[39:09] I can replace all that in here, and you
[39:11] see that I get exactly the same
[39:14] equilibrium condition I had before.
[39:16] Output equal to aggregate demand.
[39:18] Okay? So, this is an entirely equivalent
[39:21] way
[39:22] of deriving this, and I just want to
[39:24] show you this
[39:26] because it's the way it was originally
[39:28] done, and and and and and you'll
[39:31] understand better the terminology we use
[39:32] later on
[39:33] if you see that this is an equivalent
[39:35] way. This is also a nice way of
[39:38] illustrating something why macro can be
[39:40] counterintuitive sometimes.
[39:41] Microeconomics is very intuitive. I
[39:43] mean, things make sense.
[39:45] It's like physics, it makes sense. Macro
[39:47] is can be confusing.
[39:49] For example, there's the well-known
[39:52] paradox of saving in the short run, not
[39:54] in the long run. In the short run, you
[39:55] have the paradox of saving.
[39:57] So, you know, we all think that you save
[40:00] more is a good thing. Our parents teach
[40:02] us that it's a good thing to save more
[40:03] and so on.
[40:05] And in general,
[40:06] that is true. You'll do better in life
[40:08] if you save a little more and so on.
[40:10] But it's not true for the macro in the
[40:12] short run.
[40:16] You know, it's not good for
[40:18] macroeconomics in the short run
[40:20] unless you are in a overheated economy.
[40:22] Now, it could help.
[40:24] But otherwise, it's not very good for
[40:27] equilibrium output. Let me show you that
[40:30] very quickly with the expression I just
[40:32] showed you. Remember that I said
[40:33] equilibrium output is pinned down by
[40:35] investment equal to saving. And saving
[40:38] of the private saving here is an
[40:40] increasing is an increasing function of
[40:41] output, okay? It is equal to actually 1
[40:45] - c The function has a slope of 1 - c1.
[40:48] C1 is the share of income that you spend
[40:51] in consumption. Therefore, 1 - c1 is the
[40:53] share of your income that you spend in
[40:55] saving, okay? So, this function is
[40:57] increasing with a slope of 1 - c1.
[41:01] So, suppose I tell you now that all we
[41:03] decided to to we learn the lessons of
[41:05] our parents and say, "Okay, we should
[41:06] all save more."
[41:08] So, that means for any for any given
[41:11] level of income, now we all decide to
[41:12] save more. That means the the S function
[41:15] shifts up.
[41:17] For any given level of income,
[41:19] we save more. But
[41:21] we have a problem there because now we
[41:22] have more saving than investment.
[41:26] So, how how do we restore equilibrium?
[41:28] That's not an equilibrium.
[41:29] How do we restore equilibrium?
[41:37] So, now we all decide to be more prudent
[41:39] and save a little more.
[41:42] At the level of the economy as a whole,
[41:45] now we have more saving than investment.
[41:47] That can happen. It can It's not an
[41:49] equilibrium.
[41:51] What restores equilibrium?
[41:55] Well,
[41:55] in this very simple model, our
[41:57] investment is fixed. So, I nothing can
[41:59] adjust on the investment side because
[42:01] it's fixed. Later on, it's going to
[42:02] move, but now it's fixed.
[42:04] Nothing can adjust in the public saving
[42:06] part because, you know, it can't move.
[42:09] We assume that it's exogenous.
[42:10] So, something has to happen endogenously
[42:12] here that that reverses the increase in
[42:15] savings. That's the only thing that can
[42:17] happen. And the only thing that can
[42:18] happen endogenously here is a declining
[42:20] output.
[42:22] Output declines, saving declines.
[42:24] So, here you end up in a situation in
[42:26] which we all decided to be sort of, you
[42:28] know, better people, save a little more,
[42:30] and we end up sinking the economy in a
[42:32] recession.
[42:34] Yeah,
[42:35] output declines.
[42:36] Okay, that's the reason it's called the
[42:37] paradox of saving.
[42:41] That's not going to happen to you
[42:42] individually, but to an economy as a
[42:44] whole, that's the reason I said it's
[42:46] counterintuitive.
[42:47] It it can happen.
[42:52] I get
[42:53] So, I
[42:54] Look, if you don't like this way of
[42:57] uh
[42:57] and it's not the main way we're going to
[42:59] use. If you don't like this way of
[43:00] finding equilibrium output, just ignore
[43:02] it. I I just wanted you to know it. Go
[43:04] back to The thing you really need to
[43:06] understand is not this, it's it's this,
[43:08] that, that that you need to understand.
[43:10] So, let me
[43:11] illustrate the paradox of saving
[43:14] in in the model we're using, in the one
[43:16] I want you to really remember.
[43:19] Well,
[43:20] the paradox of saving, I can capture by
[43:23] a declining c0.
[43:25] Okay? For any given level of income, now
[43:27] we decide to consume less. If we consume
[43:29] less for any given level of income, that
[43:31] means we're saving more.
[43:33] Okay?
[43:34] So, I can capture in this diagram
[43:38] uh
[43:39] the the fact that we all all become sort
[43:41] of more prudent by a declining aggregate
[43:44] demand.
[43:46] But if aggregate demand declines, so
[43:48] suppose we start at this equilibrium
[43:49] level of output and then all of a sudden
[43:51] we say, "Okay, enough is enough. We need
[43:53] We need to start saving more."
[43:55] Then,
[43:56] what happens? Well, aggregate demand
[43:58] declines.
[44:00] I mean, for any given level of income,
[44:02] if you're going to save more, that means
[44:03] you're going to consume less. So,
[44:04] aggregate demand declines.
[44:06] But what happens when aggregate demand
[44:07] declines?
[44:11] Output declines.
[44:13] What happens when out when output
[44:14] declines?
[44:18] Income declines.
[44:19] What happens when income declines?
[44:25] Well, part of that income you consume,
[44:27] so you're going to consume less.
[44:28] C1 times that. So, then and then you get
[44:31] the multiplier working against you. So,
[44:33] not only if now we all decide to save
[44:35] more, not only output falls
[44:38] by the same amount that that we increase
[44:41] savings,
[44:42] but actually it declines by more than
[44:44] that because you get the multiplier
[44:45] working against against you.
[44:47] Okay?
[44:49] That's the reason I'm a big role of
[44:51] policy makers really in recession is to
[44:54] try to maintain the calm, the you know,
[44:57] because you can get into this kind of
[44:58] things. If everybody gets scared and and
[45:00] you know, we all get scared, so the
[45:02] economy can implode just out of bad
[45:04] sentiment. Uh
[45:06] and so on.
[45:14] Now, we're on the opposite side of the
[45:16] cycle. We would want output to decline a
[45:18] little because we are having other
[45:20] problems, inflation and so on, again,
[45:22] something we'll discuss later.
[45:24] So, now you may want to scare consumers
[45:26] a little. And in fact,
[45:28] uh
[45:32] the the governors of the Federal
[45:34] Reserve, and the same is happening in
[45:35] other places in the world, are doing
[45:36] just that. I mean, when they go out
[45:38] there, say the economy is too hot,
[45:42] uh we're going to have to mess up this
[45:44] economy a little. And then they're
[45:45] telling us that.
[45:47] And and and the first ones to listen to
[45:49] these things are is the financial
[45:50] markets. So, every time they come out
[45:52] and make a speech of that kind, equity
[45:54] markets decline.
[45:56] Well, equity markets capture before the
[45:59] mood that consumers will have in the
[46:00] future. They capture it early. But
[46:02] that's the message.
[46:03] Okay? So, they're trying to At this
[46:06] moment, really,
[46:08] uh
[46:08] policy makers, at least the the central
[46:11] banks, are trying to do just that.
[46:13] Depress a little bit consumers.
[46:15] So so so we can
[46:17] cool off the economy a bit.
[46:19] Okay?
[46:22] Any questions?
[46:24] Again, very important lecture because
[46:26] we're going to build on on this and and
[46:28] later on this is going to be always in
[46:30] the background.
[46:32] And
[46:33] of this until we actually go to the
[46:35] third part of the course,
[46:36] the key model will be this. This will be
[46:38] in the background. More More things will
[46:40] be happening on top,
[46:42] but but whenever I ask you a question,
[46:45] for example, later on, one example, what
[46:48] else would produce a
[46:50] this a situation like this?
[46:54] What else would What What could have
[46:56] What kind of policy
[46:59] would generate
[47:01] that
[47:02] that movement? Well, at this point, we
[47:04] haven't introduced monetary policy, so
[47:06] you cannot talk about monetary policy.
[47:09] But we do we do have
[47:11] other kind of policy we could talk
[47:12] about.
[47:24] Remember?
[47:30] Here.
[47:32] Fiscal policy.
[47:35] Okay?
[47:36] Fiscal policy, G and T. Those are fiscal
[47:38] parameters.
[47:40] When when G goes down or T goes up, we
[47:43] call that contractionary fiscal policy.
[47:45] Why contractionary? Because it contracts
[47:47] aggregate demand.
[47:49] If If G goes down, clearly aggregate
[47:51] demand goes down immediately. If T goes
[47:54] up, well, disposable income for any
[47:55] given level of income goes down, and
[47:57] therefore consumption goes down. So, so
[47:59] we call an increase a declining G or an
[48:02] increasing T a contractionary fiscal
[48:04] policy.
[48:05] The opposite, if G goes up and T goes
[48:08] down, we call that an expansionary
[48:10] fiscal policy.
[48:11] So, I take you back to this diagram
[48:14] here,
[48:16] and I ask you the question again.
[48:18] What kind of fiscal policy will generate
[48:20] this type of
[48:22] this picture?
[48:24] Contractionary or expansionary?
[48:32] Contractionary. Contractionary. I mean,
[48:34] good mnemonic, the output declined.
[48:37] You know? So, contractionary So, that is
[48:39] a declining a reduction in G, in
[48:41] government expenditure,
[48:43] or an increase in taxes
[48:45] will shift that curve down, and then the
[48:47] multiplier will make it even more
[48:49] contractionary than the initial fiscal
[48:52] impulse.
[48:57] Very good.
[48:58] I'll see you on Wednesday.