WEBVTT 00:00:17.239 --> 00:00:22.839 Okay, let's uh let's start. Um 00:00:21.399 --> 00:00:26.079 So, what you have there in that picture 00:00:22.839 --> 00:00:27.920 is uh is the result of a survey to a 00:00:26.079 --> 00:00:30.119 bunch of economists 00:00:27.920 --> 00:00:31.640 on which are asked to assess the 00:00:30.120 --> 00:00:34.920 probability that there is a recession 00:00:31.640 --> 00:00:37.240 within the next 12 months. 00:00:34.920 --> 00:00:38.719 Recession means essentially a decline in 00:00:37.240 --> 00:00:41.560 aggregate output. 00:00:38.719 --> 00:00:43.600 Um and well, the first thing to notice 00:00:41.560 --> 00:00:45.880 here is that you know, it's not very 00:00:43.600 --> 00:00:48.200 good news. There is a very high chances 00:00:45.880 --> 00:00:50.760 at at least according to 00:00:48.200 --> 00:00:53.160 this expert that that the US enters a 00:00:50.759 --> 00:00:55.479 recession within the next 12 months or 00:00:53.159 --> 00:00:57.000 so. Pretty high probability. 00:00:55.479 --> 00:00:59.039 You can see that that number typically 00:00:57.000 --> 00:01:01.759 is very very low and it goes very high 00:00:59.039 --> 00:01:03.679 sort of real next to recessions. 00:01:01.759 --> 00:01:05.879 And now we're not in a recession, but 00:01:03.679 --> 00:01:08.200 but there is a sort of very high per se 00:01:05.879 --> 00:01:10.560 probability that we may 00:01:08.200 --> 00:01:12.920 go into recession in the near future. 00:01:10.560 --> 00:01:15.120 So, how is that these people come up 00:01:12.920 --> 00:01:17.760 with this forecast? Well, 00:01:15.120 --> 00:01:20.560 at some level, either explicitly or 00:01:17.760 --> 00:01:21.480 implicitly, they must have some model 00:01:20.560 --> 00:01:23.320 uh 00:01:21.480 --> 00:01:24.960 that of the determination of equilibrium 00:01:23.319 --> 00:01:26.479 output. I mean, you know, they need to 00:01:24.959 --> 00:01:28.079 understand 00:01:26.480 --> 00:01:29.719 they need to see certain things that 00:01:28.079 --> 00:01:32.719 suggest 00:01:29.719 --> 00:01:34.079 when you go through a model that output 00:01:32.719 --> 00:01:36.000 will decline. 00:01:34.079 --> 00:01:38.200 Um so, that's what we're going to start 00:01:36.000 --> 00:01:40.040 doing today. And 00:01:38.200 --> 00:01:40.840 and in fact, that's what we're going to 00:01:40.040 --> 00:01:42.480 do 00:01:40.840 --> 00:01:46.079 throughout this course. It's we're going 00:01:42.480 --> 00:01:49.359 to try to find ever more complex perhaps 00:01:46.079 --> 00:01:51.599 or or richer models of 00:01:49.359 --> 00:01:53.319 uh output determination, aggregate 00:01:51.599 --> 00:01:55.359 output determination. So, that's 00:01:53.319 --> 00:01:56.079 essentially what this course is about. 00:01:55.359 --> 00:01:58.239 Uh 00:01:56.079 --> 00:01:59.239 and so, and understanding sort of we're 00:01:58.239 --> 00:02:01.559 going to try to understand what is it 00:01:59.239 --> 00:02:03.479 that drives that equilibrium output and 00:02:01.560 --> 00:02:05.200 how is it that we get to one specific 00:02:03.480 --> 00:02:06.400 level of output. 00:02:05.200 --> 00:02:08.520 That's what it means to find the 00:02:06.400 --> 00:02:10.360 equilibrium level of output. 00:02:08.520 --> 00:02:11.920 Um and we're going to do it sort of in 00:02:10.360 --> 00:02:13.760 three stages. 00:02:11.919 --> 00:02:15.559 In the first part of the course, that is 00:02:13.759 --> 00:02:17.560 up to quiz one, 00:02:15.560 --> 00:02:19.879 uh we're going to focus on on on the 00:02:17.560 --> 00:02:22.479 very short run. How output is determined 00:02:19.879 --> 00:02:23.560 in the very short run, say within a year 00:02:22.479 --> 00:02:24.519 or so. 00:02:23.560 --> 00:02:25.159 Uh 00:02:24.520 --> 00:02:27.280 uh 00:02:25.159 --> 00:02:29.359 well, a little more even, but but that 00:02:27.280 --> 00:02:31.120 type of frame time frame. 00:02:29.360 --> 00:02:34.000 Then we're going to focus on the medium 00:02:31.120 --> 00:02:35.599 run. That's sort of is 00:02:34.000 --> 00:02:38.120 at the beginning of 00:02:35.599 --> 00:02:38.840 of of the second part of the course. 00:02:38.120 --> 00:02:40.480 Uh 00:02:38.840 --> 00:02:41.920 and by the medium run, simply we're 00:02:40.479 --> 00:02:44.000 going to mean by the time in which 00:02:41.919 --> 00:02:47.159 prices begin to adjust sufficiently. 00:02:44.000 --> 00:02:49.479 Okay? Before that, is most of the action 00:02:47.159 --> 00:02:52.039 happens in in quantities. There is 00:02:49.479 --> 00:02:53.599 little movement in goods prices. There's 00:02:52.039 --> 00:02:55.840 lots of movement in asset prices, but 00:02:53.599 --> 00:02:57.239 little movement in goods prices. 00:02:55.840 --> 00:02:59.200 And in the last part of the course, 00:02:57.240 --> 00:03:00.800 we're going to look at how output is 00:02:59.199 --> 00:03:02.280 determined over the long run, which is 00:03:00.800 --> 00:03:04.920 quite different from how output is 00:03:02.280 --> 00:03:06.599 determined in the short run. 00:03:04.919 --> 00:03:08.559 The determination of output in the short 00:03:06.599 --> 00:03:11.439 run is what we mostly mean by business 00:03:08.560 --> 00:03:12.759 cycle analysis. Okay? And short or 00:03:11.439 --> 00:03:14.520 medium run, the way we're going to 00:03:12.759 --> 00:03:15.879 define it here, is what we mean by 00:03:14.520 --> 00:03:17.520 business cycle. The country's in a 00:03:15.879 --> 00:03:19.359 recession, it's in a boom, it's an 00:03:17.520 --> 00:03:20.800 expansion. Those are all terminologies 00:03:19.360 --> 00:03:23.200 of the short run 00:03:20.800 --> 00:03:24.560 or short or medium run. 00:03:23.199 --> 00:03:26.679 The determination of equilibrium output 00:03:24.560 --> 00:03:29.240 in the long run is when we think about 00:03:26.680 --> 00:03:31.480 growth. When we talk about why is it 00:03:29.240 --> 00:03:32.840 China grows faster than the US today? 00:03:31.479 --> 00:03:34.759 Well, that's a that's a question not 00:03:32.840 --> 00:03:37.400 about the business cycle. It's a 00:03:34.759 --> 00:03:40.759 question about the long-run determinants 00:03:37.400 --> 00:03:42.840 of output growth. Okay? And and they're 00:03:40.759 --> 00:03:44.479 even different class of models. 00:03:42.840 --> 00:03:46.159 In more advanced models, if you were 00:03:44.479 --> 00:03:48.599 doing a PhD, those things are a lot 00:03:46.159 --> 00:03:50.079 closer to each other and and and but but 00:03:48.599 --> 00:03:52.199 in this course, they're going to be very 00:03:50.080 --> 00:03:54.160 different type of models. It's easier to 00:03:52.199 --> 00:03:56.919 analyze these things with different type 00:03:54.159 --> 00:03:59.560 of models than trying to integrate all 00:03:56.919 --> 00:04:01.439 in one big machine. Okay? But let's 00:03:59.560 --> 00:04:02.640 start with the the simple part. In the 00:04:01.439 --> 00:04:04.359 short run, 00:04:02.639 --> 00:04:08.000 the key mechanism, something that will 00:04:04.360 --> 00:04:10.480 will keep showing up uh in all the 00:04:08.000 --> 00:04:11.280 models and sub models we analyze 00:04:10.479 --> 00:04:13.560 uh 00:04:11.280 --> 00:04:15.280 in the first eight lectures or so or 00:04:13.560 --> 00:04:17.759 seven lectures of the next seven 00:04:15.280 --> 00:04:19.279 lectures or so, is this mechanism. In 00:04:17.759 --> 00:04:21.879 the very short run, 00:04:19.279 --> 00:04:23.159 output, that is equilibrium output, the 00:04:21.879 --> 00:04:25.399 thing that these economists are 00:04:23.160 --> 00:04:27.840 forecasting that will decline in the 00:04:25.399 --> 00:04:30.000 next 12 within the next 12 months, 00:04:27.839 --> 00:04:32.399 is determined primarily 00:04:30.000 --> 00:04:33.360 by act what we call demand. 00:04:32.399 --> 00:04:35.919 Okay? 00:04:33.360 --> 00:04:37.520 So, demand will determine output. That's 00:04:35.920 --> 00:04:39.160 the change in demand that will change 00:04:37.519 --> 00:04:41.319 production. 00:04:39.160 --> 00:04:43.120 But when production changes, that will 00:04:41.319 --> 00:04:44.560 also change income. That you know from 00:04:43.120 --> 00:04:47.759 national accounts. Remember we said that 00:04:44.560 --> 00:04:49.079 we could measure output from the 00:04:47.759 --> 00:04:50.639 production side, but we also could 00:04:49.079 --> 00:04:52.639 measure the income side. And they're 00:04:50.639 --> 00:04:54.159 exactly the same. More production, 00:04:52.639 --> 00:04:57.199 somebody has to receive the proceeds of 00:04:54.160 --> 00:04:59.400 that. Workers and owners, capital 00:04:57.199 --> 00:05:02.079 owners, the government, whatever. 00:04:59.399 --> 00:05:02.919 But so, changes in in So, the second 00:05:02.079 --> 00:05:04.719 step we're going to make is those 00:05:02.920 --> 00:05:07.040 changes in production that were brought 00:05:04.720 --> 00:05:08.680 about by the changes in demand will lead 00:05:07.040 --> 00:05:10.280 to a change in income. 00:05:08.680 --> 00:05:11.840 But when income changes, that will 00:05:10.279 --> 00:05:14.079 change demand again. 00:05:11.839 --> 00:05:16.560 And so on and so forth. Okay? So, that's 00:05:14.079 --> 00:05:18.639 essentially that's quintessential 00:05:16.560 --> 00:05:19.959 short-run macro. It's to to try to 00:05:18.639 --> 00:05:21.399 understand this 00:05:19.959 --> 00:05:23.359 aggregate demand, because that's the 00:05:21.399 --> 00:05:24.799 main driver, and then how it gets 00:05:23.360 --> 00:05:27.439 multiplied 00:05:24.800 --> 00:05:28.360 uh in the short run. Okay? And 00:05:27.439 --> 00:05:30.000 in this lecture, we're going to talk 00:05:28.360 --> 00:05:31.920 about just about that. 00:05:30.000 --> 00:05:33.560 You know, primarily about that. Okay? 00:05:31.920 --> 00:05:35.640 But that's that's when So, when I mean 00:05:33.560 --> 00:05:36.600 short-run macro, that's the structure I 00:05:35.639 --> 00:05:38.360 have in mind and that's the structure 00:05:36.600 --> 00:05:39.920 most people have in mind. Something 00:05:38.360 --> 00:05:41.439 where aggregate demand will determine 00:05:39.920 --> 00:05:42.480 that. That's the reason why in the short 00:05:41.439 --> 00:05:45.160 run you worry a lot about whether 00:05:42.480 --> 00:05:46.600 consumer confidence is high or low. 00:05:45.160 --> 00:05:48.680 That's demand. If consumers are very 00:05:46.600 --> 00:05:50.760 depressed, they tend to reduce demand. 00:05:48.680 --> 00:05:52.480 If consumers are very bullish, that will 00:05:50.759 --> 00:05:54.519 tend to increase 00:05:52.480 --> 00:05:56.319 demand. And since in the short run 00:05:54.519 --> 00:05:58.039 output is determined by demand, the 00:05:56.319 --> 00:06:00.319 business cycle, whether we have got a 00:05:58.040 --> 00:06:02.040 recession or not, depends on about how 00:06:00.319 --> 00:06:03.680 demand feels. So, if somebody's 00:06:02.040 --> 00:06:07.400 forecasting a recession within the next 00:06:03.680 --> 00:06:09.600 12 months, he's forecasting really that 00:06:07.399 --> 00:06:12.639 demand will decline within the next 12 00:06:09.600 --> 00:06:14.200 months. Okay? 00:06:12.639 --> 00:06:15.319 Why they're forecasting that, that's 00:06:14.199 --> 00:06:16.399 something we're going to learn in the 00:06:15.319 --> 00:06:17.959 steps 00:06:16.399 --> 00:06:19.039 uh as we go through the course. What 00:06:17.959 --> 00:06:20.639 what are the kind of things that they 00:06:19.040 --> 00:06:22.920 may be thinking about? What are the 00:06:20.639 --> 00:06:25.039 drugs on aggregate demand that are 00:06:22.920 --> 00:06:26.800 likely to depress demand? 00:06:25.040 --> 00:06:30.240 Uh and so on and so forth. But that 00:06:26.800 --> 00:06:31.759 we'll we'll get there. Okay? 00:06:30.240 --> 00:06:34.280 Anyways, first let me tell you about the 00:06:31.759 --> 00:06:35.159 components of aggregate demand. 00:06:34.279 --> 00:06:37.879 Uh 00:06:35.160 --> 00:06:39.080 the first and one of the and the largest 00:06:37.879 --> 00:06:41.399 component of aggregate demand is 00:06:39.079 --> 00:06:43.519 consumption. Okay? And when I mean 00:06:41.399 --> 00:06:45.679 aggregate demand, okay, 00:06:43.519 --> 00:06:47.399 I'll be 00:06:45.680 --> 00:06:49.759 I'll pause for a for a slide. Let me let 00:06:47.399 --> 00:06:51.599 me go over the definition. Consumption, 00:06:49.759 --> 00:06:53.959 we're going to denote by C, 00:06:51.600 --> 00:06:57.360 is the goods and services purchased by 00:06:53.959 --> 00:06:59.199 consumers. Okay? Households and so on. 00:06:57.360 --> 00:07:00.759 Investment, which we're going to denote 00:06:59.199 --> 00:07:02.879 by I, 00:07:00.759 --> 00:07:05.639 is the sum of non-residential and 00:07:02.879 --> 00:07:08.079 residential investment. So, equipment 00:07:05.639 --> 00:07:09.319 and establish and and and you know, 00:07:08.079 --> 00:07:11.159 factories 00:07:09.319 --> 00:07:12.879 on one side, and then residential 00:07:11.160 --> 00:07:14.760 investment is houses. 00:07:12.879 --> 00:07:15.800 Stuff like that, apartment buildings and 00:07:14.759 --> 00:07:17.439 so on. 00:07:15.800 --> 00:07:19.199 Which is also these are goods and 00:07:17.439 --> 00:07:21.240 services as well. They're just capital 00:07:19.199 --> 00:07:22.800 goods and so on, but they're also goods 00:07:21.240 --> 00:07:24.319 and services. 00:07:22.800 --> 00:07:26.600 Government spending, that's what we're 00:07:24.319 --> 00:07:28.519 going to denote by G, are purchases of 00:07:26.600 --> 00:07:31.160 goods and services by the federal, 00:07:28.519 --> 00:07:32.680 state, and local government. Okay? 00:07:31.160 --> 00:07:35.320 Excluding, and that's important, 00:07:32.680 --> 00:07:36.759 government transfers. 00:07:35.319 --> 00:07:38.399 What is a government transfer? Many of 00:07:36.759 --> 00:07:39.360 you may have received that during COVID. 00:07:38.399 --> 00:07:42.120 You know, the government sent you a 00:07:39.360 --> 00:07:43.879 check, for example. Okay? 00:07:42.120 --> 00:07:45.920 Well, that check that is not part of 00:07:43.879 --> 00:07:46.719 government expenditure. That check is 00:07:45.920 --> 00:07:48.480 like a 00:07:46.720 --> 00:07:50.080 it's a negative tax and it's going to 00:07:48.480 --> 00:07:51.680 enter somewhere else. 00:07:50.079 --> 00:07:54.639 When we mean government 00:07:51.680 --> 00:07:57.600 expenditure is is things the government 00:07:54.639 --> 00:08:00.719 purchases, services the government 00:07:57.600 --> 00:08:01.879 acquires and so on. Okay? 00:08:00.720 --> 00:08:05.480 Um 00:08:01.879 --> 00:08:07.240 then exports, X, which will play no role 00:08:05.480 --> 00:08:09.480 until seven lectures or eight lectures 00:08:07.240 --> 00:08:10.879 from now, or actually 10 lectures from 00:08:09.480 --> 00:08:13.439 now probably, 00:08:10.879 --> 00:08:17.199 is purchases of US goods and services, 00:08:13.439 --> 00:08:18.360 that is goods produced by US factories, 00:08:17.199 --> 00:08:19.439 uh 00:08:18.360 --> 00:08:22.960 uh 00:08:19.439 --> 00:08:22.959 by foreigners. Okay? 00:08:24.079 --> 00:08:30.159 I am is the other side of the story. 00:08:26.240 --> 00:08:32.879 Imports is the purchase of foreign goods 00:08:30.160 --> 00:08:35.399 and services by US consumers, US firms, 00:08:32.879 --> 00:08:36.879 US government. Okay? So, when you buy 00:08:35.399 --> 00:08:39.038 something that is produced in Germany, 00:08:36.879 --> 00:08:40.120 well, that's an import. When the Germans 00:08:39.038 --> 00:08:42.960 buy something that is produced in the 00:08:40.120 --> 00:08:44.320 US, that's an export. Okay? 00:08:42.960 --> 00:08:45.840 And then the last component is something 00:08:44.320 --> 00:08:47.120 we're going to going to pay any 00:08:45.840 --> 00:08:49.639 attention whatsoever in this course, 00:08:47.120 --> 00:08:51.480 which is inventory investment. Inventory 00:08:49.639 --> 00:08:53.199 investment is certainly 00:08:51.480 --> 00:08:54.759 it's almost accidental. There is some 00:08:53.200 --> 00:08:56.600 planning on it, but but there is a lot 00:08:54.759 --> 00:08:58.840 of it's just from the difference between 00:08:56.600 --> 00:09:00.639 sales and production. And over the very 00:08:58.840 --> 00:09:02.040 short run, there's lots of difference. I 00:09:00.639 --> 00:09:03.919 mean, you're not 00:09:02.039 --> 00:09:05.719 producing unless you're in a bakery, you 00:09:03.919 --> 00:09:07.240 know, you're not producing and selling 00:09:05.720 --> 00:09:08.680 immediately. There is there is certain 00:09:07.240 --> 00:09:10.720 certain lags. 00:09:08.679 --> 00:09:11.959 That's a small thing. It it's volatile, 00:09:10.720 --> 00:09:13.920 but it's a small thing, so we're going 00:09:11.960 --> 00:09:15.240 to ignore it 00:09:13.919 --> 00:09:17.479 for this this course. We're going to 00:09:15.240 --> 00:09:18.919 assume actually, unless we explicitly 00:09:17.480 --> 00:09:20.879 say the contrary, and that could show up 00:09:18.919 --> 00:09:21.959 in a piece that it would never show in a 00:09:20.879 --> 00:09:23.480 quiz, 00:09:21.960 --> 00:09:24.840 because it's not that important, we're 00:09:23.480 --> 00:09:26.800 going to assume that this inventory 00:09:24.840 --> 00:09:29.000 investment is equal to zero. 00:09:26.799 --> 00:09:30.799 Also, for this part of the course, until 00:09:29.000 --> 00:09:32.919 further notice, we're going to assume 00:09:30.799 --> 00:09:34.279 that exports and imports are equal to 00:09:32.919 --> 00:09:36.599 zero as well. 00:09:34.279 --> 00:09:39.799 That's not realistic, but it's easier to 00:09:36.600 --> 00:09:41.840 analyze what we call a closed economy. 00:09:39.799 --> 00:09:44.159 Okay? An economy that is not interacting 00:09:41.840 --> 00:09:45.519 with the rest of the world. In the in 00:09:44.159 --> 00:09:47.000 again, 10 lectures from now, we're going 00:09:45.519 --> 00:09:48.000 to open the economy to the rest of the 00:09:47.000 --> 00:09:49.360 world, and then we're going to have to 00:09:48.000 --> 00:09:51.559 talk about 00:09:49.360 --> 00:09:53.680 things like import, export, exchange 00:09:51.559 --> 00:09:55.959 rates, things of that kind. But for now, 00:09:53.679 --> 00:09:57.839 let's keep it simple. Okay? 00:09:55.960 --> 00:10:00.879 So, now you So, you get a sense this is 00:09:57.840 --> 00:10:02.200 for 2018, but I I mean the the totals 00:10:00.879 --> 00:10:03.679 change, but the composition doesn't 00:10:02.200 --> 00:10:05.480 change very much 00:10:03.679 --> 00:10:08.000 of GDP. 00:10:05.480 --> 00:10:08.000 Okay. 00:10:08.919 --> 00:10:12.759 Of of GDP 00:10:11.399 --> 00:10:16.079 output 00:10:12.759 --> 00:10:19.120 aggregate demand they're all the same 00:10:16.080 --> 00:10:21.480 in equilibrium, but we'll get there. 00:10:19.120 --> 00:10:24.799 GDP you see that consumption accounts 00:10:21.480 --> 00:10:26.879 for a big chunk close to 70% of 00:10:24.799 --> 00:10:28.439 aggregate demand. That's the reason 00:10:26.879 --> 00:10:30.159 people worry so much about consumer 00:10:28.440 --> 00:10:32.320 sentiment and so on. The 00:10:30.159 --> 00:10:34.159 University of Michigan 00:10:32.320 --> 00:10:35.800 has many claims to fame, but one of them 00:10:34.159 --> 00:10:37.719 is they produce this index of consumer 00:10:35.799 --> 00:10:39.439 sentiment, and everyone is watching that 00:10:37.720 --> 00:10:41.080 thing. Anyone that worries about macro 00:10:39.440 --> 00:10:43.640 or finance is watching that thing 00:10:41.080 --> 00:10:47.080 because it tells you a lot about one of 00:10:43.639 --> 00:10:49.879 the main drivers of output equilibrium 00:10:47.080 --> 00:10:52.720 output. Then you see investment is 00:10:49.879 --> 00:10:55.000 substantially smaller, but it's large in 00:10:52.720 --> 00:10:56.840 particular non-residential investment. 00:10:55.000 --> 00:11:00.519 Government expenditure is a big 00:10:56.840 --> 00:11:01.960 component of aggregate demand. And then 00:11:00.519 --> 00:11:04.480 I'm not going to worry too much about 00:11:01.960 --> 00:11:07.560 for a country like the US the open 00:11:04.480 --> 00:11:11.639 openness part is is relatively small. 00:11:07.559 --> 00:11:11.639 If you go to uh you know 00:11:11.759 --> 00:11:16.519 small a small economy typically will 00:11:14.519 --> 00:11:18.039 have sort of very large exports relative 00:11:16.519 --> 00:11:21.240 to GDP and so on. But that's not the 00:11:18.039 --> 00:11:23.719 case of the US. 00:11:21.240 --> 00:11:25.399 And there you see why we're going to set 00:11:23.720 --> 00:11:27.920 in inventory investment to zero. It's a 00:11:25.399 --> 00:11:30.079 small thing. It it moves a lot more than 00:11:27.919 --> 00:11:32.639 than its size, so it can account for for 00:11:30.080 --> 00:11:34.879 fluctuations in in 00:11:32.639 --> 00:11:36.838 sort of the monthly level of GDP, but 00:11:34.879 --> 00:11:39.838 it's not that important 00:11:36.839 --> 00:11:41.480 in a slightly longer periods of time. 00:11:39.839 --> 00:11:44.200 Okay. So, that's more or less the story. 00:11:41.480 --> 00:11:47.279 So, now this is the this is the model. 00:11:44.200 --> 00:11:48.520 Please stop me say if you Is there 00:11:47.279 --> 00:11:50.199 anything here you don't understand 00:11:48.519 --> 00:11:51.720 because any everything that we'll build 00:11:50.200 --> 00:11:53.120 from here to 00:11:51.720 --> 00:11:56.000 quiz one 00:11:53.120 --> 00:11:58.200 will build on understanding this what 00:11:56.000 --> 00:12:00.480 I'm about to say. Very simple, but if 00:11:58.200 --> 00:12:01.640 you miss a step here everything is going 00:12:00.480 --> 00:12:02.800 to be confusing in the next few 00:12:01.639 --> 00:12:04.159 lectures. So, 00:12:02.799 --> 00:12:05.799 and you're not supposed to understand it 00:12:04.159 --> 00:12:07.919 in the first run. So, so it's okay that 00:12:05.799 --> 00:12:10.479 you ask me. But let's make sure that you 00:12:07.919 --> 00:12:12.719 understand what's going on here. 00:12:10.480 --> 00:12:14.399 Okay. So, that's aggregate demand. First 00:12:12.720 --> 00:12:17.080 definitions. We're going to denote 00:12:14.399 --> 00:12:18.600 aggregate demand by this Z, okay? Letter 00:12:17.080 --> 00:12:21.560 Z. 00:12:18.600 --> 00:12:23.440 And aggregate demand is going to be When 00:12:21.559 --> 00:12:25.359 we say aggregate demand, remember what 00:12:23.440 --> 00:12:27.640 what what is the exercise we're trying 00:12:25.360 --> 00:12:30.720 to do. Ultimately, what we want to 00:12:27.639 --> 00:12:32.879 determine is the output the production 00:12:30.720 --> 00:12:34.360 of the US economy, say. 00:12:32.879 --> 00:12:35.679 So, when we mean when we talk about 00:12:34.360 --> 00:12:38.080 aggregate demand, we're trying to 00:12:35.679 --> 00:12:39.919 determine the demand for domestically 00:12:38.080 --> 00:12:41.080 produced goods for goods produced in the 00:12:39.919 --> 00:12:43.199 US. 00:12:41.080 --> 00:12:44.759 That's what we're trying to pin down. 00:12:43.200 --> 00:12:46.640 And so, 00:12:44.759 --> 00:12:48.439 that's the reason aggregate demand looks 00:12:46.639 --> 00:12:50.559 like that. It's well, consumers. 00:12:48.440 --> 00:12:52.280 Consumers are going to demand goods. 00:12:50.559 --> 00:12:55.279 Investment 00:12:52.279 --> 00:12:56.519 G plus exports. If foreign demand US 00:12:55.279 --> 00:12:57.679 goods, that's also increases US 00:12:56.519 --> 00:13:01.519 production. 00:12:57.679 --> 00:13:04.319 Minus imports because imports is 00:13:01.519 --> 00:13:06.838 uh goods and services that consumers, 00:13:04.320 --> 00:13:08.440 firms, and governments sort of buy from 00:13:06.839 --> 00:13:10.400 foreigners, but they're not produced by 00:13:08.440 --> 00:13:12.720 by US companies. So, they are not affect 00:13:10.399 --> 00:13:14.919 the determination of equilibrium output 00:13:12.720 --> 00:13:17.600 in the US. Okay? That's the reason you 00:13:14.919 --> 00:13:19.079 subtract it. Now, that distinction is 00:13:17.600 --> 00:13:21.200 not going to matter 00:13:19.080 --> 00:13:23.160 uh until 10 lectures from now because 00:13:21.200 --> 00:13:25.520 we're going to set X and IM equal to 00:13:23.159 --> 00:13:27.279 zero from the point of view of modeling. 00:13:25.519 --> 00:13:29.399 So, all demand is demand for 00:13:27.279 --> 00:13:31.399 domestically produced goods in this part 00:13:29.399 --> 00:13:34.919 of the course. Okay? So, aggregate 00:13:31.399 --> 00:13:36.679 demand for us will be this C plus I plus 00:13:34.919 --> 00:13:39.399 G. So, we need to understand what 00:13:36.679 --> 00:13:41.199 determines C plus I plus G. 00:13:39.399 --> 00:13:43.159 And at least initially, we're going to 00:13:41.200 --> 00:13:44.520 keep it very very simple. We're not 00:13:43.159 --> 00:13:46.719 going to think too much about what 00:13:44.519 --> 00:13:48.199 determines investment. In fact, we're 00:13:46.720 --> 00:13:49.720 going to assume it's a constant is 00:13:48.200 --> 00:13:51.280 given. So, it's determined somewhere 00:13:49.720 --> 00:13:53.000 else not in the model I'm about to 00:13:51.279 --> 00:13:55.319 solve. 00:13:53.000 --> 00:13:56.919 Government expenditure 00:13:55.320 --> 00:13:58.080 the same. I'm going to assume you know, 00:13:56.919 --> 00:14:00.519 it's determined by some other 00:13:58.080 --> 00:14:01.800 priorities, you know, green agendas and 00:14:00.519 --> 00:14:05.319 stuff like that. It has very little to 00:14:01.799 --> 00:14:07.359 do with with with what we're doing here. 00:14:05.320 --> 00:14:08.839 And then taxes is something that doesn't 00:14:07.360 --> 00:14:10.800 show up there, but it will show up very 00:14:08.839 --> 00:14:12.640 shortly. We're also going to assume that 00:14:10.799 --> 00:14:14.719 they're being determined somewhere else. 00:14:12.639 --> 00:14:16.639 In pieces and later on in the course 00:14:14.720 --> 00:14:19.200 we're going to endogenize all that, but 00:14:16.639 --> 00:14:21.319 not now. Let's assume I'm trying to come 00:14:19.200 --> 00:14:22.920 up with a the simplest possible model of 00:14:21.320 --> 00:14:24.680 aggregate demand. 00:14:22.919 --> 00:14:27.599 And I'm making two of these terms 00:14:24.679 --> 00:14:30.399 trivial just constants. Okay? And I'm 00:14:27.600 --> 00:14:31.839 going to focus all my effort here in 00:14:30.399 --> 00:14:34.480 this component here, which I already 00:14:31.839 --> 00:14:35.680 told you is the most important component 00:14:34.480 --> 00:14:37.800 of aggregate demand, which is 00:14:35.679 --> 00:14:39.599 consumption. Okay? 00:14:37.799 --> 00:14:41.000 So, we're going to assume here we're 00:14:39.600 --> 00:14:42.279 going to have a function. Something has 00:14:41.000 --> 00:14:44.879 to move so for the model to be 00:14:42.279 --> 00:14:47.159 interesting. So, this this this we're 00:14:44.879 --> 00:14:49.320 going to assume that consumption 00:14:47.159 --> 00:14:51.078 is an increasing function of disposable 00:14:49.320 --> 00:14:52.640 income. I'm about to define what 00:14:51.078 --> 00:14:53.958 disposable income is, but you can 00:14:52.639 --> 00:14:56.799 imagine what it is. It's something you 00:14:53.958 --> 00:14:58.239 can use to consume and so on. So, very 00:14:56.799 --> 00:14:59.879 naturally, if you have a higher 00:14:58.240 --> 00:15:01.839 disposable income, you're going to 00:14:59.879 --> 00:15:03.600 consume more. That's what this says. 00:15:01.839 --> 00:15:05.680 Okay? 00:15:03.600 --> 00:15:07.200 In reality, that consumption function is 00:15:05.679 --> 00:15:09.279 a lot more complex. There are lots of 00:15:07.200 --> 00:15:11.680 things that enter there that that we're 00:15:09.279 --> 00:15:14.439 not modeling for now. But let's 00:15:11.679 --> 00:15:15.719 start from the basics. Okay? So, that's 00:15:14.440 --> 00:15:17.360 going to be the only behavioral 00:15:15.720 --> 00:15:18.639 assumption we're going to make for a 00:15:17.360 --> 00:15:21.959 while. 00:15:18.639 --> 00:15:24.720 That that the consumers consume more 00:15:21.958 --> 00:15:27.078 when they have more disposable income. 00:15:24.720 --> 00:15:27.079 Okay. 00:15:27.480 --> 00:15:31.720 And I'm going to make it even simpler. 00:15:29.480 --> 00:15:34.159 I'm going to assume that consumption is 00:15:31.720 --> 00:15:36.399 a linear function of disposable income. 00:15:34.159 --> 00:15:38.838 Okay? So, there's going to be some 00:15:36.399 --> 00:15:40.159 constant C0, which captures lots of 00:15:38.839 --> 00:15:42.360 things that we're not modeling here. For 00:15:40.159 --> 00:15:44.360 example, the fact that for any given 00:15:42.360 --> 00:15:47.240 level of disposable income, 00:15:44.360 --> 00:15:48.959 if you know, if you if you 00:15:47.240 --> 00:15:51.120 if you're richer, suppose you have some 00:15:48.958 --> 00:15:52.479 shares and now the shares double in 00:15:51.120 --> 00:15:53.720 value, you probably are going to consume 00:15:52.480 --> 00:15:55.200 more as well. 00:15:53.720 --> 00:15:56.160 Okay? There are lots of other things 00:15:55.200 --> 00:15:58.200 that affect 00:15:56.159 --> 00:16:01.919 consumption, which are different from 00:15:58.200 --> 00:16:02.959 aside from your disposable income. 00:16:01.919 --> 00:16:03.958 But we're not going to model that. So, 00:16:02.958 --> 00:16:05.799 that's we're going to call it 00:16:03.958 --> 00:16:07.119 autonomous. Autonomous in the sense that 00:16:05.799 --> 00:16:08.399 we're not going to determine it here. 00:16:07.120 --> 00:16:10.279 We're going to take it as a parameter 00:16:08.399 --> 00:16:12.078 that comes from somewhere else. We may 00:16:10.279 --> 00:16:15.639 do some experiments moving that variable 00:16:12.078 --> 00:16:17.958 around, but it's not going to 00:16:15.639 --> 00:16:19.958 be part of what we model. 00:16:17.958 --> 00:16:21.479 C1 is a more interesting parameter for 00:16:19.958 --> 00:16:23.119 this part of the course, and it's what 00:16:21.480 --> 00:16:25.159 we call the marginal propensity to 00:16:23.120 --> 00:16:27.560 consume 00:16:25.159 --> 00:16:30.759 out of disposable income in this case. 00:16:27.559 --> 00:16:32.159 That is C1 tells you the share if you 00:16:30.759 --> 00:16:34.439 get an extra dollar of disposable 00:16:32.159 --> 00:16:37.319 income, how much of that do you spend in 00:16:34.440 --> 00:16:41.480 consumption? Okay? So, say you get an 00:16:37.320 --> 00:16:44.200 extra dollar of income, if you spend 00:16:41.480 --> 00:16:47.039 60 cents in in the things you normally 00:16:44.200 --> 00:16:49.640 consume of that extra dollar, well, then 00:16:47.039 --> 00:16:51.559 your C1 is .6. Okay? That's the marginal 00:16:49.639 --> 00:16:52.919 propensity to consume. 00:16:51.559 --> 00:16:54.359 And that's what gives us our increasing 00:16:52.919 --> 00:16:55.719 function. You get an extra dollar, 00:16:54.360 --> 00:16:56.839 you're going to do you're going to save 00:16:55.720 --> 00:16:58.639 part, but some of it you're going to 00:16:56.839 --> 00:17:02.920 spend. That part you're going to spend 00:16:58.639 --> 00:17:04.240 is the C1 that we have there. Okay? 00:17:02.919 --> 00:17:06.720 Good. 00:17:04.240 --> 00:17:06.720 Uh 00:17:07.559 --> 00:17:10.639 And I 00:17:08.640 --> 00:17:12.560 Now, let me tell you what how we define 00:17:10.640 --> 00:17:14.480 disposable income. Disposable income is 00:17:12.559 --> 00:17:16.039 just equal to income, which is equal to 00:17:14.480 --> 00:17:18.400 production, you 00:17:16.039 --> 00:17:20.838 minus taxes. That's disposable income. 00:17:18.400 --> 00:17:24.519 Okay? It's whatever you earn as a either 00:17:20.838 --> 00:17:25.958 as a worker as a capital owner, 00:17:24.519 --> 00:17:27.400 well, then the government takes its 00:17:25.959 --> 00:17:29.400 something out of it. That's your 00:17:27.400 --> 00:17:31.160 disposable income, and that's where you 00:17:29.400 --> 00:17:32.679 have to decide how much to save and how 00:17:31.160 --> 00:17:34.080 much to consume. 00:17:32.679 --> 00:17:35.720 Okay? 00:17:34.079 --> 00:17:37.519 That's 00:17:35.720 --> 00:17:38.839 So, so that means that our consumption 00:17:37.519 --> 00:17:40.519 function is 00:17:38.839 --> 00:17:43.199 can be written that way 00:17:40.519 --> 00:17:45.599 after all these assumptions I made, you 00:17:43.200 --> 00:17:47.600 know, equal to this autonomous component 00:17:45.599 --> 00:17:49.359 plus C1 the marginal propensity to 00:17:47.599 --> 00:17:54.639 consume times 00:17:49.359 --> 00:17:54.639 uh income output minus taxes. 00:17:56.599 --> 00:18:00.000 Is it clear? 00:17:59.000 --> 00:18:01.599 Yes? 00:18:00.000 --> 00:18:03.079 So, all these are assumptions. Now, 00:18:01.599 --> 00:18:04.678 they're not crazy assumptions in the 00:18:03.079 --> 00:18:06.240 sense that you know, that we know that 00:18:04.679 --> 00:18:07.679 that there is a relationship between 00:18:06.240 --> 00:18:09.319 these two things. Again, 00:18:07.679 --> 00:18:11.160 the consumption function in practice is 00:18:09.319 --> 00:18:13.359 much richer than that. 00:18:11.160 --> 00:18:15.840 And there is lots of randomness random 00:18:13.359 --> 00:18:17.559 terms around and so on, but that's not 00:18:15.839 --> 00:18:18.919 what we're about here. 00:18:17.559 --> 00:18:20.399 But that's if you want to start with a 00:18:18.920 --> 00:18:24.519 consumption function, this is a pretty 00:18:20.400 --> 00:18:25.920 reasonable one to start with. Okay? 00:18:24.519 --> 00:18:28.559 Okay. So, that's going to look in the 00:18:25.920 --> 00:18:30.080 space of disposable income or income. I 00:18:28.559 --> 00:18:31.559 could have put income there not 00:18:30.079 --> 00:18:33.158 disposable income. So, it's going to 00:18:31.559 --> 00:18:34.759 look like that. 00:18:33.159 --> 00:18:37.800 Okay? 00:18:34.759 --> 00:18:39.039 So, C0 is that autonomous consumption is 00:18:37.799 --> 00:18:40.559 some something you're going to consume 00:18:39.039 --> 00:18:41.519 regardless of your level of disposable 00:18:40.559 --> 00:18:43.879 income. I mean, there is a minimum 00:18:41.519 --> 00:18:46.200 consumption you have to have. You know, 00:18:43.880 --> 00:18:47.880 say. And then 00:18:46.200 --> 00:18:50.159 and then 00:18:47.880 --> 00:18:52.240 the slope of that is is the marginal 00:18:50.159 --> 00:18:55.880 propensity to consume, which is C1, 00:18:52.240 --> 00:18:55.880 which is a number between zero and one. 00:18:57.119 --> 00:19:02.039 Okay. So, let's let's determine 00:18:59.079 --> 00:19:02.039 equilibrium output. 00:19:02.159 --> 00:19:07.640 So, we have aggregate demand, which is C 00:19:04.880 --> 00:19:09.440 plus I plus G. Okay? 00:19:07.640 --> 00:19:11.000 There we are. 00:19:09.440 --> 00:19:12.759 That's that was our definition of 00:19:11.000 --> 00:19:14.519 aggregate demand. 00:19:12.759 --> 00:19:16.319 Uh I'm going to stick in now the 00:19:14.519 --> 00:19:18.759 functional forms. Well, these guys are 00:19:16.319 --> 00:19:20.799 very boring. They're constants. And I'm 00:19:18.759 --> 00:19:23.559 plugging in here the the consumption the 00:19:20.799 --> 00:19:27.519 consumption function. Okay? So, what we 00:19:23.559 --> 00:19:29.879 have here is that aggregate demand 00:19:27.519 --> 00:19:32.000 is an increasing function of output or 00:19:29.880 --> 00:19:33.400 income. Okay? 00:19:32.000 --> 00:19:35.919 It's also a function of taxes, 00:19:33.400 --> 00:19:37.679 investment, and so on, but but it's an 00:19:35.919 --> 00:19:39.679 increasing function of output. And And 00:19:37.679 --> 00:19:42.519 this is important because I'm Remember, 00:19:39.679 --> 00:19:44.600 the the goal of this is to find 00:19:42.519 --> 00:19:46.400 equilibrium output. 00:19:44.599 --> 00:19:48.879 So, here I have on the right hand side 00:19:46.400 --> 00:19:51.519 of my aggregate demand 00:19:48.880 --> 00:19:53.600 output. That's good. I have one equation 00:19:51.519 --> 00:19:55.759 in which output shows up. 00:19:53.599 --> 00:19:57.359 Okay? Now, I cannot find equilibrium 00:19:55.759 --> 00:19:59.720 output just from this equation. Why is 00:19:57.359 --> 00:19:59.719 that? 00:20:00.319 --> 00:20:03.359 So, I'm Remember, we're trying to build 00:20:02.039 --> 00:20:05.119 a model 00:20:03.359 --> 00:20:07.879 to find 00:20:05.119 --> 00:20:09.759 equilibrium output. 00:20:07.880 --> 00:20:11.400 That's our goal. That's what will tell 00:20:09.759 --> 00:20:13.039 us whether we're in a recession or not. 00:20:11.400 --> 00:20:15.960 Output is low, recession. Output is 00:20:13.039 --> 00:20:17.599 high, we're in a boom. 00:20:15.960 --> 00:20:19.960 Obviously, I cannot solve it from this. 00:20:17.599 --> 00:20:23.079 I have two unknowns. 00:20:19.960 --> 00:20:25.519 What are my two unknowns? 00:20:23.079 --> 00:20:29.240 Two unknowns, one equation. 00:20:25.519 --> 00:20:29.240 What is my second unknown there? 00:20:37.039 --> 00:20:41.879 Aggregate demand, of course. We have to 00:20:39.319 --> 00:20:42.839 determine Z and Y. 00:20:41.880 --> 00:20:45.160 Okay? 00:20:42.839 --> 00:20:46.279 So, how are we going to do that? 00:20:45.160 --> 00:20:48.600 Well, 00:20:46.279 --> 00:20:50.160 using a second equation, which is the 00:20:48.599 --> 00:20:52.159 equilibrium condition. It's not a 00:20:50.160 --> 00:20:53.400 function. This is a function. This is 00:20:52.160 --> 00:20:56.560 not a function. This is an equilibrium 00:20:53.400 --> 00:20:59.120 condition. It says, "In equilibrium, not 00:20:56.559 --> 00:21:02.799 outside equilibrium. In equilibrium, 00:20:59.119 --> 00:21:03.919 output is equal to aggregate demand." 00:21:02.799 --> 00:21:05.159 Okay? 00:21:03.920 --> 00:21:07.160 That's what this 00:21:05.160 --> 00:21:08.519 equilibrium condition tells us. Off 00:21:07.160 --> 00:21:10.120 equilibrium, this doesn't hold. That's 00:21:08.519 --> 00:21:12.799 the reason this is not a function. This 00:21:10.119 --> 00:21:14.079 holds everywhere. It's a function. 00:21:12.799 --> 00:21:16.599 This is an equilibrium condition. It 00:21:14.079 --> 00:21:18.679 says, "At equilibrium, aggregate demand 00:21:16.599 --> 00:21:19.919 is equal to output." 00:21:18.680 --> 00:21:23.840 So, now we're done because we have two 00:21:19.920 --> 00:21:23.840 equations with two unknowns. Okay? 00:21:24.680 --> 00:21:27.920 Good. 00:21:25.799 --> 00:21:29.839 And the reason I post on this is that I 00:21:27.920 --> 00:21:30.920 see that mistake made often. 00:21:29.839 --> 00:21:32.959 Okay? 00:21:30.920 --> 00:21:34.840 That this is interpreted as a function. 00:21:32.960 --> 00:21:36.840 It's not. It's an equilibrium condition. 00:21:34.839 --> 00:21:38.480 At equilibrium, it holds. And that you 00:21:36.839 --> 00:21:40.159 can see, actually, I'm going to 00:21:38.480 --> 00:21:42.920 illustrate the same point in in the 00:21:40.160 --> 00:21:44.440 diagram. So, this is the 00:21:42.920 --> 00:21:46.920 Let me Let me keep going. So, this is 00:21:44.440 --> 00:21:48.640 clear, no? So, this is This is just a 00:21:46.920 --> 00:21:50.360 summary of what we had in the previous 00:21:48.640 --> 00:21:53.000 slides. It's 00:21:50.359 --> 00:21:55.159 And this is the new thing here, which is 00:21:53.000 --> 00:21:56.920 in equilibrium, output is equal to 00:21:55.160 --> 00:22:00.320 aggregate demand. 00:21:56.920 --> 00:22:02.120 And and and the and the 00:22:00.319 --> 00:22:04.359 And again, that's what makes 00:22:02.119 --> 00:22:07.319 this a really a short 00:22:04.359 --> 00:22:08.959 short-run model. You see, I'm saying 00:22:07.319 --> 00:22:12.359 output in the short run is whatever 00:22:08.960 --> 00:22:12.360 demand wants it to be. 00:22:12.400 --> 00:22:17.040 Which is different from from from 00:22:15.359 --> 00:22:18.678 the long run that says, "No, no. Hold on 00:22:17.039 --> 00:22:20.159 a second. I mean, but you 00:22:18.679 --> 00:22:21.920 How much output you can produce is a 00:22:20.160 --> 00:22:23.279 function of the capital you have, of the 00:22:21.920 --> 00:22:24.320 workers you have." Yeah, yeah, that's 00:22:23.279 --> 00:22:26.079 true in the long run. But in the short 00:22:24.319 --> 00:22:27.879 run, you have lots of flexibility 00:22:26.079 --> 00:22:29.000 because you have lots of unused capacity 00:22:27.880 --> 00:22:31.280 and so on. 00:22:29.000 --> 00:22:33.039 Okay? So, this is pretty It's a big 00:22:31.279 --> 00:22:35.799 assumption, and there is schools of 00:22:33.039 --> 00:22:37.920 thoughts within microeconomy that split 00:22:35.799 --> 00:22:40.039 by this assumption, whether you believe 00:22:37.920 --> 00:22:43.080 that that that in the short run, output 00:22:40.039 --> 00:22:45.279 is aggregate demand determined or not. 00:22:43.079 --> 00:22:47.159 At MIT, we tend to believe that in the 00:22:45.279 --> 00:22:48.839 short run. The long run, no. But in the 00:22:47.160 --> 00:22:51.120 short run, that's what it does. 00:22:48.839 --> 00:22:53.480 Now, sometimes the long run gets to you 00:22:51.119 --> 00:22:54.599 very quickly. And at this point, we're 00:22:53.480 --> 00:22:55.960 in a situation like that. That's the 00:22:54.599 --> 00:22:57.000 reason we're seeing inflation and so on, 00:22:55.960 --> 00:22:58.039 but that's something you'll understand 00:22:57.000 --> 00:23:01.559 later on. 00:22:58.039 --> 00:23:03.159 Okay? But but but for now, so this is 00:23:01.559 --> 00:23:04.559 this is important. We're going to We're 00:23:03.160 --> 00:23:06.200 saying here 00:23:04.559 --> 00:23:07.519 output I don't need another equation. I 00:23:06.200 --> 00:23:08.880 could have done aggregate demand like 00:23:07.519 --> 00:23:11.000 this, and then output a function of 00:23:08.880 --> 00:23:12.160 capital, labor, lots of things. 00:23:11.000 --> 00:23:14.519 I'm not going to even do that. I'm going 00:23:12.160 --> 00:23:17.480 to say, "No, no. Output will be whatever 00:23:14.519 --> 00:23:18.759 demand wants it to be." Okay? 00:23:17.480 --> 00:23:20.480 And that means in equilibrium, they have 00:23:18.759 --> 00:23:21.440 to be equal. 00:23:20.480 --> 00:23:24.360 Good. 00:23:21.440 --> 00:23:24.360 You had a question. 00:23:28.079 --> 00:23:31.439 No, they are the same for us. 00:23:31.880 --> 00:23:35.840 That's our definition. GDP for us is 00:23:33.920 --> 00:23:38.039 output. 00:23:35.839 --> 00:23:39.199 So, when I say aggregate output, I mean 00:23:38.039 --> 00:23:41.119 GDP. 00:23:39.200 --> 00:23:43.200 Remember? Real GDP. We're talking all 00:23:41.119 --> 00:23:44.239 about real GDP. Okay? 00:23:43.200 --> 00:23:46.039 Uh 00:23:44.240 --> 00:23:47.519 And it's also equal to income. Not 00:23:46.039 --> 00:23:49.240 disposable, but it's equal to income. 00:23:47.519 --> 00:23:50.639 Remember when we did those little tables 00:23:49.240 --> 00:23:52.079 where we look on our 00:23:50.640 --> 00:23:55.160 the three different ways of doing it? 00:23:52.079 --> 00:23:56.879 Well, the first two were output. 00:23:55.160 --> 00:23:58.800 And the last one was income, and they 00:23:56.880 --> 00:23:59.960 had to be the same. 00:23:58.799 --> 00:24:04.480 Okay? 00:23:59.960 --> 00:24:04.480 So, why is real GDP for us? 00:24:04.559 --> 00:24:07.759 That's real GDP. 00:24:07.960 --> 00:24:13.240 What happens in the table I show you, 00:24:11.200 --> 00:24:14.600 I already used the fact that real GDP is 00:24:13.240 --> 00:24:15.799 equal to aggregate demand, and that's 00:24:14.599 --> 00:24:17.799 the reason I show you the different 00:24:15.799 --> 00:24:20.720 components of Z. 00:24:17.799 --> 00:24:23.720 I show you that, that, and that. 00:24:20.720 --> 00:24:23.720 Okay? But in equilibrium, they're equal. 00:24:28.640 --> 00:24:32.520 There's really a figure that that will 00:24:30.960 --> 00:24:34.880 clarify, I think, a lot of that. But 00:24:32.519 --> 00:24:36.599 let's Let me keep solving this. So, 00:24:34.880 --> 00:24:38.360 we have that And so, what I'm going to 00:24:36.599 --> 00:24:39.759 do next is just solve it. So, we have 00:24:38.359 --> 00:24:42.519 this equilibrium condition. I'm going to 00:24:39.759 --> 00:24:43.440 plug in my aggregate demand function 00:24:42.519 --> 00:24:45.359 here, 00:24:43.440 --> 00:24:47.120 and so I can solve out for equilibrium 00:24:45.359 --> 00:24:48.678 output. And here we have the first for 00:24:47.119 --> 00:24:50.919 the first time in this course, an 00:24:48.679 --> 00:24:52.160 equation for equilibrium output. 00:24:50.920 --> 00:24:55.600 There you are. That's your equilibrium 00:24:52.160 --> 00:24:55.600 output in this economy. 00:24:56.160 --> 00:24:58.519 Okay? 00:24:58.880 --> 00:25:02.880 Now, this guy here 00:25:01.160 --> 00:25:04.679 is very famous, 00:25:02.880 --> 00:25:06.679 and is very macro. 00:25:04.679 --> 00:25:11.560 Doesn't happen in micro. It happens in 00:25:06.679 --> 00:25:11.560 macro only. Okay? This guy here. 00:25:11.880 --> 00:25:16.280 Another guy there is called the 00:25:13.400 --> 00:25:16.280 multiplier. 00:25:16.440 --> 00:25:18.559 Okay? 00:25:19.200 --> 00:25:24.480 And it's a very important macro concept. 00:25:20.880 --> 00:25:24.480 A huge concept in macro. 00:25:24.799 --> 00:25:28.678 Now, why do you think it's called a 00:25:26.200 --> 00:25:29.720 multiplier? 00:25:28.679 --> 00:25:32.160 Well, obviously, it multiplies 00:25:29.720 --> 00:25:34.079 something, but a multiplier sounds like, 00:25:32.160 --> 00:25:36.080 you know, 00:25:34.079 --> 00:25:38.599 that multiplies that makes something 00:25:36.079 --> 00:25:38.599 bigger, no? 00:25:39.119 --> 00:25:45.678 So, what happens if C1 is 00:25:42.400 --> 00:25:45.679 uh greater than zero? 00:25:48.240 --> 00:25:51.559 Is What happens if C1 is greater than 00:25:50.079 --> 00:25:53.439 zero? Remember, it's between zero and 00:25:51.559 --> 00:25:54.879 one. But what happens if it's greater 00:25:53.440 --> 00:25:59.559 than zero? What happened with that 00:25:54.880 --> 00:25:59.560 number there, one over one minus C1? 00:26:02.559 --> 00:26:06.039 It's greater than one. That's what this 00:26:04.079 --> 00:26:07.240 is. It multiplies. Okay? So, that's the 00:26:06.039 --> 00:26:09.759 reason we call it a multiplier. There's 00:26:07.240 --> 00:26:11.519 not nothing deep there. Uh okay? So, 00:26:09.759 --> 00:26:12.720 this thing here is sort of autonomous 00:26:11.519 --> 00:26:14.279 stuff, you know? It's what the 00:26:12.720 --> 00:26:15.679 government spends, what firms are 00:26:14.279 --> 00:26:19.399 spending, capital. 00:26:15.679 --> 00:26:21.600 This is autonomous consumption. Uh 00:26:19.400 --> 00:26:24.759 And this Actually, this is a typo there. 00:26:21.599 --> 00:26:25.959 There should be a C1 in front of that. 00:26:24.759 --> 00:26:28.480 Typo. 00:26:25.960 --> 00:26:29.559 It comes from there. C1 times 00:26:28.480 --> 00:26:31.240 T. 00:26:29.559 --> 00:26:33.000 So, fix that typo, please. I I'm going 00:26:31.240 --> 00:26:35.920 to upload the slides again with with the 00:26:33.000 --> 00:26:35.920 typo fixed. Okay? 00:26:36.799 --> 00:26:42.240 I'm just It comes from here. C1 times T. 00:26:40.679 --> 00:26:44.160 Okay, so that's what this does. It 00:26:42.240 --> 00:26:45.679 multiplies. So, whatever it is that that 00:26:44.160 --> 00:26:47.800 is happening here, whatever it is that 00:26:45.679 --> 00:26:49.759 the government is spending or whatever, 00:26:47.799 --> 00:26:53.879 this term multiplies it. And that's a 00:26:49.759 --> 00:26:55.879 huge thing. Uh There was a big debate uh 00:26:53.880 --> 00:26:57.160 almost always when you're trying to get 00:26:55.880 --> 00:26:58.920 out of a recession and the governments 00:26:57.160 --> 00:27:00.880 are spending, a big question is, "Well, 00:26:58.920 --> 00:27:02.120 how big is the multiplier?" If the 00:27:00.880 --> 00:27:03.840 multiplier is small, you're going to 00:27:02.119 --> 00:27:05.799 have to spend a lot to get the economy 00:27:03.839 --> 00:27:07.759 out of the recession. If the multiplier 00:27:05.799 --> 00:27:09.960 is large, 00:27:07.759 --> 00:27:11.519 then then uh 00:27:09.960 --> 00:27:13.000 you you're going to have have to spend 00:27:11.519 --> 00:27:14.759 very little, and then the multiplier 00:27:13.000 --> 00:27:16.759 will take you away from from that 00:27:14.759 --> 00:27:18.119 recession. 00:27:16.759 --> 00:27:20.960 So, what is it that makes the multiplier 00:27:18.119 --> 00:27:20.959 large or small? 00:27:23.000 --> 00:27:27.679 Well, mechanically, when is it that 00:27:25.000 --> 00:27:30.119 multiplier large? 00:27:27.679 --> 00:27:31.440 When C1 is closer to one. So, when when 00:27:30.119 --> 00:27:34.199 people are spending more of their income 00:27:31.440 --> 00:27:35.840 on Exactly. When C1 is large. 00:27:34.200 --> 00:27:38.480 And that that gives you the logic, and 00:27:35.839 --> 00:27:40.039 that's very important in macro. It's 00:27:38.480 --> 00:27:42.720 Why is it that a big multiplier? Well, 00:27:40.039 --> 00:27:45.119 because think what happens in macro. If 00:27:42.720 --> 00:27:47.640 the government spends, 00:27:45.119 --> 00:27:49.879 that increases output. 00:27:47.640 --> 00:27:51.560 But now, output increases income. And if 00:27:49.880 --> 00:27:52.960 consumers spend a big share of their 00:27:51.559 --> 00:27:55.039 extra income 00:27:52.960 --> 00:27:57.120 in output and consumption again, then 00:27:55.039 --> 00:27:59.279 that increases output again, which 00:27:57.119 --> 00:28:00.519 increases income again, and 00:27:59.279 --> 00:28:01.799 you keep going. 00:28:00.519 --> 00:28:03.119 Okay? 00:28:01.799 --> 00:28:04.839 So, that's the sequence. On the 00:28:03.119 --> 00:28:06.079 contrary, if consumers are very scared, 00:28:04.839 --> 00:28:07.599 they don't want to spend any extra 00:28:06.079 --> 00:28:09.759 dollar they receive, anything of the 00:28:07.599 --> 00:28:11.879 extra dollar they receive, then you 00:28:09.759 --> 00:28:13.839 don't get any multiplier because this 00:28:11.880 --> 00:28:16.160 initial increase in output that comes 00:28:13.839 --> 00:28:17.519 from the government expansion, that does 00:28:16.160 --> 00:28:19.080 lead to increase in income, but if 00:28:17.519 --> 00:28:20.920 consumers don't spend it, it doesn't 00:28:19.079 --> 00:28:22.918 recirculate into the economy, and then 00:28:20.920 --> 00:28:24.919 you don't get a multiplier. Okay? So, 00:28:22.919 --> 00:28:27.600 that's that's the reason we call it the 00:28:24.919 --> 00:28:27.600 multiplier. 00:28:27.919 --> 00:28:32.360 So, that diagram is is an important 00:28:29.679 --> 00:28:34.519 diagram. I'm just 00:28:32.359 --> 00:28:34.519 uh 00:28:34.559 --> 00:28:39.200 doing this, actually. In that diagram, 00:28:37.119 --> 00:28:40.639 I'm plotting the aggregate demand 00:28:39.200 --> 00:28:42.679 function, 00:28:40.640 --> 00:28:44.960 and then this equilibrium condition, 00:28:42.679 --> 00:28:46.480 output equal to aggregate demand, 00:28:44.960 --> 00:28:47.480 in the space 00:28:46.480 --> 00:28:48.799 of 00:28:47.480 --> 00:28:51.559 uh 00:28:48.799 --> 00:28:53.759 aggregate demand and output, production, 00:28:51.559 --> 00:28:55.639 and income here. But remember, income is 00:28:53.759 --> 00:28:58.919 equal to production. Okay? 00:28:55.640 --> 00:29:01.360 So, there's your aggregate demand, 00:28:58.919 --> 00:29:03.520 and that's your 45 degree line because 00:29:01.359 --> 00:29:05.319 this output equal to So, whatever is in 00:29:03.519 --> 00:29:07.079 this axis is equal to that axis. That's 00:29:05.319 --> 00:29:09.279 the 45 degree line. 00:29:07.079 --> 00:29:12.240 Okay? That's your equilibrium condition. 00:29:09.279 --> 00:29:13.720 It says, "At equilibrium, this guy here, 00:29:12.240 --> 00:29:16.279 aggregate demand Z, will have to be 00:29:13.720 --> 00:29:17.519 equal to Y." Those are That's straight 00:29:16.279 --> 00:29:20.039 there. 00:29:17.519 --> 00:29:23.720 This is aggregate demand. 00:29:20.039 --> 00:29:23.720 Why is this line flatter than that? 00:29:25.440 --> 00:29:29.000 Why is aggregate demand flatter than 00:29:30.839 --> 00:29:34.678 Uh because people don't spend their 00:29:32.159 --> 00:29:36.640 entire dollar on Exactly. Because C1 is 00:29:34.679 --> 00:29:38.400 less than one. 00:29:36.640 --> 00:29:40.360 So, the slope of the aggregate demand in 00:29:38.400 --> 00:29:42.440 this space is C1. 00:29:40.359 --> 00:29:44.079 It's the marginal propensity to consume. 00:29:42.440 --> 00:29:46.000 How much more they demand if they get an 00:29:44.079 --> 00:29:48.480 extra dollar? Well, And don't get They 00:29:46.000 --> 00:29:51.920 don't demand one one extra unit they 00:29:48.480 --> 00:29:53.920 demand C1 unit and C1 is less than one. 00:29:51.920 --> 00:29:56.120 Okay, that's the reason this. 00:29:53.920 --> 00:29:58.039 So, if C1 is very small, 00:29:56.119 --> 00:29:59.959 this line is going to be very flat. 00:29:58.039 --> 00:30:01.480 If C1 is very large, very high marginal 00:29:59.960 --> 00:30:02.759 propensity to consume, this is going to 00:30:01.480 --> 00:30:03.920 be very steep, 00:30:02.759 --> 00:30:05.359 the red line. 00:30:03.920 --> 00:30:06.480 The other one doesn't change, the 45° 00:30:05.359 --> 00:30:09.479 line. 00:30:06.480 --> 00:30:11.360 Okay? And what I said is that 00:30:09.480 --> 00:30:13.120 at equilibrium So, you see if I take an 00:30:11.359 --> 00:30:14.399 off-equilibrium level of output, say 00:30:13.119 --> 00:30:15.599 this, 00:30:14.400 --> 00:30:16.920 aggregate demand is different from 00:30:15.599 --> 00:30:19.480 output. 00:30:16.920 --> 00:30:22.279 It's only at equilibrium that these two 00:30:19.480 --> 00:30:22.279 things will hold. 00:30:22.880 --> 00:30:27.280 Okay? 00:30:23.720 --> 00:30:28.680 This function I can plot it everywhere. 00:30:27.279 --> 00:30:30.399 But this one will hold only at 00:30:28.680 --> 00:30:31.320 equilibrium. 00:30:30.400 --> 00:30:34.640 Okay? 00:30:31.319 --> 00:30:34.639 That's when these two things are equal. 00:30:35.559 --> 00:30:41.720 So, what I solve here, 00:30:39.319 --> 00:30:42.960 here I just found this point. 00:30:41.720 --> 00:30:46.400 Okay? 00:30:42.960 --> 00:30:46.960 So, parameters here are C0, 00:30:46.400 --> 00:30:50.960 uh 00:30:46.960 --> 00:30:53.319 C1 * T, and G. They all shifters of this 00:30:50.960 --> 00:30:55.200 aggregate demand up and down. 00:30:53.319 --> 00:30:59.279 Okay? 00:30:55.200 --> 00:31:01.640 And and that point here 00:30:59.279 --> 00:31:03.480 is exactly that. And those all those 00:31:01.640 --> 00:31:05.800 things are parameters in my aggregate 00:31:03.480 --> 00:31:05.799 demand. 00:31:11.240 --> 00:31:15.319 I really want you to internalize this 00:31:12.839 --> 00:31:15.319 diagram. 00:31:15.720 --> 00:31:18.480 Any questions about 00:31:19.640 --> 00:31:24.360 Just stare at this little bit because 00:31:21.559 --> 00:31:25.839 it's going to show up repeatedly. 00:31:24.359 --> 00:31:28.359 And and later on it's not going to show 00:31:25.839 --> 00:31:29.919 up, but whenever you get confused, the 00:31:28.359 --> 00:31:31.599 way to get yourself out of that 00:31:29.920 --> 00:31:32.960 confusion is going to be to go back to 00:31:31.599 --> 00:31:34.839 the diagram. 00:31:32.960 --> 00:31:37.240 You'll see. I'll remind you when when 00:31:34.839 --> 00:31:39.839 when that's likely to happen. 00:31:37.240 --> 00:31:42.839 Okay? So, so you better understand 00:31:39.839 --> 00:31:44.480 this diagram. Play with it. Move 00:31:42.839 --> 00:31:46.559 Here the only thing you can move around 00:31:44.480 --> 00:31:48.599 is the ZZ, the the the aggregate demand 00:31:46.559 --> 00:31:49.960 curve. Okay? 00:31:48.599 --> 00:31:52.559 The other thing is our equilibrium 00:31:49.960 --> 00:31:55.400 condition. You can't move that that 45° 00:31:52.559 --> 00:31:58.079 line. But ZZ you can move it around. So, 00:31:55.400 --> 00:32:00.320 let's do a a few exercises. Well, one, 00:31:58.079 --> 00:32:05.039 the most obvious. 00:32:00.319 --> 00:32:06.678 Suppose that C0 increases by 1 billion. 00:32:05.039 --> 00:32:07.960 Okay? So, autonomous consumption, that 00:32:06.679 --> 00:32:09.560 is that level of consumption which is 00:32:07.960 --> 00:32:10.480 independent of income, goes up by 1 00:32:09.559 --> 00:32:12.119 billion. 00:32:10.480 --> 00:32:14.559 And that could be, you know, we're all 00:32:12.119 --> 00:32:16.199 in a better mood. You know, okay, 00:32:14.559 --> 00:32:18.399 disposable income is whatever it is 00:32:16.200 --> 00:32:20.880 today, but you know, there's great 00:32:18.400 --> 00:32:24.120 expectation that that in the that the 00:32:20.880 --> 00:32:26.040 economy will enter a boom next year. 00:32:24.119 --> 00:32:28.199 And so, then you feel richer and so on, 00:32:26.039 --> 00:32:29.440 and you may decide to consume not wait 00:32:28.200 --> 00:32:31.559 until next year, you may decide to 00:32:29.440 --> 00:32:34.400 consume more today. That kind of thought 00:32:31.559 --> 00:32:36.639 experiment can be captured by a C0 type 00:32:34.400 --> 00:32:38.679 shift, go up. And that's when you I talk 00:32:36.640 --> 00:32:41.120 about consumer sentiment. Well, consumer 00:32:38.679 --> 00:32:42.320 sentiment is about a lot about C0. For 00:32:41.119 --> 00:32:45.239 any given level of income, will 00:32:42.319 --> 00:32:47.000 consumers are likely to to to consume 00:32:45.240 --> 00:32:48.160 more than they would otherwise or or 00:32:47.000 --> 00:32:50.039 less. 00:32:48.160 --> 00:32:52.000 And that's what C0 captures. 00:32:50.039 --> 00:32:53.279 So, let's go 00:32:52.000 --> 00:32:54.599 everything in this model, there's no 00:32:53.279 --> 00:32:57.079 dynamics 00:32:54.599 --> 00:32:59.119 in this simple model, so we immediately 00:32:57.079 --> 00:33:00.678 but we know is if just were to solve the 00:32:59.119 --> 00:33:03.199 equation, 00:33:00.679 --> 00:33:05.120 and I tell you what happens to if output 00:33:03.200 --> 00:33:07.319 what happens to output if C0 goes up by 00:33:05.119 --> 00:33:09.159 1 billion, 00:33:07.319 --> 00:33:11.559 you know that output will rise by how 00:33:09.160 --> 00:33:11.560 much? 00:33:12.279 --> 00:33:15.440 Let's keep it simple. 00:33:14.759 --> 00:33:17.160 I 00:33:15.440 --> 00:33:19.160 just staring at that equation. If I tell 00:33:17.160 --> 00:33:20.560 you autonomous consumption goes up by 1 00:33:19.160 --> 00:33:22.279 billion, 00:33:20.559 --> 00:33:25.960 what happens to equilibrium output? Goes 00:33:22.279 --> 00:33:29.759 up by more or less than 1 billion? 00:33:25.960 --> 00:33:29.759 Or or exactly 1 billion? 00:33:33.519 --> 00:33:37.799 Exactly. And the multiplier is greater 00:33:35.359 --> 00:33:40.399 than one. So, we know that the output 00:33:37.799 --> 00:33:41.919 will increase by more than 1 billion. 00:33:40.400 --> 00:33:43.759 Will increase by 1 billion times the 00:33:41.920 --> 00:33:46.480 multiplier. 00:33:43.759 --> 00:33:49.599 If C1 is .5, then it will increase by 2 00:33:46.480 --> 00:33:51.880 billion dollars equilibrium output. 00:33:49.599 --> 00:33:54.319 Now, I'm going to get you to from the 1 00:33:51.880 --> 00:33:55.960 billion to the 2 billion in a steps 00:33:54.319 --> 00:33:58.200 using the diagram. That's what I intend 00:33:55.960 --> 00:34:00.240 to do next. 00:33:58.200 --> 00:34:02.319 Okay? So, 00:34:00.240 --> 00:34:04.440 this shift here, so we're starting from 00:34:02.319 --> 00:34:06.960 this equilibrium output here. 00:34:04.440 --> 00:34:08.039 This shift here, 00:34:06.960 --> 00:34:10.240 boom, 00:34:08.039 --> 00:34:14.679 is increasing C0. That's a 1 billion. 00:34:10.239 --> 00:34:16.119 So, distance A to B is 1 billion. That's 00:34:14.679 --> 00:34:17.720 it will be because what I did is for any 00:34:16.119 --> 00:34:20.199 given level of output I shift this 00:34:17.719 --> 00:34:22.000 aggregate demand up by 1 billion. That's 00:34:20.199 --> 00:34:23.039 autonomous consumption up. 00:34:22.000 --> 00:34:24.039 Okay? 00:34:23.039 --> 00:34:27.079 Well, 00:34:24.039 --> 00:34:30.279 because output is whatever demand wants, 00:34:27.079 --> 00:34:32.279 that immediately increases output 00:34:30.280 --> 00:34:35.720 by 1 billion. So, B, the distance 00:34:32.280 --> 00:34:36.679 between B and C is also 1 billion. 00:34:35.719 --> 00:34:38.480 Okay? 00:34:36.679 --> 00:34:41.918 Demand increase by 1 billion, boom, 00:34:38.480 --> 00:34:45.000 output immediately catches up. 00:34:41.918 --> 00:34:48.000 So, output increases by 1 billion. 00:34:45.000 --> 00:34:51.119 But if output increases by 1 billion, 00:34:48.000 --> 00:34:51.119 what has happened to income? 00:34:56.239 --> 00:35:01.000 It also increased by 1 billion. Income 00:34:58.440 --> 00:35:02.079 is the same as output. 00:35:01.000 --> 00:35:04.400 So, 00:35:02.079 --> 00:35:05.880 income has increased by 1 billion. 00:35:04.400 --> 00:35:09.358 Well, if income has increased by 1 00:35:05.880 --> 00:35:11.400 billion and C1 is different from zero, 00:35:09.358 --> 00:35:12.840 that means part of that extra billion is 00:35:11.400 --> 00:35:15.358 going to be spent 00:35:12.840 --> 00:35:18.800 in consumption, second round. 00:35:15.358 --> 00:35:21.000 So, say C1 is .5, then now you get 500 00:35:18.800 --> 00:35:22.880 million dollars more of expenditure. 00:35:21.000 --> 00:35:25.358 But if it's of consumption, and if 00:35:22.880 --> 00:35:26.760 there's 500 dollars that's that's a C 00:35:25.358 --> 00:35:29.000 CD. 00:35:26.760 --> 00:35:31.720 Shift, that's 500 million. 00:35:29.000 --> 00:35:33.320 Obviously, this C1 here is is less than 00:35:31.719 --> 00:35:35.000 .5 because otherwise 00:35:33.320 --> 00:35:37.519 you know, this would be half of that, 00:35:35.000 --> 00:35:39.800 but but it's not. Anyway, 00:35:37.519 --> 00:35:41.679 you get 500 million more. 00:35:39.800 --> 00:35:43.640 But if you if now there's 500 million 00:35:41.679 --> 00:35:45.679 more of demand, since output does 00:35:43.639 --> 00:35:47.559 whatever production does whatever demand 00:35:45.679 --> 00:35:49.079 wants, then you get 500 more of 00:35:47.559 --> 00:35:51.119 production. 00:35:49.079 --> 00:35:52.599 And if you have 500 more million dollars 00:35:51.119 --> 00:35:54.199 more of production, then you have 500 00:35:52.599 --> 00:35:56.039 million more of income. 00:35:54.199 --> 00:35:57.960 And if you have 500 more of income and 00:35:56.039 --> 00:36:00.159 so your C1 is greater than zero, 00:35:57.960 --> 00:36:02.000 say .5, you're going to spend 250 00:36:00.159 --> 00:36:05.358 million more. 00:36:02.000 --> 00:36:06.880 But 250 million more will generate 250 00:36:05.358 --> 00:36:09.079 million dollars of production, which 00:36:06.880 --> 00:36:10.400 also will generate 250 million dollars 00:36:09.079 --> 00:36:11.880 more 00:36:10.400 --> 00:36:13.358 of 00:36:11.880 --> 00:36:16.480 income, 00:36:13.358 --> 00:36:17.920 which will generate 125 million more 00:36:16.480 --> 00:36:20.440 of consumption, and blah blah blah blah 00:36:17.920 --> 00:36:22.039 blah. You you you get your Okay? 00:36:20.440 --> 00:36:24.119 So, that's and that's what is happening 00:36:22.039 --> 00:36:25.800 here. 00:36:24.119 --> 00:36:27.920 Boom. 00:36:25.800 --> 00:36:27.920 Yeah. 00:36:29.358 --> 00:36:34.840 From C 00:36:30.679 --> 00:36:38.159 to D. Okay. So, this is initial 00:36:34.840 --> 00:36:39.440 shift in aggregate demand up, 1 billion. 00:36:38.159 --> 00:36:41.559 That 00:36:39.440 --> 00:36:42.280 lead to leads to 00:36:41.559 --> 00:36:45.159 uh 00:36:42.280 --> 00:36:48.120 1 billion more of production as well, 00:36:45.159 --> 00:36:50.679 which means 1 billion more of income. 00:36:48.119 --> 00:36:53.719 Okay? But now these consumers not only 00:36:50.679 --> 00:36:55.199 have this C0 1 billion higher in C0, but 00:36:53.719 --> 00:36:57.279 they also have 1 00:36:55.199 --> 00:36:59.159 uh billion more of income. 00:36:57.280 --> 00:37:01.200 And since they have 1 billion income and 00:36:59.159 --> 00:37:03.839 they're going to spend part of it, C1 00:37:01.199 --> 00:37:06.319 times that, and I assume C1 was .5, 00:37:03.840 --> 00:37:09.039 that's what gives me CD. 00:37:06.320 --> 00:37:10.720 That's the the extra five 500 million 00:37:09.039 --> 00:37:12.039 dollars. 00:37:10.719 --> 00:37:13.559 And then this that thing here there is 00:37:12.039 --> 00:37:18.519 also 500 million dollars, and then there 00:37:13.559 --> 00:37:20.358 was 250 million, 250 million, 125, 125, 00:37:18.519 --> 00:37:23.559 62 and a half, blah blah blah. 00:37:20.358 --> 00:37:23.559 That's that's the way you get there. 00:37:24.280 --> 00:37:28.160 There's an alternative way of 00:37:26.760 --> 00:37:30.240 finding equilibrium output, which is 00:37:28.159 --> 00:37:32.519 entirely equivalent. And it's the way it 00:37:30.239 --> 00:37:34.759 was initially done, by the way. 00:37:32.519 --> 00:37:37.239 Uh and and and you'll see later on a 00:37:34.760 --> 00:37:38.400 very important curve in this course will 00:37:37.239 --> 00:37:40.959 be 00:37:38.400 --> 00:37:43.200 the IS curve, which is a curve that 00:37:40.960 --> 00:37:45.199 describes all the equilibrium in goods 00:37:43.199 --> 00:37:47.000 markets. We'll get there. 00:37:45.199 --> 00:37:48.439 But but the reason it's called IS is 00:37:47.000 --> 00:37:50.679 because of this alternative way of 00:37:48.440 --> 00:37:52.200 deriving the same I have derived, 00:37:50.679 --> 00:37:54.599 which is 00:37:52.199 --> 00:37:55.919 through you you can arrive to the same 00:37:54.599 --> 00:37:58.599 equilibrium by saying, "Look, 00:37:55.920 --> 00:38:01.840 equilibrium output is that output at 00:37:58.599 --> 00:38:03.319 which investment is equal to saving." 00:38:01.840 --> 00:38:05.840 That's the reason that curve is going to 00:38:03.320 --> 00:38:07.240 be called IS, investment equal to 00:38:05.840 --> 00:38:08.680 saving, S. 00:38:07.239 --> 00:38:10.159 So, let me very quickly do it for you 00:38:08.679 --> 00:38:11.679 and and then make a point and connect 00:38:10.159 --> 00:38:14.559 the two things. 00:38:11.679 --> 00:38:16.639 So, say private saving is, you know, 00:38:14.559 --> 00:38:19.358 what con- sumers do and so on, 00:38:16.639 --> 00:38:21.599 and firms, is just disposable income 00:38:19.358 --> 00:38:22.599 minus consumption. That's your saving. 00:38:21.599 --> 00:38:24.960 Okay? 00:38:22.599 --> 00:38:27.759 So, it's equal to Y minus T, that's 00:38:24.960 --> 00:38:31.079 disposable income, minus C. 00:38:27.760 --> 00:38:32.480 Government saving is taxes minus 00:38:31.079 --> 00:38:34.400 government expenditure. So, if the 00:38:32.480 --> 00:38:36.400 government has a deficit, that thing is 00:38:34.400 --> 00:38:38.840 negative. Governments often have 00:38:36.400 --> 00:38:42.480 negative saving. Okay? If you have a 00:38:38.840 --> 00:38:45.320 surplus, then taxes are greater than G, 00:38:42.480 --> 00:38:47.440 then you have a fiscal surplus. Again, 00:38:45.320 --> 00:38:49.880 rarely happens in the US 00:38:47.440 --> 00:38:51.760 or in the Americas in general. Okay? 00:38:49.880 --> 00:38:53.480 Happens a lot in Asia, but not doesn't 00:38:51.760 --> 00:38:54.800 happen very much in this part of the 00:38:53.480 --> 00:38:57.880 world. 00:38:54.800 --> 00:39:00.200 But there we are. So, in equilibrium, 00:38:57.880 --> 00:39:02.559 investment, I, 00:39:00.199 --> 00:39:03.799 has to be equal to saving. So, that's 00:39:02.559 --> 00:39:06.639 what you are going to use the saving 00:39:03.800 --> 00:39:08.280 for, to invest. Okay? 00:39:06.639 --> 00:39:09.480 So, investment is equal to the sum of 00:39:08.280 --> 00:39:11.880 savings. 00:39:09.480 --> 00:39:14.599 I can replace all that in here, and you 00:39:11.880 --> 00:39:16.599 see that I get exactly the same 00:39:14.599 --> 00:39:18.960 equilibrium condition I had before. 00:39:16.599 --> 00:39:21.079 Output equal to aggregate demand. 00:39:18.960 --> 00:39:22.119 Okay? So, this is an entirely equivalent 00:39:21.079 --> 00:39:24.239 way 00:39:22.119 --> 00:39:26.400 of deriving this, and I just want to 00:39:24.239 --> 00:39:28.639 show you this 00:39:26.400 --> 00:39:31.119 because it's the way it was originally 00:39:28.639 --> 00:39:32.759 done, and and and and and you'll 00:39:31.119 --> 00:39:33.839 understand better the terminology we use 00:39:32.760 --> 00:39:35.280 later on 00:39:33.840 --> 00:39:38.200 if you see that this is an equivalent 00:39:35.280 --> 00:39:40.400 way. This is also a nice way of 00:39:38.199 --> 00:39:41.839 illustrating something why macro can be 00:39:40.400 --> 00:39:43.720 counterintuitive sometimes. 00:39:41.840 --> 00:39:45.840 Microeconomics is very intuitive. I 00:39:43.719 --> 00:39:47.559 mean, things make sense. 00:39:45.840 --> 00:39:49.880 It's like physics, it makes sense. Macro 00:39:47.559 --> 00:39:52.000 is can be confusing. 00:39:49.880 --> 00:39:54.200 For example, there's the well-known 00:39:52.000 --> 00:39:55.400 paradox of saving in the short run, not 00:39:54.199 --> 00:39:57.480 in the long run. In the short run, you 00:39:55.400 --> 00:40:00.280 have the paradox of saving. 00:39:57.480 --> 00:40:02.079 So, you know, we all think that you save 00:40:00.280 --> 00:40:03.840 more is a good thing. Our parents teach 00:40:02.079 --> 00:40:05.079 us that it's a good thing to save more 00:40:03.840 --> 00:40:06.320 and so on. 00:40:05.079 --> 00:40:08.079 And in general, 00:40:06.320 --> 00:40:10.680 that is true. You'll do better in life 00:40:08.079 --> 00:40:12.519 if you save a little more and so on. 00:40:10.679 --> 00:40:15.079 But it's not true for the macro in the 00:40:12.519 --> 00:40:15.079 short run. 00:40:16.360 --> 00:40:20.760 You know, it's not good for 00:40:18.519 --> 00:40:22.759 macroeconomics in the short run 00:40:20.760 --> 00:40:24.520 unless you are in a overheated economy. 00:40:22.760 --> 00:40:27.080 Now, it could help. 00:40:24.519 --> 00:40:30.079 But otherwise, it's not very good for 00:40:27.079 --> 00:40:32.279 equilibrium output. Let me show you that 00:40:30.079 --> 00:40:33.440 very quickly with the expression I just 00:40:32.280 --> 00:40:35.920 showed you. Remember that I said 00:40:33.440 --> 00:40:38.639 equilibrium output is pinned down by 00:40:35.920 --> 00:40:40.000 investment equal to saving. And saving 00:40:38.639 --> 00:40:41.599 of the private saving here is an 00:40:40.000 --> 00:40:45.079 increasing is an increasing function of 00:40:41.599 --> 00:40:48.799 output, okay? It is equal to actually 1 00:40:45.079 --> 00:40:51.440 - c The function has a slope of 1 - c1. 00:40:48.800 --> 00:40:53.960 C1 is the share of income that you spend 00:40:51.440 --> 00:40:55.679 in consumption. Therefore, 1 - c1 is the 00:40:53.960 --> 00:40:57.880 share of your income that you spend in 00:40:55.679 --> 00:41:01.279 saving, okay? So, this function is 00:40:57.880 --> 00:41:03.119 increasing with a slope of 1 - c1. 00:41:01.280 --> 00:41:05.240 So, suppose I tell you now that all we 00:41:03.119 --> 00:41:06.799 decided to to we learn the lessons of 00:41:05.239 --> 00:41:08.879 our parents and say, "Okay, we should 00:41:06.800 --> 00:41:11.080 all save more." 00:41:08.880 --> 00:41:12.800 So, that means for any for any given 00:41:11.079 --> 00:41:15.840 level of income, now we all decide to 00:41:12.800 --> 00:41:17.519 save more. That means the the S function 00:41:15.840 --> 00:41:19.960 shifts up. 00:41:17.519 --> 00:41:21.280 For any given level of income, 00:41:19.960 --> 00:41:22.599 we save more. But 00:41:21.280 --> 00:41:26.080 we have a problem there because now we 00:41:22.599 --> 00:41:26.079 have more saving than investment. 00:41:26.159 --> 00:41:29.759 So, how how do we restore equilibrium? 00:41:28.199 --> 00:41:32.960 That's not an equilibrium. 00:41:29.760 --> 00:41:32.960 How do we restore equilibrium? 00:41:37.480 --> 00:41:42.519 So, now we all decide to be more prudent 00:41:39.559 --> 00:41:45.239 and save a little more. 00:41:42.519 --> 00:41:47.400 At the level of the economy as a whole, 00:41:45.239 --> 00:41:49.319 now we have more saving than investment. 00:41:47.400 --> 00:41:51.400 That can happen. It can It's not an 00:41:49.320 --> 00:41:54.720 equilibrium. 00:41:51.400 --> 00:41:54.720 What restores equilibrium? 00:41:55.039 --> 00:41:57.759 Well, 00:41:55.960 --> 00:41:59.720 in this very simple model, our 00:41:57.760 --> 00:42:01.120 investment is fixed. So, I nothing can 00:41:59.719 --> 00:42:02.759 adjust on the investment side because 00:42:01.119 --> 00:42:04.599 it's fixed. Later on, it's going to 00:42:02.760 --> 00:42:06.320 move, but now it's fixed. 00:42:04.599 --> 00:42:09.000 Nothing can adjust in the public saving 00:42:06.320 --> 00:42:10.720 part because, you know, it can't move. 00:42:09.000 --> 00:42:12.679 We assume that it's exogenous. 00:42:10.719 --> 00:42:15.719 So, something has to happen endogenously 00:42:12.679 --> 00:42:17.119 here that that reverses the increase in 00:42:15.719 --> 00:42:18.719 savings. That's the only thing that can 00:42:17.119 --> 00:42:20.920 happen. And the only thing that can 00:42:18.719 --> 00:42:22.199 happen endogenously here is a declining 00:42:20.920 --> 00:42:24.639 output. 00:42:22.199 --> 00:42:26.759 Output declines, saving declines. 00:42:24.639 --> 00:42:28.519 So, here you end up in a situation in 00:42:26.760 --> 00:42:30.840 which we all decided to be sort of, you 00:42:28.519 --> 00:42:32.280 know, better people, save a little more, 00:42:30.840 --> 00:42:34.400 and we end up sinking the economy in a 00:42:32.280 --> 00:42:35.120 recession. 00:42:34.400 --> 00:42:36.880 Yeah, 00:42:35.119 --> 00:42:37.960 output declines. 00:42:36.880 --> 00:42:41.119 Okay, that's the reason it's called the 00:42:37.960 --> 00:42:41.119 paradox of saving. 00:42:41.519 --> 00:42:44.559 That's not going to happen to you 00:42:42.440 --> 00:42:46.039 individually, but to an economy as a 00:42:44.559 --> 00:42:47.559 whole, that's the reason I said it's 00:42:46.039 --> 00:42:50.559 counterintuitive. 00:42:47.559 --> 00:42:50.559 It it can happen. 00:42:52.400 --> 00:42:54.639 I get 00:42:53.440 --> 00:42:57.240 So, I 00:42:54.639 --> 00:42:57.879 Look, if you don't like this way of 00:42:57.239 --> 00:42:59.039 uh 00:42:57.880 --> 00:43:00.360 and it's not the main way we're going to 00:42:59.039 --> 00:43:02.400 use. If you don't like this way of 00:43:00.360 --> 00:43:04.039 finding equilibrium output, just ignore 00:43:02.400 --> 00:43:06.119 it. I I just wanted you to know it. Go 00:43:04.039 --> 00:43:08.079 back to The thing you really need to 00:43:06.119 --> 00:43:10.719 understand is not this, it's it's this, 00:43:08.079 --> 00:43:11.920 that, that that you need to understand. 00:43:10.719 --> 00:43:14.399 So, let me 00:43:11.920 --> 00:43:16.039 illustrate the paradox of saving 00:43:14.400 --> 00:43:19.119 in in the model we're using, in the one 00:43:16.039 --> 00:43:20.960 I want you to really remember. 00:43:19.119 --> 00:43:23.480 Well, 00:43:20.960 --> 00:43:25.280 the paradox of saving, I can capture by 00:43:23.480 --> 00:43:27.240 a declining c0. 00:43:25.280 --> 00:43:29.360 Okay? For any given level of income, now 00:43:27.239 --> 00:43:31.119 we decide to consume less. If we consume 00:43:29.360 --> 00:43:33.800 less for any given level of income, that 00:43:31.119 --> 00:43:34.799 means we're saving more. 00:43:33.800 --> 00:43:38.080 Okay? 00:43:34.800 --> 00:43:39.360 So, I can capture in this diagram 00:43:38.079 --> 00:43:41.559 uh 00:43:39.360 --> 00:43:44.039 the the fact that we all all become sort 00:43:41.559 --> 00:43:46.519 of more prudent by a declining aggregate 00:43:44.039 --> 00:43:46.519 demand. 00:43:46.719 --> 00:43:49.599 But if aggregate demand declines, so 00:43:48.199 --> 00:43:51.039 suppose we start at this equilibrium 00:43:49.599 --> 00:43:53.119 level of output and then all of a sudden 00:43:51.039 --> 00:43:55.599 we say, "Okay, enough is enough. We need 00:43:53.119 --> 00:43:56.719 We need to start saving more." 00:43:55.599 --> 00:43:58.839 Then, 00:43:56.719 --> 00:44:00.239 what happens? Well, aggregate demand 00:43:58.840 --> 00:44:02.200 declines. 00:44:00.239 --> 00:44:03.319 I mean, for any given level of income, 00:44:02.199 --> 00:44:04.480 if you're going to save more, that means 00:44:03.320 --> 00:44:06.480 you're going to consume less. So, 00:44:04.480 --> 00:44:07.840 aggregate demand declines. 00:44:06.480 --> 00:44:10.400 But what happens when aggregate demand 00:44:07.840 --> 00:44:10.400 declines? 00:44:11.039 --> 00:44:14.400 Output declines. 00:44:13.159 --> 00:44:17.039 What happens when out when output 00:44:14.400 --> 00:44:17.039 declines? 00:44:18.079 --> 00:44:23.279 Income declines. 00:44:19.800 --> 00:44:23.280 What happens when income declines? 00:44:25.519 --> 00:44:28.840 Well, part of that income you consume, 00:44:27.079 --> 00:44:31.599 so you're going to consume less. 00:44:28.840 --> 00:44:33.320 C1 times that. So, then and then you get 00:44:31.599 --> 00:44:35.358 the multiplier working against you. So, 00:44:33.320 --> 00:44:38.680 not only if now we all decide to save 00:44:35.358 --> 00:44:41.079 more, not only output falls 00:44:38.679 --> 00:44:42.440 by the same amount that that we increase 00:44:41.079 --> 00:44:44.079 savings, 00:44:42.440 --> 00:44:45.639 but actually it declines by more than 00:44:44.079 --> 00:44:47.719 that because you get the multiplier 00:44:45.639 --> 00:44:49.599 working against against you. 00:44:47.719 --> 00:44:51.839 Okay? 00:44:49.599 --> 00:44:54.880 That's the reason I'm a big role of 00:44:51.840 --> 00:44:57.320 policy makers really in recession is to 00:44:54.880 --> 00:44:58.640 try to maintain the calm, the you know, 00:44:57.320 --> 00:45:00.880 because you can get into this kind of 00:44:58.639 --> 00:45:02.759 things. If everybody gets scared and and 00:45:00.880 --> 00:45:04.358 you know, we all get scared, so the 00:45:02.760 --> 00:45:06.480 economy can implode just out of bad 00:45:04.358 --> 00:45:08.799 sentiment. Uh 00:45:06.480 --> 00:45:08.800 and so on. 00:45:14.159 --> 00:45:18.799 Now, we're on the opposite side of the 00:45:16.320 --> 00:45:20.519 cycle. We would want output to decline a 00:45:18.800 --> 00:45:22.200 little because we are having other 00:45:20.519 --> 00:45:24.239 problems, inflation and so on, again, 00:45:22.199 --> 00:45:26.159 something we'll discuss later. 00:45:24.239 --> 00:45:28.279 So, now you may want to scare consumers 00:45:26.159 --> 00:45:30.480 a little. And in fact, 00:45:28.280 --> 00:45:30.480 uh 00:45:32.599 --> 00:45:35.599 the the governors of the Federal 00:45:34.039 --> 00:45:36.920 Reserve, and the same is happening in 00:45:35.599 --> 00:45:38.319 other places in the world, are doing 00:45:36.920 --> 00:45:42.440 just that. I mean, when they go out 00:45:38.320 --> 00:45:44.080 there, say the economy is too hot, 00:45:42.440 --> 00:45:45.519 uh we're going to have to mess up this 00:45:44.079 --> 00:45:47.119 economy a little. And then they're 00:45:45.519 --> 00:45:49.480 telling us that. 00:45:47.119 --> 00:45:50.880 And and and the first ones to listen to 00:45:49.480 --> 00:45:52.358 these things are is the financial 00:45:50.880 --> 00:45:54.680 markets. So, every time they come out 00:45:52.358 --> 00:45:56.799 and make a speech of that kind, equity 00:45:54.679 --> 00:45:59.319 markets decline. 00:45:56.800 --> 00:46:00.800 Well, equity markets capture before the 00:45:59.320 --> 00:46:02.640 mood that consumers will have in the 00:46:00.800 --> 00:46:03.920 future. They capture it early. But 00:46:02.639 --> 00:46:06.199 that's the message. 00:46:03.920 --> 00:46:08.200 Okay? So, they're trying to At this 00:46:06.199 --> 00:46:08.759 moment, really, 00:46:08.199 --> 00:46:11.039 uh 00:46:08.760 --> 00:46:13.320 policy makers, at least the the central 00:46:11.039 --> 00:46:15.519 banks, are trying to do just that. 00:46:13.320 --> 00:46:17.880 Depress a little bit consumers. 00:46:15.519 --> 00:46:19.880 So so so we can 00:46:17.880 --> 00:46:22.119 cool off the economy a bit. 00:46:19.880 --> 00:46:22.119 Okay? 00:46:22.480 --> 00:46:26.400 Any questions? 00:46:24.079 --> 00:46:28.639 Again, very important lecture because 00:46:26.400 --> 00:46:30.079 we're going to build on on this and and 00:46:28.639 --> 00:46:32.079 later on this is going to be always in 00:46:30.079 --> 00:46:33.039 the background. 00:46:32.079 --> 00:46:35.199 And 00:46:33.039 --> 00:46:36.960 of this until we actually go to the 00:46:35.199 --> 00:46:38.960 third part of the course, 00:46:36.960 --> 00:46:40.519 the key model will be this. This will be 00:46:38.960 --> 00:46:42.320 in the background. More More things will 00:46:40.519 --> 00:46:45.480 be happening on top, 00:46:42.320 --> 00:46:48.240 but but whenever I ask you a question, 00:46:45.480 --> 00:46:50.719 for example, later on, one example, what 00:46:48.239 --> 00:46:54.439 else would produce a 00:46:50.719 --> 00:46:54.439 this a situation like this? 00:46:54.920 --> 00:46:59.039 What else would What What could have 00:46:56.760 --> 00:47:01.040 What kind of policy 00:46:59.039 --> 00:47:02.440 would generate 00:47:01.039 --> 00:47:04.840 that 00:47:02.440 --> 00:47:06.320 that movement? Well, at this point, we 00:47:04.840 --> 00:47:09.039 haven't introduced monetary policy, so 00:47:06.320 --> 00:47:11.440 you cannot talk about monetary policy. 00:47:09.039 --> 00:47:12.719 But we do we do have 00:47:11.440 --> 00:47:15.159 other kind of policy we could talk 00:47:12.719 --> 00:47:15.159 about. 00:47:24.159 --> 00:47:26.679 Remember? 00:47:30.559 --> 00:47:34.840 Here. 00:47:32.000 --> 00:47:34.840 Fiscal policy. 00:47:35.199 --> 00:47:38.919 Okay? 00:47:36.559 --> 00:47:40.119 Fiscal policy, G and T. Those are fiscal 00:47:38.920 --> 00:47:43.000 parameters. 00:47:40.119 --> 00:47:45.719 When when G goes down or T goes up, we 00:47:43.000 --> 00:47:47.559 call that contractionary fiscal policy. 00:47:45.719 --> 00:47:49.279 Why contractionary? Because it contracts 00:47:47.559 --> 00:47:51.199 aggregate demand. 00:47:49.280 --> 00:47:54.000 If If G goes down, clearly aggregate 00:47:51.199 --> 00:47:55.839 demand goes down immediately. If T goes 00:47:54.000 --> 00:47:57.519 up, well, disposable income for any 00:47:55.840 --> 00:47:59.559 given level of income goes down, and 00:47:57.519 --> 00:48:02.759 therefore consumption goes down. So, so 00:47:59.559 --> 00:48:04.639 we call an increase a declining G or an 00:48:02.760 --> 00:48:05.960 increasing T a contractionary fiscal 00:48:04.639 --> 00:48:08.480 policy. 00:48:05.960 --> 00:48:10.000 The opposite, if G goes up and T goes 00:48:08.480 --> 00:48:11.440 down, we call that an expansionary 00:48:10.000 --> 00:48:14.199 fiscal policy. 00:48:11.440 --> 00:48:16.480 So, I take you back to this diagram 00:48:14.199 --> 00:48:18.358 here, 00:48:16.480 --> 00:48:20.280 and I ask you the question again. 00:48:18.358 --> 00:48:22.000 What kind of fiscal policy will generate 00:48:20.280 --> 00:48:24.160 this type of 00:48:22.000 --> 00:48:27.559 this picture? 00:48:24.159 --> 00:48:27.559 Contractionary or expansionary? 00:48:32.760 --> 00:48:37.280 Contractionary. Contractionary. I mean, 00:48:34.760 --> 00:48:39.640 good mnemonic, the output declined. 00:48:37.280 --> 00:48:41.720 You know? So, contractionary So, that is 00:48:39.639 --> 00:48:43.319 a declining a reduction in G, in 00:48:41.719 --> 00:48:45.599 government expenditure, 00:48:43.320 --> 00:48:47.960 or an increase in taxes 00:48:45.599 --> 00:48:49.920 will shift that curve down, and then the 00:48:47.960 --> 00:48:52.119 multiplier will make it even more 00:48:49.920 --> 00:48:54.760 contractionary than the initial fiscal 00:48:52.119 --> 00:48:54.759 impulse. 00:48:57.639 --> 00:49:01.879 Very good. 00:48:58.639 --> 00:49:01.879 I'll see you on Wednesday.