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7/21/2019 Principles of Economics- The Classical Long Run Model
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PowerPoint Slides prepared by: Andreea CHIRITESCUEastern Illinois University
PowerPoint Slides prepared by: Andreea CHIRITESCUEastern Illinois University
The Classical Long-Run Model
CHAPTER
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%a&roe&ono+i& %odels
• Classi&al +odel
- %a&roe&ono+i& +odel t$at e)plains t$elon!,r(n be$avior o* t$e e&ono+y
- .eveloped by e&ono+ists in t$e 1/t$ and
early 20t$ &ent(ries - %aret *or&es drive t$e e&ono+y toward
*(ll e+ploy+ent
• reat .epression - (tp(t was st(& *ar below its potential *or
+any years
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3i!(reU#S# Real .P' 1420-2010 5"o!arit$+i& S&ale6
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1
7/21/2019 Principles of Economics- The Classical Long Run Model
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7/21/2019 Principles of Economics- The Classical Long Run Model
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%a&roe&ono+i& %odels
• 9eyness ideas
- And t$eir *(rt$er develop+ent $elp (s(nderstand e&ono+i& *l(&t(ations• %ove+ents in o(tp(t aro(nd its lon!,r(n trend
• Classi&al +odel - Has proven +ore (se*(l in e)plainin! t$e
lon!,r(n trend itsel*
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%a&roe&ono+i& %odels
• Ass(+ption in &lassi&al +odel
- So+e si+pli*yin! ass(+ptions - Ass(+ption abo(t $ow t$e world wors:
+arets &lear • T$e pri&e in every +aret will ad=(st (ntil
>(antity s(pplied and >(antity de+anded aree>(al
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How %(&$ (tp(t ?ill ?e Prod(&e@
• 200< t$ro(!$ 200 5be*ore t$e re&ession6
- T$e U#S# e&ono+y prod(&ed an avera!eo* abo(t B1 trillion wort$ o* !oods andservi&es per year 5val(ed in 200< dollars6
• Reason *or all t$is prod(&tion: - (r desire *or !oods and servi&es
- (r need *or in&o+e in order to b(y t$e+
• People !et in&o+e
- S(pplyin! labor and ot$er reso(r&es to*ir+s
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How %(&$ (tp(t ?ill ?e Prod(&e@
• 3ir+s
- Use t$ese reso(r&es to +ae t$e !oodsand servi&es t$at people de+and
• "abor +aret ass(+ptions
- 3ir+s are already (sin! t$e available>(antities o* t$e ot$er reso(r&es
- A!!re!ate all t$e di**erent types o* labor
into a sin!le variable' labor
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T$e "abor %aret
• "abor +aret
- Ho(se$olds s(pply labor
- 3ir+s de+and labor - Horiontal a)is: n(+ber o* worers
- Derti&al a)is: real $o(rly wa!e rate
• Real wa!e
- %eas(red in t$e dollars o* so+e base year - T$e a+o(nt o* !oods t$at worers &an
b(y wit$ an $o(rs earnin!s
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T$e "abor %aret
• "abor s(pply &(rve
- How +any people will want to wor atvario(s real wa!e rates
- Slopes (pward• As t$e wa!e rate in&reases' +ore and +ore
individ(als de&ide t$ey are better o** worin!t$an not worin!
•
A rise in t$e wa!e rate in&reases t$e n(+bero* people in t$e e&ono+y w$o want to wor
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T$e "abor %aret
• "abor de+and &(rve
- How +any worers *ir+s will want to $ireat vario(s real wa!e rates
- .ownward slopin!• As t$e wa!e rate in&reases' ea&$ *ir+ in t$e
e&ono+y will *ind: – To +a)i+ie pro*it' it s$o(ld e+ploy *ewer worers
t$an be*ore
• ?$en all *ir+s be$ave t$is way to!et$er – A rise in t$e wa!e rate will de&rease t$e >(antity
o* labor de+anded in t$e e&ono+y
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3i!(re
T$e e>(ilibri(+ wa!e rate o*B2< per $o(r is deter+inedat point E' w$ere t$e(pward,slopin! labor s(pply&(rve &rosses t$e
downward,slopin! laborde+and &(rve# At any ot$erwa!e' an e)&ess de+and ore)&ess s(pply o* labor will&a(se an ad=(st+ent ba& toe>(ilibri(+#
T$e "abor %aret
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2
(+ber o*?orers
RealHo(rly?a!e
".
"S
E
B0
2<
20
1<0 +illion F
3(ll E+ploy+ent
E)&ess S(pply
o* "abor
E)&ess .e+and
*or "abor
8H
G A
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T$e "abor %aret
• I* e)&ess s(pply o* labor
- Co+petition a+on! worers wo(ld drivet$e wa!e downward
• I* e)&ess de+and *or labor
- Co+petition a+on! *ir+s wo(ld drive t$ewa!e (pward
• E>(ilibri(+ total e+ploy+ent
- %aret &lears
- E&ono+y a&$ieves *(ll e+ploy+ent on itsown
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3ro+ E+ploy+ent to (tp(t
• Ass(+ptions
- (antities o* ot$er reso(r&es: *i)ed - Te&$nolo!y: *i)ed
• A!!re!ate prod(&tion *(n&tion
- How +(&$ total o(tp(t &an be prod(&edwit$ di**erent >(antities o* labor
- ?$en >(antities o* all ot$er reso(r&es andte&$nolo!y are $eld &onstant
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3i!(re(tp(t .eter+ination in t$e Classi&al %odel
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(+ber o* ?orers
RealHo(rly
?a!e
".
"S
B2<
1<0 +illion
In t$e labor +aret' t$e de+andand s(pply &(rves interse&t todeter+ine e+ploy+ent o* 1<0+illion worers#
(+ber o* ?orers
Total (tp(t5Real .P6
1<0 +illion
T$e prod(&tion *(n&tion s$owst$at t$ose 1<0 +illion worers &anprod(&e B10 trillion o* real .P#
A!!re!ate Prod(&tion 3(n&tion
B10 Trillion
F3(llE+ploy+ent
(tp(t
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3ro+ E+ploy+ent to (tp(t
• A!!re!ate prod(&tion *(n&tion
- .e&linin! slope: di+inis$in! ret(rns tolabor • (tp(t rises w$en anot$er worer is added
• T$e rise is s+aller and s+aller wit$ ea&$s(&&essive worer
• E>(ilibri(+ real .P
- In t$e &lassi&al' lon!,r(n view - E&ono+y rea&$es its potential o(tp(t
a(to+ati&ally
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T$e Role o* Spendin!
• Total spendin! in a very si+ple e&ono+y
- .o+esti& $o(se$olds• Spend all in&o+e on do+esti& o(tp(t
• o savin!
- .o+esti& b(siness *ir+s - Total spendin! +(st be e>(al to total
o(tp(t
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3i!(re
An e&ono+y prod(&in! total o(tp(t o* B10 trillion will' by de*inition' &reate B10 trillion in *a&torpay+ents or total in&o+e# I* $o(se$olds spend all o* t$is in&o+e on &ons(+ption !oods' t$entotal spendin! will e>(al B10 trillion as well#
Total Spendin! in a Si+ple E&ono+y
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;
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T$e Role o* Spendin!
• Says law
- Total spendin! will be s(**i&ient top(r&$ase t$e total o(tp(t prod(&ed
- Gy prod(&in! !oods and servi&es• 3ir+s &reate a total de+and *or !oods and
servi&es e>(al to w$at t$ey $ave prod(&ed
- S(pply &reates its own de+and
- 3(ll,e+ploy+ent &an be +aintained
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Total Spendin! in a %ore Realisti& E&ono+y
• Ass(+ptions
- Closed e&ono+y - overn+ent
• Colle&ts ta)es and p(r&$ases !oods and
servi&es - Ho(se$olds
• Send t$eir in&o+e on &ons(+ption' ta)es'
and savin!s - G(siness *ir+s
• P(r&$ase &apital !oods 5invest+ent spendin!6
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T bl 1
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Table3lows in t$e E&ono+y o* Classi&a' 2012
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1
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Total Spendin! in a %ore Realisti& E&ono+y
• Planned invest+ent spendin! 5IP6
- G(siness p(r&$ases o* plant ande>(ip+ent
- Total invest+ent 5I6 +in(s &$an!e in
inventoriesIPFI, inventories
• et ta)es 5T6
- Total !overn+ent ta) reven(e +in(s!overn+ent trans*er pay+ents
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Total Spendin! in a %ore Realisti& E&ono+y
• .isposable in&o+e
- Ho(se$old in&o+e +in(s net ta)es - It is eit$er spent or saved
• Ho(se$old savin! 5S6
- Portion o* a*ter,ta) in&o+e t$at$o(se$olds do not spend on &ons(+ption
- S F .isposable In&o+e - C
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Total Spendin! in a %ore Realisti& E&ono+y
• Total spendin! in Classi&a
- S(+ o* t$e p(r&$ases +ade by• Ho(se$old se&tor 5C6
• G(siness se&tor 5IP6
•
overn+ent se&tor 56Total spendin! F C J IP J
• "eaa!es F T J S
- In&o+e earned by $o(se$olds t$at t$ey donot spend on t$e &o(ntrys o(tp(t d(rin! a!iven year
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Total Spendin! in a %ore Realisti& E&ono+y
• In=e&tions F J IP
- Spendin! on a &o(ntrys o(tp(t *ro+so(r&es ot$er t$an its $o(se$olds
• Total spendin! will e>(al total o(tp(t
- I* and only i* total leaa!es are e>(al tototal in=e&tions
S J T F IP J
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3i <
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3i!(re"eaa!es and In=e&tions
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<
Gy de*inition' total o(tp(t e>(als total in&o+e# "eaa!esKnet ta)es 5T6 and savin! 5S6Kred(&e&ons(+ption spendin! below total in&o+e# In=e&tionsK !overn+ent p(r&$ases 56 pl(s plannedinvest+ent spendin! 5Ip6K&ontrib(te to total spendin!# ?$en leaa!es e>(al in=e&tions' totalspendin! e>(als total o(tp(t#
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T$e "oanable 3(nds %aret
• "oanable *(nds +aret
- Savers +aer t$eir *(nds available toborrowers
• Total s(pply o* loanable *(nds
- Is e>(al to $o(se$old savin! - 3(nds s(pplied are loaned o(t
• Ho(se$olds re&eive interest pay+ents on
t$ese *(nds
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T$ " bl 3 d %
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T$e "oanable 3(nds %aret
• S(pply o* *(nds &(rve
- "evel o* $o(se$old savin! at vario(sinterest rates
- Slopes (pward: >(antity o* *(nds s(pplied
to t$e *inan&ial +aret depends positivelyon t$e interest rate
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3i!(re 7
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3i!(reHo(se$old S(pply o* "oanable 3(nds
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7
Trillions
o* .ollars
per Lear
Interest
Rate
<M
M
1#<
Total S(pply o* 3(nds5Savin!6
A
1#<
G
As t$e interest rate rises' savin!or t$e >(antity o* loanable *(nds
s(pplied in&reases
T$ " bl 3 d % t
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T$e "oanable 3(nds %aret
• .e+and *or loanable *(nds
- Gy b(siness *ir+s and !overn+enta!en&ies
• G(sinesses de+and *or loanable *(nds
- Is e>(al to t$eir planned invest+entspendin!
- 3(nds obtained are borrowed
- 3ir+s pay interest on t$ese *(nds
0© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
T$ " bl 3 d % t
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T$e "oanable 3(nds %aret
• G(d!et de*i&it' - T
- E)&ess o* !overn+ent p(r&$ases over netta)es
• overn+ents de+and *or loanable *(nds
- Is e>(al to its b(d!et de*i&it - 3(nds are borrowed
- overn+ent pays interest on its loans
1© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
T$ " bl 3 d % t
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T$e "oanable 3(nds %aret
• G(d!et s(rpl(s' T ,
- E)&ess o* net ta)es over !overn+entp(r&$ases
• G(siness de+and *or *(nds &(rve
- "evel o* invest+ent spendin! *ir+s plan atvario(s interest rates
• ?$en t$e interest rate *alls
- Invest+ent spendin! rises
- G(siness borrowin! rises
2© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
3i!(re
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3i!(reG(siness .e+and *or "oanable 3(nds
© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
Trillions o*.ollars per
Lear
Interest
Rate
<M
M
1#<
Planned Invest+ent 5I p )
5G(siness .e+and *or 3(nds6
A
1#0
G
As t$e interest rate *alls' b(siness*ir+s de+and +ore loanable *(nds*or invest+ent pro=e&ts#
T$ " bl 3 d % t
7/21/2019 Principles of Economics- The Classical Long Run Model
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T$e "oanable 3(nds %aret
• overn+ent de+and *or *(nds &(rve
- A+o(nt o* !overn+ent borrowin! atvario(s interest rates
• Independent o* t$e interest rate
- overn+ent se&tors de*i&it - overn+ent de+and *or *(nds
;© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
T$ " bl 3 d % t
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T$e "oanable 3(nds %aret
• Total de+and *or *(nds &(rve
- Total a+o(nt o* borrowin!• At vario(s interest rates
• As interest rate de&reases
- Total >(antity o* *(nds de+anded rises - (antity o* *(nds de+anded by b(siness
*ir+s in&reases
- (antity de+anded by t$e !overn+entre+ains (n&$an!ed
<© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
3i!(re 4
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3i!(reT$e .e+and *or 3(nds
7© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
4
Trillions o* dollars per year
Interest Rate
5&6
Trillions o* dollars per year
Interest Rate
5a6
Trillions o* dollars per year
Interest Rate
5b6
G(siness .e+and*or 3(nds 5I p )
<M
M
1#<1#0
overn+ent.e+and *or3(nds 5G-T )
0#<
Total .e+and *or
3(nds NI p+(G-T)]
<M
M
2#2<1#<
S(++in! b(sinessde+and *or loanable *(nds
at ea&$ interest rate O
and t$e !overn+ents
de+and *or loanable
*(nds O
!ives (s t$e e&ono+ys totalde+and *or loanable *(nds at
ea&$ interest rate#
<M
M A
G
A
G
A
G
T$ " bl 3 d % t
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T$e "oanable 3(nds %aret
• E>(ilibri(+ in t$e loanable *(nds +aret
- "oanable *(nds +aret: ass(+ed to &lear - Interest rate will rise or *all
• Until t$e >(antities o* *(nds s(pplied and
de+anded are e>(al• Says law
- It $olds as lon! as t$e loanable *(nds
+aret &lears - Total spendin! e>(als total o(tp(t
• Tr(e even in a +ore realisti& e&ono+y
© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
3i!(re /
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3i!(re
S(ppliers and de+anders o**(nds intera&t to deter+inet$e interest rate in t$eloanable *(nds +aret# At an
interest rate o* <M' >(antitys(pplied and >(antityde+anded are bot$ e>(al toB1#< trillion#
"oanable 3(nds %aret E>(ilibri(+
4© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
/
Trillions o*.ollars per Lear
Interest
Rate
<M
Total .e+and *or
3(nds NI p+(G-T)]
1#<
Total S(pply
o* 3(nds 5Savin!6
E
3i!(re 10
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3i!(re
Ge&a(se t$e loanable*(nds +aret &lears'we now t$at totalleaa!es willa(to+ati&ally e>(altotal in=e&tions# T$eleaa!e o* net ta)es!oes to t$e
!overn+ent and isspent on !overn+entp(r&$ases# I* t$e!overn+ent isr(nnin! a b(d!etde*i&it' it will alsoborrow part o* t$eleaa!e o* $o(se$oldsavin! and spendt$at too#
How t$e "oanable 3(nds %aret Ens(res T$at TotalSpendin! F Total (tp(t
/© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
10
Any $o(se$old savin! le*t over will be borrowed by b(siness *ir+s and spent on &apital# T$(s' every dollar o*leaa!es t(rns into spendin! by eit$er !overn+ent or private b(siness *ir+s#
T$e "oanable 3(nds %aret
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T$e "oanable 3(nds %aret
• Says law wit$ e>(ations
;0© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
{
{ {
Quantity of Quantity of
funds funds
Leakages Injections
⇒
⇒
⇒
1 42 43P
supplied demandedP
Loanable unds ma!"e#s clea! $ % & '() - T*
Loanable unds ma!"e#s clea! $ 'T % & ')
Lea"ages %&n+ec#ions To#al spending %To#al ou#pu#
3is&al Poli&y in t$e Classi&al %odel
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3is&al Poli&y in t$e Classi&al %odel
• 3is&al poli&y
- C$an!e in !overn+ent p(r&$ases or netta)es desi!ned to &$an!e total o(tp(t
• .e+and,side e**e&ts
- %a&roe&ono+i& poli&y e**e&ts on totalo(tp(t t$at wor t$ro(!$ &$an!es in totalspendin!
• Classi&al +odel - 3is&al poli&y $as no de+and,side e**e&ts
;1© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
An In&rease in overn+ent P(r&$ases
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An In&rease in overn+ent P(r&$ases
• In&rease in :
- overn+ent borrows t$e additional *(nds - Interest rate in&reases
• .e&rease in planned invest+ent spendin!
• .e&rease in &ons(+ption spendin! 5in&reasein savin!s6
• overn+ents p(r&$ases
- Have &rowded o(t t$e spendin! o*$o(se$olds 5C6 and b(sinesses 5Ip6
;2© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
3i!(re 11
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3i!(re
Ge!innin! *ro+ e>(ilibri(+ at point A' an in&rease in t$e b(d!et de*i&it &a(sed by additional !overn+entp(r&$ases s$i*ts t$e de+and *or *(nds &(rve *ro+ Ip J 1 Q T to Ip J 2 Q T# At point H' t$e >(antity o*
*(nds de+anded e)&eeds t$e >(antity s(pplied' so t$e interest rate be!ins to rise# As it rises' $o(se$oldsare led to save +ore' and b(siness *ir+s invest less# In t$e new e>(ilibri(+ at point G' bot$ &ons(+ptionand invest+ent spendin! $ave been &o+pletely &rowded o(t by t$e in&reased !overn+ent spendin!#
Crowdin! (t *ro+ an In&rease in overn+ent P(r&$ases
;© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
11
Trillions o* .ollars per Lear
InterestRate
<M
I p+G1-T
1#<
Total S(pply
o* 3(nds 5Savin!6
A
I p+G2 -T
M
2#2<
H
2#0<
G
3
C IP
AH F
An In&rease in overn+ent P(r&$ases
7/21/2019 Principles of Economics- The Classical Long Run Model
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An In&rease in overn+ent P(r&$ases
• Crowdin! o(t
- A de&line in one se&tors spendin! - Ca(sed by an in&rease in so+e ot$er
se&tors spendin!
• Co+plete &rowdin! o(t - A dollar,*or,dollar de&line in one se&tors
spendin!
- Ca(sed by an in&rease in so+e ot$erse&tors spendin!
;;© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
An In&rease in overn+ent P(r&$ases
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An In&rease in overn+ent P(r&$ases
• Rise in !overn+ent p(r&$ases' &lassi&al
+odel - Co+pletely &rowds o(t private se&tor
spendin!
- Total spendin! re+ains (n&$an!ed - o de+and,side e**e&ts on total o(tp(t or
total e+ploy+ent
;<© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
A .e&rease in et Ta)es
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A .e&rease in et Ta)es
• overn+ent &(ts net ta)es 5T6
- To in&rease total spendin! - Ass(+e: $o(se$olds spend t$e entire ta)
&(t
- G(d!et de*i&it in&reases - In&rease in !overn+ent de+and *or *(nds
- Interest rate in&rease• .e&rease in planned invest+ent spendin!• .e&rease in &ons(+ption spendin! 5+ore
savin!6
;7© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
3i!(re 12
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3i!(re
Ge!innin! *ro+ e>(ilibri(+ at point A' an in&rease in t$e b(d!et de*i&it &a(sed by a ta) &(t s$i*ts t$e de+and*or *(nds &(rve *ro+ Ip J Q T1 to Ip J Q T2# I* t$e ta) &(t is entirely spent' &ons(+ption initially rises by t$e
distan&e AH# At t$e ori!inal interest rate o* < per&ent' t$e >(antity o* *(nds de+anded now e)&eeds t$e>(antity s(pplied# T$is &a(ses t$e interest rate to rise# As t$e interest rate rises' we +ove *ro+ A to G alon!t$e s(pply o* *(nds &(rve# Savin! rises 5and &ons(+ption *alls6 by t$e distan&e A3# T$e *inal rise in&ons(+ption is 3H# ?e also +ove alon! t$e de+and *or *(nds &(rve *ro+ H to G' so invest+ent *alls by t$edistan&e 3H# In t$e new e>(ilibri(+ at point G' &ons(+ption 5w$i&$ $as risen by 3H6 $as &o+pletely &rowdedo(t invest+ent 5w$i&$ $as dropped by 3H6#
Crowdin! (t *ro+ a Ta) C(t
;© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
12
Trillions o* .ollars per Lear
Interest
Rate
<M
I p+G-T 1
1#<
Total S(pply
o* 3(nds 5Savin!6
A
I p+G-T 2
M
2#2<
H
2#0<
G
3
CIP
AH F T
F Initial C
A .e&rease in et Ta)es
7/21/2019 Principles of Economics- The Classical Long Run Model
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A .e&rease in et Ta)es
• C(t in net ta)es' &lassi&al +odel
- Raises &ons(+ption• ?$i&$ &o+pletely &rowds o(t planned
invest+ent
- Total spendin! re+ains (n&$an!ed - o de+and,side e**e&ts on total o(tp(t or
e+ploy+ent
;4© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
T$e Classi&al %odel: A S(++ary
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T$e Classi&al %odel: A S(++ary
• overn+ent
- eednt worry abo(t e+ploy+ent• T$e e&ono+y will a&$ieve *(ll e+ploy+ent on
its own
- eednt worry abo(t total spendin!• T$e e&ono+y will !enerate =(st eno(!$
spendin! on its own to b(y t$e o(tp(t t$at a*(lly e+ployed labor *or&e prod(&es
• 3is&al poli&y• Has no de+and,side e**e&ts on o(tp(t or
e+ploy+ent
;/© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
Classi&al %odel: pen E&ono+y
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Classi&al %odel: pen E&ono+y
• "eaa!es F I% J S J T
- I+ports' savin!' ta)es• In=e&tions F J IP J
- E)ports' planned invest+ent' !overn+entp(r&$ases
• Total spendin! F C J IP J J5,I%6
• Galan&ed trade: E)ports F I+ports• Says law $olds: Total spendin! on t$e
&o(ntrys o(tp(t will be e>(al in val(e to itstotal o(tp(t
<0© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
Classi&al %odel: pen E&ono+y
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Classi&al %odel: pen E&ono+y
• Unbalan&ed trade: I+ports E)ports
- Trade de*i&it F I% - - 3orei!ners , s(pply loanable *(nds to t$at
&o(ntry F its trade de*i&it 5I% - 6• Total s(pply o* *(nds F S J 5I% - 6• Total de+and *or *(nds F IP J 5 - T6
- E>(ilibri(+: S J 5I% - 6 F IP J 5 - T6• S J T J I% F IP J J • "eaa!es F In=e&tions
- Says law $olds
<1© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
3i!(re A#1
7/21/2019 Principles of Economics- The Classical Long Run Model
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!( e
?$en Classi&a r(ns a trade
de*i&it 5its i+ports e)&eed itse)ports6' *orei!ners earn +oredollars 5Classi&as &(rren&y6sellin! !oods to Classi&a t$ant$ey spend on !oods *ro+Classi&a# T$e e)&ess dollarsare ret(rned to Classi&as
loanable *(nds +aret' w$eret$ey be&o+e part o* t$es(pply o* loanable *(nds#?$en t$e loanable *(nds+aret &lears' we $ave S J I%Q F Ip J Q T# T$is' in t(rn'
+eans t$at total leaa!es 5SJ T J I%6 e>(al total in=e&tions5Ip J J 6#
T$e "oanable 3(nds %aret wit$ a Trade .e*i&it
<2© 201 Cen!a!e "earnin!# All Ri!$ts Reserved# %ay not be &opied' s&anned' or d(pli&ated' in w$ole or in part' e)&ept *or (se asper+itted in a li&ense distrib(ted wit$ a &ertain prod(&t or servi&e or ot$erwise on a password,prote&ted website *or &lassroo+ (se#
A#1
Trillions o*.ollars per
Lear
Interest Rate
<M
Total .e+and *or
3(nds NI p
+(G-T)]
2#2<
Total S(pplyo* 3(nds NS J5I%,6V
E
Classi&al %odel: pen E&ono+y
7/21/2019 Principles of Economics- The Classical Long Run Model
http://slidepdf.com/reader/full/principles-of-economics-the-classical-long-run-model 53/53
Classi&al %odel: pen E&ono+y
• An in&rease in !overn+ent p(r&$ases in
one &o(ntry - %ay not &a(se &o+plete &rowdin! o(t in
t$at &o(ntry
- G(t worldwide' &rowdin! o(t will be&o+plete• T$e rise in !overn+ent p(r&$ases in one
&o(ntry• ?ill be +at&$ed by an e>(al drop in !lobal
&ons(+ption and invest+ent spendin!