Macroeconomics Aggregate Demand

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One of the main titles of the macroeconomics with examples.
  Aggregate Demand and Economic Fluctiations As we discuss the ins and outs of stabilization  policy, there are two stylized facts  that you need to keep in mind. ã Stylized Fact 1 :  During an economic contraction, unemployment rises, while in a recovery or expansion, unemployment falls. Arthur M. Okun estimated that a 1% drop in the unemployment rate was associated with an approximately 3% boost to real GDP. ã Stylized Fact 2 :  If an economic expansion is very strong, it tends to leads to an increase in the inflation rate. Great Depression : The biggest downturn in U.S. history. Production dropped dramatically from 1929 to 1930 and unemployment was over 25%. Aggregate Demand What households and firms intend to spend on consumption and investment. Aggregate Demand = Consumption + Intended Investment (AD = C + II) The Problem of Leakages ã When households save rather than spend part of their incomes, a leakage happens.When firms spend on investment goods, an injection happens. ã The following situations represent an economy in equilibrium1) If amount that households want to save is equal to the amount that firms want to invest   2) leakages = injections (S=II)   3) Y=AD ã If the leakages exceed the injections, 1) leakages > injections2) S > II3) Y > AD Here, Classicals and Keynesians present solutions for the situation of leakages > injections.  The Classical Solution to Leakages Banks help people to earn interest. Therefore people prefer the banks for their saving instead of under a mattress. In this market, households are the suppliers of loanable funds and firms are the demanders of loanable funds. If interest rate is high, gain is more. If interest rate is low, gain is less. As the interest rate increases, saving is appealing. What does the solution tell us? Firms decided to invest less. The demand for loanable funds curve shifts leftward and interest rate fall to 3%. And now, firms can have cheaper interest rate so part of drop in investment will be reserved. And also, households prefer to save less and prefer to consume more due to the interest rate falls. As a result, fall in investment was balanced by a decrease in saving. The Keynesian Model   In the model of Keynes, there are two consumption components.   C is autonomous consumption and mpc is the marginal propensity. ã C is the consumption value when the income is equal to zero.   at an any point on the table The Keynesian Model The horizontal axis measures income (Y) while the vertical axis measures consumption (C). The consumption function is the autonomous consumption (starts from 20). The slope of the consumption function line is equal to mpc.  And also there is a line 45 degree. This line tells us what happen if people consumed all their income instead of saving part of it. So this line expresses the consumption = income. And also the vertical distance between the 45 degree line  and consumption function expresses how much people save. The Factors that cause to change on the consumption function   - Wealth. If people feel wealthier, even if their incomes don't change; they can consume more.- If people feel less confident about the future, they may tend to consume less.- Government policies. A leader of a country can encourage people to spend or save. The Difference between the Classican Model and Keynesian Model   Classical model assumes that people made decisions about saving or spending according to interest rate. But Keynesian model never mention the interest rate at all because according to Keynesian Model, the effects of interest rate are uncertain on the saving. The Aggregate Demand on the Graph Consumption function starts from autonomuos consumption. We know that AD=C+II so aggregate demand function starts from 80. The distance difference between consumption line and aggregate demand line is equal to intended investment. Shifting up or down on the Graph   As autonomuous consumption or autonomuous investment changes, the AD shifts up or down. For example, when II increases to 140;  The Possibility of Unintended Investment   Investment = Intended Investment + Excees Inventory or Depletion Y = C + I AD = C + IIso  Y - AD = Excees Inventory Accumulation(-) or Depletion(+) On the graph, When income is equal to 800, AD is equal to 720 so income exceeds to aggregate demand. Therefore, 870-720=80 unintended inventories. The Multiplier If Intended investment decreases, output and aggregate demand decreases more. For example, 80 falling on the II is equal to 400 falling on the output. We can calculate how the falling on the intended investment affect the falling on the output and aggregate demand with multiplier . Y = multiplier x II in this equation, Y is the changing on the output and aggregate demand   II is the decreasing value on the intended investmentmultiplier is 1/(1-mpc) For example, mpc=0.8 and there is a 80 falling on the inteded investment. Y=5.(-80)=-400 -400 is the falling value on the output and aggregate demand.
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