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GDP in an open economy with govt

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The document discusses GDP in an open economy with government. It covers how government spending, taxes, and the budget surplus/deficit affect aggregate demand. A budget surplus occurs when tax revenues exceed spending, while a deficit is when spending exceeds revenues. The net export function is negatively sloped, as imports increase with national income. Equilibrium GDP occurs when aggregate demand equals output. The size of the multiplier is affected by tax rates and import propensities. An increase in government spending shifts the aggregate demand curve up, increasing equilibrium GDP.

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GDP in an Open Economy with Government Chapter 17
Learning Outcomes  Government consumption contributes to aggregate spending in the same way as any other component of autonomous spending.  Taxes affect private consumption via their effect on disposable income.  Net exports are negatively related to domestic income.
Learning Outcomes  A necessary condition for GDP to be in equilibrium is that desired aggregate domestic spending is equal to national output.  The size of the multiplier is negatively related to the income tax rate and the marginal propensity to import.
GDP IN OPEN ECONOMY WITH GOVERNMENT Government Spending and Taxes • Government consumption is part of autonomous aggregate spending. • Taxes minus transfer payments are called net taxes and affect aggregate spending indirectly. • Taxes reduce disposable income, whereas transfers increase disposable income.
GDP IN OPEN ECONOMY WITH GOVERNMENT Government Spending and Taxes • Disposable income, in turn, determines desired private consumption, according to the consumption function. • The budget balance is defined as government revenues minus government spending. • When this difference is positive, the budget is in surplus; when it is negative, the budget is in deficit.
GDP IN OPEN ECONOMY WITH GOVERNMENT • When the budget is in surplus, there is positive public saving, because the government is spending less on the national product than the amount of income that it is withdrawing from the circular flow of income and spending. • When the government budget is in deficit, public saving is negative. • Government spending and tax rates are exogenous factors while tax revenue is an endogenous factor.
GDP IN OPEN ECONOMY WITH GOVERNMENT Net Exports • Since desired imports increase as national income increases, desired net exports decrease as national income [GDP] increases, other things being equal. • Hence the net export function is negatively sloped [net exports fall as GDP rises]. • Shifts in the net export function are due to foreign GDP and relative international prices. Changes in relative international prices might be due to national differences in inflation rates, exchange rate variation.
Equilibrium GDP  GDP is in equilibrium when desired aggregate expenditure, C + I + G [X - IM], equals national output.  The sum of investment and net exports is called national asset formation because investment is the increase in the domestic capital stock and net exports result in investment in foreign assets.  At the equilibrium level of GDP, desired national saving, S + T - G, is equal to national asset formation, I + X - IM. GDP IN OPEN ECONOMY WITH GOVERNMENT
Changes in Aggregate Spending  The size of the multiplier is negatively related to the income tax rate.  A shift in exogenous spending changes GDP by the value of the shift times the simple multiplier.  A shift in aggregate spending can be brought about by fiscal policy changes or by a change in official interest rate. GDP IN OPEN ECONOMY WITH GOVERNMENT
The budget surplus function (£million)
0 National Income [GDP][£m] 1000 2000 3000 4000 5000 6000 0 Budget Surplus Function
National Income [GDP][£m] 1000 2000 3000 4000 5000 6000 T - G 0 0 -170 Budget Surplus Function
The budget surplus function  The budget surplus is negative at low levels of GDP and becomes positive at high levels of GDP.  Tax revenue increases with GDP while government spending is assumed not to vary with GDP.  The slope of the budget surplus function is 0.1 when the income tax rate is assumed to be 10%.
The net export function (£million)
1000 2000 3000 X = 540 540 Imports and Exports [£m] Export and Import Functions IM = 0.25Y 0 Real National Income [GDP] [£m] [i]. Export and Import Functions
Export and Import Functions 1000 2000 3000 Net Exports [£m] Real National Income [GDP] [£m] [ii]. Net Export Function (X - IM) = 540 - 0.25Y 0 540 2160
The net export function  Net exports, defined as exports minus imports, are negatively related to GDP.  Exports are assumed to be constant at £540 million while imports are 0.25 of National income.  So the net export function is given by: 540-0.25Y
The aggregate spending function (£million)
AE 1060 1000 2000 3000 4000 5000 Real National Income [GDP] [£m] An Aggregate Spending Curve and Equilibrium GDP Desired Expenditure [£m] 0 450 AE = Y E0 2000
Aggregate expenditure  The aggregate expenditure function is the sum of desired consumption, investment, government spending, and net exports.  Equilibrium GDP occurs at E0 where the desired aggregate expenditure line intersects the 450 line.  Only when GDP is £2000 will desired spending equal national output.
AE0 Real National Income [GDP] [£m] 0 AE = Y 45o AE1 Y0 Y0 Desired Expenditure [£m] The Effect of Change in Government Spending
 A change in government spending changes GDP by shifting the AE line parallel to its initial position.  The initial level of AE is at AE0 and GDP is Y0 with desired expenditures at e0.  An increase in government spending raises AE to AE1.  GDP rises to Y1 at which level desired expenditures are e1.  The increase in GDP from Y0 to Y1 is equal to the increase in government spending times the multiplier. The Effect of Change in Government Spending

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GDP in an open economy with govt

  • 1. GDP in an Open Economy with Government Chapter 17
  • 2. Learning Outcomes  Government consumption contributes to aggregate spending in the same way as any other component of autonomous spending.  Taxes affect private consumption via their effect on disposable income.  Net exports are negatively related to domestic income.
  • 3. Learning Outcomes  A necessary condition for GDP to be in equilibrium is that desired aggregate domestic spending is equal to national output.  The size of the multiplier is negatively related to the income tax rate and the marginal propensity to import.
  • 4. GDP IN OPEN ECONOMY WITH GOVERNMENT Government Spending and Taxes • Government consumption is part of autonomous aggregate spending. • Taxes minus transfer payments are called net taxes and affect aggregate spending indirectly. • Taxes reduce disposable income, whereas transfers increase disposable income.
  • 5. GDP IN OPEN ECONOMY WITH GOVERNMENT Government Spending and Taxes • Disposable income, in turn, determines desired private consumption, according to the consumption function. • The budget balance is defined as government revenues minus government spending. • When this difference is positive, the budget is in surplus; when it is negative, the budget is in deficit.
  • 6. GDP IN OPEN ECONOMY WITH GOVERNMENT • When the budget is in surplus, there is positive public saving, because the government is spending less on the national product than the amount of income that it is withdrawing from the circular flow of income and spending. • When the government budget is in deficit, public saving is negative. • Government spending and tax rates are exogenous factors while tax revenue is an endogenous factor.
  • 7. GDP IN OPEN ECONOMY WITH GOVERNMENT Net Exports • Since desired imports increase as national income increases, desired net exports decrease as national income [GDP] increases, other things being equal. • Hence the net export function is negatively sloped [net exports fall as GDP rises]. • Shifts in the net export function are due to foreign GDP and relative international prices. Changes in relative international prices might be due to national differences in inflation rates, exchange rate variation.
  • 8. Equilibrium GDP  GDP is in equilibrium when desired aggregate expenditure, C + I + G [X - IM], equals national output.  The sum of investment and net exports is called national asset formation because investment is the increase in the domestic capital stock and net exports result in investment in foreign assets.  At the equilibrium level of GDP, desired national saving, S + T - G, is equal to national asset formation, I + X - IM. GDP IN OPEN ECONOMY WITH GOVERNMENT
  • 9. Changes in Aggregate Spending  The size of the multiplier is negatively related to the income tax rate.  A shift in exogenous spending changes GDP by the value of the shift times the simple multiplier.  A shift in aggregate spending can be brought about by fiscal policy changes or by a change in official interest rate. GDP IN OPEN ECONOMY WITH GOVERNMENT
  • 10. The budget surplus function (£million)
  • 11. 0 National Income [GDP][£m] 1000 2000 3000 4000 5000 6000 0 Budget Surplus Function
  • 12. National Income [GDP][£m] 1000 2000 3000 4000 5000 6000 T - G 0 0 -170 Budget Surplus Function
  • 13. The budget surplus function  The budget surplus is negative at low levels of GDP and becomes positive at high levels of GDP.  Tax revenue increases with GDP while government spending is assumed not to vary with GDP.  The slope of the budget surplus function is 0.1 when the income tax rate is assumed to be 10%.
  • 14. The net export function (£million)
  • 15. 1000 2000 3000 X = 540 540 Imports and Exports [£m] Export and Import Functions IM = 0.25Y 0 Real National Income [GDP] [£m] [i]. Export and Import Functions
  • 16. Export and Import Functions 1000 2000 3000 Net Exports [£m] Real National Income [GDP] [£m] [ii]. Net Export Function (X - IM) = 540 - 0.25Y 0 540 2160
  • 17. The net export function  Net exports, defined as exports minus imports, are negatively related to GDP.  Exports are assumed to be constant at £540 million while imports are 0.25 of National income.  So the net export function is given by: 540-0.25Y
  • 19. AE 1060 1000 2000 3000 4000 5000 Real National Income [GDP] [£m] An Aggregate Spending Curve and Equilibrium GDP Desired Expenditure [£m] 0 450 AE = Y E0 2000
  • 20. Aggregate expenditure  The aggregate expenditure function is the sum of desired consumption, investment, government spending, and net exports.  Equilibrium GDP occurs at E0 where the desired aggregate expenditure line intersects the 450 line.  Only when GDP is £2000 will desired spending equal national output.
  • 21. AE0 Real National Income [GDP] [£m] 0 AE = Y 45o AE1 Y0 Y0 Desired Expenditure [£m] The Effect of Change in Government Spending
  • 22.  A change in government spending changes GDP by shifting the AE line parallel to its initial position.  The initial level of AE is at AE0 and GDP is Y0 with desired expenditures at e0.  An increase in government spending raises AE to AE1.  GDP rises to Y1 at which level desired expenditures are e1.  The increase in GDP from Y0 to Y1 is equal to the increase in government spending times the multiplier. The Effect of Change in Government Spending