Commodity Market (3)

Source : Principles of Economics Karl

Case , Ray Fair by Fernando Quijano
and Yvonn Quijano
 Goverment in the Economy
• Government can affect the
macroeconomy through two
policy channels: fiscal policy and
monetary policy.
– Fiscal policy is the manipulation of
government spending and taxation.
– Monetary policy refers to the
behavior of the Federal Reserve
regarding the nation’s money
supply.
 Fiscal Policy
• Tax rates are controlled by the government, but tax
revenue depends on changes in household income and
the size of corporate profits, which the government
cannot control.
• Net taxes are taxes paid by firms and households to
the government minus transfer payments made to
households by the government.
• Disposable, or after-tax, income (Yd) equals total
income minus taxes. Yd  Y  T
Adding Net Taxes (T) and Government Purchases (G)
to the Circular Flow of Income
• When government enters the picture, the aggregate
income identity gets cut into three pieces:
Yd  Y  T
Yd  C  S Y  T  C S Y  C S  T
• And aggregate expenditure (AE) equals:
AE  C  I  G
 Adding Taxes to the
Consumption Function
C  a  bY
C  a  bYd Yd  Y  T
C  a  b( Y  T )
• With taxes a part of the picture, the aggregate
consumption function is a function of disposable, or
after-tax, income.
 Equilibrium Output: Y = C + I + G
C  100 .75Yd C  100 .75( Y  T )
Finding Equilibrium for I = 100, G = 100, and T = 100
(All Figures in Billions of Dollars)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
PLANNED PLANNED UNPLANNED
OUTPUT NET DISPOSABLE CONSUMPTION SAVING INVESTMENT GOVERNMENT AGGREGATE INVENTORY ADJUSTMENT
(INCOME) TAXES INCOME SPENDING S SPENDING PURCHASES EXPENDITURE CHANGE TO
Y T Yd / Y  T (C = 100 + .75 Yd) (Yd – C) I G C+I+G Y  (C + I + G) DISEQUILIBRIUM

300 100 200 250  50 100 100 450  50 Output8

500 100 400 400 0 100 100 600  100 Output8
700 100 600 550 50 100 100 750  50 Output8
900 100 800 700 100 100 100 900 0 Equilibrium
1,100 100 1,000 850 150 100 100 1,050 + 50 Output9
1,300 100 1,200 1,000 200 100 100 1,200 + 100 Output9
1,500 100 1,400 1,150 250 100 100 1,350 + 150 Output9
 The Leakages/Injections Approach
• Taxes (T) are a leakage from the flow of income. Saving (S) is also
a leakage.
• In equilibrium, aggregate output (income) (Y) equals planned
aggregate expenditure (AE), and leakages (S + T) must equal
planned injections (I + G). Algebraically,
AE  C  I  G
Y  C S  T
C S  T  C I  G
S T  I  G
The Government Spending Multiplier
1
Government spending multiplier 
MPS
 The Tax Multiplier
 1 
 Y  (initial increase in aggregate expenditure)   
 MPS 

 1   MPC 
 Y  (   T  MPC )      T   
 MPS   MPS 

 MPC 
Tax multiplier    
 MPS 

• However, a tax cut has no direct impact on

spending. The tax multiplier for a change in
taxes is smaller than the multiplier for a
change in government spending.
 Adding the International Sector
• We can think of imports (IM) as a leakage from the circular flow and
exports (EX) as an injection into the circular flow.
• With imports and exports, the equilibrium condition for the economy is:

Open-economy equilibrium: Y  C  I  G  ( X  M )

• The quantity (EX – IM) is referred to as net exports.

Increases or decreases in net exports can throw the
economy out of equilibrium and cause national income to
change.
Terima Kasih