ECON 1102: Week 7
Money, Private Banks and the RBA
Read Chapter 7

1

Recap Week 6: Equation for PAE
PAE  C d  I P  G  X

C  C  cT  c(1  t )Y

Substitute
PAE  C  cT  I P  G  X  c(1  t )Y

Collect the exogenous variables
PAE  [C  cT  I P  G  X ]  c(1  t )Y
PAE  [C  cT  I P  G  X ]  c(1  t )Y
2

Recap Week 6: Short Run Equilibrium
Equilibrium condition

Y  PAE
Y  [C  cT  I  G  X ]  c(1  t )Y
P

Solve for equilibrium GDP
Y [1  c(1  t )]  [C  cT  I P  G  X ]
Ye 

1
[C  cT  I P  G  X ]
[1  c(1  t )]
3

Recap Week 6: Keynesian model – recessionary gap .

PAE (planned aggregate expenditure)

PAE = Cd + IP + G + X

0

IP+ G + X
IP + G
IP
Y*
Y (= GDP)
Starting at potential output (Y*), a fall in exogenous C, I, G, NX will lead to a recessionary gap

4

Recap Week 6: If we assume that the planned

aggregate expenditure is given by the equation
PAE = 960 + 0.8Y a 10-unit drop in exogenous expenditure would result in a _____________ in short-run equilibrium output.

A. 50-unit decline
B. 40-unit decline
C. 950-unit decline
D. 4-unit decline
5

Recap Week 6: Keynesian model – recessionary gap
.

PAE (planned aggregate expenditure)

PAE = C + IP + G + NX

0

Ye

Y*

I P + G + NX
IP + G
IP
Y (= GDP)

Recessionary gap

6

Recap Week 6: Keynesian model – expansionary gap
.

PAE (planned aggregate expenditure)

PAE = C + IP + G + NX

I P + G + NX
IP + G
0

IP

Y*

Ye

Expansionary gap

Y (= GDP)
7

Recap Week 6: Multipliers
 The government expenditure multiplier is greater than the tax/transfers multiplier
 Withdrawals – higher income taxes and imports – reduce the impact of the multipliers

8

Recap Week 6: The short-run effect of equilibrium GDP of

an equal change in government expenditure and net