Aggregate Expenditure and Equilibrium

Output
case 8: The Paradox of Thrift, page 472

S0 = Initial saving
S1 = New saving
Y = Aggregate Output
I = Investment

A  Initial Equilibrium 
Y = 500
B  New Equilibrium 
Y = 300
 S0 = Initial saving
S1 = New saving
Y = Aggregate Output
I = Investment

C  Newest Equilibrium  Y
= 480 The Paradox of Thrift

• It becomes paradox because it is C

not justify the traditional New Investme

economy belief that “a penny
saved, a penny earned”
• In their attempt to save more,
house-holds have caused a
contraction in output
• The paradox will averted if the I
(investment) shift up
• A new equilibrium can be
achieved at a higher level of
saving and income
The Government and Fiscal Policy
case: Spending Flight at G-20, page 493
• Government can affect the macroeconomics 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.
Net Taxes (T), and Disposable Income (Yd)
• 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.

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:
• And aggregate
Yd  Y  T
expenditure (AE)
Yd  C  S equals:
Y  T  C S AE  C  I  G
Y  C S  T
 The Budget Deficit
• A government’s budget deficit is the
difference between what it spends (G) and
what it collects in taxes (T) in a given period:
Budget deficit  G  T
• If G exceeds T, the government must
borrow from the public to finance the deficit.
It does so by selling Treasury bonds and
bills. In this case, a part of household
saving (S) goes to the government.
Spending Fight at G-20
US:
- To press economic partners at the summit to be careful with plans to tighten their
fiscal policy during global economic recovery remain uncertain.

-Urge to continue some level of simulative spending as a way of sustaining

economic growth. If the rate of spending decline too quickly, demand could
decrease and “Hoover moment” could happen again.

European:
- More cautious about spending because of Greece Example

China:
- Worried to continue stimulus can create unsustainable asset bubble

Japan:
- Japan wants to double sales tax and cap next year’s national budget the same as
this year.