Page 133 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 7.2.4 Balanced Budget Multiplier

Given that government already has a balanced budget, i.e. G=T. Suppose government wants to
increase G by imposing the same amount of T. It means G T. G raises aggregate spending
(AE) by G. T reduces AE by the amount of ( T. MPC ) . Therefore, the net increase in
AE ( AE) is
AE G ( – T. MPC)

The AE changes on account of G and T.According to the government spending multiplier G
leads to 1/MPS times change in income. And, according to the tax multiplier T leads to
(–MPC/MPS) times change in income. Thus both G and T together lead to change in income
by
1 MPC
(– ) times.
MPS MPS
The balanced budget multiplier thus is:
1 MPC
(– )
MPS MPS

1 MPC
(– )
MPS MPS
1 – MPC
MPS
MPS
MPS ( 1 – MPC MPS)

= 1
7.2.5 Foreign Trade Multiplier

In an open economy we can write the national income identity as
Y+M = C+I+X ...(1)
Total = Three ways in supply which total output can be used
Y = domestic supply
M = imports
C = consumption
I = investment
Y = exports
In a closed economy, we know that savings have to equal investments in equilibrium. In an
open economy we have to take into account that there can be a net inflow or outflow of capital.
In an open economy, thus the equilibrium condition is
S = I+X–M ...(2)
Or S+M = I+X ...(3)
If there is a change in any of the four variables, the change in the left side of (3) must equal the
change in the right side as a condition for reaching a new equilibrium.
Thus, S + M = I + X ...(4)

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