WEBVTT 00:00:00.000 --> 00:00:02.465 align:middle line:90% [SQUEAKING] 00:00:02.465 --> 00:00:03.944 align:middle line:90% [RUSTLING] 00:00:03.944 --> 00:00:05.423 align:middle line:90% [CLICKING] 00:00:05.423 --> 00:00:17.260 align:middle line:90% 00:00:17.260 --> 00:00:21.230 align:middle line:84% RICARDO J. CABALLERO: OK, let's start. 00:00:21.230 --> 00:00:22.930 align:middle line:84% So what you have there in that picture 00:00:22.930 --> 00:00:28.870 align:middle line:84% is the result of a survey to a bunch of economists on-- 00:00:28.870 --> 00:00:30.700 align:middle line:84% which are asked to assess the probability 00:00:30.700 --> 00:00:34.940 align:middle line:84% that there is a recession within the next 12 months. 00:00:34.940 --> 00:00:39.200 align:middle line:84% Recession means, essentially, a decline in aggregate output. 00:00:39.200 --> 00:00:41.900 align:middle line:84% And well, the first thing to notice here 00:00:41.900 --> 00:00:44.270 align:middle line:90% is that it's not very good news. 00:00:44.270 --> 00:00:46.730 align:middle line:84% There are very high chances that, at least 00:00:46.730 --> 00:00:50.750 align:middle line:84% according to these experts, that the US enters 00:00:50.750 --> 00:00:53.810 align:middle line:84% a recession within the next 12 months or so-- 00:00:53.810 --> 00:00:55.220 align:middle line:90% pretty high probability. 00:00:55.220 --> 00:00:57.990 align:middle line:84% You can see that that number typically is very, very low, 00:00:57.990 --> 00:01:01.460 align:middle line:84% and it goes very high sort of next to recessions. 00:01:01.460 --> 00:01:03.680 align:middle line:84% And now we're not in a recession, 00:01:03.680 --> 00:01:05.930 align:middle line:84% but there is a sort of very high perceived 00:01:05.930 --> 00:01:10.380 align:middle line:84% probability that we may go into a recession in the near future. 00:01:10.380 --> 00:01:14.000 align:middle line:84% So how is it that these people come up with this forecast? 00:01:14.000 --> 00:01:18.530 align:middle line:84% Well, at some level, either explicitly or implicitly, 00:01:18.530 --> 00:01:23.390 align:middle line:84% they must have some model of the termination of equilibrium 00:01:23.390 --> 00:01:24.530 align:middle line:90% output. 00:01:24.530 --> 00:01:26.210 align:middle line:90% And they need to understand-- 00:01:26.210 --> 00:01:28.130 align:middle line:84% they need to see certain things that 00:01:28.130 --> 00:01:34.470 align:middle line:84% suggest, once you go through a model, that output will decline. 00:01:34.470 --> 00:01:37.140 align:middle line:84% So that's what we're going to start doing today. 00:01:37.140 --> 00:01:40.080 align:middle line:84% And in fact, that's what we're going 00:01:40.080 --> 00:01:42.550 align:middle line:90% to do throughout this course. 00:01:42.550 --> 00:01:46.260 align:middle line:84% We're going to try to find evermore complex, perhaps, 00:01:46.260 --> 00:01:52.050 align:middle line:84% or richer models of output determination, aggregate output 00:01:52.050 --> 00:01:52.840 align:middle line:90% determination. 00:01:52.840 --> 00:01:56.050 align:middle line:84% So that's essentially what this course is about. 00:01:56.050 --> 00:01:57.648 align:middle line:90% And so an understanding. 00:01:57.648 --> 00:01:59.190 align:middle line:84% We're going to try to understand what 00:01:59.190 --> 00:02:01.200 align:middle line:84% is it that drives equilibrium output, 00:02:01.200 --> 00:02:05.100 align:middle line:84% and how is it that we get to one specific level of output. 00:02:05.100 --> 00:02:08.470 align:middle line:84% That's what it means to find the equilibrium level of output. 00:02:08.470 --> 00:02:11.890 align:middle line:84% And we're going to do it sort of in three stages. 00:02:11.890 --> 00:02:15.900 align:middle line:84% In the first part of the course-- that is, up to quiz 1-- 00:02:15.900 --> 00:02:19.410 align:middle line:84% we're going to focus on the very short run, how output 00:02:19.410 --> 00:02:25.320 align:middle line:84% is determined in the very short run, say within a year or so-- 00:02:25.320 --> 00:02:29.220 align:middle line:84% or a little more even, but that type of frame, time frame. 00:02:29.220 --> 00:02:31.800 align:middle line:84% Then we're going to focus on the medium run. 00:02:31.800 --> 00:02:36.990 align:middle line:84% That's sort of at the beginning of the second part 00:02:36.990 --> 00:02:38.640 align:middle line:90% of the course. 00:02:38.640 --> 00:02:40.530 align:middle line:84% And by the medium run, simply we're 00:02:40.530 --> 00:02:42.750 align:middle line:84% going to mean by the time in which prices begin 00:02:42.750 --> 00:02:44.340 align:middle line:90% to adjust sufficiently, OK? 00:02:44.340 --> 00:02:48.960 align:middle line:84% Before that, it's most of the action happens in quantities. 00:02:48.960 --> 00:02:51.740 align:middle line:84% There is little movement in goods prices. 00:02:51.740 --> 00:02:53.490 align:middle line:84% There's lots of movements in asset prices, 00:02:53.490 --> 00:02:55.590 align:middle line:84% but little movement in goods prices. 00:02:55.590 --> 00:02:57.400 align:middle line:84% And in the last part of the course, 00:02:57.400 --> 00:02:59.700 align:middle line:84% we're going to look at how output is determined 00:02:59.700 --> 00:03:02.310 align:middle line:84% over the long run, which is quite different from how output 00:03:02.310 --> 00:03:04.680 align:middle line:90% is determined in the short run. 00:03:04.680 --> 00:03:06.840 align:middle line:84% The determination of output in the short run 00:03:06.840 --> 00:03:10.860 align:middle line:84% is what we mostly mean by business cycle analysis. 00:03:10.860 --> 00:03:13.560 align:middle line:84% And short or medium run, the way we're going to find it here, 00:03:13.560 --> 00:03:15.780 align:middle line:84% is what we mean by business cycle-- the country's 00:03:15.780 --> 00:03:18.240 align:middle line:84% in a recession, it's in a boom, is an expansion. 00:03:18.240 --> 00:03:20.550 align:middle line:84% Those are all terminologies of the short run 00:03:20.550 --> 00:03:22.950 align:middle line:90% or short or medium run. 00:03:22.950 --> 00:03:25.200 align:middle line:84% The termination of equilibrium output in the long run 00:03:25.200 --> 00:03:27.330 align:middle line:90% is when we think about growth. 00:03:27.330 --> 00:03:31.530 align:middle line:84% When we talk about why China grows faster than the US today, 00:03:31.530 --> 00:03:34.410 align:middle line:84% well, that's a question not about the business cycle. 00:03:34.410 --> 00:03:37.430 align:middle line:84% It's a question about the long-run determinants 00:03:37.430 --> 00:03:39.780 align:middle line:90% of output growth, OK? 00:03:39.780 --> 00:03:42.560 align:middle line:84% And they are even different class of models. 00:03:42.560 --> 00:03:45.350 align:middle line:84% In more advanced models, if you were doing a PhD, 00:03:45.350 --> 00:03:48.440 align:middle line:84% those things are a lot closer to each other. 00:03:48.440 --> 00:03:49.250 align:middle line:90% But in this course. 00:03:49.250 --> 00:03:51.420 align:middle line:84% They're going to be very different type of models. 00:03:51.420 --> 00:03:53.600 align:middle line:84% It's easier to analyze these things 00:03:53.600 --> 00:03:56.180 align:middle line:84% with different type of models than trying to integrate 00:03:56.180 --> 00:03:59.060 align:middle line:90% all in one big machine, OK? 00:03:59.060 --> 00:04:01.220 align:middle line:84% But let's start with the simple part. 00:04:01.220 --> 00:04:03.770 align:middle line:84% In the short run, the key mechanism, 00:04:03.770 --> 00:04:08.450 align:middle line:84% something that will keep showing up in all the models 00:04:08.450 --> 00:04:12.740 align:middle line:84% and submodels we analyze in the first eight lectures 00:04:12.740 --> 00:04:15.320 align:middle line:84% or so or seven lectures-- the next seven 00:04:15.320 --> 00:04:17.660 align:middle line:84% lectures or so is this mechanism. 00:04:17.660 --> 00:04:20.209 align:middle line:90% In the very short run, output-- 00:04:20.209 --> 00:04:23.270 align:middle line:84% that is, equilibrium output, the thing that these economists are 00:04:23.270 --> 00:04:27.560 align:middle line:84% forecasting that will decline in within the next 12 months-- 00:04:27.560 --> 00:04:33.140 align:middle line:84% is determined primarily by what we call demand. 00:04:33.140 --> 00:04:35.180 align:middle line:90% So demand will determine output. 00:04:35.180 --> 00:04:36.960 align:middle line:84% Thus, if there's a change in demand, 00:04:36.960 --> 00:04:39.130 align:middle line:90% that will change production. 00:04:39.130 --> 00:04:42.375 align:middle line:84% But when production changes, that will also change income. 00:04:42.375 --> 00:04:43.980 align:middle line:84% That you know from national accounts. 00:04:43.980 --> 00:04:46.110 align:middle line:84% Remember, we said that we could measure output 00:04:46.110 --> 00:04:50.430 align:middle line:84% from the production side but we also measured the income side. 00:04:50.430 --> 00:04:51.810 align:middle line:90% And they're exactly the same. 00:04:51.810 --> 00:04:54.900 align:middle line:84% More production, somebody has to receive the proceeds of that-- 00:04:54.900 --> 00:04:58.590 align:middle line:84% workers and owners, capital owners, the government, 00:04:58.590 --> 00:04:59.700 align:middle line:90% whatever. 00:04:59.700 --> 00:05:04.170 align:middle line:84% So changes in-- so the second step is changes in production 00:05:04.170 --> 00:05:06.570 align:middle line:84% that were brought about by the changes in demand 00:05:06.570 --> 00:05:08.620 align:middle line:90% will lead to a change in income. 00:05:08.620 --> 00:05:12.300 align:middle line:84% But when income changes, that will change demand again and so 00:05:12.300 --> 00:05:13.680 align:middle line:90% on and so forth, OK? 00:05:13.680 --> 00:05:18.300 align:middle line:84% So that's essentially-- that's quintessential short-run macro, 00:05:18.300 --> 00:05:20.910 align:middle line:84% to try to understand this aggregate demand, 00:05:20.910 --> 00:05:23.010 align:middle line:84% because that's the main driver, and then 00:05:23.010 --> 00:05:27.390 align:middle line:84% how it gets multiplied in the short run, OK? 00:05:27.390 --> 00:05:30.750 align:middle line:84% In this lecture, we're going to talk just about that, primarily 00:05:30.750 --> 00:05:31.920 align:middle line:90% about that. 00:05:31.920 --> 00:05:35.015 align:middle line:84% But that's one-- so when I mean short-run macro, that's 00:05:35.015 --> 00:05:36.140 align:middle line:90% a structure I have in mind. 00:05:36.140 --> 00:05:38.012 align:middle line:84% And that's what most people have in mind, 00:05:38.012 --> 00:05:40.220 align:middle line:84% something where aggregate demand will determine that. 00:05:40.220 --> 00:05:41.660 align:middle line:84% That's the reason why, in the short run, 00:05:41.660 --> 00:05:43.827 align:middle line:84% you worry a lot about whether consumer confidence is 00:05:43.827 --> 00:05:44.960 align:middle line:90% high or low. 00:05:44.960 --> 00:05:45.800 align:middle line:90% That's demand. 00:05:45.800 --> 00:05:48.740 align:middle line:84% If consumers are very depressed, they tend to reduce demand. 00:05:48.740 --> 00:05:50.630 align:middle line:84% If consumers are very bullish, that 00:05:50.630 --> 00:05:53.400 align:middle line:90% will tend to increase demand. 00:05:53.400 --> 00:05:54.860 align:middle line:84% And since, in the short run, output 00:05:54.860 --> 00:05:57.290 align:middle line:84% is determined by demand, the business cycle, 00:05:57.290 --> 00:05:59.270 align:middle line:84% whether we have a recession or not, 00:05:59.270 --> 00:06:01.380 align:middle line:84% depends a lot on how demand feels. 00:06:01.380 --> 00:06:03.980 align:middle line:84% So if somebody's forecasting a recession within the next 12 00:06:03.980 --> 00:06:08.630 align:middle line:84% months, is forecasting really that demand will decline 00:06:08.630 --> 00:06:12.570 align:middle line:90% within the next 12 months, OK? 00:06:12.570 --> 00:06:14.610 align:middle line:84% Why they're forecasting that-- that's something 00:06:14.610 --> 00:06:17.790 align:middle line:84% we're going to learn in steps as we go through the course. 00:06:17.790 --> 00:06:20.220 align:middle line:84% What are the kind of things they may be thinking about? 00:06:20.220 --> 00:06:22.350 align:middle line:84% What are the drags on aggregate demand 00:06:22.350 --> 00:06:26.670 align:middle line:84% that are likely to depress demand and so on and so forth? 00:06:26.670 --> 00:06:30.200 align:middle line:90% But we'll get there, OK? 00:06:30.200 --> 00:06:32.450 align:middle line:84% Anyways, first, let me tell you about the components 00:06:32.450 --> 00:06:35.040 align:middle line:90% of aggregate demand. 00:06:35.040 --> 00:06:36.970 align:middle line:90% The first and one of-- 00:06:36.970 --> 00:06:40.730 align:middle line:84% the largest component of aggregate demand is consumption. 00:06:40.730 --> 00:06:42.410 align:middle line:84% And what I mean aggregate demand-- 00:06:42.410 --> 00:06:45.740 align:middle line:90% OK, I'll be-- 00:06:45.740 --> 00:06:47.000 align:middle line:90% I'll pause for a slide. 00:06:47.000 --> 00:06:48.860 align:middle line:90% Let me go over the definition. 00:06:48.860 --> 00:06:51.380 align:middle line:84% Consumption-- we're going to denote by C-- 00:06:51.380 --> 00:06:55.410 align:middle line:84% is the goods and service purchased by consumers, 00:06:55.410 --> 00:06:57.300 align:middle line:90% households, and so on. 00:06:57.300 --> 00:07:00.480 align:middle line:84% Investment, which we're going to denote by I, 00:07:00.480 --> 00:07:04.050 align:middle line:84% is the sum of nonresidential and residential investments-- 00:07:04.050 --> 00:07:10.170 align:middle line:84% so equipment and factories on one side, 00:07:10.170 --> 00:07:13.770 align:middle line:84% and then residential investment is houses, stuff like that, 00:07:13.770 --> 00:07:16.800 align:middle line:84% apartment buildings and so on, which is also-- 00:07:16.800 --> 00:07:20.110 align:middle line:84% these are goods and services, as well, capital goods and so on. 00:07:20.110 --> 00:07:22.698 align:middle line:84% But they're are also goods and services. 00:07:22.698 --> 00:07:24.990 align:middle line:84% Government spending-- that's what we're going to denote 00:07:24.990 --> 00:07:28.720 align:middle line:84% by G-- are purchases of goods and services by the federal, 00:07:28.720 --> 00:07:32.070 align:middle line:84% state, and local government, excluding-- 00:07:32.070 --> 00:07:35.200 align:middle line:84% that's important-- government transfers. 00:07:35.200 --> 00:07:36.490 align:middle line:90% What is a government transfer? 00:07:36.490 --> 00:07:38.650 align:middle line:84% Many of you may have received that during COVID. 00:07:38.650 --> 00:07:41.890 align:middle line:84% The government sent you a check, for example, OK? 00:07:41.890 --> 00:07:45.070 align:middle line:84% Well, that check is not part of government expenditure. 00:07:45.070 --> 00:07:48.010 align:middle line:84% That check is like a-- is a negative tax 00:07:48.010 --> 00:07:49.900 align:middle line:84% and is going to enter somewhere else. 00:07:49.900 --> 00:07:52.390 align:middle line:84% When we mean government expenditure 00:07:52.390 --> 00:07:56.080 align:middle line:84% is things the government purchases, services 00:07:56.080 --> 00:08:00.790 align:middle line:84% the government acquires and so on, OK? 00:08:00.790 --> 00:08:06.370 align:middle line:84% And then exports, X, which will play no role until seven 00:08:06.370 --> 00:08:07.810 align:middle line:84% lectures, eight lectures from now, 00:08:07.810 --> 00:08:10.660 align:middle line:84% or actually 10 lectures from now probably, 00:08:10.660 --> 00:08:14.080 align:middle line:84% is purchases of US goods and services-- that is, 00:08:14.080 --> 00:08:16.490 align:middle line:90% goods produced by US factories-- 00:08:16.490 --> 00:08:19.240 align:middle line:90% 00:08:19.240 --> 00:08:20.530 align:middle line:90% by foreigners. 00:08:20.530 --> 00:08:24.140 align:middle line:90% 00:08:24.140 --> 00:08:27.110 align:middle line:84% IM is the other side of the story, inputs. 00:08:27.110 --> 00:08:31.010 align:middle line:84% It's the purchase of foreign goods and services 00:08:31.010 --> 00:08:34.289 align:middle line:84% by US consumers, US firms, US government. 00:08:34.289 --> 00:08:36.950 align:middle line:84% So when you buy something that is produced in Germany, 00:08:36.950 --> 00:08:38.179 align:middle line:90% well, that's an import. 00:08:38.179 --> 00:08:39.650 align:middle line:84% When the Germans buy something that 00:08:39.650 --> 00:08:42.740 align:middle line:84% is produced in the US, that's an export, OK? 00:08:42.740 --> 00:08:44.420 align:middle line:84% And then the last component is something 00:08:44.420 --> 00:08:46.730 align:middle line:84% we're not going to pay any attention whatsoever 00:08:46.730 --> 00:08:49.280 align:middle line:84% in this course, which is inventory investment. 00:08:49.280 --> 00:08:51.260 align:middle line:84% Inventory investment is certainly-- 00:08:51.260 --> 00:08:52.700 align:middle line:90% it's almost accidental. 00:08:52.700 --> 00:08:55.550 align:middle line:84% There is some planning on it, but there is a lot of-- it's 00:08:55.550 --> 00:08:57.980 align:middle line:84% just when there's difference between sales and production. 00:08:57.980 --> 00:09:00.650 align:middle line:84% And over the very short run, there's lots of differences. 00:09:00.650 --> 00:09:04.100 align:middle line:84% I mean, you're not producing-- unless you're in a bakery, 00:09:04.100 --> 00:09:06.560 align:middle line:84% you're not producing and selling immediately. 00:09:06.560 --> 00:09:08.420 align:middle line:90% There are certain lags. 00:09:08.420 --> 00:09:09.780 align:middle line:90% That's a small thing. 00:09:09.780 --> 00:09:11.700 align:middle line:84% It's volatile, but it's a small thing. 00:09:11.700 --> 00:09:15.120 align:middle line:84% So we're going to ignore it for this course. 00:09:15.120 --> 00:09:17.455 align:middle line:84% We're going to assume, actually, unless we explicitly 00:09:17.455 --> 00:09:19.580 align:middle line:84% say the contrary, and that could show up in a pset. 00:09:19.580 --> 00:09:23.168 align:middle line:84% It would never show in a quiz, because it's not that important. 00:09:23.168 --> 00:09:25.460 align:middle line:84% We're going to assume that this inventory investment is 00:09:25.460 --> 00:09:26.570 align:middle line:90% equal to 0. 00:09:26.570 --> 00:09:30.180 align:middle line:84% Also, for this part of the course, until further notice, 00:09:30.180 --> 00:09:32.670 align:middle line:84% we're going to assume that exports and imports are 00:09:32.670 --> 00:09:34.350 align:middle line:90% equal to 0 as well. 00:09:34.350 --> 00:09:36.510 align:middle line:84% That's not realistic, but it's easier 00:09:36.510 --> 00:09:41.163 align:middle line:84% to analyze what we call a closed economy, an economy that 00:09:41.163 --> 00:09:43.080 align:middle line:84% is not interacting with the rest of the world. 00:09:43.080 --> 00:09:45.275 align:middle line:84% In, again, 10 lectures from now, we're 00:09:45.275 --> 00:09:47.400 align:middle line:84% going to open the economy to the rest of the world, 00:09:47.400 --> 00:09:48.900 align:middle line:84% and then we're going to have to talk 00:09:48.900 --> 00:09:51.917 align:middle line:84% about things like import/exports, exchange rates, 00:09:51.917 --> 00:09:52.750 align:middle line:90% things of that kind. 00:09:52.750 --> 00:09:55.770 align:middle line:84% But for now, let's keep it simple, OK? 00:09:55.770 --> 00:09:58.920 align:middle line:84% So now, so you get a sense, this is for 2018. 00:09:58.920 --> 00:10:02.310 align:middle line:84% But I mean, the totals change, but the composition doesn't 00:10:02.310 --> 00:10:04.320 align:middle line:90% change very much, of GDP-- 00:10:04.320 --> 00:10:09.130 align:middle line:90% 00:10:09.130 --> 00:10:14.020 align:middle line:90% of GDP output, aggregate demand. 00:10:14.020 --> 00:10:16.780 align:middle line:84% They're are all the same in equilibrium, 00:10:16.780 --> 00:10:18.730 align:middle line:90% but we'll get there. 00:10:18.730 --> 00:10:23.170 align:middle line:84% In GDP, you see that consumption accounts for a big chunk, close 00:10:23.170 --> 00:10:25.580 align:middle line:90% to 70% of aggregate demand. 00:10:25.580 --> 00:10:29.170 align:middle line:84% That's the reason people worry so much about consumer sentiment 00:10:29.170 --> 00:10:29.980 align:middle line:90% and so on. 00:10:29.980 --> 00:10:33.473 align:middle line:84% University of Michigan has many claims to fame. 00:10:33.473 --> 00:10:35.890 align:middle line:84% But one of them is that they produce its index of consumer 00:10:35.890 --> 00:10:36.460 align:middle line:90% sentiment. 00:10:36.460 --> 00:10:38.050 align:middle line:84% And everyone is watching that thing. 00:10:38.050 --> 00:10:40.150 align:middle line:84% Anybody that worries about macro or finance 00:10:40.150 --> 00:10:42.370 align:middle line:84% is watching that thing because it tells you 00:10:42.370 --> 00:10:47.140 align:middle line:84% a lot about one of the main drivers of output, equilibrium 00:10:47.140 --> 00:10:48.020 align:middle line:90% output. 00:10:48.020 --> 00:10:50.740 align:middle line:84% Then you see investment is substantially smaller, 00:10:50.740 --> 00:10:55.010 align:middle line:84% but it's large, in particular, nonresidential investment. 00:10:55.010 --> 00:10:59.590 align:middle line:84% Government expenditure is a big component of aggregate demand. 00:10:59.590 --> 00:11:01.990 align:middle line:84% And then I'm not going to worry too much about-- 00:11:01.990 --> 00:11:05.380 align:middle line:84% for a country like the US, the openness part 00:11:05.380 --> 00:11:07.490 align:middle line:90% is relatively small. 00:11:07.490 --> 00:11:09.430 align:middle line:90% If you go to a-- 00:11:09.430 --> 00:11:12.140 align:middle line:90% 00:11:12.140 --> 00:11:16.210 align:middle line:84% a small economy typically will have sort of very large exports 00:11:16.210 --> 00:11:17.660 align:middle line:90% relative to GDP and so on. 00:11:17.660 --> 00:11:22.080 align:middle line:84% But that's not the case of the US. 00:11:22.080 --> 00:11:23.810 align:middle line:84% And there you see why we're going to set 00:11:23.810 --> 00:11:25.260 align:middle line:90% inventory investment to 0. 00:11:25.260 --> 00:11:26.220 align:middle line:90% It's a small thing. 00:11:26.220 --> 00:11:28.750 align:middle line:84% It moves a lot more than its size, 00:11:28.750 --> 00:11:32.595 align:middle line:84% so it can account for fluctuations in sort 00:11:32.595 --> 00:11:34.710 align:middle line:90% of the monthly level of GDP. 00:11:34.710 --> 00:11:39.820 align:middle line:84% But it's not that important in a slightly longer period of time, 00:11:39.820 --> 00:11:40.320 align:middle line:90% OK? 00:11:40.320 --> 00:11:41.695 align:middle line:84% So that's more or less the story. 00:11:41.695 --> 00:11:44.250 align:middle line:90% So now this is the model. 00:11:44.250 --> 00:11:46.330 align:middle line:90% Please stop me. 00:11:46.330 --> 00:11:48.600 align:middle line:84% Is there anything here you don't understand, 00:11:48.600 --> 00:11:52.980 align:middle line:84% because everything that we build from here to quiz 1 00:11:52.980 --> 00:11:56.760 align:middle line:84% will build on understanding this, what I'm about to say. 00:11:56.760 --> 00:11:59.730 align:middle line:84% Very simple, but if you miss a step here, 00:11:59.730 --> 00:12:01.200 align:middle line:84% everything is going to be confusing 00:12:01.200 --> 00:12:02.670 align:middle line:90% in the next few lectures. 00:12:02.670 --> 00:12:05.130 align:middle line:84% And you're not supposed to understand it in the first run, 00:12:05.130 --> 00:12:06.655 align:middle line:90% so it's OK that you ask me. 00:12:06.655 --> 00:12:08.280 align:middle line:84% But let's make sure that you understand 00:12:08.280 --> 00:12:10.590 align:middle line:90% what is going on here. 00:12:10.590 --> 00:12:12.270 align:middle line:90% OK, so that's aggregate demand. 00:12:12.270 --> 00:12:15.150 align:middle line:84% First, definition-- so we're going to denote aggregate demand 00:12:15.150 --> 00:12:20.460 align:middle line:84% by this Z, letter Z. And aggregate demand is going 00:12:20.460 --> 00:12:21.270 align:middle line:90% to be-- 00:12:21.270 --> 00:12:23.340 align:middle line:84% when we say aggregate demand, remember 00:12:23.340 --> 00:12:26.370 align:middle line:84% what is the exercise we're trying to do. 00:12:26.370 --> 00:12:28.200 align:middle line:84% Ultimately, what we want to determine 00:12:28.200 --> 00:12:32.700 align:middle line:84% is the output, the production of the US economy, say. 00:12:32.700 --> 00:12:35.190 align:middle line:84% So when we meet-- when we talk about aggregate demand, 00:12:35.190 --> 00:12:36.990 align:middle line:84% we're trying to determine the demand 00:12:36.990 --> 00:12:40.950 align:middle line:84% for domestically produced goods, for goods produced in the US. 00:12:40.950 --> 00:12:43.120 align:middle line:84% That's what we're trying to pin down. 00:12:43.120 --> 00:12:46.680 align:middle line:84% And so that's the reason aggregate demand looks 00:12:46.680 --> 00:12:48.610 align:middle line:90% like that, is, well, consumers. 00:12:48.610 --> 00:12:50.530 align:middle line:84% Consumers are going to demand goods. 00:12:50.530 --> 00:12:54.250 align:middle line:90% Investment, G, plus exports. 00:12:54.250 --> 00:12:55.990 align:middle line:84% If foreign demands US goods, that also 00:12:55.990 --> 00:12:59.140 align:middle line:84% increases US production-- minus imports 00:12:59.140 --> 00:13:04.990 align:middle line:84% because imports is goods and services that consumers, firms, 00:13:04.990 --> 00:13:07.300 align:middle line:84% and governments sort of buy from foreigners, 00:13:07.300 --> 00:13:09.460 align:middle line:84% but they're not produced by US companies. 00:13:09.460 --> 00:13:11.800 align:middle line:84% So they do not affect the determination of equilibrium 00:13:11.800 --> 00:13:14.193 align:middle line:90% output in the US, OK? 00:13:14.193 --> 00:13:15.610 align:middle line:84% That's the reason you subtract it. 00:13:15.610 --> 00:13:17.890 align:middle line:84% Now, that distinction is not going 00:13:17.890 --> 00:13:21.340 align:middle line:84% to matter until 10 lectures from now, because we're 00:13:21.340 --> 00:13:24.640 align:middle line:84% going to set X and IM equal to 0 from the point of view 00:13:24.640 --> 00:13:25.490 align:middle line:90% of modeling. 00:13:25.490 --> 00:13:28.780 align:middle line:84% So all demand is demand for domestically produced goods 00:13:28.780 --> 00:13:30.550 align:middle line:90% in this part of the course, OK? 00:13:30.550 --> 00:13:35.530 align:middle line:84% So aggregate demand for US will be this C plus I plus G. 00:13:35.530 --> 00:13:39.220 align:middle line:84% So we need to understand what determines C plus I plus G. 00:13:39.220 --> 00:13:41.200 align:middle line:84% And at least initially, we're going 00:13:41.200 --> 00:13:42.757 align:middle line:90% to keep it very, very simple. 00:13:42.757 --> 00:13:44.590 align:middle line:84% We're not going to think too much about what 00:13:44.590 --> 00:13:46.247 align:middle line:90% determines investment. 00:13:46.247 --> 00:13:48.830 align:middle line:84% In fact, we're going to assume that it's a constant, is given. 00:13:48.830 --> 00:13:50.247 align:middle line:84% So it's determined somewhere else, 00:13:50.247 --> 00:13:52.930 align:middle line:84% not in the model I'm about to solve. 00:13:52.930 --> 00:13:56.062 align:middle line:84% Government expenditure, the same-- 00:13:56.062 --> 00:13:57.520 align:middle line:84% I'm going to assume it's determined 00:13:57.520 --> 00:14:01.090 align:middle line:84% by some other priorities, green agendas and stuff like that. 00:14:01.090 --> 00:14:05.300 align:middle line:84% It has very little to do with what we're doing here. 00:14:05.300 --> 00:14:07.990 align:middle line:84% And then taxes is something that doesn't show up there, 00:14:07.990 --> 00:14:09.402 align:middle line:84% but it will show up very shortly. 00:14:09.402 --> 00:14:11.110 align:middle line:84% We're also going to assume that they have 00:14:11.110 --> 00:14:12.520 align:middle line:90% been determined somewhere else. 00:14:12.520 --> 00:14:14.840 align:middle line:84% In psets and later on in the course, 00:14:14.840 --> 00:14:17.320 align:middle line:84% we're going to endogenize all that, but not now. 00:14:17.320 --> 00:14:19.390 align:middle line:84% Let's assume-- I'm trying to come up 00:14:19.390 --> 00:14:22.850 align:middle line:84% with the simplest possible model of aggregate demand. 00:14:22.850 --> 00:14:26.650 align:middle line:84% And I'm making two of these terms trivial, just constants, 00:14:26.650 --> 00:14:27.190 align:middle line:90% OK? 00:14:27.190 --> 00:14:31.150 align:middle line:84% And I'm going to focus all my effort here in this component 00:14:31.150 --> 00:14:33.220 align:middle line:84% here, which I already told you is 00:14:33.220 --> 00:14:35.680 align:middle line:84% the most important component of aggregate demand, which 00:14:35.680 --> 00:14:37.600 align:middle line:90% is consumption, OK? 00:14:37.600 --> 00:14:39.100 align:middle line:90% So we're going to assume-- 00:14:39.100 --> 00:14:40.600 align:middle line:84% here we're going to have a function. 00:14:40.600 --> 00:14:43.030 align:middle line:84% Something has to move for the model to be interesting. 00:14:43.030 --> 00:14:46.990 align:middle line:84% So this-- we're going to assume that consumption 00:14:46.990 --> 00:14:49.900 align:middle line:84% is an increasing function of disposable income. 00:14:49.900 --> 00:14:52.310 align:middle line:84% I'm about to define what disposable income is, 00:14:52.310 --> 00:14:53.730 align:middle line:90% but you can imagine what it is. 00:14:53.730 --> 00:14:55.920 align:middle line:84% It's something you can use to consume and so on. 00:14:55.920 --> 00:14:59.600 align:middle line:84% So very naturally, if you have a higher disposable income, 00:14:59.600 --> 00:15:00.830 align:middle line:90% you're going to consume more. 00:15:00.830 --> 00:15:03.640 align:middle line:90% That's what this says, OK? 00:15:03.640 --> 00:15:06.810 align:middle line:84% In reality, that consumption function is a lot more complex. 00:15:06.810 --> 00:15:09.520 align:middle line:84% There are lots of things that enter there that we're not 00:15:09.520 --> 00:15:10.730 align:middle line:90% modeling for now. 00:15:10.730 --> 00:15:13.390 align:middle line:84% But let's start from the basics, OK? 00:15:13.390 --> 00:15:16.330 align:middle line:84% So that's going to be the only behavioral assumption we're 00:15:16.330 --> 00:15:20.920 align:middle line:84% going to make for a while, that the consumers consume 00:15:20.920 --> 00:15:23.770 align:middle line:84% more when they have more disposable income. 00:15:23.770 --> 00:15:27.650 align:middle line:90% 00:15:27.650 --> 00:15:29.450 align:middle line:84% And then we're going to get even simpler. 00:15:29.450 --> 00:15:32.510 align:middle line:84% I'm going to assume that consumption is a linear function 00:15:32.510 --> 00:15:34.940 align:middle line:90% of this disposable income. 00:15:34.940 --> 00:15:38.750 align:middle line:84% So there's going to be some constant C0 which captures lots 00:15:38.750 --> 00:15:41.130 align:middle line:84% of things that we're not modeling here-- for example, 00:15:41.130 --> 00:15:45.270 align:middle line:84% the fact that, for any given level of disposable income, 00:15:45.270 --> 00:15:47.120 align:middle line:90% if you-- 00:15:47.120 --> 00:15:49.520 align:middle line:84% if you're richer, suppose you have some shares, 00:15:49.520 --> 00:15:51.590 align:middle line:84% and now the shares double in value, 00:15:51.590 --> 00:15:54.290 align:middle line:84% you probably are going to consume more as well. 00:15:54.290 --> 00:15:56.820 align:middle line:84% There are lots of other things that affect consumption 00:15:56.820 --> 00:15:58.370 align:middle line:90% which are different from-- 00:15:58.370 --> 00:16:01.593 align:middle line:84% aside from your disposable income. 00:16:01.593 --> 00:16:03.010 align:middle line:84% But we're not going to model that. 00:16:03.010 --> 00:16:04.910 align:middle line:84% So thus, we're going to call it autonomous, 00:16:04.910 --> 00:16:06.180 align:middle line:84% autonomous in the sense that we're not 00:16:06.180 --> 00:16:07.270 align:middle line:90% going to determine it here. 00:16:07.270 --> 00:16:08.670 align:middle line:84% We're going to take it as a parameter that 00:16:08.670 --> 00:16:09.960 align:middle line:90% comes from somewhere else. 00:16:09.960 --> 00:16:12.750 align:middle line:84% We may do some experiments moving that variable around, 00:16:12.750 --> 00:16:17.760 align:middle line:84% but it's not going to be part of what we model. 00:16:17.760 --> 00:16:19.890 align:middle line:84% C1 is a more interesting parameter 00:16:19.890 --> 00:16:21.160 align:middle line:90% for this part of the course. 00:16:21.160 --> 00:16:25.270 align:middle line:84% And it's what we call the marginal propensity to consume-- 00:16:25.270 --> 00:16:27.450 align:middle line:84% out of disposable income, in this case. 00:16:27.450 --> 00:16:30.420 align:middle line:90% That is, C1 tells you the share. 00:16:30.420 --> 00:16:32.980 align:middle line:84% If you get an extra dollar of disposable income, 00:16:32.980 --> 00:16:36.300 align:middle line:84% how much of that do you spend in consumption? 00:16:36.300 --> 00:16:39.990 align:middle line:84% So say you get an extra dollar of income. 00:16:39.990 --> 00:16:45.690 align:middle line:84% If you spend $0.60 in the things you normally consume of that 00:16:45.690 --> 00:16:48.900 align:middle line:84% extra dollar, well, then your C1 is 0.6, OK? 00:16:48.900 --> 00:16:51.438 align:middle line:84% That's the marginal propensity to consume. 00:16:51.438 --> 00:16:53.480 align:middle line:84% And that's what gives us our increasing function. 00:16:53.480 --> 00:16:54.560 align:middle line:84% If you get an extra dollar, you're 00:16:54.560 --> 00:16:56.630 align:middle line:84% going to do-- you're going to save part, but some of it 00:16:56.630 --> 00:16:57.590 align:middle line:90% you're going to spend. 00:16:57.590 --> 00:16:59.720 align:middle line:84% That part you're going to spend is the C1 00:16:59.720 --> 00:17:02.805 align:middle line:90% that we have there, OK? 00:17:02.805 --> 00:17:03.305 align:middle line:90% Good. 00:17:03.305 --> 00:17:08.740 align:middle line:90% 00:17:08.740 --> 00:17:11.750 align:middle line:84% Now let me tell you how we define disposable income. 00:17:11.750 --> 00:17:13.970 align:middle line:84% Disposable income is just equal to income, 00:17:13.970 --> 00:17:17.140 align:middle line:84% which is equal to production, minus taxes. 00:17:17.140 --> 00:17:18.670 align:middle line:90% That's disposable income. 00:17:18.670 --> 00:17:24.430 align:middle line:84% It's whatever you earn as a worker or as a capital owner-- 00:17:24.430 --> 00:17:27.069 align:middle line:84% well, then the government takes some out of it. 00:17:27.069 --> 00:17:29.162 align:middle line:84% That's your disposable income, and that's 00:17:29.162 --> 00:17:31.870 align:middle line:84% what you have to decide how much to save and how much to consume. 00:17:31.870 --> 00:17:35.650 align:middle line:90% 00:17:35.650 --> 00:17:38.050 align:middle line:84% So that means that our consumption function 00:17:38.050 --> 00:17:42.400 align:middle line:84% can be written that way after all these assumptions I've 00:17:42.400 --> 00:17:43.570 align:middle line:90% made-- 00:17:43.570 --> 00:17:46.612 align:middle line:84% equal to its autonomous component plus C1, 00:17:46.612 --> 00:17:48.070 align:middle line:84% the marginal propensity to consume, 00:17:48.070 --> 00:17:52.435 align:middle line:84% times income, output, minus taxes. 00:17:52.435 --> 00:17:56.630 align:middle line:90% 00:17:56.630 --> 00:17:59.130 align:middle line:90% Is it clear? 00:17:59.130 --> 00:17:59.910 align:middle line:90% Yes? 00:17:59.910 --> 00:18:01.290 align:middle line:90% So all these are assumptions. 00:18:01.290 --> 00:18:03.420 align:middle line:84% Now, they're not crazy assumptions in the sense 00:18:03.420 --> 00:18:06.280 align:middle line:84% that we know that there is a relationship between these two 00:18:06.280 --> 00:18:06.780 align:middle line:90% things. 00:18:06.780 --> 00:18:09.240 align:middle line:84% Again, the consumption function in practice 00:18:09.240 --> 00:18:11.110 align:middle line:90% is much richer than that. 00:18:11.110 --> 00:18:14.590 align:middle line:84% And there is lots of randomness, random terms around and so on. 00:18:14.590 --> 00:18:17.213 align:middle line:84% But that's not what we're about here. 00:18:17.213 --> 00:18:19.380 align:middle line:84% But that's-- if you want to start with a consumption 00:18:19.380 --> 00:18:22.230 align:middle line:84% function, this is a pretty reasonable one to start with, 00:18:22.230 --> 00:18:24.630 align:middle line:90% OK? 00:18:24.630 --> 00:18:27.690 align:middle line:84% OK, so that's going to look in the space of disposable income, 00:18:27.690 --> 00:18:28.530 align:middle line:90% or income-- 00:18:28.530 --> 00:18:31.420 align:middle line:84% I could have put income there, not disposable income-- 00:18:31.420 --> 00:18:33.240 align:middle line:90% so that it looks like that. 00:18:33.240 --> 00:18:34.620 align:middle line:90% OK? 00:18:34.620 --> 00:18:37.477 align:middle line:84% So C0 is that autonomous consumption. 00:18:37.477 --> 00:18:39.060 align:middle line:84% It's something you're going to consume 00:18:39.060 --> 00:18:40.977 align:middle line:84% regardless of your level of disposable income. 00:18:40.977 --> 00:18:43.170 align:middle line:84% And there is a minimum consumption you have to have. 00:18:43.170 --> 00:18:49.050 align:middle line:84% [CHUCKLES] And then the slope of that 00:18:49.050 --> 00:18:51.010 align:middle line:84% is the marginal propensity to consume, 00:18:51.010 --> 00:18:54.180 align:middle line:84% which is C1, which is a number between 0 and 1. 00:18:54.180 --> 00:18:57.230 align:middle line:90% 00:18:57.230 --> 00:19:02.210 align:middle line:84% OK, so let's determine equilibrium output. 00:19:02.210 --> 00:19:07.750 align:middle line:84% So we have aggregate demand, which is C plus I plus G, OK? 00:19:07.750 --> 00:19:09.600 align:middle line:90% There we are. 00:19:09.600 --> 00:19:12.940 align:middle line:84% That was our definition of aggregate demand. 00:19:12.940 --> 00:19:15.490 align:middle line:84% I'm going to stick in now the functional forms. 00:19:15.490 --> 00:19:17.150 align:middle line:84% Well, these guys are very boring. 00:19:17.150 --> 00:19:18.250 align:middle line:90% They're constants. 00:19:18.250 --> 00:19:22.930 align:middle line:84% And I'm plugging in here the consumption function. 00:19:22.930 --> 00:19:27.840 align:middle line:84% So what we have here is that aggregate demand is 00:19:27.840 --> 00:19:32.130 align:middle line:84% an increasing function of output, or income, OK? 00:19:32.130 --> 00:19:34.810 align:middle line:84% It's also a function of taxes, investment, and so on. 00:19:34.810 --> 00:19:37.320 align:middle line:84% But it's an increasing function of output. 00:19:37.320 --> 00:19:41.220 align:middle line:84% And this is important because, remember, the goal of this 00:19:41.220 --> 00:19:44.640 align:middle line:90% is to find equilibrium output. 00:19:44.640 --> 00:19:46.460 align:middle line:84% So here I have, on the right-hand side 00:19:46.460 --> 00:19:49.930 align:middle line:90% of my aggregate demand, output. 00:19:49.930 --> 00:19:50.620 align:middle line:90% That's good. 00:19:50.620 --> 00:19:54.100 align:middle line:84% I have one equation in which output shows up, [CHUCKLES] OK? 00:19:54.100 --> 00:19:57.100 align:middle line:84% Now, I cannot find equilibrium output just from this equation. 00:19:57.100 --> 00:20:00.260 align:middle line:90% Why is that? 00:20:00.260 --> 00:20:03.070 align:middle line:84% So remember, we're trying to build a model 00:20:03.070 --> 00:20:07.660 align:middle line:90% to find equilibrium output. 00:20:07.660 --> 00:20:08.857 align:middle line:90% That's our goal. 00:20:08.857 --> 00:20:11.440 align:middle line:84% That's what will tell us whether we're in a recession or not-- 00:20:11.440 --> 00:20:15.975 align:middle line:84% output is low, recession, output is high, we're in a boom. 00:20:15.975 --> 00:20:17.600 align:middle line:84% Obviously, I cannot solve it from this. 00:20:17.600 --> 00:20:19.900 align:middle line:90% I have two unknowns. 00:20:19.900 --> 00:20:23.080 align:middle line:90% What are my two unknowns? 00:20:23.080 --> 00:20:25.370 align:middle line:90% Two unknowns, one equation. 00:20:25.370 --> 00:20:27.470 align:middle line:90% What is my second unknown there? 00:20:27.470 --> 00:20:35.808 align:middle line:90% 00:20:35.808 --> 00:20:37.100 align:middle line:90% AUDIENCE: The aggregate demand. 00:20:37.100 --> 00:20:39.183 align:middle line:84% RICARDO J. CABALLERO: Aggregate demand, of course. 00:20:39.183 --> 00:20:45.000 align:middle line:84% We have to determine Z and Y. So how are we going to do that? 00:20:45.000 --> 00:20:48.350 align:middle line:84% Well, using a second equation, which 00:20:48.350 --> 00:20:49.880 align:middle line:90% is the equilibrium condition. 00:20:49.880 --> 00:20:50.720 align:middle line:90% It's not a function. 00:20:50.720 --> 00:20:51.802 align:middle line:90% This is a function. 00:20:51.802 --> 00:20:52.760 align:middle line:90% This is not a function. 00:20:52.760 --> 00:20:54.180 align:middle line:84% This is an equilibrium condition. 00:20:54.180 --> 00:20:57.500 align:middle line:84% It says, in equilibrium-- not outside equilibrium, 00:20:57.500 --> 00:20:59.060 align:middle line:90% in equilibrium-- 00:20:59.060 --> 00:21:02.810 align:middle line:84% output is equal to aggregate demand. 00:21:02.810 --> 00:21:03.710 align:middle line:90% OK? 00:21:03.710 --> 00:21:06.830 align:middle line:84% That's what this equilibrium condition tells us. 00:21:06.830 --> 00:21:08.390 align:middle line:84% Off equilibrium, this doesn't hold. 00:21:08.390 --> 00:21:10.098 align:middle line:84% That's the reason this is not a function. 00:21:10.098 --> 00:21:11.510 align:middle line:90% This holds everywhere. 00:21:11.510 --> 00:21:12.560 align:middle line:90% It's a function. 00:21:12.560 --> 00:21:14.130 align:middle line:84% This is an equilibrium condition. 00:21:14.130 --> 00:21:16.670 align:middle line:84% It says, at equilibrium, aggregate demand 00:21:16.670 --> 00:21:18.433 align:middle line:90% is equal to output. 00:21:18.433 --> 00:21:20.600 align:middle line:84% So now we're done because we have two equations, two 00:21:20.600 --> 00:21:21.785 align:middle line:90% unknowns, OK? 00:21:21.785 --> 00:21:24.700 align:middle line:90% 00:21:24.700 --> 00:21:25.970 align:middle line:90% Good. 00:21:25.970 --> 00:21:27.970 align:middle line:84% And the reason I post on this is that I 00:21:27.970 --> 00:21:31.780 align:middle line:84% see that mistake made often, that this 00:21:31.780 --> 00:21:32.988 align:middle line:90% is interpreted as a function. 00:21:32.988 --> 00:21:33.488 align:middle line:90% It's not. 00:21:33.488 --> 00:21:34.810 align:middle line:90% It's an equilibrium condition. 00:21:34.810 --> 00:21:36.250 align:middle line:90% At equilibrium, it holds. 00:21:36.250 --> 00:21:38.350 align:middle line:84% And that you can see, actually, I'm 00:21:38.350 --> 00:21:41.000 align:middle line:84% going to illustrate the same point in the diagram. 00:21:41.000 --> 00:21:42.980 align:middle line:90% So this is the-- 00:21:42.980 --> 00:21:44.010 align:middle line:90% let me keep going. 00:21:44.010 --> 00:21:45.080 align:middle line:90% So this is clear, no? 00:21:45.080 --> 00:21:47.690 align:middle line:84% So this is just a summary of what 00:21:47.690 --> 00:21:50.090 align:middle line:90% we had in the previous slides. 00:21:50.090 --> 00:21:54.672 align:middle line:84% And this is the new thing here, which is, in equilibrium, output 00:21:54.672 --> 00:21:55.880 align:middle line:90% is equal to aggregate demand. 00:21:55.880 --> 00:22:00.110 align:middle line:90% 00:22:00.110 --> 00:22:05.420 align:middle line:84% And again, that's what makes this really a short-term model. 00:22:05.420 --> 00:22:08.510 align:middle line:84% You see, I'm saying output, in the short term, 00:22:08.510 --> 00:22:12.370 align:middle line:84% is whatever demand wants it to be, 00:22:12.370 --> 00:22:16.020 align:middle line:84% which is different from the long run that 00:22:16.020 --> 00:22:17.370 align:middle line:90% says, no, no, hold on a second. 00:22:17.370 --> 00:22:19.980 align:middle line:84% I mean, but how much output you can produce 00:22:19.980 --> 00:22:22.800 align:middle line:84% is a function of the capital you have, of the workers you have. 00:22:22.800 --> 00:22:24.010 align:middle line:84% Yeah, yeah, that's true in the long run. 00:22:24.010 --> 00:22:26.093 align:middle line:84% But in the short run, you have lots of flexibility 00:22:26.093 --> 00:22:29.490 align:middle line:84% because you have lots of unused capacity and so on, OK? 00:22:29.490 --> 00:22:31.860 align:middle line:84% So this is pretty-- is a big assumption. 00:22:31.860 --> 00:22:34.590 align:middle line:84% And there are schools of thought within macroeconomics 00:22:34.590 --> 00:22:36.660 align:middle line:84% that are split by this assumption, 00:22:36.660 --> 00:22:39.720 align:middle line:84% whether you believe that, in the short run, 00:22:39.720 --> 00:22:43.080 align:middle line:84% output is aggregate demand-determined or not. 00:22:43.080 --> 00:22:46.152 align:middle line:84% Ultimately, we tend to believe that in the short run-- 00:22:46.152 --> 00:22:46.860 align:middle line:90% the long run, no. 00:22:46.860 --> 00:22:48.610 align:middle line:84% But in the short run, that's what it does. 00:22:48.610 --> 00:22:51.960 align:middle line:84% Now, sometimes the long run gets to you very quickly. 00:22:51.960 --> 00:22:54.480 align:middle line:84% And at this point, we're in a situation like that. 00:22:54.480 --> 00:22:56.605 align:middle line:84% That's the reason we're seeing inflation and so on. 00:22:56.605 --> 00:22:59.700 align:middle line:84% But that's something you'll understand later on, OK? 00:22:59.700 --> 00:23:02.570 align:middle line:84% But for now, so this is important. 00:23:02.570 --> 00:23:04.930 align:middle line:90% We're saying here, output-- 00:23:04.930 --> 00:23:06.180 align:middle line:90% I don't need another equation. 00:23:06.180 --> 00:23:08.013 align:middle line:84% I could have done aggregate demand like this 00:23:08.013 --> 00:23:10.800 align:middle line:84% and then output a function of capital, labor, lots of things. 00:23:10.800 --> 00:23:12.100 align:middle line:90% I'm not going to even do that. 00:23:12.100 --> 00:23:14.550 align:middle line:84% I'm going to say, no, no, output will be whatever 00:23:14.550 --> 00:23:17.250 align:middle line:90% demand wants it to be, OK? 00:23:17.250 --> 00:23:19.500 align:middle line:84% And that means, in equilibrium, they have to be equal. 00:23:19.500 --> 00:23:21.660 align:middle line:90% [CHUCKLES] Good. 00:23:21.660 --> 00:23:22.530 align:middle line:90% You had a question. 00:23:22.530 --> 00:23:27.280 align:middle line:84% AUDIENCE: [INAUDIBLE] can you [INAUDIBLE] output and GDP 00:23:27.280 --> 00:23:27.931 align:middle line:90% [INAUDIBLE]? 00:23:27.931 --> 00:23:30.056 align:middle line:84% RICARDO J. CABALLERO: No, they are the same for us. 00:23:30.056 --> 00:23:31.960 align:middle line:90% AUDIENCE: They are [INAUDIBLE]? 00:23:31.960 --> 00:23:33.793 align:middle line:84% RICARDO J. CABALLERO: That's our definition. 00:23:33.793 --> 00:23:35.780 align:middle line:90% GDP, for us, is output. 00:23:35.780 --> 00:23:39.160 align:middle line:84% So when they say aggregate output, I mean GDP. 00:23:39.160 --> 00:23:39.940 align:middle line:90% Remember? 00:23:39.940 --> 00:23:43.990 align:middle line:84% Real GDP-- we're talking all about real GDP, OK? 00:23:43.990 --> 00:23:45.792 align:middle line:90% And it's also equal to income-- 00:23:45.792 --> 00:23:47.500 align:middle line:84% not disposable, but it's equal to income. 00:23:47.500 --> 00:23:49.810 align:middle line:84% Remember when we did those little tables where we look 00:23:49.810 --> 00:23:52.160 align:middle line:84% [INAUDIBLE], the three different ways of doing it? 00:23:52.160 --> 00:23:54.910 align:middle line:90% Well, the first two were output. 00:23:54.910 --> 00:23:56.620 align:middle line:90% And the last one was income. 00:23:56.620 --> 00:23:59.820 align:middle line:90% And they had to be the same, OK? 00:23:59.820 --> 00:24:04.480 align:middle line:90% So Y is real GDP for us? 00:24:04.480 --> 00:24:07.860 align:middle line:90% That's real GDP. 00:24:07.860 --> 00:24:11.170 align:middle line:84% What happens, in the table I showed you, 00:24:11.170 --> 00:24:13.142 align:middle line:84% I already used the fact that real GDP 00:24:13.142 --> 00:24:14.350 align:middle line:90% is equal to aggregate demand. 00:24:14.350 --> 00:24:15.767 align:middle line:84% And that's the reason I showed you 00:24:15.767 --> 00:24:18.550 align:middle line:84% the different components of Z I showed you 00:24:18.550 --> 00:24:20.602 align:middle line:84% that, that, and that, [CHUCKLES] OK? 00:24:20.602 --> 00:24:22.060 align:middle line:84% But in equilibrium, they are equal. 00:24:22.060 --> 00:24:29.280 align:middle line:90% 00:24:29.280 --> 00:24:31.432 align:middle line:84% There's really a figure that will clarify, 00:24:31.432 --> 00:24:32.390 align:middle line:90% I think, a lot of that. 00:24:32.390 --> 00:24:34.080 align:middle line:90% But let me keep solving this. 00:24:34.080 --> 00:24:35.943 align:middle line:90% So we have that-- 00:24:35.943 --> 00:24:37.860 align:middle line:84% so what I'm going to do next is just solve it. 00:24:37.860 --> 00:24:39.443 align:middle line:84% So we have this equilibrium condition. 00:24:39.443 --> 00:24:43.320 align:middle line:84% I'm going to plug in my aggregate demand function here. 00:24:43.320 --> 00:24:45.930 align:middle line:84% And so I can solve out for equilibrium output. 00:24:45.930 --> 00:24:47.660 align:middle line:84% And here we have, for the first time 00:24:47.660 --> 00:24:50.720 align:middle line:84% in this course, an equation for equilibrium output. 00:24:50.720 --> 00:24:51.380 align:middle line:90% There you are. 00:24:51.380 --> 00:24:56.190 align:middle line:84% That's your equilibrium output in this economy. 00:24:56.190 --> 00:24:58.730 align:middle line:90% OK? 00:24:58.730 --> 00:25:02.630 align:middle line:84% Now, this guy here is very famous 00:25:02.630 --> 00:25:06.080 align:middle line:84% and is very macro It doesn't happen in micro. 00:25:06.080 --> 00:25:11.890 align:middle line:84% It happens in macro only, this guy here. 00:25:11.890 --> 00:25:14.130 align:middle line:84% Another guy there is called the multiplier. 00:25:14.130 --> 00:25:19.180 align:middle line:90% 00:25:19.180 --> 00:25:21.000 align:middle line:84% And it's a very important macro concept. 00:25:21.000 --> 00:25:24.700 align:middle line:90% It's a huge concept in macro. 00:25:24.700 --> 00:25:28.412 align:middle line:84% Now, why do you think it's called a multiplier? 00:25:28.412 --> 00:25:30.120 align:middle line:84% Well, obviously, it multiplies something. 00:25:30.120 --> 00:25:35.160 align:middle line:84% But a multiplier sounds like it multiplies-- 00:25:35.160 --> 00:25:36.540 align:middle line:90% that makes something bigger. 00:25:36.540 --> 00:25:38.960 align:middle line:90% [CHUCKLES] 00:25:38.960 --> 00:25:43.585 align:middle line:84% So what happens if C1 is greater than 0? 00:25:43.585 --> 00:25:48.650 align:middle line:90% 00:25:48.650 --> 00:25:50.630 align:middle line:84% What happens if C1 is greater than 0. 00:25:50.630 --> 00:25:52.020 align:middle line:90% Remember, it's between 0 and 1. 00:25:52.020 --> 00:25:54.140 align:middle line:84% But what happens if it's greater than 0? 00:25:54.140 --> 00:25:57.455 align:middle line:84% What happens with that number there, 1 over 1 minus C1? 00:25:57.455 --> 00:26:01.170 align:middle line:90% 00:26:01.170 --> 00:26:02.170 align:middle line:90% AUDIENCE: Bigger than 1. 00:26:02.170 --> 00:26:03.920 align:middle line:84% RICARDO J. CABALLERO: It's greater than 1. 00:26:03.920 --> 00:26:05.608 align:middle line:90% It multiplies. 00:26:05.608 --> 00:26:07.150 align:middle line:84% So the reason we call it a multiplier 00:26:07.150 --> 00:26:09.610 align:middle line:90% is not nothing deep there. 00:26:09.610 --> 00:26:12.340 align:middle line:84% So this thing here is sort of autonomous stuff. 00:26:12.340 --> 00:26:14.860 align:middle line:84% It's what the government spends, what firms are spending, 00:26:14.860 --> 00:26:15.430 align:middle line:90% capital. 00:26:15.430 --> 00:26:18.610 align:middle line:90% This is autonomous consumption. 00:26:18.610 --> 00:26:21.520 align:middle line:84% And this actually is a typo there. 00:26:21.520 --> 00:26:24.810 align:middle line:84% There should be a C1 in front of that-- 00:26:24.810 --> 00:26:26.010 align:middle line:90% typo. 00:26:26.010 --> 00:26:30.930 align:middle line:84% It comes from there, C1 times T. So fix that typo, please. 00:26:30.930 --> 00:26:34.200 align:middle line:84% I'm going to upload the slides again with the typo fixed, OK? 00:26:34.200 --> 00:26:36.730 align:middle line:90% 00:26:36.730 --> 00:26:40.720 align:middle line:84% I'm just-- it comes from here, C1 times T. 00:26:40.720 --> 00:26:42.190 align:middle line:90% OK, so that's what this does. 00:26:42.190 --> 00:26:42.950 align:middle line:90% It multiplies. 00:26:42.950 --> 00:26:45.100 align:middle line:84% So whatever it is that is happening here, 00:26:45.100 --> 00:26:47.017 align:middle line:84% whatever it is that the government is spending 00:26:47.017 --> 00:26:49.480 align:middle line:84% or whatever, this term is multiplied. 00:26:49.480 --> 00:26:51.580 align:middle line:90% And that's a huge thing. 00:26:51.580 --> 00:26:53.710 align:middle line:90% There was a big debate-- 00:26:53.710 --> 00:26:55.417 align:middle line:84% almost always, when you're trying 00:26:55.417 --> 00:26:58.000 align:middle line:84% to get out of a recession, and the government starts spending, 00:26:58.000 --> 00:27:00.430 align:middle line:84% a big question is, well, how big is the multiplier? 00:27:00.430 --> 00:27:01.905 align:middle line:84% If the multiplier is small, you're 00:27:01.905 --> 00:27:04.030 align:middle line:84% going to have to spend a lot to get the economy out 00:27:04.030 --> 00:27:04.870 align:middle line:90% of the recession. 00:27:04.870 --> 00:27:10.620 align:middle line:84% If the multiplier is large, then you're 00:27:10.620 --> 00:27:12.180 align:middle line:84% going to have to spend very little, 00:27:12.180 --> 00:27:14.430 align:middle line:84% and then the multiplier will take you away 00:27:14.430 --> 00:27:16.500 align:middle line:90% from that recession. 00:27:16.500 --> 00:27:18.915 align:middle line:84% So what is it that makes a multiplier large or small? 00:27:18.915 --> 00:27:22.990 align:middle line:90% 00:27:22.990 --> 00:27:28.000 align:middle line:84% Well, mechanically, when is it that multiplier large? 00:27:28.000 --> 00:27:29.530 align:middle line:84% AUDIENCE: When C1 is closer to 1, 00:27:29.530 --> 00:27:31.940 align:middle line:84% so when people are spending more of their income. 00:27:31.940 --> 00:27:33.940 align:middle line:84% RICARDO J. CABALLERO: Exactly, when C1 is large. 00:27:33.940 --> 00:27:35.770 align:middle line:90% And that gives you the logic. 00:27:35.770 --> 00:27:37.300 align:middle line:84% And that's very important in macro, 00:27:37.300 --> 00:27:39.860 align:middle line:90% is why is it a big multiplier? 00:27:39.860 --> 00:27:42.740 align:middle line:84% Well, because think what happens in macro. 00:27:42.740 --> 00:27:47.600 align:middle line:84% The government spends-- not increases output. 00:27:47.600 --> 00:27:49.610 align:middle line:90% But now output increases income. 00:27:49.610 --> 00:27:52.820 align:middle line:84% And if consumers spend a big share of their extra income, 00:27:52.820 --> 00:27:54.740 align:middle line:84% an output, and consumption again, 00:27:54.740 --> 00:27:56.930 align:middle line:84% then that increases output again, 00:27:56.930 --> 00:28:01.480 align:middle line:84% which increases the income again, and you keep going, OK? 00:28:01.480 --> 00:28:02.780 align:middle line:90% So that's the sequence. 00:28:02.780 --> 00:28:04.778 align:middle line:84% On the contrary, if consumers are very scared, 00:28:04.778 --> 00:28:07.070 align:middle line:84% they don't want to spend any extra dollar they receive, 00:28:07.070 --> 00:28:10.100 align:middle line:84% anything of the extra dollar they receive, then you don't get 00:28:10.100 --> 00:28:13.670 align:middle line:84% any multiplier, because this initial increase in output that 00:28:13.670 --> 00:28:16.145 align:middle line:84% comes from the government expansion, that does 00:28:16.145 --> 00:28:17.270 align:middle line:90% lead to increase in income. 00:28:17.270 --> 00:28:18.830 align:middle line:84% But if consumers don't spend it, it 00:28:18.830 --> 00:28:20.640 align:middle line:84% doesn't recirculate into the economy, 00:28:20.640 --> 00:28:22.640 align:middle line:84% and then you don't get a multiplier. 00:28:22.640 --> 00:28:27.700 align:middle line:84% So that's the reason we call it the multiplier. 00:28:27.700 --> 00:28:30.200 align:middle line:84% So that diagram is an important diagram. 00:28:30.200 --> 00:28:36.210 align:middle line:90% I'm just doing this, actually. 00:28:36.210 --> 00:28:40.380 align:middle line:84% In that diagram, I'm plotting the aggregate demand function 00:28:40.380 --> 00:28:43.140 align:middle line:84% and then this equilibrium condition, output 00:28:43.140 --> 00:28:46.230 align:middle line:84% equal to aggregate demand, in the space 00:28:46.230 --> 00:28:52.800 align:middle line:84% of aggregate demand and output, production, and income here. 00:28:52.800 --> 00:28:55.380 align:middle line:84% But remember, income is equal to production, OK? 00:28:55.380 --> 00:28:59.400 align:middle line:84% So there's your aggregate demand and, thus, 00:28:59.400 --> 00:29:03.450 align:middle line:84% your 45-degree line because this output equal to-- so whatever is 00:29:03.450 --> 00:29:07.890 align:middle line:84% in this axis equal to that axis, that's the 45-degree line, OK? 00:29:07.890 --> 00:29:09.570 align:middle line:84% So that's your equilibrium conditions. 00:29:09.570 --> 00:29:12.270 align:middle line:84% It's, at equilibrium, these guys here, 00:29:12.270 --> 00:29:13.800 align:middle line:84% aggregate demand, Z, will have to be 00:29:13.800 --> 00:29:17.390 align:middle line:84% equal to Y. Those are-- that's traced there. 00:29:17.390 --> 00:29:19.940 align:middle line:90% This is aggregate demand. 00:29:19.940 --> 00:29:21.650 align:middle line:84% Why is this line flatter than that? 00:29:21.650 --> 00:29:25.490 align:middle line:90% 00:29:25.490 --> 00:29:27.230 align:middle line:84% Why is aggregate demand flatter than-- 00:29:27.230 --> 00:29:31.115 align:middle line:90% 00:29:31.115 --> 00:29:33.490 align:middle line:84% AUDIENCE: Because people don't spend their entire dollar. 00:29:33.490 --> 00:29:36.420 align:middle line:84% RICARDO J. CABALLERO: Exactly, because C1 is less than 1. 00:29:36.420 --> 00:29:39.090 align:middle line:84% So the slope of the aggregate demand in this space 00:29:39.090 --> 00:29:42.280 align:middle line:84% is C1, is the marginal propensity to consume. 00:29:42.280 --> 00:29:44.820 align:middle line:84% How much more they demand if they get an extra dollar? 00:29:44.820 --> 00:29:48.390 align:middle line:84% Well, they don't get-- they don't demand one extra unit. 00:29:48.390 --> 00:29:52.260 align:middle line:84% They demand C1 unit, and C1 is less than 1. 00:29:52.260 --> 00:29:53.710 align:middle line:90% So that's the reason this. 00:29:53.710 --> 00:29:57.810 align:middle line:84% So if C1 is very small, this line is going to be very flat. 00:29:57.810 --> 00:30:00.120 align:middle line:84% If C1 is very large, very high propensity 00:30:00.120 --> 00:30:03.690 align:middle line:84% to consume, this is going to be very steep, the red line. 00:30:03.690 --> 00:30:06.870 align:middle line:84% The other one doesn't change, the 45-degree line. 00:30:06.870 --> 00:30:10.370 align:middle line:90% And what I said is that, at-- 00:30:10.370 --> 00:30:12.480 align:middle line:84% so you see, if I take an off-equilibrium level 00:30:12.480 --> 00:30:14.370 align:middle line:90% of output-- say, this-- 00:30:14.370 --> 00:30:16.640 align:middle line:84% aggregate demand is different from output. 00:30:16.640 --> 00:30:20.460 align:middle line:84% It's only at equilibrium that these two things will hold. 00:30:20.460 --> 00:30:23.470 align:middle line:90% 00:30:23.470 --> 00:30:27.180 align:middle line:84% This function, I can plot it everywhere. 00:30:27.180 --> 00:30:31.080 align:middle line:84% But this one will hold only at equilibrium, OK? 00:30:31.080 --> 00:30:32.730 align:middle line:84% That's when these two things are equal. 00:30:32.730 --> 00:30:35.470 align:middle line:90% 00:30:35.470 --> 00:30:39.210 align:middle line:90% So what I solve here-- 00:30:39.210 --> 00:30:42.800 align:middle line:90% here, I just found this point. 00:30:42.800 --> 00:30:48.400 align:middle line:84% So parameters here are C0, C1 times T, 00:30:48.400 --> 00:30:52.255 align:middle line:84% and G. They all shifters of this aggregate demand, up and down. 00:30:52.255 --> 00:30:55.920 align:middle line:90% 00:30:55.920 --> 00:31:00.540 align:middle line:84% And that point here is exactly that. 00:31:00.540 --> 00:31:02.850 align:middle line:84% And all those things are parameters 00:31:02.850 --> 00:31:04.020 align:middle line:90% in my aggregate demand. 00:31:04.020 --> 00:31:11.310 align:middle line:90% 00:31:11.310 --> 00:31:15.690 align:middle line:84% I really want you to internalize this diagram. 00:31:15.690 --> 00:31:17.000 align:middle line:90% Any questions about it? 00:31:17.000 --> 00:31:19.610 align:middle line:90% 00:31:19.610 --> 00:31:21.740 align:middle line:84% Just stare at it a little because it's 00:31:21.740 --> 00:31:24.140 align:middle line:90% going to show up repeatedly. 00:31:24.140 --> 00:31:26.330 align:middle line:84% And later, it's not going to show up. 00:31:26.330 --> 00:31:28.610 align:middle line:84% But whenever you get confused, the way 00:31:28.610 --> 00:31:30.380 align:middle line:84% to get yourself out of that confusion 00:31:30.380 --> 00:31:32.880 align:middle line:84% is going to be to go back to the diagram. 00:31:32.880 --> 00:31:33.440 align:middle line:90% You'll see. 00:31:33.440 --> 00:31:37.930 align:middle line:84% I'll remind you when that's likely to happen. 00:31:37.930 --> 00:31:40.750 align:middle line:84% So you better understand this diagram. 00:31:40.750 --> 00:31:41.680 align:middle line:90% Play with it. 00:31:41.680 --> 00:31:44.530 align:middle line:84% Move-- here, the only thing you can move around 00:31:44.530 --> 00:31:48.532 align:middle line:84% is the ZZ, the aggregate demand curve, OK? 00:31:48.532 --> 00:31:50.365 align:middle line:84% The other thing is an equilibrium condition. 00:31:50.365 --> 00:31:53.050 align:middle line:84% [CHUCKLES] You can't move that 45-degree line. 00:31:53.050 --> 00:31:55.160 align:middle line:90% But ZZ, you can move it around. 00:31:55.160 --> 00:31:57.550 align:middle line:90% So let's do a few exercises. 00:31:57.550 --> 00:32:05.260 align:middle line:84% One, the most obvious, suppose that C0 increases by $1 billion. 00:32:05.260 --> 00:32:06.760 align:middle line:84% So autonomous consumption-- that is, 00:32:06.760 --> 00:32:09.177 align:middle line:84% that level of consumption which is independent of income-- 00:32:09.177 --> 00:32:10.210 align:middle line:90% goes up by $1 billion. 00:32:10.210 --> 00:32:14.530 align:middle line:84% And that could be we're only in a better mood. 00:32:14.530 --> 00:32:17.770 align:middle line:84% Disposable income is whatever it is today. 00:32:17.770 --> 00:32:21.490 align:middle line:84% But there is great expectation that the economy 00:32:21.490 --> 00:32:23.960 align:middle line:90% will enter a boom next year. 00:32:23.960 --> 00:32:26.050 align:middle line:84% And so then you feel richer and so on. 00:32:26.050 --> 00:32:27.700 align:middle line:90% And you may decide to consume-- 00:32:27.700 --> 00:32:28.870 align:middle line:90% not wait until next year. 00:32:28.870 --> 00:32:30.580 align:middle line:84% You may decide to consume more today. 00:32:30.580 --> 00:32:34.480 align:middle line:84% That kind of thought experiment can be captured by a C0 type 00:32:34.480 --> 00:32:35.560 align:middle line:90% shift, go up. 00:32:35.560 --> 00:32:38.000 align:middle line:84% And that's when I talk about consumer sentiment. 00:32:38.000 --> 00:32:40.790 align:middle line:84% Well, consumer sentiment is a lot about C0-- 00:32:40.790 --> 00:32:42.790 align:middle line:84% for any given level of income, whether consumers 00:32:42.790 --> 00:32:48.050 align:middle line:84% are likely to consume more than they would otherwise or less. 00:32:48.050 --> 00:32:49.880 align:middle line:90% And that's what C0 captures. 00:32:49.880 --> 00:32:53.300 align:middle line:84% So let's go-- everything in this model-- there's 00:32:53.300 --> 00:32:55.650 align:middle line:84% no dynamics in this simple model. 00:32:55.650 --> 00:32:58.160 align:middle line:84% So we immediately-- what we know is, 00:32:58.160 --> 00:33:00.630 align:middle line:84% if you just were to solve the equation, 00:33:00.630 --> 00:33:02.210 align:middle line:90% and I tell you what happens to-- 00:33:02.210 --> 00:33:05.150 align:middle line:84% if output-- what happens to output if C0 goes up 00:33:05.150 --> 00:33:09.520 align:middle line:84% by $1 billion, you know that output will rise by how much? 00:33:09.520 --> 00:33:12.940 align:middle line:90% 00:33:12.940 --> 00:33:15.540 align:middle line:90% Let's keep it simple. 00:33:15.540 --> 00:33:18.000 align:middle line:84% Just staring at that equation, if I tell you autonomous 00:33:18.000 --> 00:33:20.490 align:middle line:84% consumption goes up by $1 billion, 00:33:20.490 --> 00:33:22.020 align:middle line:84% what happens to equilibrium output? 00:33:22.020 --> 00:33:25.950 align:middle line:84% Goes up by more or less than $1 billion? 00:33:25.950 --> 00:33:27.990 align:middle line:90% Or exactly $1 billion? 00:33:27.990 --> 00:33:30.804 align:middle line:90% 00:33:30.804 --> 00:33:33.120 align:middle line:90% AUDIENCE: [INAUDIBLE] 00:33:33.120 --> 00:33:34.370 align:middle line:90% RICARDO J. CABALLERO: Exactly. 00:33:34.370 --> 00:33:36.140 align:middle line:84% And the multiplier is greater than 1. 00:33:36.140 --> 00:33:39.680 align:middle line:84% So we know that the output will increase by more than $1 00:33:39.680 --> 00:33:43.490 align:middle line:84% billion, will increase by 1 billion times the multiplier. 00:33:43.490 --> 00:33:47.690 align:middle line:84% If C1 is 0.5, then it will increase by $2 billion 00:33:47.690 --> 00:33:49.440 align:middle line:90% equilibrium output. 00:33:49.440 --> 00:33:53.360 align:middle line:84% Now, I'm going to get you from the $1 billion to the $2 billion 00:33:53.360 --> 00:33:55.280 align:middle line:90% in steps using the diagram. 00:33:55.280 --> 00:33:58.230 align:middle line:90% That's what I intend to do next. 00:33:58.230 --> 00:33:58.740 align:middle line:90% OK? 00:33:58.740 --> 00:34:03.060 align:middle line:84% So this shift here-- so we're starting from this equilibrium 00:34:03.060 --> 00:34:04.230 align:middle line:90% output here. 00:34:04.230 --> 00:34:09.210 align:middle line:84% This shift here, boom, is increasing C0. 00:34:09.210 --> 00:34:10.199 align:middle line:90% That's at $1 billion. 00:34:10.199 --> 00:34:13.530 align:middle line:84% So distance A to B is $1 billion. 00:34:13.530 --> 00:34:17.159 align:middle line:84% That's because what I did is, for any given level of output. 00:34:17.159 --> 00:34:19.949 align:middle line:84% I shift this aggregate demand up by $1 billion. 00:34:19.949 --> 00:34:22.800 align:middle line:84% Thus, autonomous consumption, up, OK? 00:34:22.800 --> 00:34:26.850 align:middle line:84% Well, because output is whatever demand wants, 00:34:26.850 --> 00:34:31.050 align:middle line:84% that immediately increases output by $1 billion. 00:34:31.050 --> 00:34:36.409 align:middle line:84% So the distance between B and C is also $1 billion. 00:34:36.409 --> 00:34:38.870 align:middle line:84% Demand increased by $1 billion, boom, output 00:34:38.870 --> 00:34:41.900 align:middle line:90% immediately catches up. 00:34:41.900 --> 00:34:44.800 align:middle line:84% So output increases by $1 billion. 00:34:44.800 --> 00:34:47.837 align:middle line:84% But if output increases by $1 billion, 00:34:47.837 --> 00:34:49.004 align:middle line:90% what has happened to income? 00:34:49.004 --> 00:34:56.199 align:middle line:90% 00:34:56.199 --> 00:34:57.970 align:middle line:90% It also increased by $1 billion. 00:34:57.970 --> 00:35:00.960 align:middle line:90% Income is the same as output. 00:35:00.960 --> 00:35:04.130 align:middle line:84% So income has increased by $1 billion. 00:35:04.130 --> 00:35:06.500 align:middle line:84% Well, if income has increased by $1 billion, 00:35:06.500 --> 00:35:11.150 align:middle line:84% and C1 is different from 0, that means part of that extra billion 00:35:11.150 --> 00:35:15.080 align:middle line:84% is going to be spent in consumption, second round. 00:35:15.080 --> 00:35:19.400 align:middle line:84% So say C1 is 0.5, then now you get $500 million 00:35:19.400 --> 00:35:20.850 align:middle line:90% more of expenditure. 00:35:20.850 --> 00:35:22.580 align:middle line:90% But if it's-- of consumption. 00:35:22.580 --> 00:35:26.990 align:middle line:90% And it's $500, that's the CD. 00:35:26.990 --> 00:35:28.970 align:middle line:90% That's $500 million. 00:35:28.970 --> 00:35:32.090 align:middle line:84% Obviously, this C1 here is less than 0.5 00:35:32.090 --> 00:35:36.200 align:middle line:84% because otherwise this would be half of that, but it's not. 00:35:36.200 --> 00:35:40.130 align:middle line:84% But anyway, you get $500 million more. 00:35:40.130 --> 00:35:42.710 align:middle line:84% But if now there's $500 million more of demand, 00:35:42.710 --> 00:35:44.930 align:middle line:84% since output does whatever-- production 00:35:44.930 --> 00:35:48.800 align:middle line:84% does whatever demand wants, then you get $500 more of production. 00:35:48.800 --> 00:35:51.023 align:middle line:84% And if you have $500 more, million dollars 00:35:51.023 --> 00:35:52.940 align:middle line:84% of more production, then you have $500 million 00:35:52.940 --> 00:35:54.030 align:middle line:90% more of income. 00:35:54.030 --> 00:35:55.940 align:middle line:84% And if you have $500 more of income, 00:35:55.940 --> 00:35:57.980 align:middle line:84% and you have C1 is greater than 0-- 00:35:57.980 --> 00:36:02.030 align:middle line:84% say, 0.5-- you're going to spend $250 million more. 00:36:02.030 --> 00:36:06.020 align:middle line:84% But $250 million more will generate $250 million 00:36:06.020 --> 00:36:09.140 align:middle line:84% of production, which also will generate $250 million 00:36:09.140 --> 00:36:15.430 align:middle line:84% more of income, which will generate $125 million 00:36:15.430 --> 00:36:18.400 align:middle line:84% more of consumption, and blah, blah, blah, blah, blah. 00:36:18.400 --> 00:36:20.200 align:middle line:90% You [INAUDIBLE] OK? 00:36:20.200 --> 00:36:22.480 align:middle line:84% So that's-- and that's what is happening here. 00:36:22.480 --> 00:36:25.770 align:middle line:90% [WHISTLING] Boom. 00:36:25.770 --> 00:36:26.530 align:middle line:90% Yeah? 00:36:26.530 --> 00:36:28.790 align:middle line:84% AUDIENCE: [INAUDIBLE] the movement from C to D 00:36:28.790 --> 00:36:29.290 align:middle line:90% [INAUDIBLE]? 00:36:29.290 --> 00:36:32.710 align:middle line:84% RICARDO J. CABALLERO: From C to D. OK, 00:36:32.710 --> 00:36:38.070 align:middle line:84% so this is the initial shift in aggregate demand up, $1 billion. 00:36:38.070 --> 00:36:43.690 align:middle line:84% That leads to a $1 billion more of production 00:36:43.690 --> 00:36:48.680 align:middle line:84% as well, which means $1 billion more of income, OK? 00:36:48.680 --> 00:36:51.800 align:middle line:84% But now these consumers not only have this C0-- 00:36:51.800 --> 00:36:55.760 align:middle line:84% $1 billion higher in C0, but they also have $1 billion 00:36:55.760 --> 00:36:57.150 align:middle line:90% more of income. 00:36:57.150 --> 00:36:59.120 align:middle line:84% And since they have $1 billion more income, 00:36:59.120 --> 00:37:00.770 align:middle line:84% and they're going to spend part of it-- 00:37:00.770 --> 00:37:03.590 align:middle line:84% C1 times that, and I assume C1 was 0.5-- 00:37:03.590 --> 00:37:06.110 align:middle line:90% that's what gives me CD. 00:37:06.110 --> 00:37:10.490 align:middle line:90% That's the extra $500 million. 00:37:10.490 --> 00:37:13.220 align:middle line:84% And then that thing there is also $500 million. 00:37:13.220 --> 00:37:20.180 align:middle line:84% And there was $250 million, $250 million, $125, $125 $62.5. 00:37:20.180 --> 00:37:24.200 align:middle line:90% That's the way you get there. 00:37:24.200 --> 00:37:28.020 align:middle line:84% There is an alternative way of finding equilibrium output, 00:37:28.020 --> 00:37:29.390 align:middle line:90% which is entirely equivalent. 00:37:29.390 --> 00:37:32.660 align:middle line:84% And it's the way it was initially done, by the way. 00:37:32.660 --> 00:37:37.100 align:middle line:84% And you'll see later on a very important curve in this course 00:37:37.100 --> 00:37:41.090 align:middle line:84% will be the IS curve, which is a curve that 00:37:41.090 --> 00:37:43.820 align:middle line:84% describes all the equilibrium in goods markets. 00:37:43.820 --> 00:37:45.060 align:middle line:90% We'll get there. 00:37:45.060 --> 00:37:48.410 align:middle line:84% But the reason it's called IS because of this alternative way 00:37:48.410 --> 00:37:52.940 align:middle line:84% of deriving the same I have derived, which is through-- 00:37:52.940 --> 00:37:55.680 align:middle line:84% you can arrive to the same equilibrium by saying, 00:37:55.680 --> 00:37:59.210 align:middle line:84% look, equilibrium output is that output at which 00:37:59.210 --> 00:38:01.580 align:middle line:90% investment is equal to savings. 00:38:01.580 --> 00:38:04.580 align:middle line:84% That's the reason that curve is going to be called IS, 00:38:04.580 --> 00:38:07.050 align:middle line:90% investment equal to savings, S. 00:38:07.050 --> 00:38:09.770 align:middle line:84% So let me very quickly do it for you and then make a point 00:38:09.770 --> 00:38:11.490 align:middle line:90% and connect the two things. 00:38:11.490 --> 00:38:16.610 align:middle line:84% So private saving is what consumers do and so on, 00:38:16.610 --> 00:38:17.540 align:middle line:90% and firms. 00:38:17.540 --> 00:38:20.360 align:middle line:84% It's just disposable income minus consumption. 00:38:20.360 --> 00:38:22.310 align:middle line:90% That's your saving, OK? 00:38:22.310 --> 00:38:25.140 align:middle line:84% So it's equal to Y minus T. That's 00:38:25.140 --> 00:38:27.740 align:middle line:90% disposable income minus C. 00:38:27.740 --> 00:38:32.220 align:middle line:84% Government saving is taxes minus government expenditure. 00:38:32.220 --> 00:38:35.210 align:middle line:84% So if the government has a deficit, that thing is negative. 00:38:35.210 --> 00:38:38.240 align:middle line:84% Governments often have negative saving, OK? 00:38:38.240 --> 00:38:42.290 align:middle line:84% If it has a surplus, then taxes are greater than G, 00:38:42.290 --> 00:38:44.450 align:middle line:90% then you have a fiscal surplus. 00:38:44.450 --> 00:38:49.850 align:middle line:84% Again, rarely happens in the US or in the Americas in general. 00:38:49.850 --> 00:38:52.790 align:middle line:84% It happens a lot in Asia, but it doesn't happen very much 00:38:52.790 --> 00:38:54.560 align:middle line:90% in this part of the world. 00:38:54.560 --> 00:38:56.360 align:middle line:90% But there we are. 00:38:56.360 --> 00:39:02.120 align:middle line:84% So in equilibrium, investment, I, has to be equal to saving. 00:39:02.120 --> 00:39:05.850 align:middle line:84% So that's what you are going to use the saving for, to invest, 00:39:05.850 --> 00:39:06.380 align:middle line:90% OK? 00:39:06.380 --> 00:39:09.380 align:middle line:84% So investment is equal to the sum of savings. 00:39:09.380 --> 00:39:11.960 align:middle line:84% I can replace all that in here, and you 00:39:11.960 --> 00:39:15.130 align:middle line:84% see that I get exactly the same equilibrium 00:39:15.130 --> 00:39:16.570 align:middle line:90% condition I had before-- 00:39:16.570 --> 00:39:19.450 align:middle line:84% output equal to aggregate demand. 00:39:19.450 --> 00:39:23.470 align:middle line:84% So this is an entirely equivalent way of deriving this. 00:39:23.470 --> 00:39:27.670 align:middle line:84% And I just want to show you this because it's 00:39:27.670 --> 00:39:29.080 align:middle line:90% the way it was originally done. 00:39:29.080 --> 00:39:32.500 align:middle line:84% And you'll understand better the terminology 00:39:32.500 --> 00:39:35.860 align:middle line:84% we use later on if you see that this is an equivalent way. 00:39:35.860 --> 00:39:39.400 align:middle line:84% This is also a nice way of illustrating something, 00:39:39.400 --> 00:39:41.890 align:middle line:84% why macro can be counterintuitive sometimes. 00:39:41.890 --> 00:39:43.760 align:middle line:84% Microeconomics is very intuitive. 00:39:43.760 --> 00:39:45.730 align:middle line:90% I mean, things make sense. 00:39:45.730 --> 00:39:46.480 align:middle line:90% It's like physics. 00:39:46.480 --> 00:39:47.140 align:middle line:90% It makes sense. 00:39:47.140 --> 00:39:49.730 align:middle line:90% Macro can be confusing. 00:39:49.730 --> 00:39:53.170 align:middle line:84% For example, there is a well-known paradox of savings, 00:39:53.170 --> 00:39:54.770 align:middle line:84% in the short run, not in the long run. 00:39:54.770 --> 00:39:58.270 align:middle line:84% In the short run, you have the paradox of saving. 00:39:58.270 --> 00:40:01.340 align:middle line:84% So we all think that you save more is a good thing. 00:40:01.340 --> 00:40:03.220 align:middle line:84% Our parents teach us that is a good thing 00:40:03.220 --> 00:40:04.940 align:middle line:90% to save more and so on. 00:40:04.940 --> 00:40:07.090 align:middle line:90% And in general, that is true. 00:40:07.090 --> 00:40:10.550 align:middle line:84% You'll do better in life if you save a little more and so on. 00:40:10.550 --> 00:40:13.075 align:middle line:84% But it's not true for the macro in the short run. 00:40:13.075 --> 00:40:16.960 align:middle line:90% 00:40:16.960 --> 00:40:20.650 align:middle line:84% It's not good for macroeconomics in the short run, 00:40:20.650 --> 00:40:22.840 align:middle line:84% unless you are in an overheated economy. 00:40:22.840 --> 00:40:24.250 align:middle line:90% Now it could help. 00:40:24.250 --> 00:40:28.240 align:middle line:84% But otherwise, it's not very good for equilibrium output. 00:40:28.240 --> 00:40:31.840 align:middle line:84% And let me show you that very quickly with the expression 00:40:31.840 --> 00:40:32.590 align:middle line:90% I just showed you. 00:40:32.590 --> 00:40:34.300 align:middle line:84% Remember I said, equilibrium output 00:40:34.300 --> 00:40:37.720 align:middle line:84% is pinned down by investment equal to saving. 00:40:37.720 --> 00:40:39.730 align:middle line:84% And saving-- the private saving here 00:40:39.730 --> 00:40:43.270 align:middle line:84% is an increasing function of output, OK? 00:40:43.270 --> 00:40:45.700 align:middle line:84% It's equal to, actually, 1 minus-- 00:40:45.700 --> 00:40:49.006 align:middle line:84% the function has a slope of 1 minus C1. 00:40:49.006 --> 00:40:52.390 align:middle line:84% C1 is the share of income that you spend in consumption. 00:40:52.390 --> 00:40:55.210 align:middle line:84% Therefore, 1 minus C1 is the share of your income 00:40:55.210 --> 00:40:56.860 align:middle line:90% that you spend in saving, OK? 00:40:56.860 --> 00:41:01.030 align:middle line:84% So this function is increasing with a slope of 1 minus C1. 00:41:01.030 --> 00:41:03.190 align:middle line:84% So suppose I tell you now that all we 00:41:03.190 --> 00:41:05.830 align:middle line:84% decided to learn the lessons of our parents 00:41:05.830 --> 00:41:08.720 align:middle line:84% and say, OK, we should all save more. 00:41:08.720 --> 00:41:11.830 align:middle line:84% So that means, for any given level of income, 00:41:11.830 --> 00:41:13.750 align:middle line:90% now we all decide to save more. 00:41:13.750 --> 00:41:17.570 align:middle line:84% That means the S function shifts up. 00:41:17.570 --> 00:41:20.750 align:middle line:84% For any given level of income, we save more. 00:41:20.750 --> 00:41:23.390 align:middle line:84% But we have a problem there because now we have more savings 00:41:23.390 --> 00:41:26.380 align:middle line:90% than investment. 00:41:26.380 --> 00:41:28.270 align:middle line:84% So how do we restore equilibrium? 00:41:28.270 --> 00:41:29.530 align:middle line:90% That's not in equilibrium. 00:41:29.530 --> 00:41:31.180 align:middle line:90% How do we restore equilibrium? 00:41:31.180 --> 00:41:37.460 align:middle line:90% 00:41:37.460 --> 00:41:42.570 align:middle line:84% So now we all decided to be more prudent and save a little more. 00:41:42.570 --> 00:41:45.160 align:middle line:84% At the level of the economy as a whole, 00:41:45.160 --> 00:41:47.460 align:middle line:84% now we have more saving than investment. 00:41:47.460 --> 00:41:49.030 align:middle line:90% That can't happen. 00:41:49.030 --> 00:41:51.320 align:middle line:90% It's not an equilibrium. 00:41:51.320 --> 00:41:54.860 align:middle line:90% What restores equilibrium? 00:41:54.860 --> 00:41:58.820 align:middle line:84% Well, in this very simple model, our investment is fixed. 00:41:58.820 --> 00:42:00.920 align:middle line:84% So nothing can adjust on the investment side 00:42:00.920 --> 00:42:02.000 align:middle line:90% because it's fixed. 00:42:02.000 --> 00:42:04.370 align:middle line:84% Later on, it's going to move, but now it's fixed. 00:42:04.370 --> 00:42:06.620 align:middle line:84% Nothing can adjust in the public savings part 00:42:06.620 --> 00:42:08.990 align:middle line:90% because it can't move. 00:42:08.990 --> 00:42:10.430 align:middle line:90% We assume that it's exogenous. 00:42:10.430 --> 00:42:12.770 align:middle line:84% So something has to happen endogenously 00:42:12.770 --> 00:42:16.428 align:middle line:84% here that the reverses the increase in savings, 00:42:16.428 --> 00:42:17.720 align:middle line:90% the only thing that can happen. 00:42:17.720 --> 00:42:20.330 align:middle line:84% And the only thing can happen endogenously here 00:42:20.330 --> 00:42:22.205 align:middle line:90% is a decline in output-- 00:42:22.205 --> 00:42:24.510 align:middle line:84% output declines, saving declines. 00:42:24.510 --> 00:42:26.660 align:middle line:84% So here you end up in a situation 00:42:26.660 --> 00:42:29.600 align:middle line:84% in which we all decided to be better people, 00:42:29.600 --> 00:42:30.680 align:middle line:90% save a little more. 00:42:30.680 --> 00:42:35.140 align:middle line:84% And we ended up sinking the economy in a recession-- 00:42:35.140 --> 00:42:36.843 align:middle line:90% output decline. 00:42:36.843 --> 00:42:39.010 align:middle line:84% That's the reason it's called the paradox of saving. 00:42:39.010 --> 00:42:41.322 align:middle line:90% 00:42:41.322 --> 00:42:43.280 align:middle line:84% That's not going to happen to you individually, 00:42:43.280 --> 00:42:45.470 align:middle line:84% but to an economy as a whole, that's 00:42:45.470 --> 00:42:47.660 align:middle line:84% the reason I said it's counterintuitive. 00:42:47.660 --> 00:42:48.485 align:middle line:90% It can happen. 00:42:48.485 --> 00:42:53.400 align:middle line:90% 00:42:53.400 --> 00:42:57.605 align:middle line:84% So look, if you don't like this way of-- 00:42:57.605 --> 00:42:59.480 align:middle line:84% and it's not the main way we're going to use. 00:42:59.480 --> 00:43:01.855 align:middle line:84% If you don't like this way of finding equilibrium output, 00:43:01.855 --> 00:43:02.630 align:middle line:90% just ignore it. 00:43:02.630 --> 00:43:03.950 align:middle line:90% I just wanted you to know it. 00:43:03.950 --> 00:43:06.560 align:middle line:84% Go back to-- the thing you really need to understand 00:43:06.560 --> 00:43:07.320 align:middle line:90% is not this. 00:43:07.320 --> 00:43:09.060 align:middle line:90% It's this, that, that. 00:43:09.060 --> 00:43:10.530 align:middle line:90% That you need to understand. 00:43:10.530 --> 00:43:14.210 align:middle line:84% So let me illustrate the paradox of saving 00:43:14.210 --> 00:43:16.100 align:middle line:84% in the model we're using, in the one 00:43:16.100 --> 00:43:18.950 align:middle line:90% I want you to really remember. 00:43:18.950 --> 00:43:25.640 align:middle line:84% Well, the paradox of saving I can capture by a decline in C0. 00:43:25.640 --> 00:43:28.550 align:middle line:84% For any given level of income, now we decide to consume less. 00:43:28.550 --> 00:43:31.040 align:middle line:84% If we consume less for any given level of income, 00:43:31.040 --> 00:43:34.530 align:middle line:90% that means we're saving more. 00:43:34.530 --> 00:43:40.160 align:middle line:84% So I can capture in this diagram the fact 00:43:40.160 --> 00:43:42.770 align:middle line:84% that we have all become sort of more prudent 00:43:42.770 --> 00:43:46.680 align:middle line:84% by a decline in aggregate demand. 00:43:46.680 --> 00:43:48.260 align:middle line:84% But if aggregate demand declines-- so 00:43:48.260 --> 00:43:50.468 align:middle line:84% suppose we start at this equilibrium level of output, 00:43:50.468 --> 00:43:52.980 align:middle line:84% and then, all of a sudden, we say, OK, enough is enough. 00:43:52.980 --> 00:43:55.490 align:middle line:90% We need to start saving more. 00:43:55.490 --> 00:43:57.650 align:middle line:90% Then what happens? 00:43:57.650 --> 00:44:00.260 align:middle line:90% Well, aggregate demand declines. 00:44:00.260 --> 00:44:02.240 align:middle line:84% I mean, for any given level of income, 00:44:02.240 --> 00:44:03.350 align:middle line:84% if you're going to save more, that means 00:44:03.350 --> 00:44:04.558 align:middle line:90% you're going to consume less. 00:44:04.558 --> 00:44:06.260 align:middle line:90% So aggregate demand declines. 00:44:06.260 --> 00:44:10.027 align:middle line:84% But what happens when aggregate demand declines? 00:44:10.027 --> 00:44:11.110 align:middle line:90% AUDIENCE: Output declines. 00:44:11.110 --> 00:44:12.970 align:middle line:84% RICARDO J. CABALLERO: Output declines. 00:44:12.970 --> 00:44:17.174 align:middle line:84% What happens when output declines? 00:44:17.174 --> 00:44:18.110 align:middle line:90% AUDIENCE: [INAUDIBLE] 00:44:18.110 --> 00:44:19.693 align:middle line:84% RICARDO J. CABALLERO: Income declines. 00:44:19.693 --> 00:44:21.140 align:middle line:84% What happens when income declines? 00:44:21.140 --> 00:44:25.517 align:middle line:90% 00:44:25.517 --> 00:44:27.100 align:middle line:84% Well, part of that income you consume. 00:44:27.100 --> 00:44:28.630 align:middle line:90% So you're going to consume less. 00:44:28.630 --> 00:44:30.010 align:middle line:90% C1 times that. 00:44:30.010 --> 00:44:33.290 align:middle line:84% So then-- and then you get the multiplier working against you. 00:44:33.290 --> 00:44:36.070 align:middle line:84% So not only-- if now we all decide to save more, 00:44:36.070 --> 00:44:39.790 align:middle line:84% not only output falls by the same amount 00:44:39.790 --> 00:44:43.150 align:middle line:84% that we increase savings, but actually 00:44:43.150 --> 00:44:45.700 align:middle line:84% declines by more than that because you get the multiplier 00:44:45.700 --> 00:44:49.360 align:middle line:90% working against you, OK? 00:44:49.360 --> 00:44:53.320 align:middle line:84% That's the reason a big role of policymakers, really, 00:44:53.320 --> 00:44:57.232 align:middle line:84% in recession is to try to maintain the calm because you 00:44:57.232 --> 00:44:58.690 align:middle line:84% can get into these kinds of things. 00:44:58.690 --> 00:45:02.290 align:middle line:84% It's everybody gets scared, and we all get scared. 00:45:02.290 --> 00:45:07.090 align:middle line:84% So the economy can implode just out of bad sentiment and so on. 00:45:07.090 --> 00:45:14.110 align:middle line:90% 00:45:14.110 --> 00:45:16.930 align:middle line:84% Now we're on the opposite side of the cycle. 00:45:16.930 --> 00:45:20.310 align:middle line:84% We would want output to decline a little because we are having 00:45:20.310 --> 00:45:22.560 align:middle line:84% other problems, inflation and so on-- again, something 00:45:22.560 --> 00:45:24.160 align:middle line:90% we'll discuss later. 00:45:24.160 --> 00:45:26.730 align:middle line:84% So now you may want to scare consumers a little. 00:45:26.730 --> 00:45:34.227 align:middle line:84% And in fact, the governance of the Federal Reserve-- 00:45:34.227 --> 00:45:36.560 align:middle line:84% and the same is happening in other places in the world-- 00:45:36.560 --> 00:45:37.590 align:middle line:90% are doing just that. 00:45:37.590 --> 00:45:42.790 align:middle line:84% I mean, when they go out there, says the economy is too hot, 00:45:42.790 --> 00:45:45.090 align:middle line:84% we're going to have to mess up this economy a little. 00:45:45.090 --> 00:45:47.110 align:middle line:84% [CHUCKLES] They're telling us that. 00:45:47.110 --> 00:45:50.160 align:middle line:84% And the first one is listen to these things 00:45:50.160 --> 00:45:51.370 align:middle line:90% is the financial markets. 00:45:51.370 --> 00:45:54.420 align:middle line:84% So every time they come out and make a speech of that kind, 00:45:54.420 --> 00:45:56.610 align:middle line:90% equity markets decline. 00:45:56.610 --> 00:45:59.670 align:middle line:84% Well, equity markets capture before the mood 00:45:59.670 --> 00:46:02.490 align:middle line:84% that consumers will have in the future, captures it early. 00:46:02.490 --> 00:46:04.470 align:middle line:90% But that's the message, OK? 00:46:04.470 --> 00:46:06.840 align:middle line:84% So they're trying-- at this moment, 00:46:06.840 --> 00:46:11.460 align:middle line:84% really, policymakers-- at least the central banks-- 00:46:11.460 --> 00:46:15.990 align:middle line:84% are trying to do just that, depress a little bit consumers 00:46:15.990 --> 00:46:19.980 align:middle line:84% so we can cool off the economy a bit. 00:46:19.980 --> 00:46:22.400 align:middle line:90% OK. 00:46:22.400 --> 00:46:24.080 align:middle line:90% Any questions? 00:46:24.080 --> 00:46:26.660 align:middle line:84% Again, very important lecture because we're 00:46:26.660 --> 00:46:29.420 align:middle line:84% going to build on this and, later on, this 00:46:29.420 --> 00:46:32.010 align:middle line:84% is going to be always in the background. 00:46:32.010 --> 00:46:35.060 align:middle line:84% And of this-- until we actually go 00:46:35.060 --> 00:46:38.390 align:middle line:84% to the third part of the course, the key model will be this. 00:46:38.390 --> 00:46:39.830 align:middle line:90% This will be in the background. 00:46:39.830 --> 00:46:42.110 align:middle line:84% More things will be happening on top. 00:46:42.110 --> 00:46:45.260 align:middle line:84% But whenever I ask you a question-- 00:46:45.260 --> 00:46:47.960 align:middle line:84% for example, later-- ah, one example-- 00:46:47.960 --> 00:46:54.930 align:middle line:84% what else would produce a situation like this? 00:46:54.930 --> 00:46:56.840 align:middle line:90% What else-- what could happen? 00:46:56.840 --> 00:47:03.902 align:middle line:84% What kind of policy would generate that movement? 00:47:03.902 --> 00:47:06.360 align:middle line:84% Well, at this point, we haven't introduced monetary policy. 00:47:06.360 --> 00:47:09.050 align:middle line:84% So you cannot talk about monetary policy. 00:47:09.050 --> 00:47:13.055 align:middle line:84% But we do have other kinds of policy we could talk about. 00:47:13.055 --> 00:47:24.060 align:middle line:90% 00:47:24.060 --> 00:47:24.560 align:middle line:90% Remember? 00:47:24.560 --> 00:47:30.470 align:middle line:90% 00:47:30.470 --> 00:47:32.720 align:middle line:90% Here, fiscal policy. 00:47:32.720 --> 00:47:35.260 align:middle line:90% 00:47:35.260 --> 00:47:36.590 align:middle line:90% OK? 00:47:36.590 --> 00:47:37.300 align:middle line:90% Fiscal policy. 00:47:37.300 --> 00:47:39.920 align:middle line:84% G and T, those are fiscal parameters. 00:47:39.920 --> 00:47:43.130 align:middle line:84% When G goes down or T goes up, we 00:47:43.130 --> 00:47:45.470 align:middle line:84% call that contractionary fiscal policy. 00:47:45.470 --> 00:47:46.700 align:middle line:90% Why contractionary? 00:47:46.700 --> 00:47:49.170 align:middle line:84% Because it contracts aggregate demand. 00:47:49.170 --> 00:47:51.560 align:middle line:84% If G goes down, clearly aggregate demand 00:47:51.560 --> 00:47:52.790 align:middle line:90% goes down immediately. 00:47:52.790 --> 00:47:55.580 align:middle line:84% If T goes up, well, disposable income 00:47:55.580 --> 00:47:57.410 align:middle line:84% for any given level of income goes down, 00:47:57.410 --> 00:47:59.270 align:middle line:84% and therefore, consumption goes down. 00:47:59.270 --> 00:48:03.500 align:middle line:84% So we call an increase-- a decline in G or an increase in T 00:48:03.500 --> 00:48:05.930 align:middle line:90% a contractionary fiscal policy. 00:48:05.930 --> 00:48:08.910 align:middle line:84% The opposite-- if G goes up, and T goes down, 00:48:08.910 --> 00:48:11.250 align:middle line:84% we call that an expansionary fiscal policy. 00:48:11.250 --> 00:48:16.510 align:middle line:84% So I take you back to this diagram here. 00:48:16.510 --> 00:48:18.070 align:middle line:84% And I ask you the question again, 00:48:18.070 --> 00:48:21.790 align:middle line:84% what kind of fiscal policy will generate this type of-- 00:48:21.790 --> 00:48:24.040 align:middle line:90% this picture? 00:48:24.040 --> 00:48:25.810 align:middle line:90% Contractionary or expansionary? 00:48:25.810 --> 00:48:32.590 align:middle line:90% 00:48:32.590 --> 00:48:33.590 align:middle line:90% AUDIENCE: Contractionary 00:48:33.590 --> 00:48:35.132 align:middle line:84% RICARDO J. CABALLERO: Contractionary. 00:48:35.132 --> 00:48:37.700 align:middle line:84% I mean, a good mnemonic, the output decline. 00:48:37.700 --> 00:48:41.600 align:middle line:84% So contractionary-- so that is a decline-- a reduction in G, 00:48:41.600 --> 00:48:43.100 align:middle line:90% in going expenditure. 00:48:43.100 --> 00:48:47.630 align:middle line:84% Or an increase in taxes will shift that curve down. 00:48:47.630 --> 00:48:50.720 align:middle line:84% And then the multiplier will make it even more contractionary 00:48:50.720 --> 00:48:52.595 align:middle line:90% than the initial fiscal impulse. 00:48:52.595 --> 00:48:55.190 align:middle line:90% 00:48:55.190 --> 00:48:57.690 align:middle line:90% OK? 00:48:57.690 --> 00:49:01.280 align:middle line:90% Very good, see you on Wednesday. 00:49:01.280 --> 00:49:13.000 align:middle line:90%