Crowding In or Crowding Out?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Classical Macro Model

 

 

 

 

 

 

 

 

 

 

 

 

1. AGGREGATE DEMAND FUNCTION

 

AD = C + I + G

 

C = CONSUMPTION SPENDING FROM HOUSEHOLD SECTOR

 

I = INVESTMENT SPENDING FROM BUSINESS SECTOR

 

G = GOVERNMENT SPENDING BY PUBLIC SECTOR

 

 

 

 

 

 

 

 

 

 

2. CONSUMPTION FUNCTION

 

C = A + B (Y - T)

 

"B" = marginal propensity to consume

 

T = GOVERNMENT TAXES

 

(Y - T) = DISPOSABLE PERSONAL INCOME

 

"A" IS AUTONOMoUS SPENDING FROM WEALTH

 

 

 

 

 

 

 

 

 

 

 

3. INCOME/AGGREGATE DEMAND IDENTITY

Y = AD

ONE PERSON'S SPENDING IS ANOTHER PERSON'S INCOME

 

 

 

 

 

 

 

 

 

 

 

 

Keynesian Macro Model

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FISCAL POLICY TOOL BOX

BASIC multiplier a = 1 / (1 - b)

 

 

 

 

 

 

 

 

 

 

Example:

If b = .8 then a = 5 and -ab = -4

and the Balanced Budget (DG= DT)

Multiplier is = (5 - 4) = 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crowding Out compromise

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CLOSING THE BACK DOOR

("Internal" Rate of Return)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

keynesian investment decision

INTEREST BUSINESS   AGGREGATE
RATEs INVESTMENT DEMAND

 

 

 

 

 

 

 

 

 

 

 

 

 

INTERNAL RATE OF RETURN

IRR = CF/ K

Project BOOM RECESSION
k = cost
CF
IRR
CF
 IRR
A $450M
$54M
12%
$36M
 8%
B $450M
$36M
8%
$18M
 4%
C $450M
$18M
4%
$0
 0%

investment RULE:

Compare IRR to Market Rate R

if IRR > r, then DO it .

 

 

 

 

 

 

 

 

 

 

 

internal rate of return

 

 

 

 

 

 

 

 

 

 

© 2007 Vanderbilt