Adding Government and Net Exports to the expenditure function

IMPORTANT: We spent a lot of time determining equilibrium values in this course, but it's important to remember that equilibrium is NOT NECESSARILY A GOOD THING: You could have an equilibrium level of national income which is abysmal and leads to unprecedented unemployment. The only thing we can state about the equilibrium level is that it does not change over time! Ye = the National Income at equilibrium

THE GOVERNMENT

Government purchases are added as a separate category to aggregate expenditure, but transfer payments are not (don't worry, they get factored in later)
-Remember, we are still assuming a constant price level
-Fiscal policy directs government purchases (which increase aggregate expenditure) and taxation (which decreases aggregate expenditure) to effect the equilibrium level of national income
-Government purchases affect aggregate expenditure DIRECTLY
-Taxes affect aggregate expenditure INDIRECTLY (they affect disposable income and consumption)
-Government SPENDING includes transfer payments AND government purchases. We don't include transfer payments in government purchases, however.

Government purchases are usually a function of election promises, not national income!

THEREFORE: Government purchases are a constant in the functional relationship with national income (not unlike investments, government spending as a function of national income is a flat line)


NET TAXES:
-Taxes DECREASE disposable income, while transfer payments increase disposable income
-Disposable income = Income minus net taxes
-Net taxes = Taxes minus transfer payments
-Usually, taxes are a function of income, and change with income: T = f(Y)
-We could say that T = tY, where t = the net tax rate (also called the marginal propensity to tax, or the marginal rate of taxation)
-If t is constant, then that is a flat tax rate
-Taxes include income tax, corporate tax, sales taxes, excise taxes, property taxes, and others!


THE BUDGET FUNCTION!

The government's budget is net taxation minus government purchases (money in minus money out): It's important to remember that this is withdrawals and injections for the GOVERNMENT, not for the circular flow economy (in terms of the economy, it's the opposite: taxes are withdrawals and government purchases are injections)

There are 3 types of budgets which a government can ring up:
-A budget surplus, where net taxes are higher than purchases, and therefore government revenues outweigh government expenditures
-A budget defecit, where net taxes are lower than purchases, and therefore government expenditures outweigh government revenues
-A balanced budget, where net taxes are equal to government purchases, and therefore government expenditure is equal to government revenue

THE PUBLIC SAVINGS FUNCTION is the budget surplus function: This is derived by graphing both government purchases and net taxes as functions of national income. While taxes increase with income (and thus form an upward-sloping line), purchases are flat. The point where taxes and purchases intersect is a balanced budget. The area where government purchases are greater than the level of net taxation represents budget deficits, while the area where net taxes are higher than government purchases represents budget surpluses.

The public savings function combines these two into one function to represent budget savings!
It is equal to Net Taxes minus Government Purchases as a function of national income
(T - G) = f(Y)

This shows that the budget changes as GDP changes. REMEMEBER: This budget represents money inflows and outflows for the government: while a government budget deficit is bad for the government in that they are losing money, it is good for the economy, in that the economy receives a monetary injection.

THE FEDERAL GOVERNMENT taxes about equal to provincial and municipal taxes, but federal government purchases are less than provincial municipal purchases. As a result, the feds spend more on transfer payments to the provinces. We include spending and taxing on all levels in our national income and expenditure accounts.

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NET EXPORTS AND THE NET EXPORT FUNCTION

Net exports = imports minus exports (another name for this is the balance of trade)

-A balance of trade surplus occurs when there is more foreign money spent on exports than domestic money spent on imports (money in is higher than money out)
-A balance of trade deficit occurs when there is more domestic money spent on imports than foreign money spent on exports (money out is higher than money in)
-A balance of trade occurs when there are equal exports and imports, and money in is equal to money out

Exports are autonomous, since they depend on foreign economies, so we see than as a constant (flat line graph) in a functional relationship with national income
Imports, however, increase with national income, so we could say that:
Imports = m(Y) (where m is the marginal propensity to import [the slope of the import function], and Y is national income, not disposable income)

We can graph both imports and exports as functions of national income, and then find the difference between the value of exports and the value of imports to determine net exports.

Net exports = (imports minus exports) as a function in national income
fY = X-M

This appears as a downward sloping line. When the national income is very low, there will not be a lot of imports, but there will be a constant amount of exports, so the value of the exports will outweigh the value of the imports, leading to a positive value for net exports. When national income is high, however, imports outweigh exports, leading to a negative value for net exports.

SHIFTS IN THE NET EXPORT FUNCTION
-Two things affect net exports as ceteris paribus variables
1) Foreign income (which affects domestic export levels)
2) Relative prices of goods (aka: the exchange rate)
-Domestic prices rise if domestic inflation rises or if the external value of domestic currencies rise
-Foreign prices rise if foreign inflation rates rise, or if the exchange rate of foreign currencies rise.
-Foreigners like to buy things that are CHEAPER, so the higher the exchange rate of their currencies, and the lower the external value of domestic currencies, the more they will want to import!

Generally, an increase in exports causes the net export function to shift up (and a decrease would cause it to shift down)
Meanwhile. an increase in the marginal propensity to import (the slope of the import function) causes net exports to rotate down (so net exports fall more steeply as a function of national income if MPM is higher)

Examples:
If a foreign country's national income decreases, then exports will decrease, and the net export function will shift downward
If relative canadian prices increase, this will lead to a reduction in exports, so the net export function will shift downward. However, this will ALSO lead to an increase in domestic consumers importing products (an increase in the marginal propensity to import), so the net export function will also rotate downward.
-An increase in external value (appreciation of domestic currencies) causes the same affect as an increase in the general domestic price level (fewer exports, and an increase in the MPS)

That's all for today