ACC 818 — Module 9: Adding Government & Trade
Module 8’s Keynesian cross treated G and NX as constants. This module makes them endogenous — and then graduates from the Keynesian cross to the more general AD/AS model by adding the price level.
Learning Outcomes
- Add government purchases and tax revenues to the macro model
- Add foreign trade (exports and imports)
- Explore fiscal stabilization policy
- Examine the aggregate demand curve and what causes it to shift
- Examine aggregate supply
Topic 1: Government and Trade
Government in the model
- G (government purchases of goods/services) is treated as horizontal — independent of GDP, set by political budget process.
- T (taxes net of transfers) rises with GDP — income tax revenue grows with income; sales tax grows with sales.
- Why net of transfers? Transfers are negative taxes — both affect disposable income, just with opposite signs.
- “Government” includes federal + provincial + municipal. In Canada, provinces collectively spend more than the federal government.
Trade in the model
- Exports (X) — autonomous w.r.t. domestic GDP. (Other countries’ incomes determine our exports.)
- Imports (IM) — rise with domestic GDP. The slope is the Marginal Propensity to Import (MPI).
- Net exports (NX = X − IM) — slopes downward in GDP.
Topic 2: Aggregate Supply (AS)
AS curve: relationship between the price level and total output firms wish to supply, holding factor prices and technology constant.
Why short-run AS slopes upward:
- Wages are rigid in the short run (contracts, legal minimums, annual reviews).
- When the price level rises but wages don’t, output prices grow relative to wages → firms find hiring more attractive → output expands.
AS shifts when factor prices (wages, raw materials) or technology change.
Topic 3: Aggregate Demand (AD)
AD curve: total quantity of goods/services demanded across all four sources (C, I, G, NX) at each price level.
Why AD slopes downward — two effects:
- Wealth effect: higher P → real value of money/savings falls → consumption falls → AD falls.
- Net exports effect: higher P → domestic goods more expensive vs. foreign → exports fall, imports rise → NX falls → AD falls.
(Note: this is a different mechanism from individual demand curves. Don’t conflate.)
AD/AS Equilibrium
The intersection of AD and AS gives the equilibrium price level and real GDP — what the textbook calls macroeconomic equilibrium.
Demand shocks shift AD (e.g. a change in consumer confidence, fiscal policy, money supply). Supply shocks shift AS (e.g. OPEC oil price rises in the 1970s; the post-Asian-crisis fall in raw materials in 1997–98; COVID-19 had both demand and supply components).
Key Terms
Government Purchases · Net Taxes · Marginal Propensity to Import · Net Exports · Aggregate Supply · Aggregate Demand · Wealth Effect · Macroeconomic Equilibrium · Demand Shock · Supply Shock