Transcript Ch 8 Basic Macro Relationships [Building AE 1] [AP]

AE[C+Ig+G]
AD2 LRAS SRAS
AE2[C+Ig+G]
AE1[C+Ig]
AD1
PL
PL
o
45
YR Y*
Real GDP
YR Y*
Real GDP
AE[C+Ig+G]
AE1[C+Ig1]
AE2[C+Ig2]
LRAS SRAS
AD1
AD2
PL
PL
o
45
Y* YI
RGDP
Y* YI
Weaknesses [Limitations] of the AE Model
•
•
•
•
•
RGDP
Does Not Show Price Level Changes
Does not show Demand-Pull Inflation
Does Not Deal With Cost-Push Inflation [Stagflation]
It ignores premature demand-pull inflation [Inflation just before FE GDP]
It does not allow for “self-correction”
In this Chapter we will learn:
1. How changes in income affect consumption [& saving].
2. About factors other than income that can affect
consumption [like wealth or expectations]
3. How changes in real interest rates affect investment.
4. How factors other than the real interest rate can affect
investment (like profit expectations or stock on hand).
5. Why changes in investment increase or decrease real
GDP by a multiple amount due to the multiplier effect.
[Simple [Basic] economy to Complex economy]
[C + Ig]
Private - closed Private-closed
[C + Ig + Xn] Private-open
[C+Ig+G+Xn]
Private-open
Mixed - open Mixed-open
(AE3)630
(AE2)550
(AE1)470
C=390
+80 +80 +80
45°
0 390 470 550 630 Real GDP
“ME” = 4
AE(C+Ig)
AE3 (C+Ig+G+Xn) (Complex Economy) [Mixed-open]
AE2 (C+Ig+Xn) (Private-open) [X(40)-M(20)]
AE1(C+Ig)[Basic Economy][Private(no G)-Closed(no X or M)]
S
AE(C+Ig2)
Consumption
500
AE(C+Ig1)
460
45°
460
YR
500 Real GDP
Y*
AE[C + Ig]
Multiplier=4
(billions of dollars)
AE[C+Ig] [“Basic” or “Simple” economy]
C + Ig
Private - Closed
Consumption
Equilibrium
470
Ig = $20 Billion
450
390
+20 +60 more
370
[increase 80]
C =$450 Billion
45º
o
Real GDP
GDP will increase by a “multiple” of 4 &
that is why it is called the “multiplier”.
370
390
410 430 450
470
490 510 530 550
[Income change, movement from point to point]
SAVING
Consumption
Consumption
C2
Breakeven
C1
DISSAVING
DI2 Disposable Income
S
SAVING
o
DISSAVING
o
o DI3 DI1
Saving
[Negative saving]
45
So, the key to a
change in QC(QS)
is a change in ?
S
Disposable Income
Decrease in PL
Expect. PL incr.
Expect. of positive Y
Expect. of shortages
Decrease in debt
*Decrease in taxes
Consumption
[shift/whole curve/non-income]
C2
May be caused by:
Increase in wealth
C1
Saving
*Decrease in taxes
o
increases both C & S
I’ll buy more and
save even more.
o
Increases in
consumption
means…
45
o
Disposable Income
S1 Decrease
S2 in saving
Disposable
Income
[shift/whole curve/non-income]
May be caused by:
o
o
Decreases in
consumption
means…
45
Disposable Income
Increase
S2
S in saving
0
Saving
*Increase in taxes
decreases both C & S
Consumption
Decrease in wealth
Increase in PL
Expect. PL decrease
Expect. neg. future Y
Increase in debt
*Increase in taxes
C1
C2
o
Disposable Income
Global Perspective
Average Propensities to Consume
Select Nations GDPs
Average Propensities to Consume
.80
.85
.90
.95
1.00
United States
.963
Canada
.958
United Kingdom
.953
Japan
.942
Germany
.896
Netherlands
.893
Italy
France
.840
.833
Source: Statistical Abstract of the United States, 2006
[Nominal I.R. – inflation rate = Real I.R.]
-
2%
8%
Nominal
Interest
Rate
=
-
Inflation
Premium
=
6%
Real
Interest
Rate
Marginal Efficiency of Investment [MEI]
[If expected returns equal or exceed the real interest rate of
interest, the firm will normally make the investment.]
[One firm’s demand
curve for investment]
MEI = 27%
30%
Real Interest Rate
25%
MEI=20%
20%
MEI=15%
15%
MEI=12%
10%
5%
Add new
wing to
factory
$1 mil.
Renovate plant
$2 million
0
1
2
MEI = 7%
Acquire
additional
power
facilities Install computer
$1.5 mil. system $1 mil.
Purchase
machines
$1.5 mil.
3
4
5
6
[QID] Quantity of Investment Demanded (millions)
Real Interest Rates
[MEI]
Firms invest with their profits
25%
& also borrow(5%) to invest.(10%)
20%
[A 20% cost of
funds attract
$100 billion of
investment
15%
10%
5%
I.R.
DI (MEI)
A 5% cost of funds
attracts $200 bil. Ig
0
50
100
QID1
QID
150 200 250
QID2
Change in QID
[interest rate change, point to point movements]
Single Firm
Positive profit expectations and the real interest
rate are the most important determinants of investment.
Drill Press - $1,000
A. Expected gross profits = $1,100 or a 10% return.
[$100/$1,000 x 100 = 10%]
[At 8%, invest in the drill; at 12%, don’t invest]
B. Real interest rate [nominal interest rate-inflation]
(percents)
Expected rate of return,
and interest rate,
10
r,
16
i
(Interest rate change, point to point movement)
DI
Firms will undertake all investments
[additions to plant, equipment, inventory,
14
and residential construction] which have an
expected rate of net profit greater than
[or equal to] the real rate of interest.
12
Monetary Policy – by lowering
interest rates, the Fed can
increase Ig & employment.
8%
6
4%
2
0
1
10
15 20 25 30 35 40
Investment (billions)
QID
QID
[Inverse relationship between real interest rate and QID]
Increase in Investment
1.
2.
3.
4.
5.
I1
Positive profit expectations
Scarcity of inventory
Technology [innovation]
Decrease in production costs
Decrease in business taxes
I2
8%
QID1 QID2
Investment
Investment
Schedule
Ig independent of Y
DI
Investment
(billions of dollars)
Expected rate of return, r, and
real interest rate, i (percents)
Demand Curve
8
20
Ig
20
20
20
20
Investment
(billions of dollars)
Y1
Y2
Y3
Real Domestic Product, GDP
(billions of dollars)
Ig on the AE graph will be independent [not influenced] by income.
Investment decisions are forward-looking and made months ahead.
“Closed” Closed and “private” [C+Ig] “Simple Economy”
“Open” & “private” [C+Ig+Xn]
“Open” & “mixed”
[C+Ig+G+Xn] “Complex Economy”
C+Ig Assumptions: No internat. trade
or “G”
; no business saving;
depreciation & NFFIEUS are 0; PL is constant [Keynesian] [GDP = DI]
1. The most important determinant of consumer spending is
(wealth/indebtedness/income).
2. As aggregate income increases, consumption and saving
both (increase/decrease).
3. The (consumption/saving) schedule shows how much
households plan to consume at various income levels.
4. Dissaving occurs where consumption (exceeds/is less than) Y.
5. If the consumption schedule shifts upward [not caused by
a tax change], the saving schedule will shift (upward/downward).
6. (The expectation of a recession/A change in consumer incomes/
An expected change in the price level) will not cause the
consumption curve to shift.
APC
and APS
APC - percentage of income (“Y”) consumed.
APS – percentage of income (“Y”) saved.
APC = C/Y(DI)=$48,000/$50,000 = .96
1
APS = S/Y(DI)= $2,000/$50,000 = .04
APC = C/Y=$52,000/$50,000 = 1.04
1
APS = S/Y= -$2,000/$50,000 = -.04
“Econ,
Econ,
APS=S/Y
“High maintenance
Econ teacher”
What in the
world is AE?
AE=GDP
APC=C/Y
MPC, MPS, & the Multiplier
ME=1/MPS
MPC - % change in Y consumed.
MPS - % change in Y saved.
MPC = C/ Y = $750/$1,000 = .75
MPS = S/ Y = $250/$1,000 = .25
Multiplier [1/MPS]=1/.25=$1/.25 = “ME” of 4
[MPC is important for G in policy making decisions.]
*The ME is the reciprocal of the MPS.
The “ME” works like a concentric circle.
$20 billion “G”
[with ME of 4]
15 bil.
11.25 bil.
8.5 bil.
MPC of 75%
G spends $200 billion on the highways.
Highway workers save 25% of $200 billion [$50
billion] & spend 75% or $150 billion on boats.
Boat makers save 25% of $150 billion [$37.50 billion]
and spend 75% or $112.50 billion on iPhones, etc.
ME = 1/MPS, 1/.25 = $1/.25 = ME of 4
(billions )
ME is 4 & we are short of Y*[$860] by $60 billion
AE[C+Ig+G]
Equilibrium
AE[C+Ig+G]
AE[C+Ig]
G = $15 Billion
+60
Recess. Spending gap
o
Recessionary GDP Gap
45
o
Recess. Gap
800
Yr
“M” =
860
Y*
Real GDP
Y/ E = 60/15 = 4
Now, let’s look at the Tax Multiplier [MT]
MT = -MPC/MPS, -.75/.25 = ME of -3
MT is -3 & we are short of Y*[$860] by $60 billion
-3 x ? will close a $60 billion GDP gap?
With this situation, [short of Y* by $60 bil.],
we would need to decrease taxes by $20
billion, with a multiplier of -3.
[-3 x -$20 = $60]
MT = -MPC/MPS, -.75/.25 = MT of -3
(billions )
MT is -3 & we are short of Y*[$860] by $60 billion
AE[C+Ig+G]
Equilibrium
AE[C+Ig+G]
AE[C+Ig]
+60
Recess. Spending gap
o
Recessionary GDP Gap
45
o
Recess. Gap
800
Yr
-3 x -$20 = $60 billion
860
Y*
Real GDP
ME and MT
Let’s say that we have a Recessionary GDP [Output] Gap of $60
billion & the MPS is .50. Let’s correct the economy by first using:
1.) Government spending, and then using a
2.) Tax cut
With a MPS of .50, what is the ME?
1/.5 =
With a MPS of .50, what is the MT?
-.5/.5 = -
AE[C+Ig+G]
Equilibrium
AE[C+Ig]
G = $30 Billion
AE[C+Ig+G]
(billions of dollars)
ME = 1/MPS, 1/.50 = $1/.50 = ME of 2
ME is 2 & we are short of Y*[$860] by $60 billion
Recess. Spending gap
o
Recessionary GDP Gap
+60
45
o
Recess. Gap
800
YR
“M” =
-2 x -$30 = $60 billion
860
Y*
Real GDP
Y/ E = 60/30 = 2
MT = -MPC/MPS, -.50/.50 = MT of -1
recessionary
gap with a tax
cut. MPS=.5
Recess. Spending gap
o
Recessionary GDP Gap
AE[C+Ig+G]
Equilibrium
AE[C+Ig]
AE[C+Ig+G]
Now, let’s look
at correcting
this $60 billion
(billions of dollars)
MT is -1 & we are short of Y*[$860] by $60 billion
+60
45
o
Recess. Gap
800
YR
-1 x -$60 = $60 billion
860
Y*
Real GDP
ME = 1/MPS, 1/.50 = $1/.50 = ME of 2
ME is 2 & we are beyond Y*[$840] by $40 billion
AE [C+Ig+G]
AE[C+Ig+G]
(billions of dollars)
2 x -? [Decrease in G] = -40
o
AE[C+Ig-G]
Equilibrium
Inflationary Spending
gap=$20 B
-40
45
o
Inflat. Gap
840
Y*
880 Real GDP
YI
Inflationary GDP Gap
MT = -MPC/MPS, -.50/.50 = MT of -1
MT is -1 & we are beyond Y*[$840] by $40 billion
AE[C+Ig+G]
Now, with a MT
of 1, we would
need a tax increase
of how much to
close the $40 bil.
inflationary gap?
(billions of dollars)
AE [C+Ig+G]
Equilibrium
-40
-1 x ? [incre in T] = -40
$40 billion
tax increase
o
AE[C+Ig+G]
45º
Inflat. Gap
840
Y*
880 Real GDP
YI
Inflationary GDP Gap
ME
The ME is always positive.
MPC
.90
.80
.75
.60
.50
1/MPS
1/.10
1/.20
1/.25
1/.40
1/.50
= ME
= 10
= 5
= 4
= 2.5
= 2
Reasons why the “Simple Multiplier” is not as strong as indicated.
1. Some spending will be on imports, reducing the size of the M.
2. It ignores PL changes which reduce the multiplier.
3. It ignores taxes which reduce the multiplier.
MT
The MT is always negative.
MPC
.90
.80
.75
.60
.50
-MPC/MPS =
-MPC/.10
-MPC/.20
-MPC/.25
-MPC/.40
-MPC/.50
=
=
=
=
=
MT
-9
-4
-3
-1.5
-1
When the G gives a tax cut, the MT is smaller than the
ME because a fraction [MPS] is saved and only the
MPC is initially spent. So, the MT = -MPC/MPS.
MBB
Why is the MBB always “1”?
1/
-MPC/
+
MPS
MPS
= 1- MPC/MPS = MPS/MPS = “1”
Let’s say the MPC is .90
1/
-.90/
1- .90/
.10/
+
=
=
.10
.10
.10
.10 = “1”
Or, Let’s say the MPC is .75
1/
-.75/
1- .75/
.25/
+
=
=
.25
.25
.25
.25 = “1”
Notice the 2nd round with
MT=-MPC/MPS
.9 [10] versus .5 [2]
MBB=1 G
ME=1/MPS
2 Round at .9
90%
-9 1
.9 2 Round at .510 50%
nd
nd
.8
.75
.60
.5
5
-4 1
When Arlington gets the Super Bowl in 2012,
it will have an estimated economic impact of
$419 million. 200,000 people will visit the area.
2008 Final Four in San Antonio brought 57,000
4 -31 The
visitors[$223 per day], $47 M in 4 days & $120 M trickle effect.
The Texas-Oklahoma game brings $34 mil to D-FW.
2.5 -1.5 1 2007 Cotton Bowl brought $30 million to D-FW.
Super Bowl brought $336 million to Houston.
Fiesta Bowl for national title brought in $85 million.
2 -1 1
Big 12 Tournament brought $45 million to D-FW
The larger the MPC, the smaller the MPS, and the
greater the multiplier. This is the “simple multiplier”
because it is based on a “simple model of the economy”.
OU
• $150 - Parking rates around the stadium
• $500-$600 per Super Bowl ticket
[$2,000-$6,000 on E-Bay for a seat]
• $12,000 – cost of Super Bowl trophy
Reliant Stadium
• $2.3 million – 30 second ad
• $50,000 – Super Bowl Ring
• 68,000 to each player on the winning team
• $36,500 to each player on the losing team.
• $3.35 million to the winning team
• $2.59 million to the losing team
• Hotels - $69 M; bars & restaurants-$27 M; entertainment-$15 M;
transportation-$15 M; and retail sales-$41 M
Government increases spending by $1 billion with a multiplier of 2
$1,000.00 On new highways
500.00 Highway workers buy new boats
250.00 Boat builders buy plasma TVs
125.00 TV factory workers buy new cars
62.50 Auto workers buy “wife beater shirts”
31.25 Apparel workers spend $ on movies
15.625 Movie moguls spend money on Christina
7.8125 Agulera songs.
3.90625
1.953125
“What A Girl
.9765625
Wants.”
.48828125
.244140625
.1220703125
.06103515625
.030517578125
.015258789062
$2,000,000,000
[Increased by a multiple of 2]
Let’s Go To Padre Island and Party With The Multiplier
UT student
These are
Texas A&M
students
at Padre.
• During spring break, college students like to head to Padre Island.
•
•
•
•
•
The “multiplier” is getting ready to work.
With dollars in their pockets, the students spend money on food and
drink, motel rooms, dance clubs, etc. These dollars raise total income
there by some multiple of itself.
College students buy pizzas, beer, and sodas. The people who sell
these items find their incomes rising. They spend some fraction
of their increased income, which generates additional income for
others.
If the students spend $8 million at Padre and the MPC is .60, then
college students will increase income in Padre by $20 million.
When the networks show scenes on the beach, the average person
simply sees college students having a good time.
But – economists see the multiplier at work, generating higher levels
of income for many of the residents of Padre Island.
If business activity slows, then sales of houses and
autos decrease. Home construction workers and
auto workers get laid off. Auto companies cancel
their orders for steel and steel workers laid off.
Furniture sales are down so some of the furniture
workers are laid off. Laid off people don’t buy new
clothes or cars so more lay-offs. They also don’t eat
out as much so some restaurant workers laid off.
Company profits are down, depressing stock prices,
making people poorer, so they buy even less.
And so it goes, the multiplier in reverse.
NS 7 – 10
7. The APC indicates the percent of total income
that will be (consumed/saved).
8. The MPC is the fraction of a change in income
which is (spent/saved).
9. The greater is the MPC, the (larger/smaller) the
MPS, and the (larger/smaller) the multiplier.
10. With a MPS of .4, the MPC will be (.4/.2/.6)
and the multiplier will be (2/2.5/4).
Multiplier – As the money goes from
one person, to another, to another…
[From “Simple” to “Complex” economy]
[C+Ig]
Private
Closed
(private-closed)
[C+Ig+Xn] Private Open (private-open)
[C+Ig+G+Xn]
“ME” = 4
Mixed Open (mixed-open)
S
AE3 (C+Ig+G+Xn) (Complex Economy) [Mixed-open]
(AE3)550
AE21)470
)470
((AE
C=390
AE1(C+Ig)[B
asic(Private-open)
Economy][Private
(no G)-Closed(no X or M)]
AE2 (C+Ig+Xn)
[X(10)-M(10)]
+20 G
Consumption
+20
Ig
+ Xn
+80 +80
45º
0 390 470 550
Real GDP
Injections
Leakages
1. Investment [20]= 1. Saving[20]
Notice that the injections are
2. Exports
[10]= 2. Imports[10]
autonomous (independent) of Y
3. Government [20]= 3. Taxes [20]
How to figure the MPC & MPS
Consumption
[MPC =
C/ Y]
[MPS =
S
D
S/ Y]
SAVING
Consumption
C2
C
A
C1
Dissaving
o
MPC=? BC/EF[or AB]
B MPS=? CD/EF
45
H
E
F
Disposable Income
[C+Ig]
AE
$1,000
$700
$400
$100
H
AE1[C+Ig]
Consumption
I
J
P
o
45
200 400
0 N Q
1,000 bil.
Real
K
GDP
Consumption will be equal to income at income level ? $400
With Ig [C+Ig], the MPC is? PI/QK
The MPS is ? HI/QK
What income level represents “dissaving”?
$200
Consumption
D
1,000
Consumption
700
A
400
45
0
C
B
o
200 400
1,000
F
H E
Income
11. The APC is one at letter
(A/B/C/D).
12. The MPC is equal to (AE/OE
or BC/EF[or AB]). [moving
from OE(400) to OF(1,000)]
13. At income level “OF” the
volume of saving is (CB/CD).
14. Consumption will be equal to
income at income level (OH/OE).
15. The economy is dissaving at
income level (OH/OF).
16. The MPS is (CD/EF or CB/EF).
[moving from OE to OF]
An Increase in G of $20B is more expansionary than a decrease in T of $20 B
[If the MPC is .75, ME is 4 but the MT is only 3]
AE
AE2(C+Ig+G)
AE1(C+Ig)
+80
YR
F*
500
580
Incr G spending by $20 bil.
“ME” of 4 [1/.25]
[20 x 4 = $80]
Let’s see, anyone’s spending
(G,Ig, or Xn) becomes someone
else’s income, so there will be
an increase in “C”.
AE
AE2
AE1
“Big 12” Tournament brings $45
million to the DFW economy.
AAC
“Tax cut” of $20 billion
“MT” = -3 [-.75/.25] x -20 = $60
+60
YR 560 Y*
500
580
[Need a 25% larger “Tax cut” to get to $580]
“Tax cut of -$25.67 billion x -3 = $80]
Increase in G of $40 Billion with MPS of .5
1st Round = $40 billion spent on the highways
2nd Round=$20 billion on motorcycles
The multiplier is the multiple in which
an initial change in aggregate spending
will alter total spending after an infinite
# of spending cycles.
Total spending change =
M X new spending injection.
3rd Round,
only $10 billion
spent on corvettes
Decrease in Taxes of $40 B with MPS of .5
With MPS of .50, $20 is saved &
& only $20 bil is spent 1st round.
Leakage of 50%
[saving of $20 bil.]
in the first round
2nd Round: only
$10 bil. is spent.
3rd Round
only $5 bil.
is spent.
Balanced Budget Multiplier (“1”)
$20
G
$20
T
[Increase G & T by $20 billion]
ME of 2 & MT of -1
ME of “2” [So MT is -“1”]
AE2[C+Ig]
AE1[C+Ig]
AE
“G”
[+20]
40
-20
“T”
ME of 5 & MT of 4
ME of “5” [So MT is -“4”]
“G”
[+20] -80
+$20
$600 $620
100
“T”
ME of 10 & MT of 9
MBB = 1 x G
1 x $20
ME of “10”
“G”
[+20] -180
[So MT is -“9”]
200
“T”
1993 Macro Free Response Long Question
1. Suppose that the following conditions describe the current U.S. economy.
- The unemployment rate is 5%
- Inflation is 2%
- Real GDP is growing at the rate of 3%
I. First assume that the federal government increases its spending and
increases taxes so as to maintain a balanced budget. Using AD/AS
analysis, explain the short-run effects of these policies on each of the following.
(a) Output/employment
(b) The price level
(c) Interest rates
PL
With G&T increased by the same amount, & since
1st round G is not subject to the MPS but T is, this 3%
would result in an “expansionary fiscal policy” and 2%
increase GDP by the same amount as the equal
increase in G and T, which would increase AD.
LRAS SRAS
D1 D2
5% 4.8%
RGDP
This increase in AD would increase GDP, employment and price level. The
increase in price level *increases demand for money and this increases
interest rates.
Balanced Budget Multiplier [$20 billion]
[“T” affects AD indirectly thru “C”; “G” affects AD directly]
Net Change in GDP =
The increase in “T” means we
would have consumed $15 and
kept $5 in our pockets.
Sa= -$5
T
The increase in “G”
flows directly into
the economy.
+$20
GDP=
-$60
$20
Ca= -$15
GDP
=$80
MT = -MPC/MPS = -.75/.25=-3
So, -3 x $20 = -$60
AS
AD1AD2
PL
$470 billion
$490
billion
G
$20
ME = 1/MPS
ME = 1/.25 = 4
So, 4 x $20 = $80
The ME, MT, & MBB Multipliers
ME [C, Ig, G, or Xn] = 1/MPS = 1/.25 = 4
So, G increase of $20 bil. will incr Y by $80 bil. [+$20x4=$80]
And a G decrease of $20 bil. will decrease Y by $80 bil. [-$20x4=-$80 bil.]
MT = -MPC/MPS = -.75/.25 = -3
So, T decrease of $20 bil. will incr Y by $60 bil. [-$20 x-3=$60]
And a T increase of $20 bil. will decr Y by $60 bil. [+$20x-3=-$60]
MBB = 1 X
(
G)
So, an increase in G&T of $20 bil. will incr Y by $20 bil. [1X$20=$20]
And a decrease in G&T of $20 bil. will decr Y
by $20 bil.[1X-$20=-$20]
Any increase in expenditures x the M will increase GDP..
Any decrease in expenditures x the M will decrease GDP.
1.
INSTRUCTIONS FOR THE NEXT FOUR AE SLIDES
We will start at $500 equilibrium GDP on each.
Inflationary spending gap
2. Of the three items (equilibrium GDP, change
in expenditures, & MPC), you will be given
two and if you know 2 you can always figure
out the 3rd. For instance, if you knew that
equilibrium GDP increased by $400 and the
multiplier was 4, then the change in expenditures
was obviously $100.
AE2
AE
E2
AE1
E1
AE3
E3
500
Recessionary spending gap
Recessionary Inflationary
GDP gap
3. Except for 6, 9, 15, & 18, you will increase GDP gap
equilibrium GDP above $500, because there
is an increase in G, or a decrease in T, or
an equal increase in G&T.
Ex: With MPC of .75 & therefore a ME of 4,
an increase in G of $20 means +$20 x 4 = $580
4. On questions 6, 9, 15, & 18, you will decrease equilibrium
GDP below $500 because you are either decreasing G,
increasing T, or there is an equal decrease in G & T.
Ex: With MPC of .75 & therefore a ME of 4, a decrease
in G of $20 means -$20 x 4 = -$80; so ends up at $420.
The Multiplier & Equilibrium GDP
[Give the correct equilibrium GDP [start from $500] using the ME, MT, MBB]
ME=1/MPS [chg in G, Xg, or Xn] MT = -MPC/MPS [Chg in T ] MBB = 1 X[ G ]
Inflationary
Spending gap
AE
E2
E1
Chg in
Equilibrium GDP
Change in
Expenditures
MPC
[So MPS &
ME, MT, & MBB]
[+G] 1. ME = ____
560
[-T]
2. MT = ____
548
[+G&T] 3. MBB =____
512
1
60 Y with ME
____
48 with MT
____Y
12 with
____Y
MBB
______
$12
ME__
5
______
-$12
-4
MT___
.80
$12
______
MBB1
___
ME’s
[G,Ig,Xn]
MPC M
.90 = 10
.87.5= 8
.80 = 5
.75 = 4
.60 =2.5
.50 = 2
540
[+G] 1. ME = ____
S
[-T]
2. MT = ____
520
AE1
520
AE2 [+G&T] 3. MBB =____
AE3
E3
45°
Recessionary $500
Spending gap
700
[+G] 1. ME = ____
[-T]
2. MT = ____
650
[+G&T] 3. MBB =____
550
2
$200 Y with ME
_____Y with MT
150
50 with MBB
_____Y
______
$50
______
-$50
______
$50
.75
ME__
4
MT___
-3
MBB___
1
40
___ Y with ME
20 with MT
____Y
20 with MBB
____Y
______
$20
2
ME__
______
-1
-$20 .50 MT___
MBB___
1
$20
______
MT’s
MPC M
.90 = -9
.87.5= -7
.80 = -4
.75 = -3
.60= -1.5
.50 = -1
[+G] 1. ME = ____
600
[-T]
2. MT = ____
590
510
[+G&T] 3. MBB =____
3
$100 Y with ME
90
___Y with MT
10
___Y with MBB
______
$10
______
-$10
$10
______
__
.9 ME10
-9
?
MT___
1
MBB___
[+G] 1. ME = ____
550
[-T]
2. MT = ____
530
[+G&T] 3. MBB =____
520
4
___ Y with ME
50
____Y
30 with MT
____Y
20 with MBB
.60
______
$20 ME__
2.5
______
-$20 MT___
-1.5
______
$20 MBB___
1
[+G] 1. ME = ____
575
[-T]
2. MT = ____
560
[+G&T] 3. MBB =____
515
7
___
75 Y with ME
____Y
60 with MT
15 with MBB
____Y
.80
______
$15 ME__
5
______
-$15 MT-4
___
______
$15 MBB___
1
[+G] 1. ME = ____
600
[-T]
2. MT = 550
____
[+G&T] 3. MBB =____
550
5
100
___ Y with ME
50 with MT
____Y
____Y with MBB
50
$50
______
?
______
-$50
______
$50
.50
ME__
2
MT___
-1
MBB___
1
[+G] 1. ME = ____
900
[-T]
2. MT = 800
____
[+G&T] 3. MBB =____
600
8
___ Y with ME
400
____Y with MT
300
____Y with MBB
100
.75
______
$100 ME__
4
______ MT___
-$100
-3
______ MBB___
$100
1
[-G] 1. ME = 460
___
465
[+T] 2. MT =___
[-G&T]3.MBB=___
495
6
-40
___ Y with ME
-35
____Y with MT
____Y
-5 with MBB
-$5
______
______
$5
______
-$5
87.5
ME__
8
-7
MT___
MBB___
1
[-G] 1. ME =___
300
[+T] 2. MT =___
320
[-G&T]3.MBB=___
480
9
___ Y with ME
-200
-180
____Y with MT
____Y with MBB
-20
.9
______
-$20 ME__
10
______
$20 MT___
-9
______
-$20 MBB___
1
[+G] 1. ME = ____
625
[-T]
2. MT = ____
575
[+G&T] 3. MBB =____
550
___ Y with ME
10 125
____Y
75 with MT
____Y
50 with MBB
_____
$50
_____
-$50
_____
$50
.60
ME__
2.5
MT-1.5
___
1
MBB___
[+G] 1. ME = ____
560
[-T]
2. MT = ____
545
[+G&T] 3. MBB =____
515
13 ___
60 Y with ME
____Y
45 with MT
15 with MBB
____Y
_____
$15
_____
-$15
_____
$15
.75
ME__
4
MT___
-3
MBB___
1
[+G] 1. ME = ____
540
[-T]
2. MT = 538
____
[+G&T] 3. MBB =____
502
[+G] 1. ME = 550
___
540
[-T]
2. MT =___
[+G&T]3.MBB=___
510
11 ___
40 Y with ME
12 ___
50 Y with ME
38 with MT
____Y
____Y
2 with MBB
?_____
$2
_____
-$2
_____
-$2
.95
ME__
20
MT-19
___
1
MBB___
[+G] 1. ME = ____
700
[-T]
2. MT = 600
____
[+G&T] 3. MBB =____
600
14
___
200 Y with ME
____Y with MT
100
____Y with MBB
100
? .50
$______
100 ME__
2
-$______
100 MT___
-1
1
$______
100 MBB___
40 with MT
____Y
____Y
10 with MBB
?
_____ .80
$10
ME__
5
_____
-$10 MT___
-4
_____
$10 MBB___
1
[-G] 1. ME =___
420
[+T] 2. MT =___
430
[-G&T]3.MBB=___
490
15
-80 Y with ME
___
____Y with MT
-70
____Y with MBB
-10
______
-$10
______
$10
______
-$10
87.5
ME__
8
MT___
-7
MBB___
1
[+G] 1. ME = ____
625
[-T]
2. MT = ____
600
[+G&T] 3. MBB =____
525
16 125
___ Y with ME
100
____Y with MT
25 with MBB
____Y
.80
_______
$25 ME__5
_______ MT-4
-$25
___
_______
$25 MBB___
1
532
[+G] 1. ME = ____
[-T]
2. MT = 524
____
[+G&T] 3. MBB =____
508
[-G] 1. ME = ___
400
410
[+T] 2. MT =___
[-G&T]3.MBB=___
490
17 ___
32 Y with ME
18 -100
___ Y with ME
24 with MT
____Y
8 with MBB
____Y
.75
_______
$8 ME__
4
_______
-$8 MT___
-3
_______
$8 MBB___
1
____Y with MT
-90
____Y with MBB
-10
.9
_______
-$10 ME10
__
_______
$10 MT___
-9
_______
-$10 MBB___
1
U.S. Consumption and Income
$7000
2000
CONSUMPTION (billions)
6000
5000
4000
3000
2000
1000
45°
0
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
Actual consumer spending [so, gives us APC]
C = YD
$1000
2000
3000
4000
5000
6000
7000
DISPOSABLE INCOME (billions of dollars per year)
The Consumption Function: How large we
expect the basic flow of consumer spending
to be at different levels of GDP (income)
C/Y = $4,425/$4,800 = 92%
1993 Saving
= $375.0 billion
“C” = $4,425
“S” = $375
1929 – Saving = $4 bil.
1933 – Dissaving
1944 – Saving = 20%
= Equilibrium GDP [$470]
530
(C + Ig = GDP)
Consumption (billions of dollars)
510
Equilibrium
Point
490
470
C + Ig
C
450
430
410
390
C = $450 Billion
370
45°
370 390 410 430 450 470 490 510 530 550
Disposable Income (billions of dollars)
(2)
Real
Domestic (3)
(5)
(6)
Output Con(1)
(4)
Investment Aggregate
(and sumpEmploy- Income) tion Saving (S)
(Ig)
Expenditures
ment (GDP=DI) (C)
(1-2)
(C+Ig)
(7)
(8)
MPC
MPS
…in Billions of Dollars
(1) 40
$370
$375
$-5
20
$395
.75
.25
(2) 45
390
390
0
20
410
.75
.25
(3) 50
410
405
5
20
425
.75
.25
(4) 55
430
420
10
20
440
.75
.25
(5) 60
450
435
15
20
455
.75
.25
(6) 65
470
450
20
20
470
.75
.25
(7) 70
490
465
25
20
485
.75
.25
(8) 75
510
480
30
20
500
.75
.25
(9) 80
530
495
35
20
515
.75
.25
(10) 85
550
510
40
20
530
.75
.25
Leakage (S of $20 B) = Injection (Ig of $20 B)
At Equilibrium, Any Injections = Any Leakages
Injections = Leakages
C+Ig
Ig(20)
=
S(20)
=
S(20)+ M(10)
[Private-closed]
C+Ig+Xn
Ig(20)+X(10)
[Private-open]
C+Ig+G+Xn Ig(20)+G(20)+X(10)
= S(20)+T(20)+M(10)
[Mixed-open]
=
Autonomous v. Induced Investment
So Ig is said to be “forward looking”,
based more on profit expectations,
rather than current income.
Investment induced by income
(dependent” or “stimulated by Y”
Autonomous Investment
“Independent of” or “not stimulated by Y”
Autonomous-independent of [not stimulated] by income
Induced - ”dependent” [stimulated] by income
Percentage Change
40
30
Gross Investment
20
10
GDP
0
-10
-20
-30
R
R
1971 1975
1979
R1983
R
R1995
1987 1991
Year
1999
R
2003
• Durability
– Capital has a long life-span, therefore once it is built there
is no immediate need for further investment.
• Irregularity of Innovation
– Innovation does not proceed in a smooth linear fashion,
instead there are bursts of innovation followed by periods
of relative stability.
• Variability of Profits
– Profitability is subject to the forces of competition, cyclical
changes in the economy, & human management decisions.
• Variability of Expectations
– Political, social & natural phenomenon shape our positive
and negative expectations of the future.
Inflation and the Multiplier [4]
Full Multiplier Effect
Price Level
AD1
AD2
AS
AD3
+20
+20
Reduced
Multiplier
Effect Due
to Inflation
P2
P1
+ 80 bil.
M(4) = Y/ E
[80] [20]
GDP1
+ 40 bil.
GDP2
GDP3
M(2) =
Y/ E
[40] [20]
[MPS=.20] the multiplier at work...
$5 billion initial direct increase in spending
AS
AD1 AD
2
Full $25 billion
increase in AD
Price level
+5
PL1
$475
500
Real GDP (billions)
$5 billion initial direct increase in spending
Price level
AD1
AD2
+5
Reduced
AS Multiplier
Effect Due
to Inflation
ME = 4
20/5=4
PL2
PL1
$20 billion
$25 billion
520
$500
Real GDP (billions)
ME = 5
25/5=5
525