Transcript Equilibrium National Income

Chapter 22
DERIVING EQUILIBRIUM
NATIONAL INCOME
© 2013 Cengage Learning
Gottheil — Principles of Economics, 7e
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Economic Principles
Aggregate expenditure
The equilibrium level of national
income
The relationship between saving
and investment
The income multiplier
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Economic Principles
The relationship between aggregate
expenditure and aggregate demand
The paradox of thrift
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Equilibrium National Income
Equilibrium price is determined by
the equal contribution of both
demand and costs of production. In
particular, it is their interaction that
determines equilibrium price.
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Equilibrium National Income
Similarly, the interaction of aggregate
expenditure and aggregate supply
contribute to equilibrium national
income. In this case, however,
aggregate expenditure plays a
stronger role than aggregate supply.
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Interaction Between
Consumers and Producers
Aggregate expenditure
• Spending by consumers on consumption
goods, spending by businesses on
investment goods, spending by government,
and spending by foreigners on net exports.
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Interaction Between
Consumers and Producers
Recall that the amount of consumer
income spent on consumption and
saving is represented by:
Y=C+S
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Interaction Between
Consumers and Producers
And recall that the amount of production
goods and investment goods produced
by producers is represented by:
Y = C + Ii
where the subscript i indicates intended
as distinct from actual.
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Interaction Between
Consumers and Producers
If, by chance, what producers intend to
produce for consumption turns out to be
precisely what consumers intend to
consume, the match between intended
investment and savings is written as:
Ii = S
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Interaction Between
Consumers and Producers
The I = S equation describes the
economy in macroequilibrium. No
excess demand or supply exists.
Aggregate expenditure equal
aggregate supply.
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The Economy Moves Toward
Equilibrium
The national economy, if not already
in equilibrium, is always moving
toward it.
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The Economy Moves Toward
Equilibrium
Equilibrium level of national income
• C + Ii = C + S, where saving equals intended
investment.
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The Economy Moves Toward
Equilibrium
Unwanted inventories
• Goods produced for consumption that remain
unsold.
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The Economy Moves Toward
Equilibrium
Actual investment (Ia)
• Investment spending that producers actually
make, which is, intended investment
(investment spending that producers intend
to undertake) plus or minus unintended
changes in inventories.
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EXHIBIT 1
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CONSUMERS’ AND PRODUCERS’
INTENTIONS AND ACTIVITIES, BY STAGES,
WHEN Y = $900 BILLION
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Exhibit 1: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $900 Billion
Suppose the economy is at Y = $900
billion, autonomous consumption
= $60 billion, MPC = 0.80 and producers’
intended investment is $100 billion.
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Exhibit 1: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $900 Billion
1. What are consumers’ consumption
expenditures and savings in
Exhibit 1?
• If Y = C + S and C = a + bY, then consumption
expenditures (C) = $60 billion + 0.8 ($900
billion) = $780 billion.
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Exhibit 1: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $900 Billion
1. What are consumers’ consumption
expenditures and saving in
Exhibit 1?
• If S = Y – C, then saving (S) = $900 billion
– $780 billion = $120 billion.
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Exhibit 1: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $900 Billion
2. What is intended production by
producers?
• If C = Y - Ii and Ii = $100 billion, then intended
production = $900 billion - $100 billion = $800
billion.
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Exhibit 1: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $900 Billion
3. What is the difference between
consumers’ consumption
expenditures and producers’
intended production?
• Producers’ intended production ($800
billion) – consumers’ consumption
expenditures ($780 billion) = $20 billion.
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Exhibit 1: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $900 Billion
3. What is the difference between
consumers’ consumption
expenditures and producers’
intended production?
• The $20 billion difference is described as
unwanted inventories and must be absorbed
as investment.
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Exhibit 1: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $900 Billion
3. What is the difference between
producers’ intended production
and consumers’ consumption
expenditures?
• Producers’ actual investment ($120 billion)
ends up being greater than what they had
intended to invest ($100 billion).
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EXHIBIT 2
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CONSUMERS’ AND PRODUCERS’
INTENTIONS AND ACTIVITIES, BY STAGES,
WHEN Y = $700 BILLION
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Exhibit 2: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $700 Billion
Suppose national income changes
to Y = $700 billion, but MPC,
autonomous consumption and
intended investment all remain the
same.
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Exhibit 2: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $700 Billion
1. What are consumers’ consumption
expenditures?
• C = $60 billion + 0.8 ($700 billion)
= $620 billion
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Exhibit 2: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $700 Billion
2. What is intended production by
producers?
• C = $700 billion – $100 billion = $600 billion
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Exhibit 2: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $700 Billion
3. What is the difference between
consumers’ consumption
expenditures and producers’
intended production?
• Consumers’ consumption ($620 billion)
– Producers’ production ($600 billion)
= $20 billion
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Exhibit 2: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $700 Billion
3. What is the difference between
consumers’ consumption
expenditures and producers’
intended production?
• The $20 billion difference must be converted
from intended investment to consumption
goods to meet demand.
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Exhibit 2: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $700 Billion
3. What is the difference between
consumers’ consumption
expenditures and producers’
intended production?
• Actual investment ends up being less than
intended investment.
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EXHIBIT 3
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CONSUMERS’ AND PRODUCERS’
INTENTIONS AND ACTIVITIES, BY STAGES,
WHEN Y = $800 BILLION
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Exhibit 3: Consumers’ and
Producers’ Intentions and Activities,
by Stages, When Y = $800 Billion
What is the difference between
production and consumers’
expenditures in Exhibit 3?
• Production and consumption are equal at
$700 billion. The economy is in equilibrium.
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Equilibrium National Income
Aggregate expenditure curve (AE)
• A curve that shows the quantity of aggregate
expenditures at different levels of national
income or GDP.
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Equilibrium National Income
Aggregate expenditure curve (AE)
• The intersection of the 45° income curve and
AE identifies the economy’s equilibrium
position.
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Equilibrium National Income
• When Ii > S, producers hire more
workers to replace depleted
inventories. Y increases and
continues to increase until Ii = S.
• When S > Ii, inventories build up and
producers lay off workers. Y
decreases until Ii = S.
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EXHIBIT 4A THE EQUILIBRIUM LEVEL OF NATIONAL
INCOME
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EXHIBIT 4B THE EQUILIBRIUM LEVEL OF NATIONAL
INCOME
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Exhibit 4: The Equilibrium Level
of National Income
At a national income of $700 billion,
aggregate expenditure is ____ the
national income in panel a of Exhibit 4.
i. Greater than
ii. Less than
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Exhibit 4: The Equilibrium Level
of National Income
At a national income of $700 billion,
aggregate expenditure is ____ the
national income in panel a of Exhibit 4.
i. Greater than
ii. Less than
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Changes in Investment Change
National Income Equilibrium
As long as the consumption function
and the investment demand function
remain unchanged, there is no reason to
suppose that the level of national
income would move away from
equilibrium.
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Changes in Investment Change
National Income Equilibrium
Functions do change, however.
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EXHIBIT 5
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CONSUMERS’ AND PRODUCERS’
INTENTIONS AND ACTIVITIES, BY STAGES,
WHEN INVESTMENT INCREASES TO $130
BILLION AND Y = $800 BILLION
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Exhibit 5: Consumers’ and Producers’
Intentions and Activities, by Stages,
when Investment Increases to $130
Billion and Y = $800 Billion
What happens to the equilibrium level of
national income when intended investment
increases in Exhibit 5?
• When intended investment increases, the
supply of consumption goods decreases to
$670 billion.
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Exhibit 5: Consumers’ and Producers’
Intentions and Activities, by Stages,
when Investment Increases to $130
Billion and Y = $800 Billion
What happens to the equilibrium level of
national income when intended investment
increases in Exhibit 5?
• Consumers’ consumption expenditures remain
at $700 billion. Consumers’ demand is greater
than producers’ production.
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Exhibit 5: Consumers’ and Producers’
Intentions and Activities, by Stages,
when Investment Increases to $130
Billion and Y = $800 Billion
What happens to the equilibrium level of
national income when intended investment
increases in Exhibit 5?
• In an effort to meet consumers’ demand,
producers hire more workers and national
income increases. The equilibrium also
increases.
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EXHIBIT 6A DERIVING EQUILIBRIUM AT Y = $950 BILLION
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EXHIBIT 6B DERIVING EQUILIBRIUM AT Y = $950 BILLION
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Exhibit 6: Deriving Equilibrium
at Y = $950 Billion
What is the equilibrium level of
national income when intended
investment increases to $130 billion
in Exhibit 6?
• The equilibrium level increases to
$950 billion, where Ii = S.
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Changes in Investment Change
National Income Equilibrium
The formula Y = (a + bY) + Ii can be
used to calculate equilibrium national
income when specific values for
autonomous consumption, MPC and
intended investment are known.
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The Income Multiplier
While consumption spending, MPC,
and autonomous consumption have all
remained relatively stable over time,
investment spending has been volatile.
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The Income Multiplier
Economists identify changes in
aggregate expenditure, in particular
investment spending, as the key to
our understanding of why national
income changes.
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The Income Multiplier
Income multiplier
• The multiple by which income changes as a
result of a change in aggregate expenditure. It
is written as:
Multiplier = (Change in Y)/(Change in AE)
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The Income Multiplier
The size of the multiplier depends on
the marginal propensity to consume.
An initial change in investment sets
in motion a chain of events that
creates a larger change in national
income.
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The Income Multiplier
For example, suppose a business
owner decides to invest $1,000 in a
new technology. The producer of the
technology receives an increase in
income of $1,000. If MPC = 0.80, the
technology producer’s consumption
spending increases by $800.
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The Income Multiplier
Suppose the $800 is then spent on a
custom-made water bed. The
carpenter that makes the water bed
receives $800 of additional income.
Based on MPC, we know that she
will spend $640 and save the rest.
The chain of events continues.
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Changes in Foreign Trade Change
National Income Equilibrium
The influence of foreign trade on
national income determination is less
obvious than are the other components
of aggregate expenditure. It includes
both exports and imports, which have
offsetting effects on the direction a
national economy takes.
.
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EXHIBIT 7
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IMPACT OF FOREIGN TRADE ON NATIONAL
INCOME EQUILIBRIUM
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Exhibit 7: Impact of Foreign Trade
on National Income Equilibrium
In panel a, the AE curve shifts
upward by $60 billion of exports,
increasing national income to $1,100
billion.
• This is effect those exports have on theU.S.
economy’s equilibrium.
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Exhibit 7: Impact of Foreign Trade
on National Income Equilibrium
In panel b, the AE curve shifts
downward by $20 billion of imports,
decreasing national income by $100
billion.
• This is the impact of imports on aggregate
expenditure.
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Exhibit 7: Impact of Foreign Trade
on National Income Equilibrium
In panel c, the combined effect of
exports and imports shifts the AE
curve upward by $40 billion ($60 –
$20) of foreign trade, increasing
national income by $1,000.
• That is, what was once AE = C + I is now AE
= C + I + (X - M).
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EXHIBIT 8
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THE MAKING OF THE INCOME MULTIPLIER
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Exhibit 8: The Making of the
Income Multiplier
The additions to national income in
Exhibit 8 become _____ as economic
activity progresses through
successive rounds.
i. Smaller and smaller
ii. Bigger and bigger
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Exhibit 8: The Making of the
Income Multiplier
The additions to national income in
Exhibit 8 become _____ as economic
activity progresses through
successive rounds.
i. Smaller and smaller. For example, in round 2,
$800 is added. In round 3, $640 is added.
ii. Bigger and bigger
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The Income Multiplier
The formula to determine the income
multiplier is written:
1/(1 – MPC)
Since (1 – MPC) = MPS, the formula
can be written:
1/MPS
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The Income Multiplier
For example, for a $1,000 change in
investment, when MPC = 0.80, the
income multiplier is:
1/(1 – 0.80) = 1/(0.2) = 5
A $1,000 investment leads to a
$5,000 change in national income.
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The Income Multiplier
Just as increases in aggregate
expenditure stimulate the economy,
cuts in aggregate expenditure drag it
down.
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The Paradox of Thrift
Some people believe that putting a
higher percentage of their income into
saving will provide greater economic
security. This is not necessarily the
case, however. By trying to save more,
people may actually end up saving
less, or at least saving no more.
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The Paradox of Thrift
The paradox of thrift
• The more people try to save, the more income
falls, leaving them with no more and perhaps
even less saving.
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The Paradox of Thrift
The intention to save more causes the
saving curve to shift upwards. Saving
then becomes greater than intended
investment (S > Ii). The equilibrium
level of national income falls.
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The Paradox of Thrift
• If the level of intended investment
curve is horizontal, then the level of
saving remains unchanged.
• If the intended investment curve is
upward sloping, then the level of
saving declines.
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EXHIBIT 9
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THE PARADOX OF THRIFT
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Exhibit 9: The Paradox of Thrift
1. What happens to national income
and saving when the saving curve
shifts from S to S′ in panel a of
Exhibit 9?
• National income falls from $800 billion to $650
billion. Saving remains unchanged.
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Exhibit 9: The Paradox of Thrift
2. What happens to national income
and saving in panel b when the
saving curve shifts from S to S′?
• The equilibrium level of national income falls
from $800 billion to $550 billion.
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Exhibit 9: The Paradox of Thrift
2. What happens to national income
and saving in panel b when the
saving curve shifts from S to S′?
• Because the intended investment curve is
upward sloping, the shift in the saving
curve causes a decline in the level of
investment as well.
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Exhibit 9: The Paradox of Thrift
2. What happens to national income
and saving in panel b when the
saving curve shifts from S to S′?
• Saving falls from $100 billion to $75 billion.
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The Paradox of Thrift
Increased saving is not always
detrimental to our economic health. If
accompanied by increased
investment, increased saving is both
inevitable and desirable.
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The Paradox of Thrift
During the 2008–2011 recession:
The inclinations of consumers to
increase their saving and of producers
to hold off on intended investment
might have augmented both the
decline in national saving and national
income
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