Transcript Economics R. Glenn Hubbard, Anthony Patrick O`Brien, 2e.

Output and Expenditure in the Short Run
Chapter 11: Output and Expenditure in the Short Run
Aggregate expenditure (AE)
The total amount of spending on the economy’s output:
Aggregate Expenditure
AE = C + I + G + NX
• Consumption (C)
• Planned Investment (I)
• Government Purchases of Goods + Services (G)
• Net Exports (NX)
Actual investment in a year can differ from planned investment: businesses
“invest” in unintended inventories if sales fall short of what they expected
Macroeconomic Equilibrium: Aggregate Expenditure = Output (Y)
AE = C + I + G + NX = Y
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Chapter 11: Output and Expenditure in the Short Run
Components of Real Aggregate Expenditure, 2006
EXPENDITURE
CATEGORY
Consumption
EXPENDITURE
(BILLIONS OF 2000 DOLLARS)
$8,091
Investment
1,946
Government
1,998
Net Exports
−618
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The Aggregate Expenditure Model
Chapter 11: Output and Expenditure in the Short Run
Adjustments to Macroeconomic Equilibrium
Actual investment in a year can differ from planned investment: businesses
“invest” in unintended inventories if sales fall short of what they expected
IF …
Aggregate expenditure is
equal to GDP
Aggregate expenditure is
less than GDP
THEN …
AND …
inventories are
unchanged
the economy is in
macroeconomic
equilibrium.
inventories rise
GDP and employment
decrease.
Aggregate Expenditure is
greater than GDP
inventories fall
GDP and employment
increase.
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Chapter 11: Output and Expenditure in the Short Run
Real Consumption Expenditure C = $C/CPI
FIGURE 11-1
Real Consumption, 1979–2006
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The most important variables that determine the level of
consumption:
Chapter 11: Output and Expenditure in the Short Run
• Current
disposable income
• Household wealth: Assets minus liabilities
• Expected future income
People try to keep their consumption fairly steady from
year-to-year  save for a rainy day
• The price level
Higher price level reduces real value of monetary wealth
• The interest rate
High interest rate discourages spending on credit and
encourages saving
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The Consumption Function: The relation between consumption and
disposable income
Chapter 11: Output and Expenditure in the Short Run
The Relationship between
Consumption and Income,
1960– 2006
Marginal propensity to consume (MPC)
The amount by which consumption
spending changes when disposable
income changes = slope of
consumption function.
Consumption Function
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Chapter 11: Output and Expenditure in the Short Run
The Consumption Function
Marginal propensity to consume (MPC) The slope of the
consumption function: The amount by which consumption spending
changes when disposable income changes.
Change in consumptio n
C
MPC 

Change in disposable income YD
We can also use the MPC to determine how much consumption will
change as income changes:
Change in consumptio n
MPC 
Change in disposable income
Change in consumption = Change in disposable income × MPC
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Chapter 11: Output and Expenditure in the Short Run
The Relationship between Consumption and National Income
when net taxes are constant
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Determining the Level of Aggregate
Expenditure in the Economy
Chapter 11: Output and Expenditure in the Short Run
Income, Consumption, and Saving
National income = Consumption + Saving + Taxes
Y=C+S+T
Change in national income = Change in consumption + Change in saving
+ Change in taxes
Y  C  S  T
If taxes are always a constant amount, ΔT = 0
ΔY = ΔC + ΔS
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Chapter 11: Output and Expenditure in the Short Run
Income, Consumption, and Saving
Marginal propensity to save (MPS)
The change in saving divided by the
change in disposable income.
Y C S


Y Y Y
or,
1 = MPC + MPS
MPS = 1 - MPC
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Solved Problem
11-2
Chapter 11: Output and Expenditure in the Short Run
Calculating the Marginal Propensity to
Consume and the Marginal Propensity to Save
C
MPC 
Y
NATIONAL
INCOME AND
REAL GDP (Y)
S
MPS 
Y
CONSUMPT
ION
SAVING
(C)
(S)
$9,000
$8,000
1,000
10,000
8,600
1,400
11,000
9,200
1,800
12,000
9,800
2,200
13,000
10,400
2,600
MARGINAL
PROPENSITY TO
CONSUME (MPC)
MARGINAL
PROPENSITY TO
SAVE (MPS)
—
—
0.6
0.4
0.6
0.4
0.6
0.4
0.6
0.4
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Determining the Level of Aggregate
Expenditure in the Economy
Chapter 11: Output and Expenditure in the Short Run
Planned Investment (I)
Real Investment, 1979–2006
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The most important variables that determine the level of
investment:
Chapter 11: Output and Expenditure in the Short Run
• Expectations of future profitability
Waves of optimism and pessimism
• Major technology changes: new products & processes
• The interest rate
• Taxes
• Cash flow
• Current capacity utilization
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Chapter 11: Output and Expenditure in the Short Run
The “new” information economy of the 1990s
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Chapter 11: Output and Expenditure in the Short Run
Government Purchases (G)
Real Government Purchases, 1979–2006
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Chapter 11: Output and Expenditure in the Short Run
Net Exports (NX)
Real Net Exports, 1979–2006
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Chapter 11: Output and Expenditure in the Short Run
Net Exports (NX)
The most important variables that determine the level of net exports:
• The price level in the United States relative to
the price levels in other countries
• The growth rate of GDP in the United States
relative to the growth rates of GDP in other
countries
• The exchange rate between the dollar and
other currencies
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Learning Objective 11.3
Graphing Macroeconomic Equilibrium
Chapter 11: Output and Expenditure in the Short Run
FIGURE 11-8
The Relationship between
Planned Aggregate
Expenditure and GDP on
a 45°-Line Diagram
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Chapter 11: Output and Expenditure in the Short Run
Graphing Macroeconomic Equilibrium
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Chapter 11: Output and Expenditure in the Short Run
Graphing Macroeconomic Equilibrium
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Learning Objective 11.3
Graphing Macroeconomic Equilibrium
Chapter 11: Output and Expenditure in the Short Run
Showing a Recession on the 45°-Line Diagram
FIGURE 11-11
Showing a Recession
on the 45°-Line Diagram
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Chapter 11: Output and Expenditure in the Short Run
Macroeconomic Equilibrium
Consump
tion
(C)
Govern
Planned Unplan
Planned
ment
Net
Aggregate
ned
Invest Purchase Export Expendi Change
ment
s
s
ture
in Invent
(I)
(G)
(NX)
(AE)
ories
Real
GDP
Will …
$8,00
0
$6,200
$1,500
$1,500
–
$500
$8,700
–$700
increase
9,000
6,850
1,500
1,500
–500
9,350
–350
increase
Real
GDP
(Y)
be in
equili
brium
10000
7,500
1,500
1,500
–500
10,000
0
11000
8,150
1,500
1,500
–500
10,650
+350
decrease
12000
8,800
1,500
1,500
–500
11,300
+700
decrease
Don’t Let This Happen to YOU!
Don’t Confuse Aggregate Expenditure
with Consumption Spending
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Chapter 11: Output and Expenditure in the Short Run
The Multiplier Effect
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Learning Objective 11.4
Chapter 11: Output and Expenditure in the Short Run
The Multiplier Effect
Autonomous expenditure An
expenditure that does not depend on
the level of GDP.
Multiplier The increase in equilibrium real GDP in
response to increase in autonomous expenditure, e.g.
Expenditure multiplier = ΔY/ΔI
Multiplier effect The process by which an increase in autonomous
expenditure leads to a larger increase in real GDP: ΔY = ΔI + ΔC
= Change in autonomous spending that sparks an expansion
+
Change in consumption spending induced by increasing output and
income.
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Chapter 11: Output and Expenditure in the Short Run
The Multiplier Effect in Action
ADDITIONAL
AUTONOMOUS
EXPENDITURE
(INVESTMENT)
ROUND 1
$100 billion
ADDITIONAL
INDUCED
EXPENDITURE
(CONSUMPTION)
$0
TOTAL ADDITIONAL
EXPENDITURE =
TOTAL ADDITIONAL GDP
$100 billion
ROUND 2
0
75 billion
175 billion
ROUND 3
0
56 billion
231 billion
ROUND 4
ROUND 5
.
.
.
ROUND 10
.
.
.
ROUND 15
.
.
.
0
0
.
.
.
0
.
.
.
0
.
.
.
42 billion
32 billion
.
.
.
8 billion
.
.
.
2 billion
.
.
.
273 billion
305 billion
.
.
.
377 billion
.
.
.
395 billion
.
.
.
ROUND 19
0
1 billion
398 billion
n
0
0
$400 billion
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Making
the
Chapter 11: Output and Expenditure in the Short Run
Connection
The Multiplier in Reverse:
The Great Depression of the 1930s
The multiplier
effect contributed
to the very high
levels of
unemployment
during the Great
Depression.
Year
Consumption
Investment
Net Exports
Real GDP
Unemployment Rate
1929
$661 billion
$91.3 billion
-$9.4illion
$865 billion
3.2%
1933
$541 billion
$17.0 billion
-$10.2 billion
$636 billion
24.9%
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The Multiplier Effect
Chapter 11: Output and Expenditure in the Short Run
A Formula for the Multiplier
1
1  MPC
Change in equilibriu m real GDP
1
Multiplier 

Change in autonomous expenditur e 1  MPC
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Chapter 11: Output and Expenditure in the Short Run
Summarizing the Multiplier Effect
1 The multiplier effect occurs both when autonomous
expenditure increases and when it decreases.
2 The multiplier effect makes the economy more sensitive
to changes in autonomous expenditure than it would
otherwise be.
3 The larger the MPC, the larger the value of the multiplier.
4 The formula for the multiplier, 1/(1 − MPC), is oversimplified
because it ignores some real-world complications, such as
the effect that an increasing GDP can have on taxes,
imports, prices and interest rates.
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Chapter 11: Output and Expenditure in the Short Run
The Aggregate Demand Curve
The Effect of a Change in
the Price Level on Real GDP
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Chapter 11: Output and Expenditure in the Short Run
Aggregate demand curve A curve that shows the
relationship between the price level and the level of
planned aggregate expenditure, holding constant all
other factors that affect aggregate expenditure.
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Key Terms
Chapter 11: Output and Expenditure in the Short Run
Aggregate demand curve
Aggregate expenditure (AE)
Marginal propensity to
consume (MPC)
Autonomous expenditure
Marginal propensity to
save (MPS)
Cash flow
Multiplier
Consumption function
Multiplier effect
Aggregate expenditure model
Inventories
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Appendix
Chapter 11: Output and Expenditure in the Short Run
The Algebra of Macroeconomic Equilibrium
1 C  C  MPC (Y ) Consumption function
2 I 1
Planned investment function
3 G G
Government spending function
4 NX  N X
Net export function
5
Y  C  I  G  NX
Equilibrium condition
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Appendix
Chapter 11: Output and Expenditure in the Short Run
The Algebra of Macroeconomic Equilibrium
The letters with bars over them represent fixed, or autonomous,
values. So, C represents autonomous consumption, which had a value
of 1,000 in our original example. Now, solving for equilibrium, we get:
Y  C  MPC(Y)  I  G  NX
Or,
Y - MPC(Y)  C  I  G  NX
Or,
Y (1  MPC )  C  I  G  NX
Or,
C  I  G  NX
Y
1  MPC
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Appendix
Chapter 11: Output and Expenditure in the Short Run
The Algebra of Macroeconomic Equilibrium
1
is the multiplier. Therefore an alternative
1  MPC
expression for equilibrium GDP is:
Remember that
Equilibrium GDP = Autonomous expenditure x Multiplier
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