Transcript Aggregate Expenditure/Short

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 wind up
“investing” in unintended inventories if sales fall short of what they expected
Macroeconomic Equilibrium: Aggregate Expenditure = Output (Y)
AE = C + I + G + NX = Y
The Aggregate Expenditure Model
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.
Components of Real Aggregate Expenditure, 2010
Expenditure Category
Consumption
Real Expenditure
(billions of 2005 dollars)
$9,221
Planned investment
1,715
Government purchases
2,557
Net exports
−422
Consumption
Real Consumption
Consumption follows a smooth, upward trend, interrupted only infrequently by brief
recessions.
The most important variables that determine the level of C:
•
Current disposable income
• Household wealth: Assets minus liabilities
Including equity in owner occupied houses?
Do Changes in Housing Wealth Affect Consumption Spending?
Housing wealth equals the market value of houses minus the value of
loans people have taken out to pay for the houses = Homeowner Equity
The figure
shows the
S&P/CaseShiller index
of housing
prices,
which
represents
changes in
the prices of
singlefamily
homes.
Because many macroeconomic variables move together, economists sometimes
have difficulty determining whether movements in one are causing movements in
another.
The most important variables that determine the level of C:
•
Current disposable income
• Household wealth: Assets minus liabilities
Including equity in owner occupied houses?
• Expected future income
People try to keep their consumption fairly steady from year-to-year
 tie consumption to “permanent income” and 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/encourages saving
The most important determinant of consumption is:
a. Current disposable income
b. Household wealth.
c. Expected future income.
d. The price level and the interest rate.
The Consumption Function
The Relationship between Consumption and Income, 1960–2010
The Slope of the Consumption Function is the Marginal Propensity to Consume
MPC = Change in Consumption in Response to a Change in Disposable Income
MPC = ΔConsumption/ΔDisposable Income = ΔC/ΔYD
When disposable income changes, ΔC = MPC x ΔYD
For a textbook economy:
The Relationship between Consumption and National Income
when net taxes are constant  ΔYD = ΔNI
Which of the following is correct?
a. Disposable income is equal to national income plus
government transfer payments minus taxes.
b. Taxes minus Government transfer payments equal
net taxes.
c. Disposable income = National income – Net taxes.
d. All of the above.
Income, Consumption, and Saving
National income = Consumption + Saving + Net Taxes
Y=C +S+T
Change in NI = 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
1 = MPC + MPS
Calculating the Marginal Propensity to Consume and the Marginal
Propensity to Save
Fill in the blanks in the following table. For simplicity, assume that taxes are zero.
National Income
and Real GDP (Y)
Consumption
(C)
$9,000
$8,000
10,000
8,600
11,000
9,200
12,000
9,800
13,000
10,400
Saving
(S)
Marginal Propensity
to Consume (MPC)
Marginal Propensity
to Save (MPS)
—
—
Calculating the Marginal Propensity to Consume and the Marginal
Propensity to Save
Fill in the blanks in the following table. For simplicity, assume that taxes are zero.
National Income
and Real GDP (Y)
Consumption
(C)
Saving
(S)
Marginal Propensity
to Consume (MPC)
Marginal Propensity
to Save (MPS)
$9,000
$8,000
$1,000
—
—
10,000
8,600
1,400
0.6
0.4
11,000
9,200
1,800
12,000
9,800
2,200
13,000
10,400
2,600
Fill in the table.
For example, to calculate the value of the MPC in the second row, we have:
MPC 
C
$8,600  $8,000
$600


 0.6
Y $10,000  $9,000 $1,000
To calculate the value of the MPS in the second row, we have:
MPS 
S
$1,400  $1,000
$400


 0.4
Y $10,000  $9,000 $1,000
Calculating the Marginal Propensity to Consume and the Marginal
Propensity to Save
Fill in the blanks in the following table. For simplicity, assume that taxes are zero.
National Income
and Real GDP (Y)
Consumption
(C)
Saving
(S)
Marginal Propensity
to Consume (MPC)
Marginal Propensity
to Save (MPS)
$9,000
$8,000
$1,000
—
—
10,000
8,600
1,400
0.6
11,000
9,200
1,800
0.6
0.4
12,000
9,800
2,200
0.6
0.4
13,000
10,400
2,600
0.6
0.4
Show that the MPC plus the MPS equals 1.
Show that the MPC plus the MPS equals 1.
At every level of national income, the MPC is 0.6 and the MPS is 0.4.
Therefore, the MPC plus the MPS is always equal to 1.
If the marginal propensity to consume (MPC) is 0.9,
how much additional consumption will result from an
increase of $80 billion of disposable income?
a. $88.89 billion.
b. $800 billion.
c. $72 billion.
d. None of the above.
Planned Investment
Real Investment
Investment is subject to larger changes than is consumption.
Investment declined significantly during the recessions of 1980, 1981–1982,
1990–1991, 2001, and 2007–2009.
Note: The values are quarterly data, seasonally adjusted at an annual rate.
The most important variables that determine the level of
investment:
• Expectations of future profitability
Waves of optimism and pessimism
• Major technology changes: new products & processes
• The interest rate
• Taxes
• Cash flow  Retained earnings for financing investment
• Current capacity utilization
The behavior of consumption and investment over time
can be described as follows:
a. Investment follows a smooth, upward trend, but
consumption is highly volatile.
b. Consumption follows a smooth, upward trend, but
investment is subject to significant fluctuations.
c. Both consumption and investment fluctuate
significantly over time.
d. Neither consumption nor investment fluctuate
significantly over time.
Government Purchases (including State and Local) = G
Real Government Purchases
Government purchases grew steadily for most of the 1979–2011 period, with
the exception of the early 1990s, when concern about the federal budget deficit
caused real government purchases to fall for three years, beginning in 1992 and
in recent recession when State and Local expenditures declined.
Real Net Exports
Net exports were negative in most years between 1979 and 2011.
Net exports have usually increased when the U.S. economy is in recession and decreased
when the U.S. economy is expanding, although they fell during most of the 2001 recession.
Note: The values are quarterly data, seasonally adjusted at an annual rate.
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
If inflation in the United States is lower than inflation in
other countries, then U.S. exports ________ and U.S.
imports ________, which _________ net exports.
a. increase; increase; decreases
b. increase; decrease; increases
c. decrease; increase; increases
d. decrease; increase; decreases
Graphing Macroeconomic Equilibrium
The Relationship between Planned Aggregate
Expenditure and GDP on a 45°-Line Diagram
Graphing Macroeconomic Equilibrium
Graphing Macroeconomic Equilibrium
Showing a Recession on the 45°-Line Diagram
Macroeconomic Equilibrium
Planned
Unplan
Planned
Govern
Aggregate
ned
Invest
ment
Net
Expenditur Change
ment
Purchases Export
e
in Invent
(I)
(G)
(NX)
(AE)
ories
Real
GDP
(Y)
Consump
tion
(C)
Real
GDP
Will …
$8,000
$6,200
$1,500
$1,500
– $500
$8,700
–$700
increase
9,000
6,850
1,500
1,500
–500
9,350
–350
increase
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
The Multiplier Effect
Learning Objective 11.4
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.
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
Making
the
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%
The Multiplier Effect
A Formula for the Multiplier
1
1  MPC
Y = C + I + G + NX
C depends on YD:
C = c0 + MPC x YD = c0 + MPC x (Y – T)
c0, I, G, T, and NX are autonomous—they do not depend on Y
Y = c0 + MPC x Y – MPC x T + I + G + NX
(1 – MPC) x Y = c0 + I + G – MPC x T + NX
Y = [1/(1 – MPC)] x [c0 + I + G – MPC x T + NX]
Multiplier 
Change in equilibriu m real GDP
1

Change in autonomous expenditur e 1  MPC
Find equilibrium GDP using the following macroeconomic
model:
C = 1000 + 0.75Y
Consumption function
I = 500
Investment function
G = 600
Government spending function
NX = −300
Net export function
Y = C + I + G + NX
Equilibrium condition
a.
800
b. 1800
c.
2400
d. 7200
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.
Using the Multiplier Formula
Use the information in the table to answer the following questions:
Real GDP
(Y)
Consumption
(C)
Planned
Investment
(I)
Government
Purchases
(G)
Net Exports
(NX)
$8,000
$6,900
$1,000
$1,000
−$500
9,000
7,700
1,000
1,000
−500
10,000
8,500
1,000
1,000
−500
11,000
9,300
1,000
1,000
−500
12,000
10,100
1,000
1,000
−500
Note: The values are in billions of 2005 dollars.
a. What is the equilibrium level of real GDP?
b. What is the MPC?
c. If government purchases increase by $200 billion, what will be the new equilibrium level
of real GDP?
Use the multiplier formula to determine your answer.
Using the Multiplier Formula
Use the information in the table to answer the following questions:
Real GDP
(Y)
Consumption
(C)
Planned
Investment
(I)
Government
Purchases
(G)
Net Exports
(NX)
Planned
Aggregate
Expenditure
(AE)
$8,000
$6,900
$1,000
$1,000
−$500
$8,400
9,000
7,700
1,000
1,000
−500
9,200
10,000
8,500
1,000
1,000
−500
10,000
11,000
9,300
1,000
1,000
−500
10,800
12,000
10,100
1,000
1,000
−500
11,600
Note: The values are in billions of 2005 dollars.
Determine equilibrium real GDP.
We can find macroeconomic equilibrium by calculating the level of planned aggregate
expenditure for each level of real GDP.
We can see that macroeconomic equilibrium will occur when real GDP equals $10,000
billion.
MPC 
Calculate the MPC.
In this case:
MPC 
C
Y
$800 billion
 0.8
$1,000 billion
Using the Multiplier Formula
Use the multiplier formula to calculate the new equilibrium level of real
GDP.
We could find the new level of equilibrium real GDP by constructing a new table with
government purchases increased from $1,000 billion to $1,200 billion.
But the multiplier allows us to calculate the answer directly.
In this case:
1
1
Multiplier 

5
1  MPC 1  0.8
So:
Change in equilibrium real GDP = Change in autonomous expenditure × 5
Or:
Change in equilibrium real GDP = $200 billion × 5 = $1,000 billion
Therefore:
New level of equilibrium GDP = $10,000 billion + $1,000 billion
= $11,000 billion
The Paradox of Thrift
In discussing the aggregate expenditure model, John Maynard
Keynes argued that if many households decide at the same time to
increase their saving and reduce their spending, they may make
themselves worse off by causing aggregate expenditure to fall,
thereby pushing the economy into a recession.
The lower incomes in the recession might mean that total saving does
not increase, despite the attempts by many individuals to increase
their own saving.
Keynes referred to this outcome as the paradox of thrift because what
appears to be something favorable to the long-run performance of the
economy might be counterproductive in the short run.
Aggregate Demand: The Relation Between Price and Aggregate Expenditure
Increases in the price level cause aggregate expenditure to fall, and decreases in the
price level cause aggregate expenditure to rise.
There are three main reasons for this inverse relationship between changes in the price
level and changes in aggregate expenditure:
• A rising price level decreases Consumption by decreasing the real value of
household wealth
• International competition: If the price level in the United States rises relative to the
price levels in other countries, U.S. exports will become relatively more expensive,
and foreign imports will become relatively less expensive, causing Net Exports to
fall.
• Interest rate effect: When prices rise, firms and households need more money to
finance buying and selling. If the central bank does not increase the money supply,
the result will be an increase in the interest rate, which causes Investment spending
to fall. Rising interest rates may also lead to dollar appreciation: U.S. exports will
become relatively more expensive, and foreign imports will become relatively less
expensive, causing Net Exports to fall yet more.
The Aggregate Demand Curve
The Effect of a Change in
the Price Level on Real GDP
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.
Key Terms
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
Appendix
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
Appendix
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
Appendix
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