Download 11.2 learning objective

CHAPTER
11
Chapter 11: Aggregate Expenditure and Output in the Short Run
Aggregate Expenditure
and Output
in the Short Run
Prepared by:
Fernando Quijano
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Chapter 11: Aggregate Expenditure and Output in the Short Run
Aggregate Expenditure and Output in the Short Run
Aggregate expenditure (A.E.)
The total amount of spending in the
economy: the sum of consumption,
planned investment, government
purchases, and net exports.
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11.1 LEARNING OBJECTIVE
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Aggregate Expenditure Model
Understand how macroeconomic
equilibrium s determined in the
aggregate expenditure model.
Aggregate expenditure model
A macroeconomic model that focuses
on the short-run relationship between
total spending and real GDP, assuming
that the price level is constant.
Aggregate Expenditure (A.E.)
• Consumption (C)
• Planned investment (I)
• Government purchases (G)
• Net exports (NX)
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11.1 LEARNING OBJECTIVE
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Aggregate Expenditure Model
Understand how macroeconomic
equilibrium s determined in the
aggregate expenditure model.
A.E. = Consumption + Planned investment + Government
purchases + Net exports
or
A.E. = C + I + G + NX
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11.1 LEARNING OBJECTIVE
The Aggregate Expenditure Model
Understand how macroeconomic
equilibrium s determined in the
aggregate expenditure model.
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Difference between “Planned” Investment
and “Actual” Investment
Inventories Goods that
have been produced but not
yet sold.
*According to the Keynesian school of economic
thought, macroeconomic equilibrium must occur
where A.E. = GDP.*
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11.1 LEARNING OBJECTIVE
The Aggregate Expenditure Model
Understand how macroeconomic
equilibrium s determined in the
aggregate expenditure model.
Adjustments to Macroeconomic Equilibrium
Table 11-1
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Relationship between
Aggregate Expenditure and GDP
IF …
THEN …
AND …
A.E. = GDP
inventories are
unchanged
the economy is in
macroeconomic equilibrium.
inventories rise
GDP and employment
decrease.
inventories fall
GDP and employment
increase.
A.E. < GDP
A.E. > GDP
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Determining the Level of Aggregate
Expenditure in the Economy
11.2 LEARNING OBJECTIVE
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Table 11-2
Components of Real Aggregate
Expenditure, 2012
EXPENDITURE CATEGORY
Consumption
EXPENDITURE
(BILLIONS OF 2009 DOLLARS)
$10,518
Planned investment
2,436
Government purchases
2,963
Net exports
−431
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Consumption
FIGURE 11-1
Chapter 11: Aggregate Expenditure and Output in the Short Run
Real Consumption
Consumption follows
a smooth, upward
trend, interrupted only
infrequently by brief
recessions.
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Consumption
Chapter 11: Aggregate Expenditure and Output in the Short Run
The following are the five most important variables that
determine the level of consumption:
• Disposable income (YD)
• Wealth
• Expected future income
• The price level (P)
• The real interest rate (r)
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Disposable Income (YD)
The most important determinant of consumption is
the current disposable income of households.
Wealth
Consumption depends in part on the wealth of households.
A person’s wealth is the value of his/her assets minus the
value of his/her liabilities.
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Expected future income
Consumption depends in part on expected future income.
Most people prefer to keep their consumption fairly stable
from year to year, even if their income fluctuates
significantly.
The price level (P)
The price level measures the average prices of goods and
services in the economy. Consumption is affected by changes
in the price level.
The real interest rate (r)
When the interest rate is high, the reward for saving is
increased, and households are likely to save more and spend
less.
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Making Do Changes in Housing Wealth
the Affect Consumption Spending?
Chapter 11: Aggregate Expenditure and Output in the Short Run
Connection
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Many macroeconomic
variables, such as
GDP, housing prices,
consumption
spending, and
investment spending,
rise and fall at about
the same time during
the business cycle
12 of 55
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Consumption Function
FIGURE 11-2
The Relationship between Consumption and Income, 1960– 2008
Panel (a) shows the relationship between
consumption and income. The points represent
combinations of C and YD for 1960 - 2008.
In panel (b), we draw a straight line through the
points from panel (a). The line represents the
relationship between C and YD . This line is
called the consumption function. The slope of the
consumption function is the MPC.
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Consumption Function
Consumption function The relationship
between consumption spending and
disposable income.
Marginal propensity to consume (MPC) The slope
of the consumption function; the amount by which
consumption spending changes when disposable
income changes.
MPC 
Change in consumptio n
C

Change in disposable income YD
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Consumption Function
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
or
Change in consumption = Change in disposable income * MPC
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Determining the Level of Aggregate
Expenditure in the Economy
The Relationship between Consumption
and National Income
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Disposable income = National income − Net taxes
We can rearrange the equation like this:
National income = GDP = Disposable income + Net taxes
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
FIGURE 11-3
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Relationship between
Consumption and National
Income
Because national income differs
from disposable income only by
net taxes—which, for simplicity,
we assume are constant—we can
graph the consumption function
using national income rather than
disposable income.
We can also calculate the MPC,
which is the slope of the
consumption function, using either
the change in national income or
the change in disposable income
and always get the same value.
The slope of the consumption
function between point A and point
B is equal to the change in
consumption—$1,500 billion—
divided by the change in national
income—$2,000 billion—or 0.75.
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Income, Consumption, and Saving
National income = Consumption + Saving + Taxes
Chapter 11: Aggregate Expenditure and Output in the Short Run
Change in national income = Change in consumption + Change in saving +
Change in taxes
Y=C+S+T
and
Y  C  S  T
To simplify, we can assume that taxes are always a constant
amount, in which case ΔT = 0, so the following is also true:
ΔY = ΔC + ΔS
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output 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
MPC + MPS = 1
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Solved Problem
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
11-2
Calculating the Marginal Propensity to
Consume and the Marginal Propensity to Save
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
C
MPC 
Y
MPS 
REAL GDP (Y)
CONSUMPTION
(C)
S
Y
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
0.6
0.4
12,000
9,800
2,200
0.6
0.4
13,000
10,400
2,600
0.6
0.4
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Determining the Level of Aggregate
Expenditure in the Economy
Planned Investment
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
FIGURE 11-4
Chapter 11: Aggregate Expenditure and Output in the Short Run
Real Investment
Investment is much
more volatile than
consumption.
Investment declined
significantly during
the recessions of
1980, 1981–1982,
1990–1991, 2001,
and 2007–2009.
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Planned Investment
The four most important variables that determine
the level of investment are:
• Expectations of future profitability
• The real interest rate (r)
• Taxes (τ)
• Cash flow
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Expectations of future profitability
The optimism or pessimism of firms is an important
determinant of investment spending.
The real interest rate (r)
A higher real interest rate results in less investment
spending, and a lower real interest rate results in more
investment spending.
23 of 55
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Taxes (τ)
Firms focus on the profits that remain after
they have paid taxes.
Cash flow
The difference between the cash
revenues received by a firm and the
cash spending by the firm.
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Determining the Level of Aggregate
Expenditure in the Economy
Government Purchases
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
FIGURE 11-5
Chapter 11: Aggregate Expenditure and Output in the Short Run
Real Government
Purchases
Government
purchases grew
steadily for most of
the 1979–2009
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.
25 of 55
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Determining the Level of Aggregate
Expenditure in the Economy
Net Exports
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
FIGURE 11-6
Chapter 11: Aggregate Expenditure and Output in the Short Run
Real Net Exports
Net exports were
negative in most
years between 1979
and 2009. 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.
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Determining the Level of Aggregate
Expenditure in the Economy
11.2
LEARNING
OBJECTIVE23.2
Learning
Objective
Discuss the determinants of the four
components of aggregate expenditure and
define marginal propensity to consume
and marginal propensity to save.
Chapter 11: Aggregate Expenditure and Output in the Short Run
The following are the three most important variables that determine
the level of net exports:
The price level in the United States relative to the price level in other
countries
If inflation in the United States is lower than inflation in other
countries, prices of U.S. products increase more slowly than the
prices of products of other countries.
The growth rate of GDP in the United States relative to the growth
rate of GDP in other countries
When incomes in the United States rise more slowly than incomes in
other countries, net exports will rise.
The exchange rate between the U.S. dollar and other currencies
As the value of the U.S. dollar rises, the foreign currency price of
U.S. products sold in other countries rises, and the dollar price of
foreign products sold in the United States falls.
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11.3 LEARNING OBJECTIVE
Graphing Macroeconomic Equilibrium
Use a 45°-line diagram to illustrate
macroeconomic equilibrium.
FIGURE 11-7
Chapter 11: Aggregate Expenditure and Output in the Short Run
An Example of a 45°-Line
Diagram
In geometry, a 45° line
shows all the points that
are equal distances from
both axes.
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11.3
LEARNING
OBJECTIVE
Learning
Objective
Graphing Macroeconomic Equilibrium
Use
a 45°-line diagram to illustrate
23.3
macroeconomic equilibrium.
FIGURE 11-8
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Relationship between
Planned Aggregate
Expenditure and GDP on
a 45°-Line Diagram
Every point of
macroeconomic
equilibrium is on the 45°
line, where A.E. ≡ GDP.
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11.3
LEARNING
OBJECTIVE
Learning
Objective
Graphing Macroeconomic Equilibrium
Use
a 45°-line diagram to illustrate
23.3
macroeconomic equilibrium.
FIGURE 11-9
Chapter 11: Aggregate Expenditure and Output in the Short Run
Macroeconomic Equilibrium
on the 45°-Line Diagram
Macroeconomic equilibrium
occurs where the A.E.
function crosses the 45°
line.
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11.3
LEARNING
OBJECTIVE
Learning
Objective
Graphing Macroeconomic Equilibrium
Use
a 45°-line diagram to illustrate
23.3
macroeconomic equilibrium.
FIGURE 11-10
Chapter 11: Aggregate Expenditure and Output in the Short Run
Macroeconomic Equilibrium
The Keynesian Cross
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11.3
LEARNING
OBJECTIVE
Learning
Objective
Graphing Macroeconomic Equilibrium
Use
a 45°-line diagram to illustrate
23.3
macroeconomic equilibrium.
FIGURE 11-11
Chapter 11: Aggregate Expenditure and Output in the Short Run
Showing a Recession
on the 45°-Line Diagram
How the Keynesian Cross
illustrates a recession
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11.3
LEARNING
OBJECTIVE
Learning
Objective
Graphing Macroeconomic Equilibrium
Use
a 45°-line diagram to illustrate
23.3
macroeconomic equilibrium.
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Important Role of Inventories
Whenever planned aggregate expenditure is
less than real GDP, some firms will experience
unplanned increases in inventories.
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11.3
LEARNING
OBJECTIVE
Learning
Objective
Graphing Macroeconomic Equilibrium
Use
a 45°-line diagram to illustrate
23.3
macroeconomic equilibrium.
A Numerical Example of Macroeconomic Equilibrium
Table 11-3
Chapter 11: Aggregate Expenditure and Output in the Short Run
Macroeconomic Equilibrium
REAL
GDP
(Y)
PLANNED
GOVERNMENT
NET
CONSUMPTION INVESTMENT PURCHASES EXPORTS
(C)
(I)
(G)
(NX)
PLANNED
AGGREGATE
EXPENDITURE
(A.E.)
UNPLANNED
CHANGE IN
INVENTORIES
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
10,000
7,500
1,500
1,500
–500
10,000
0
11,000
8,150
1,500
1,500
–500
10,650
+350
decrease
12,000
8,800
1,500
1,500
–500
11,300
+700
decrease
be in
equilibrium
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Solved Problem
11.3
LEARNING
OBJECTIVE
Learning
Objective
11-3
Use
a 45°-line diagram to illustrate
23.3
macroeconomic equilibrium.
Determining Macroeconomic Equilibrium
Chapter 11: Aggregate Expenditure and Output in the Short Run
Planned aggregate expenditure (A.E.) = Consumption (C) +
Investment (I) + Government purchases (G) + Net exports (NX)
Unplanned change in inventories = Real GDP (Y) −
Planned aggregate expenditure (A.E.)
Government
Purchases
(G)
Net
Exports
(NX)
Planned
Aggregate
Expenditure
(A.E.)
$1,675
$1,675
$–500
$9,050
$–1,050
6,850
1,675
1,675
–500
9,700
–700
10,000
7,500
1,675
1,675
–500
10,350
–350
11,000
8,150
1,675
1,675
–500
11,000
0
12,000
8,800
1,675
1,675
–500
11,650
350
Real
GDP
(Y)
Consumption
(C)
$8,000
$6,200
9,000
Planned
Investment
(I)
Unplanned
Change in
Inventories
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11.4 LEARNING OBJECTIVE
The Multiplier Effect
Describe the multiplier effect and use
the multiplier formula to calculate
changes in equilibrium GDP.
FIGURE 11-12
Chapter 11: Aggregate Expenditure and Output in the Short Run
The Multiplier Effect
The Keynesian Multiplier
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11.4 LEARNING OBJECTIVE
The Multiplier Effect
Describe the multiplier effect and use
the multiplier formula to calculate
changes in equilibrium GDP.
Chapter 11: Aggregate Expenditure and Output in the Short Run
Autonomous expenditure An
expenditure that does not depend on
the level of GDP.
Keynesian Multiplier The increase in
equilibrium real GDP divided by the
increase in autonomous expenditure.
Multiplier effect The process by
which an increase in autonomous
expenditure leads to a larger increase
in real GDP.
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11.4 LEARNING OBJECTIVE
The Multiplier Effect
Describe the multiplier effect and use
the multiplier formula to calculate
changes in equilibrium GDP.
Table 11-4
The Multiplier Effect in Action
Chapter 11: Aggregate Expenditure and Output in the Short Run
ADDITIONAL
AUTONOMOUS
EXPENDITURE
(INVESTMENT)
ADDITIONAL INDUCED
EXPENDITURE
(CONSUMPTION)
$0
TOTAL ADDITIONAL
EXPENDITURE =
TOTAL ADDITIONAL GDP
ROUND 1
$100 billion
$100 billion
ROUND 2
0
75 billion
175 billion
ROUND 3
0
56 billion
231 billion
ROUND 4
ROUND 5
.
.
.
ROUND 10
.
.
.
ROUND 15
.
.
.
ROUND 19
.
.
.
0
0
.
.
.
0
.
.
.
0
.
.
.
0
.
.
.
42 billion
32 billion
.
.
.
8 billion
.
.
.
2 billion
.
.
.
1 billion
.
.
.
273 billion
305 billion
.
.
.
377 billion
.
.
.
395 billion
.
.
.
398 billion
.
.
.
n
0
0
$400 billion
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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
Making The Multiplier in Reverse:
Chapter 11: Aggregate Expenditure and Output in the Short Run
the The Great Depression
Connection of the 1930s
11.4 LEARNING OBJECTIVE
Describe the multiplier effect and use
the multiplier formula to calculate
changes in equilibrium GDP.
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
$737 billion
$102 billion
-$11 billion
$977 billion
3.2%
1933
$601 billion
$19 billion
-$12 billion
$716 billion
24.9%
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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
11.4 LEARNING OBJECTIVE
The Multiplier Effect
Describe the multiplier effect and use
the multiplier formula to calculate
changes in equilibrium GDP.
Chapter 11: Aggregate Expenditure and Output in the Short Run
A Formula for the Keynesian Multiplier
1
1  MPC
Change in equilibriu m real GDP
1
Multiplier 

Change in autonomous expenditur e 1  MPC
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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
11.4 LEARNING OBJECTIVE
The Multiplier Effect
Describe the multiplier effect and use
the multiplier formula to calculate
changes in equilibrium GDP.
Summarizing the Multiplier Effect
Chapter 11: Aggregate Expenditure and Output in the Short Run
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 increases in GDP
have on imports, inflation, interest rates, and individual
income taxes.
41 of 55
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
11.4 LEARNING OBJECTIVE
The Multiplier Effect
Describe the multiplier effect and use
the multiplier formula to calculate
changes in equilibrium GDP.
Chapter 11: Aggregate Expenditure and Output in the Short Run
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 A.E. to fall. This
would push 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 longrun performance of the economy might be counterproductive in
the short-run.
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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
KEY TERMS
Aggregate expenditure (A.E.)
Keynesian Multiplier
Aggregate expenditure model
Marginal propensity to
consume (MPC)
Chapter 11: Aggregate Expenditure and Output in the Short Run
Autonomous expenditure
Consumption function
Marginal propensity to
save (MPS)
Inventories
Multiplier effect
Cash flow
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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Macroeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.