Download ECN 111 Chapter 15 Lecture Notes

ECN 111 Chapter 15 Lecture Notes
15.1 Expenditure Plans and Real GDP
A. The Economy at Full Employment
At full employment, GDP equals potential GDP and is determined by real factors. Changes in the
quantity of money change only the price level, but they have no effect on potential GDP. Away
from potential GDP, real and monetary factors interact to determine real GDP.
B. Departures from Full Employment
Away from full employment, fluctuations in aggregate supply and aggregate demand bring
fluctuations around full employment.
C. Fixed Price Level
The aggregate expenditure model tells us about the forces that determine the quantity of real
GDP demanded at any given price level.
D. Planned and Unplanned Expenditures
Aggregate planned expenditure is equal to planned consumption expenditure plus planned
investment plus planned government purchases plus planned exports minus planned imports. If
aggregate planned expenditure equals real GDP, the change in firms’ inventories is the planned
change. If aggregate planned expenditure exceeds real GDP, firms’ inventories are smaller than
planned; if aggregate planned expenditure is less than real GDP, firms’ inventories are larger
than planned.
E. Autonomous Expenditure and Induced Expenditure
The components of aggregate expenditure that do not change when real GDP changes are called
autonomous expenditure. The components of aggregate expenditure that change when real
GDP changes are called induced expenditure.
F. The Consumption Function
The consumption function is the relationship between consumption expenditure and disposable
income, other things remaining the same.
1. Consumption Plans
For households and the economy as a whole, as disposable income increases, planned
consumption expenditure increases.
2. Marginal propensity to consume (MPC) is the fraction of a change in disposable income
that is spent on consumption. The marginal propensity to consume is equal to
Changein consumption expenditure
.
Changein disposableincome
3. Other Influences on Consumption
a. A movement along the consumption function results from a change in disposable income.
b. Shifts in the consumption function result from changes in the real interest rate, the buying
power of net assets, and expected future disposable income.
G. Imports and GDP
The major factor that influences U.S. imports is U.S. real GDP. An increase in real GDP is also an
increase in income and, as income increases, consumers increase their expenditure on most
goods and services, including imports.
a. The marginal propensity to import is the fraction of an increase in real GDP that is spent on
imports—the change in imports divided by the change in real GDP.
15.2 Equilibrium Expenditure
A. Aggregate Planned Expenditure and Real GDP
Aggregate planned expenditure is the sum of planned consumption expenditure, investment,
government purchases of goods and services, and exports minus imports.
B. Equilibrium Expenditure
Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate
planned expenditure equals real GDP.
C. Convergence to Equilibrium
When aggregate planned expenditure and actual aggregate expenditure are unequal, production
plans and spending plans are inconsistent, and a process of convergence toward equilibrium
expenditure occurs.
1. If aggregate planned expenditure exceeds real GDP, inventories decrease below their target
levels. Firms increase their production to build up their inventories and GDP increases.
2. If aggregate planned expenditure is less than real GDP, inventories increase above their target
levels. Firms decrease their production to reduce their inventories and GDP decreases.
15.3 The Expenditure Multiplier
A. The Basic Idea of the Multiplier
The multiplier is the amount by which a change in any component of autonomous expenditure is
magnified or multiplied to determine the change that it generates in equilibrium expenditure and
real GDP.
1. The multiplier exists because a change in autonomous expenditure creates a change in
disposable income, which leads to additional changes in induced expenditure and disposable
income.
B. The Size of the Multiplier
Changein equilibrium expenditure
.
Multiplier =
Changein autonomousexpenditure
C. Why is the Multiplier Greater Than 1?
The multiplier is greater than 1 because an increase in autonomous expenditure induces further
increases in aggregate expenditure—induced expenditure increases.
D. The Multiplier and the MPC
The greater the marginal propensity to consume, the larger is the multiplier. Ignoring the effects of
1
imports and income taxes, the multiplier equals
.
(1  MPC )
E. Imports and Income Taxes
The larger is the marginal propensity to import and the larger is the marginal tax rate (the
fraction of a change in real GDP that is paid in income taxes), the smaller is the multiplier.
1. The general formula for the multiplier is
1
.
Multiplier =
(1  Slopeof AE curve)
F. Business-Cycle Turning Points
The forces that bring business-cycle turning points are the swings in autonomous expenditure
such as investment and exports. The mechanism that gives momentum to the economy's new
direction is the multiplier.
15.4 The AD Curve and Equilibrium Expenditure
A. Deriving the AD Curve from Equilibrium Expenditure.
The AD curve can be derived from the aggregate expenditure model.
1. An increase in the price level decreases aggregate expenditure.
2. The decrease in aggregate expenditure is reflected in a downward shift in the AE curve.
3. The decrease in aggregate expenditure leads to a decrease in equilibrium expenditure.
4. Plotting the higher price level against the lower level of equilibrium expenditure creates a point on
the aggregate demand (AD) curve.
5. Because a higher price level results in a lower quantity of real GDP demanded, the AD curve is
downward sloping.