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Disposable is your net income • Your save or spend that income Marginal Propensity to Consume (MPC) • Is the increase in consumer spending when disposable income rises by $1 • Calculated by consumer spending/ Disposable income. Marginal Propensity to Save (MPS) • Is the increase in household savings when disposable income rises by $1 • savings/ disposable income You can only spend or save that additional dollar so • MPC + MPS = 1 Assumptions • Changes in overall spending lead to changes in Aggregate output. • Interest rates are fixed • Exports and imports are all zero. Consumption function (C) • Shows how a household’s consumer spending varies with the households current disposable income (YD) • Autonomous consumer spending (A) • the amount a household would spend it current income was 0. What will change Autonomous Consumer spending • Changes in expected Future YD • Changes in Aggregate wealth • Aggregate consumer spending • Slope of the C function Is your MPC. Real GDP Investment (I) • Business plan to spending which includes unsold Items. OR Inventory Change in Autonomous Investment expenditure • It is how much a business (I) is going to change their Planned Expenditure initially Aggregate planned Investment expenditure I planned ‘ I I Planned Real GDP AE = Aggregate Planned exp. Slope of AE = MPC = rise/run Of AGG expenditure model. AE = aggregate planned expenditure = C+I planned C = consumption expenditur C+I= I = Planned investment expenditure Real GDP = Y or income • Planned aggregate spending can be different from Real GDP if there is unplanned Inventory Investment. • Negative unplanned investment = smaller than expected inventories (produced to little) Consumers bought more than expected • Positive unplanned investment = greater than expected inventories (produced to much)Consumers • Firms can correct inventories issues by increasing or decreasing production. Which will eliminate unplanned inventories. So increase I Planned or Decrease I Planned to bring Inventories to equilibrium. Real GDP YD= C= Disposable A+(MPC x Income YD) I Planned AE planned I unplanned 0 0 300 500 800 800 500 500 600 500 1100 600 1000 1000 900 500 1400 400 1500 1500 1200 500 1700 200 2000 2000 1500 500 2000 0 2500 2500 1800 500 2300 -200 3000 3000 2100 500 2600 -400 3500 3500 2400 500 2900 -600 MPC = .6 Aggregate planned expenditure Income and expenditure equilibrium 45 degree line all possible places Where planned aggregate spending is Equal to Real GDP 3k • 2.6k 2k 1.4k 1k • • 1K 2K Real GDP 3K At 1k of real GDP we have 1.4k AE planned • 400 unplanned inventories AT 2k of real GDP we have 2k of AE Planned. • 0 unplanned inventories At 3k of real GDP we have 2.6k of AE planned • -400 unplanned inventories Aggregate Planned Expenditure is < Real GDP. National inventories are decreasing or negative unplanned inventories • Autonomous (I) expenditure will increase Aggregate Planned Expenditure > Real GDP National inventories are increasing or positive unplanned inventories. • Autonomous (I) expenditure will decrease. A change in autonomous expenditure by business will cause Real GDP to increase multiple times due the multiplier 1/1-MPC or 1/MPS ex. Autonomous Investment exp. increases 2million and MPC is .2: How much can GDP increase by? $2million * 1/1-mpc = 2mm * 1/1-.2 = 2mm *1/.8 = 2mm *1.25= Government Expenditure (G) • Governments Plan to spend according to a budget. Change in Autonomous Government expenditure • How much a Government is going to change their expenditure initially Aggregate Government Expenditure G’= Change Aut .Gov. Exp G = Autonomous Government Exp. Real GDP Aggregate planned expenditure 45 degree line Income and expenditure equilibrium 3k 2.6k 2k 1.4k 1k 1K 2K Real GDP 3K A change in autonomous expenditure by government will cause Real GDP to increase multiple times due the multiplier 1/1-MPC or 1/MPS ex. Autonomous Investment exp. increases 2million and MPC is .2: How much can GDP increase by? $2million * 1/1-mpc = 2mm * 1/1-.2 = 2mm *1/.8 = 2mm *1.25= Tax Multiplier –MPC/MPS. EX. MPC IS .6 TAXES INCREASES BY 100MM -.6/.4 = - 1.5 X 100MM real GDP decreases by 150mm. MPC IS .6 TAXES BY DECREASE BY 100MM -.6/.4 = -1.5 X -100M REAL GDP WILL INCREASE BY 150MM