Download Aggregate Expenditure and Equilibrium Output

Aggregate Expenditure and
Equilibrium Output
Aggregate Output and Aggregate
Income
z Aggregate output is the total quantity of goods
and services produced (or supplied) in an
economy in a given time period.
z Aggregate income is the total income received
by all factors of production in a given period.
z Aggregate output (income) is a combined term
used to remind you of the exact equality
between aggregate output and aggregate
income.
Chapter 9
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Income, Consumption, and Saving
(Y, C, and S)
Determinants of Aggregate
Consumption
z Saving (S) is the part of income that a
household does not consume in a given period.
Distinguished from savings which is the current
stock of accumulated saving.
z
z
z
z
Saving
S
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Household income
Household wealth
Interest rates
Households’ expectations about the future
Income - Consumption
Y-C
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Consumption Function and Marginal
Propensity to Consume
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Aggregate Consumption Function
(Figure 9.4)
z A consumption function is the relationship
between consumption and income.
z Marginal propensity to consume (MPC) is that
fraction of a change in income that is consumed
or spent.
Marginal Propensity to Consume = Slope of Consumption Function
= ÄC / ÄY
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Marginal Propensity to Save
Consumption Schedule Derived from
Equation C = 100 + .75Y (Table 9.1)
Aggregate Income, Y
(billions of dollars)
z Marginal propensity to save (MPS) is that
fraction of a change in income that is saved.
0
80
100
200
400
600
800
1000
MPC + MPS = 1
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Consumption Function Derived from
C = 100 + 0.75Y (Figure 9.5)
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Deriving a Savings Schedule from a
Consumption Schedule (Table 9.2)
0
80
100
200
400
600
800
1000
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Deriving a Savings Function from a
Consumption Function (Figure 9.6)
100
160
175
250
400
550
700
850
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Aggregate Income, Y
(billions of dollars)
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Aggregate Consumption, C
(billions of dollars)
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Aggregate Consumption, C Aggregate Saving, S
(billions of dollars)
(billions of dollars)
100
160
175
250
400
550
700
850
-100
-80
-75
-50
0
50
100
150
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The Consumption Function
C = 100 + .75Y
z People buy goods even when their income is
zero
z 75% of each dollar of income is consumed
z 25% of each dollar is saved
z 0.75 is the marginal propensity to consume
(MPC)
z O.25 is the marginal propensity to save
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Increase in MPC
Increase in the Constant
Consumption
Consumption
Consumption
Function
Consumption
Function
45o
45o
Household Income
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Planned Investment (I)
z Investment is the purchases by firms of new
buildings and equipment and additions to
inventories, all of which add to the firms’ capital
stock.
z Desired or planned investment is those additions
to capital stock and inventory that are planned
by firms.
z Actual investment is the actual amount of
investment that takes place; it includes such
items as unplanned changes in inventories.
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Equilibrium Aggregate Output
(Income)
Household Income
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Planned Aggregate Expenditure (AE)
z Planned aggregate expenditure is the total
amount the economy plans to spend in a given
period.
AE = C + I + G + EX - IM
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Deriving the Planned Aggregate Expenditure
Schedule and Finding Equilibrium (Table 9.3)
z Equilibrium occurs when there is no tendency
for change. In the macroeconomic goods
market, equilibrium occurs when planned
aggregate expenditure is equal to aggregate
output.
Aggregate output = Y
Planned aggregate expenditure = AE = C + I
Equilibrium: Y = AE, or Y = C + I
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From the Table its clear that only at Y=500 are aggregate
output and planned aggregate expenditure equal. This can also
be shown algebraically and graphically.
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Finding Equilibrium Level of Output
Algebraically
Finding Equilibrium Level of Output
Graphically: Step 1 (Figure 9.8a)
(1) Y = C + I (equilibrium)
(2) C = 100 + 0.75Y (consumption function)
(3) I = 25 (planned investment)
z Planned
aggregate
expenditure is
the sum of
consumption
spending and
planned
investment
spending.
Substituting (2) and (3) into (1) we get
Y = 100 + 0.75Y + 25
Solve for Y to get
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Y = 500
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Finding Equilibrium Level of Output
Graphically: Step 2 (Figure 9.8b)
z Equilibrium occurs
when planned
aggregate
expenditure and
aggregate output
are equal. The 45
degree line
represents all
points where Y and
C+I are equal.
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Adjustment to Equilibrium
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Savings/Investment Approach to
Equilibrium (Figure 9.10)
z Output and income are equal
z Saving is income that is not spent
Y = C + S and
Y = C + I (in
equilibrium)
so in equilibrium
C+S=C+I
S= I
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Adjustment to Equilibrium when Output =
Aggregate Expenditures (Figure 9.8b)
z If planned aggregate expenditure exceeds
aggregate output unplanned inventory
reductions occur and the firm reacts by
increasing output.
z Similarly, if planned spending is less than
output, there will be unplanned increases in
inventories. In this case, firms respond by
decreasing output.
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The Multiplier
The Simple Model and the Multiplier
z The multiplier is the ratio of the change in the
equilibrium level output to a change in some
autonomous variable.
z An autonomous variable is a variable assumed
not to depend on the state of the economy that is, it is taken to be given.
z In the example investment is at 25 billion.
z If investment increases by another 25 billion to
50 billion we have created a disequilibrium; an
unplanned reduction in inventories.
z The firm however cannot restore equilibrium by
just increasing output by 25 billion because that
output goes to income, part of which goes to
consumption spending, which further increases
incomes, etc.
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The Multiplier in the Simple Model
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The Multiplier as Seen in the Planned
Expenditure Diagram (Figure 9.11)
At point A, the economy is in
equilibrium at Y=500. When I
increases by 25, planned
aggregate expenditure is initially
greater than aggregate output.
As output rises in response,
additional consumption is
generated, pushing equilibrium
output up by a multiple of the
initial increase in I. The new
equilibrium is found at B, where
Y=600. Output has increased by
100 or 4 times the increase in
the investment. The multiplier
here is therefore 4.
z The increase in output to compensate for
increased investment in this case must be
substantially greater than 25 billion.
z The multiplier (ÄY / ÄI in this case), can be
found graphically and algebraically.
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The Multiplier Equation
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The Multiplier Equation
z Remember that in order for planned aggregate
expenditure (AE = C + I) and aggregate output (Y) to
be equal, S = I.
z It is possible to calculate how much Y must increase in
response to increased planned investment, by adjusting
Y until S is again equal to I.
z Recall that the marginal propensity to save (MPS) is the
fraction of the change in income that is saved.
MPS = ÄS / ÄY
Since ÄS must be the same as ÄI for equilibrium to be
restored.
MPS = ÄI / ÄY and therefore ÄY = ÄI x 1/MPS.
Multiplier therefore is equal to 1/MPS or,
since MPS + MPC = 1, and MPS = 1 - MPC,
the Multiplier = 1 / (1 – MPC).
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The Multiplier Equation
Consequences of the Multiplier
z In the example here C = 100 + 0.75Y and the
MPC is equal to 0.75.
z Multiplier effect: Equilibrium GDP increases by
more than the change in I or another
autonomous variables.
z This may create the ability for governments to
stimulate the economy by increasing spending,
at least in the simple model.
z The Multiplier = 1 / 1 - 0.75
= 1 / 0.25
=4
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Review Terms & Concepts
z
z
z
z
z
z
z
z
z
actual investment
aggregate income
aggregate output
aggregate output(income)
autonomous variable
change in inventory
consumption function
desired or planned investment
equilibrium
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z identity
z investment
z marginal propensity to
consume (MPC)
z marginal propensity to save
(MPS)
z multiplier
z planned aggregate
expenditure
z saving
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