Download Chapter 19: Aggregate Expenditure and Equilibrium Output

CHAPTER
19
Aggregate Expenditure and
Equilibrium Output
Prepared by: Fernando Quijano
and Yvonn Quijano
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Core of Macroeconomic Theory
Chapters 19-20
The Market for
Goods and Services
• Planned aggregate
expenditure
Consumption (C)
Investment (I)
Government spending (G)
Net exports (EX – IM)
• Aggregate output (income) (Y)
• Equilibrium output
(income) (Y*)
Chapters 21-22
Chapter 23
Connections
between the
goods market
and the money
market
r*
Chapter 24
Chapter 25
Aggregate Demand and
Aggregate Supply
The Labor Market
• Aggregate demand curve
• The supply of labor
• The demand for
labor
• Employment and
unemployment
Y*
• Aggregate supply curve
The Money Market
• The supply of money
• The demand for money
• Equilibrium interest rate (r*)
Equilibrium price level
(P*)
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Aggregate Output and
Aggregate Income (Y)
• Aggregate output is the total
quantity of goods and services
produced (or supplied) in an
economy in a given period.
• Aggregate income is the total
income received by all factors of
production in a given period.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Aggregate Output and
Aggregate Income (Y)
• Aggregate output (income) (Y) is a
combined term used to remind you of the
exact equality between aggregate output
and aggregate income.
• When we talk about output (Y), we mean
real output, not nominal output. Output
refers to the quantities of goods and
services produced, not the dollars in
circulation.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Income, Consumption,
and Saving (Y, C, and S)
• A household can do two, and only two,
things with its income: It can buy goods
and services—that is, it can consume—or
it can save.
• Saving is the part of its income that a
household does not consume in a given
period. Distinguished from savings, which
is the current stock of accumulated saving.
S YC
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Saving / Aggregate Income 
Consumption
• All income is either spent on consumption or
saved in an economy in which there are no taxes.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
• Saving is the amount added to accumulated savings in
any given period.Saving is a flow variable; savings is a
stock variable.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Explaining Spending Behavior
•
Some determinants of aggregate
consumption include:
1. Household income
2. Household wealth
3. Interest rates
4. Households’ expectations about the future
•
In The General Theory, Keynes argued
that household consumption is directly
related to its income.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
A Consumption Function
for a Household
• The relationship between consumption
and income is called the consumption
function.
• The consumption
function for an
individual household
shows the level of
consumption at each
level of household
income.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
An Aggregate Consumption Function
• For simplicity, we assume that points of aggregate
consumption, when plotted against aggregate
income, lie along a straight line.
C = a  bY
• The slope of the
consumption function (b) is
called the marginal
propensity to consume
(MPC), or the fraction of a
change in income that is
consumed, or spent.
0  b<1
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
An Aggregate Consumption Function
Derived from the Equation C = 100 + .75Y
C  100 .75Y
• At a national income of
zero, consumption is
$100 billion (a).
• For every $100 billion
increase in income
(DY), consumption
rises by $75 billion
(DC).
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
An Aggregate Consumption Function
Derived from the Equation C = 100 + .75Y
C  100 .75Y
AGGREGATE
INCOME, Y
(BILLIONS OF DOLLARS)
AGGREGATE
CONSUMPTION, C
(BILLIONS OF DOLLARS)
0
100
80
160
100
175
200
250
400
400
400
550
800
700
1,000
850
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Consumption and Saving
• Since there are only two places income can go:
consumption or saving, the fraction of additional
income that is not consumed is the fraction saved.
The fraction of a change in income that is saved is
called the marginal propensity to save (MPS).
MPC+MPS  1
• Once we know how much consumption will result
from a given level of income, we know how much
saving there will be. Therefore,
S YC
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Deriving a Saving Function
from a Consumption Function
C  100 .75Y
S YC
AGGREGATE
INCOME, Y
AGGREGATE
CONSUMPTION, C
AGGREGATE
SAVING, S
(ALL IN BILLIONS OF DOLLARS)
0
100
-100
80
160
-80
100
175
-75
200
250
-50
400
400
0
400
550
50
800
700
100
1,000
850
150
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
• Where the consumption function is above the 450
line,consumption exceeds income,and saving is
negative.Where the consumption function is below the 450
line consumption is less than income, and saving is
positive.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Planned Investment (I)
• Investment refers to purchases by firms of
new buildings and equipment and
additions to inventories, all of which add to
firms’ capital stocks.
• One component of investment—inventory
change—is partly determined by how
much households decide to buy, which is
not under the complete control of firms.
change in inventory = production – sales
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
• Manufacturing firms generally have two
kinds of inventories:input and final products.
Investment is a flow variable—it represents
additions to capital stock in a specific period.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Planned Investment (I)
• Desired or planned investment
refers to the additions to capital
stock and inventory that are planned
by firms.
• Actual investment is the actual
amount of investment that takes
place; it includes items such as
unplanned changes in inventories.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Planned Investment (I)
• For now, we will assume
that planned investment
is fixed. It does not
change when income
changes.
• When a variable, such
as planned investment,
is assumed not to
depend on the state of
the economy, it is said to
be an autonomous
variable.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Planned Aggregate Expenditure (AE)
• To determine
planned aggregate
expenditure (AE), we
add consumption
spending (C) to
planned investment
spending (I) at every
level of income.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Equilibrium Aggregate Output (Income)
• In macroeconomics,
equilibrium in the goods
market is the point at which
planned aggregate
expenditure is equal to
aggregate output.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
•The definition of equilibrium can hold if, and
only if, planned investment and actual investment
are equal.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Equilibrium Aggregate Output (Income)
aggregate output / Y
planned aggregate expenditure / AE / C + I
equilibrium: Y = AE, or Y = C + I
Disequilibria:
Y>C+I
aggregate output > planned aggregate expenditure
Inventory investment is greater than planned.
Actual investment is greater than planned investment.
C+I>Y
planned aggregate expenditure > aggregate output
Inventory investment is smaller than planned.
There is unplanned inventory disinvestment.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Inventory Adjustment
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Deriving the Planned Aggregate
Expenditure Schedule.
C  100 .75Y I  25
Deriving the Planned Aggregate Expenditure Schedule and Finding Equilibrium (All Figures in
Billions of Dollars) The Figures in Column 2 are Based on the Equation C = 100 + .75Y.
(1)
(3)
(4)
(5)
(6)
AGGREGATE
CONSUMPTION (C)
PLANNED
INVESTMENT
PLANNED
AGGREGATE
EXPENDITURE (AE)
C+I
UNPLANNED
INVENTORY
CHANGE
Y  (C + I)
EQUILIBRIUM?
(Y = AE?)
100
175
25
200
 100
No
200
250
25
275
 75
No
400
400
25
425
 25
No
500
475
25
500
0
Yes
600
550
25
575
+ 25
No
800
700
25
725
+ 75
No
1,000
850
25
875
+ 125
No
AGGREGATE
OUTPUT
(INCOME) (Y)
(2)
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
Finding Equilibrium
Output Algebraically
(1)
(2)
Y  C I
C  100 .75Y
Y  100 .75Y  25
There is only one value of Y
for which this statement is
(3) I  25
true. We can find it by
By substituting (2) and (3) rearranging terms:
into (1) we get:
Y  .75Y  100  25
Y  100 .75Y  25 Y  .75Y  125
.25Y  125
125
Y
 500
.25
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Saving/Investment
Approach to Equilibrium
Saving is a leakage out of the spending stream. If planned investment is
exactly equal to saving, then planned aggregate expenditure is exactly
equal to aggregate output, and there is equilibrium.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
• The saving / investment approach to equilibrium
is also called the leakages / injections approach to
equilibrium.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The S = I Approach to Equilibrium
• Aggregate output will be equal to planned
aggregate expenditure only when saving
equals planned investment (S = I).
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Multiplier
• The multiplier is the ratio of the change in
the equilibrium level of output to a change
in some autonomous variable.
• An autonomous variable is a variable
that is assumed not to depend on the state
of the economy—that is, it does not
change when the economy changes.
• In this chapter, for example, we consider
planned investment to be autonomous.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Multiplier
• An increase in planned investment causes
output to go up. People earn more income,
consume some of it, and save the rest.
• The multiplier of autonomous investment
describes the impact of an initial increase
in planned investment on production,
income, consumption spending, and
equilibrium income.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
• Because added saving is a fraction of added
income (the MPS) , the increase in income
required to restore equilibrium must be a
multiple of the increase in planned investment.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Multiplier
• The size of the multiplier depends on the slope of
the planned aggregate expenditure line.
• The marginal propensity to save may be
expressed as:
DS
MPS 
DY
• Because DS must be equal to DI for equilibrium to be
restored, we can substitute DI for DS and solve:
DI
1
MPS 
therefore, D Y  D I 
DY
MPS
1
1
,
or
multiplier 
multiplier 
1  MPC
MPS
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Multiplier
• After an increase in
planned investment,
equilibrium output is
four times the
amount of the
increase in planned
investment.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Multiplier
• In reality, the size of the
multiplier is about 1.4. That is,
a sustained increase in
autonomous spending of $10
billion into the U.S. economy
can be expected to raise real
GDP over time by $14 billion.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
The Paradox of Thrift
• When households are
concerned about the
future and plan to save
more, the corresponding
decrease in consumption
leads to a drop in
spending and income.
• In their attempt to save more, households have caused
a contraction in output, and thus in income. They end
up consuming less, but they have not saved any more.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
6.You are given the following date concerning Freedonia, a legendary
country.
(1)
(2)
(3)
(4)
Consumption function: C = 200+0.8Y
Investment function I = 100
AE = C+I
AE = Y
a) What are the marginal propensity to consume in Freedonia, and
the marginal propensity to save.
b) Graph equations (3) and (4) and solve for equilibrium income.
c) Suppose equation (2) were changed to(2’) I = 110.
What is the new equilibrium level of income?
By how much does the $10 increase in planned investment change
equilibrium income?
d) Calculate the saving function of Freedonia.Plot this saving function
on a graph with equation (2).Explain why the equilibrium income
in this graph must be the same as in part b.
© 2002 Prentice Hall Business Publishing
Principles of Economics, 6/e
Karl Case, Ray Fair
6.解答
AE
Y = C+I = 200+0.8Y+100
= 300+0.8Y
0.2Y = 300
Y = 1500
I’-I = 10
1500
© 2002 Prentice Hall Business Publishing
AE = C+Y
300
450
10 / MPS = 10/0.2 = 50
Y = 1500+50 = 1550
S = Y-C = Y-200-0.8Y
= -200+0.2Y
-200+0.2Y = 100
0.2Y = 300
Y = 1500
AE = Y
1500
Y
S
100
I = 100
1500Y
-200
Principles of Economics, 6/e
Karl Case, Ray Fair