Download expenditure plans and real gdp

ECON203
Principles of Macroeconomics
Topic: Expenditure Multipliers: The
Keynesian Model
9W/10/2013
Dr. Mazharul Islam
1
EXPENDITURE PLANS AND
REAL GDP
– From the circular flow of expenditure and
income, aggregate expenditure is the sum of
• Consumption expenditure, C
• Investment, I
• Government expenditure on goods and
services, G
• Net exports, NX (= difference between
spending on imports and receipts from exports
(Balance of Payments)
– Aggregate expenditure = C + I + G + NX.
Dr. Mazharul Islam
2
EXPENDITURE PLANS AND
REAL GDP
Aggregate planned expenditure might not
equal real GDP because firms might end up
with more or less inventories than planned.
Aggregate planned expenditure is planned
consumption expenditure plus planned
investment plus planned government
expenditure plus planned exports minus
planned imports.
Dr. Mazharul Islam
3
EXPENDITURE PLANS AND
REAL GDP
• The Consumption Function
– Consumption function is the relationship
between consumption expenditure and
disposable
income,
other
things
remaining the same.
– Disposable income is aggregate income
(GDP) minus net taxes.
– Net taxes are taxes paid to the
government minus transfer payments
received from the government.
Dr. Mazharul Islam
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450 line
Consumption (trillions of dollars)
C = a + bY
Saving
9.0
F
7.5
E
D
6.0
DissavingC
4.5
3.0
Saving is
zero
B
A
1.5
2.0
Point on Consumption
Function line
Disposable income
Planned Consumption
Expenditure
4.0
6.0
8.0
10.0
Disposable
Income
A
B
C
D
E
F
0
1.5
2.0
3.0
4.0
4.5
6.0
6.0
8.0
7.5
10.0
9.0
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Dr. Mazharul Islam
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Consumption Function
• Along the 45° line, consumption
expenditure equals disposable income.
• . When the consumption function is
above the 45° line, saving is negative
(dissaving occurs).
• When the consumption function is
below the 45° line, saving is positive.
• At the point where the consumption
function intersects the 45° line, all
disposable income is consumed and
saving is zero.
Dr. Mazharul Islam
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MPConsume
– Marginal propensity to consume (MPC) is the
fraction of a change in disposable income that
is spent on consumption.
MPC =
Change in consumption expenditure
Change in disposable income
Example : Notice that when disposable income increases from $6
to $8 trillion, consumption expenditure changes from $6.0 to $7.5
trillion. Then:
$1.5
MPC 
 0.75
$2.0
Dr. Mazharul Islam
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Other Influences on Consumption
Disposable
income
+
(Expected) real
interest rate
+
Wealth
Expected future
disposable income
Real
Consumption
Spending
+
Dr. Mazharul Islam
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– A change in disposable income leads to
a change in consumption expenditure
and a movement along the consumption
function.
– A change in any other influence on
planned consumption shifts the
consumption function.
– For example,
• When the real interest rate decreases,
or wealth increases, or expected future
income increases, consumption
expenditure increases.
Dr. Mazharul Islam
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Shifts of the consumption function
CF1
Consumption (trillions of 1996 dollars)
CF0
CF2
1. Consumption
expenditure increases
and the consumption
function shifts upward
if
•
•
•
The real interest rate
falls
Wealth increases
Expected future
income increases
2. Consumption
expenditure decreases
and the consumption
function shifts
downward if
Disposable income (trillions of 1996 dollars)
• The real interest rate
rises
• Wealth decreases
• Expected future
income decreases
Dr. Mazharul Islam
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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
Dr. Mazharul Islam
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EQUILIBRIUM EXPENDITURE
– Equilibrium expenditure is the level of
aggregate expenditure when aggregate
planned expenditure equals real GDP.
– Equilibrium expenditure equals the real
GDP at which the AE curve intersects
the 45 line.
– In macroeconomics, equilibrium in the
goods market is the point at which
planned aggregate expenditure is equal
to aggregate output
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Aggregate expenditure is the sum of Consumption expenditure (C),
Investment (I), Government expenditure (G), Net export (NX) [Export
(X) minus Import (M)]
Planned Expenditures
[Y]
[C]
[I]
[G]
[X]
[M]
[AE = C + I + G +X - M]
trillions of 1996 dollars
A
0.00
0.00
2.00
1.00
1.50
0.00
4.50
B
3.00
2.25
2.00
1.00
1.50
0.75
6.00
C
6.00
4.50
2.00
1.00
1.50
1.50
7.50
D
9.00
6.75
2.00
1.00
1.50
2.25
9.00
E
12.00
9.00
2.00
1.00
1.50
3.00
10.50
F
15.00
11.25
2.00
1.00
1.50
3.75
12.00
Note: Y is real GDP
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Dr. Mazharul Islam
EQUILIBRIUM EXPENDITURE
1.When aggregate planned expenditure
exceeds real GDP, an unplanned
decrease in inventories occurs.
2.When aggregate planned expenditure is
less than real GDP, an unplanned
increase in inventories occurs.
3.When aggregate planned expenditure
equals real GDP, there are no unplanned
inventories and real GDP remains at
equilibrium expenditure
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– When aggregate planned expenditure
is less than real GDP, firms cut
production. Real GDP decreases.
– But real GDP decreases by more than
planned expenditure, so eventually the
gap between planned expenditure and
actual expenditure closes. Vice a Versa
Dr. Mazharul Islam
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The Multiplier
• An autonomous change in aggregate
spending leads to a chain reaction in
which the change in real GDP is equal to
the multiplier times the initial change in
aggregate spending.
The multiplier is the amount by which a change in
autonomous expenditure is multiplied to determine the
change in equilibrium expenditure and real GDP.
Expenditure Multiplier  DY ÷ DA
Dr. Mazharul Islam
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The Multiplier
•Why Is the Multiplier Greater than 1?
–The multiplier is greater than 1 because an
increase in autonomous expenditure causes
further increases in aggregate expenditure.
•The Size of the Multiplier
–The size of the multiplier is the change in
equilibrium expenditure divided by the change in
autonomous expenditure.
The Multiplier
When there are no income taxes and no imports, the slope
of the AE curve equals the marginal propensity to consume,
so the multiplier is
1
multiplier 
1  MPC
Marginal Propensity to Save MPS = 1-MPC
1
multiplier 
MPS
The size of the multiplier, 1/(1 − MPC), depends on the
, or
marginal propensity to consume,
: the larger the MPC, the
larger the change in real GDP for any given autonomous
increase in aggregate spending.
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Dr. Mazharul Islam
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THE EXPENDITURE MULTIPLIER
• The Basic Idea of the Multiplier
– The initial increase in investment brings
an even bigger increase in aggregate
expenditure because it encourages an
increase in consumption expenditure.
– The multiplier determines the amount of
the increase in aggregate expenditure
that results from an increase in
investment or another component of
autonomous expenditure.
Dr. Mazharul Islam
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THE EXPENDITURE MULTIPLIER
1. A $0.5 trillion increase in investment
shifts the AE curve upward by $0.5
trillion from AE0 to AE1.
2. Equilibrium expenditure increases by
$2 trillion from
$9 trillion to $11 trillion.
3. The increase in equilibrium
expenditure is 4 times the increase in
investment, so the multiplier is 4
Dr. Mazharul Islam
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THE AD CURVE AND EQUILIBRIUM
– The AE curve is the relationship between
aggregate planned expenditure and real
GDP when all other influences on
expenditure plans remain the same.
– The AD curve is the relationship between
the quantity of real GDP demanded and
the price level when all other influences
on expenditure plans remain the same.
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when the price level changes, the AE
curve shifts.
– When the price level changes, other
things remaining the same, aggregate
planned expenditure changes and
equilibrium expenditure changes.
– Aggregate
planned
expenditure
changes because a change in the
price level changes the buying power
of net assets, the real interest rate,
and the real prices of exports and
imports.
Dr. Mazharul Islam
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THE AD CURVE AND EQUILIBRIUM
When the price level rises to
130, the AE curve shifts
downward to AE2.
Equilibrium expenditure
decreases to $9 trillion at
point A.
The quantity of real GDP
demanded at the price level
of 130 is $9 trillion—a
movement along the AD
curve to point A.
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Dr. Mazharul Islam
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Now it’s over for
today. Do you have
any question?
Dr. Mazharul Islam
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