Download Aggregate Spending and Saving

The Fixed-Price
Keynesian Model:
An Economy Below
Full – Employment
Focus on the Demand
Side
Aggregate Expenditures = AE = GDP
Y
= AE = C + I + G + NX
Consumption expenditures (C) ≈ 68% of
GDP
 Investment expenditures (I) ≈ 18% of GDP
 Government expenditures (G) ≈ 18% of
GDP
 Net exports (NX) ≈ - 3 % of GDP

Imports exceed exports by about 3% of GDP
Some Identities

Disposable income = Yd = Y-T, after tax
income.
Yd = Y - T = C + S

Keynes: people save a fixed proportion of their
disposable income on average
 Consumption

is related to disposable income (Y-T).
 C = Ca +cYd
Saving either finances private investment (I) or
the government’s deficit (G – T)
S = I + (G – T) at equilibrium
 S+T=I+G

Leakages from the spending stream (S + T)
= Injections to the spending stream (I + G)
Average Propensities to Consume and to
Save

The average propensity to consume (APC):
the proportion of disposable income spent
for consumption
APC = C/Yd

The average propensity to save (APS):
proportion of disposable income saved
APS = S/Yd
APC + APS = 1
since Yd = C + S
1 = C/ Yd + S/ Yd
Consumption and Disposable Income
1947-2002
Consumption Function
= Ca +cYd is a straight line
with slope c.
C
 Ca is autonomous
consumption.
 The slope, c, is the marginal
propensity to consume from
disposable income (MPC).
Ca
0 < MPC < 1.
 MPC is C/Yd, the amount by
which consumption changes
for each dollar change in Yd
C
C
Yd
MPC = C/Yd
Yd
Saving and Dissaving
Planned C
Yd (if C = Yd)
Dissaving
C > Yd
C
Saving
Yd > C
Yd
1
Yd*
Yd2
Yd
Saving Function: When income increases,
both consumption and saving increase







Since Y = C + S + T and Yd = Y – T
Yd = C + S
C = Ca + c Yd and
S = -Ca + (1-c) Yd
S = Sa + sYd [Sa = autonomous saving = - Ca ]
S = Sa + mps x Yd ,
where mps = s = marginal propensity to save
Note: mps + mpc = 1
Consumption and Saving in
a Hypothetical Economy
Marginal Propensity to Consume: additional
consumption in response to each additional dollar of
disposable income mpc = ΔC/ΔYd
Shifts in the Consumption Function

Expected Future Income
–

Wealth
–

An increase in expected future income will cause
current consumption to rise and your saving to fall.
An increase in wealth raises current consumption
and lowers current saving.
Expected Real Interest Rate

–
Higher real return  incentive to save more … but
Higher return to saving  less needs to be put
aside to achieve the same desired future savings.
Net effect: increased real interest rates
reduce consumption and increase saving.
–


Demographics
Taxes – Ricardian Equivalence?
Autonomous Shifts in
Consumption and in
Saving
Investment Spending (I)
Capital goods have a long life.
 Capital goods take time to build.
 Capital goods involve large expenditure.
 The present value of a capital good
depends on the income it generates over
a long time horizon.
– Businesses must form expectations
about future conditions and
profitability.
– Investment is inherently risky.
 Investment expenditure tends to be
erratic.

Determinants of Investment
 Profit
expectations
 Interest
rate
 Technology
 Price (Cost) of Capital Goods
 Capacity Utilization
 Profit
expectations
Investment as a Function of Current Income
Investment depends more on expectations of the
future than on what’s happening now.
Government
Expenditures as a
Function of Real GDP
Government
Expenditures are
Largely Independent
of the Current State of
the Economy
Imports and Exports

The demand for imports depends on current
economic activity, Y
IM = IMa + imY



“im” is the marginal propensity to import (MPI).
Exports are exogenously determined
 they don’t depend on conditions in our
economy but rather on conditions in foreign
economies
Net exports is NX = EX – (IMa + imY) or
NX = (EX-IMa) – imY or
NX = NXa – imY (a downward
sloping line)
Net Exports as a Function of Real GDP
The Aggregate Expenditures Function