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Economics: Principles and
Applications, 2e
by Robert E. Hall &
Marc Lieberman
© 2001 South-Western, a division of Thomson Learning
The Short-Run Macro Model
© 2001 South-Western, a division of Thomson Learning
The Short-Run Macro Model
In the short run, spending depends on
income, and income depends on spending.
© 2001 South-Western, a division of Thomson Learning
The Short-Run Macro Model
Short-Run Macro Model
A macroeconomic model that explains how
changes in spending can affect real GDP in
the short run.
© 2001 South-Western, a division of Thomson Learning
The Short-Run Macro Model
In the short-run macro model, we focus on
spending in markets for currently produced
U.S. goods and services--that is, spending on
things that are included in U.S. GDP.
© 2001 South-Western, a division of Thomson Learning
Consumption Spending
•Consumption and Disposable Income
•Consumption and Income
•Shifts in the Consumption-Income Line
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Consumption Spending
Disposable Income
The part of household income that remains
after paying taxes.
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Consumption Spending
Consumption Function
A positively sloped relationship between real
consumption spending and real disposable
income.
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Consumption Spending
Autonomous Consumption Spending
The part of consumption spending that is
independent of income; also, the vertical
intercept of the consumption function.
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Consumption Spending
Marginal Propensity to Consume (MPC)
The amount by which consumption spending
rises when disposable income rises by one
dollar.
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Consumption Spending
Representing Consumption with an Equation
C = a + bYD
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Consumption Spending
Consumption-Income Line
A line showing aggregate consumption
spending at each level of income or GDP.
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Consumption Spending
When the government collects a fixed amount of taxes
from households, the line representing the relationship
between consumption and income is shifted downward by
the amount of the tax times the marginal propensity to
consume (MPC). The slope of this line is unaffected by
taxes, and is equal to the MPC.
© 2001 South-Western, a division of Thomson Learning
Consumption Spending
When a change in income causes consumption
spending to change, we move along the
consumption-income line. When a change in
anything else besides income causes consumption
spending to change, the line will shift.
© 2001 South-Western, a division of Thomson Learning
Getting to Total Spending
•Investment Spending
•Government Purchases
•Net Exports
•Summing Up: Aggregate Expenditure
•Income and Aggregate Expenditure
© 2001 South-Western, a division of Thomson Learning
Getting to Total Spending
In the short-run macro model, we define investment
spending as plant and equipment purchases by
business firms, and new home construction.
Inventory investment is treated as unintentional and
undesired, and is therefore excluded from our
definition of investment spending.
© 2001 South-Western, a division of Thomson Learning
Getting to Total Spending
We regard investment spending as a given
value, determined by forces outside of our
model.
© 2001 South-Western, a division of Thomson Learning
Getting to Total Spending
In the short-run macro model, government
purchases are treated as a given value,
determined by forces outside of the model.
© 2001 South-Western, a division of Thomson Learning
Getting to Total Spending
We regard net exports as a given value,
determined by forces outside of our analysis.
© 2001 South-Western, a division of Thomson Learning
Getting to Total Spending
Aggregate Expenditure (AE)
The sum of spending by households, business
firms, the government, and foreigners on final
goods and services produced in the United States.
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Getting to Total Spending
p
Aggregate expenditure = C + I + G + NX
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Getting to Total Spending
When income increases, aggregate
expenditure (AE ) will rise by the MPC times
the change in income.
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Finding Equilibrium GDP
•Inventories and Equilibrium GDP
•Finding Equilibrium GDP with a Graph
•Equilibrium GDP and Employment
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Finding Equilibrium GDP
When aggregate expenditure is less than GDP,
output will decline in the future. Thus, any level of
output at which aggregate expenditure is less than
GDP cannot be the equilibrium GDP.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
When aggregate expenditure is greater than GDP,
output will rise in the future. Thus, any level of
output at which aggregate expenditure exceeds
GDP cannot be the equilibrium GDP.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
Equilibrium GDP
In the short run, the level of output at which
output and aggregate expenditure are equal.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
The change in inventories during any period
will always equal output minus aggregate
expenditure.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
A 45 degree line is a translator line: It allows
us to measure any horizontal distance as a
vertical distance instead.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
At any output level at which the aggregate
expenditure line lies below the 45 degree line,
aggregate expenditure is less than GDP. If firms
produce any of these output levels, their inventories
will grow, and they will reduce output in the future.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
At any output level at which the aggregate
expenditure line lies above the 45 degree line,
aggregate expenditure exceeds GDP. If firms
produce any of these output levels, their inventories
will decline, and they will increase output in the
future.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
Equilibrium GDP is the output level at which the
aggregate expenditure line intersects the 45 degree
line. If firms produce this output level, their
inventories will not change, and they will be content
to continue producing the same level of output in
the future.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
In the short-run macro model, cyclical
unemployment is caused by insufficient spending.
As long as spending remains low, production will
remain low, and unemployment will remain high.
© 2001 South-Western, a division of Thomson Learning
Finding Equilibrium GDP
In the short-run macro model, the economy can
overheat because spending is too high. As long as
spending remains high, production will exceed
potential output, and unemployment will be
unusually low.
© 2001 South-Western, a division of Thomson Learning
What Happens
When Things Change?
•A Change in Investment Spending
•The Expenditure Multiplier
•The Multiplier in Reverse
•Other Spending Shocks
•A Graphical View of the Multiplier
•An Important Proviso About the Multiplier
© 2001 South-Western, a division of Thomson Learning
What Happens
When Things Change?
An increase in investment spending will set
off a chain reaction, leading to successive
rounds of increased spending and income.
© 2001 South-Western, a division of Thomson Learning
What Happens
When Things Change?
Expenditure Multiplier
The amount by which equilibrium real GDP
changes as a result of a one-dollar change in
autonomous consumption, investment, or
government purchases.
© 2001 South-Western, a division of Thomson Learning
What Happens
When Things Change?
For any value of the MPC, the formula for the
expenditure multiplier is 1/( 1 - MPC ).
© 2001 South-Western, a division of Thomson Learning
What Happens
When Things Change?
Just as increases in investment spending cause
equilibrium GDP to rise by a multiple of the
change in spending, decreases in investment
spending cause equilibrium GDP to fall by a
multiple of the change in spending.
© 2001 South-Western, a division of Thomson Learning
What Happens
When Things Change?
Changes in planned investment, government purchases,
net exports, or autonomous consumption lead to a
multiplier effect on GDP. The expenditure multiplier is
what we multiply the initial change in spending by in order
to get the change in equilibrium GDP.
© 2001 South-Western, a division of Thomson Learning
What Happens
When Things Change?
An increase in autonomous consumption spending,
investment spending, government purchases, or net
exports will shift the aggregate expenditure line
upward by the increase in spending, causing GDP
to rise.
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What Happens
When Things Change?
Automatic Stabilizers
Forces that reduce the size of the expenditure
multiplier and diminish the impact of
spending shocks.
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What Happens
When Things Change?
Real-World Automatic Stabilizers
•Taxes
•Transfer Payments
•Interest Rates
•Prices
•Imports
•Forward-looking Behavior
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What Happens
When Things Change?
In the real world, due to automatic stabilizers,
spending shocks have much weaker impacts
on the economy than our simple multiplier
formulas would suggest.
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What Happens
When Things Change?
In the long run, our multipliers have a value of zero:
No matter what the change in spending or taxes,
output will return to full employment, so the change
in equilibrium GDP will be zero.
© 2001 South-Western, a division of Thomson Learning
Comparing Models:
Long Run and Short Run
•The Role of Saving
•The Effect of Fiscal Policy
© 2001 South-Western, a division of Thomson Learning
Comparing Models:
Long Run and Short Run
In the long run, an increase in the desire to save
leads to faster economic growth and rising living
standards. In the short run, however, it can cause a
recession that pushes output below its potential.
© 2001 South-Western, a division of Thomson Learning