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Income and Expenditures Equilibrium Equilibrium Real GDP: mpc = .7, mpi = .1 (1) Real GDP (Y) (2) (3) Investment (I) (4) Gov’t Spending (G) (5) Net Exports (X) (6) Aggregate Expenditures (AE) (7) Unplanned Change in Inventories (8) Change in Real GDP Consumption (C) 0 30 50 70 50 200 -200 Up 100 100 50 70 40 260 -160 Up 200 170 50 70 30 320 -120 Up 300 240 50 70 20 380 -80 Up 400 310 50 70 10 440 -40 Up 500 380 50 70 0 500 0 No chg 600 450 50 70 -10 560 40 Down 700 520 50 70 -20 620 80 Down 2 Movement to Equilibrium o 45 line: AE = Y 700 Aggregate planned expenditure Total Expenditure 600 Increase Output, increase Employment 500 Reduce Output, Reduce Employment 400 0 300 400 500 Real GDP (Output) 600 700 3 Leakages and Injections 4 Spending Multiplier The spending multiplier measures the change in equilibrium income (real GDP) produced by change in autonomous expenditures: ΔY/ΔI = ΔY/ΔG = ΔY/ΔX – By how many dollars does real GDP change for every dollar change in autonomous expenditures? 1 1 Multiplier leakages MPS MPI 5 Computing the Spending Multiplier: Marginal propensity to save = mps = .3 Marginal propensity to import = mpi = .1 Multiplier 1 1 leakages MPS MPI If MPS = 0.30 and MPI is 0.10, then MPS + MPI = 0.40 = 4/10. 1/0.40 = 1/(4/10) = 10/4 = 2.5 The multiplier is 2.5. NOTE: The spending multiplier would be larger in a closed economy because MPI would be zero. 6 Multiplier at Work 7 Gaps: Recessionary Gap, GDP Gap 8 GDP Gap, Recessionary Gap GDP gap = potential real GDP – actual real GDP – How much does real GDP have to increase to generate full employment? Recessionary gap GDP gap Recessiona ry gap spending multiplier – How much additional spending is needed to achieve potential GDP (to create full employment)? 9 Sequence of Expenditures 10 Sequence of Expenditures 11 From Aggregate Expenditure to Aggregate Demand 12 The Fixed-Price, Keynesian AS-AD Model 13 The Paradox of Thrift 14