Download Chapter 6

Chapter 6
The Aggregate
Expenditures Model
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-1
Learning Objectives
• Describe the assumptions underlying the
aggregate expenditures model.
• Briefly outline the different motivations of
savers and investors.
• Explain the consumption–income and
saving–income relationships upon which the
aggregate expenditures model is based.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-2
Learning Objectives (cont.)
• Examine the determinants of the level of
investment (firms’ capital purchases).
• Combine our concepts of consumption,
saving and investment to produce a model
of the equilibrium level of output and
income for a private, closed economy.
• Apply our model to a discussion of the
paradox of thrift.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-3
Aggregate Expenditures
Model
Assumptions:
• 2 sectors, i.e. closed economy, no
government
• All savings are treated as personal savings
• Depreciation and net Australian income
earned abroad are zero
• Businesses make investment decisions
• Real interest rates influence investment (I)
• Fixed prices and wages
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-4
Aggregate Expenditures
(AE)
• Sum of expenditures on consumption
(C), investment (I), government
spending (G) and net exports (NX)
• Determines the level of output and
employment in economy
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-5
Consumption and Savings
• Both consumption and savings level
are determined by household
disposable income (DI)
• Households consume most of their DI
• DI that is not consumed is called
Savings
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-6
Consumption Schedule
• A schedule of the income–
consumption relationship
• Shows the various amounts
households plan or intend to consume
at various possible level of disposable
income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-7
Saving Schedule
• A schedule of the income–saving
relationship
• Shows the various amounts
households plan or intend to save at
various levels of disposable income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-8
Consumption & Saving Schedules
Consumption
C
425
Saving $5 billion
Consumption
schedule
400
375
Dissaving $5 billion
Saving
0
45
o
370 390 410 430 450
Disposable Income
S
Dissaving $5 billion
0
Saving
schedule
Saving $5 billion
370 390 410 430 450
Disposable Income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-9
Average Propensity to
Consume (APC)
• The fraction of any total income that
is spent on consumption
• APC =
Consumption
Income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-10
Average Propensity to
Save (APS)
• That fraction of total income that is
saved
• APS =
Saving
Income
• APC + APS = 1
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-11
Marginal Propensity to
Consume
• That fraction of each additional dollar
of income that is consumed
• MPC =
Change in consumption
Change in income
• Represented as the slope of the
consumption schedule
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-12
Marginal Propensity to
Save
• That fraction of each additional dollar of
income that is saved
• MPS =
Change in saving
Change in income
• Represented as the slope of the saving
schedule
• MPC + MPS = 1
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-13
Consumption & Saving Schedules
Consumption
SAVING
C
Consumption
schedule
MPC = Slope of C
0
Saving
DISSAVING
0
45
o
Disposable Income
Saving
schedule
MPS = Slope of S
S
SAVING
Disposable Income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-14
Non-Income Determinants
of Consumption & Savings
• Wealth
• Price level
• Expectations
• Consumer debt levels
• Taxation
• Changes in these determinants cause
a shift (up or down) of the curves
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-15
Shifts in the Consumption & Saving
C1
Schedules
Consumption
C0
An
increase in
consumption...
C
C
0
45
o
Saving
Disposable Income
Means
a decrease
in saving
S0
S1
0
Disposable Income
S SCopyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-16
Shifts in the Consumption & Saving
Schedules
Consumption
C
C1
A
decrease in
consumption...
C
45
0
o
Saving
Disposable Income
0
Means
an increase
S in saving
S
S
S
Disposable Income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-17
Determinants of Investment
• Expected rate of net profits that
businesses hope to realise from
investment spending
• The real rate of interest
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-18
Expected Rate of Net Profit
• Businesses are motivated by profit
• Businesses invest if they expect a net
profit from this investment
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-19
Real Rate of Interest
• The inflation-adjusted cost associated
with borrowing money
• Equals nominal interest rate minus the
inflation rate
• Investment projects will only be
undertaken if net expected profit rate
exceeds real interest rate
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-20
Investment Demand Curve
• Shows graphically the investment–
interest rate relationship
• Shows cumulative levels of investment
at possible levels of investment at
some point in time
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-21
16
and interest rate, i (per cent)
Expected rate of net profit,
r,
Investment Demand Curve
14
12
10
8
6
4
2
0
5
10
15
20
25
30
35
40
Investment (billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-22
Shifts in Investment
Demand
Other determinants of investment:
• Acquisition, operation and maintenance
costs
• Business taxes
• Technological change
• Business expectations
• Stock of capital goods on hand
Changes in these factors shift the
investment demand curve
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-23
Investment and Income
• Autonomous investment
–
desired level of investment based upon longterm profit expectations
• Induced investment
–
level of investment induced by the current level
of income
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-24
Investment (billions of dollars)
The Investment Schedule: Two
Possibilities
60
40
Autonomous
Induced
Investment Schedule Investment Schedule
I′
I
20
0
370
390
410
450
430
450
490
510
Real domestic product, GDP (billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-25
Instability of Investment
• Consumption (especially non-
durables) is relatively stable BUT
• Investment is unstable: Why?
–
–
–
–
Durable and therefore postponable purchases
Irregularity of innovation
Profit variability
Variable expectations (consider the new global
competitive environment!)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-26
The Volatility of Investment
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-27
Equilibrium Income/GDP
• Two approaches to determine the
equilibrium levels of output and
income:
–
Expenditures–Output approach
–
Leakages–Injections approach
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-28
Expenditures–Output
Approach
• Utilises relationship between AE and
income
• In a 2-sector economy, AE = C + I
• Equilibrium occurs where the total
output (measured by GDP) and
aggregate expenditures (C + I ) are
equal
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-29
Equilibrium GDP:
Expenditures–Output Approach
Private spending (billions of dollars)
(C + I = GDP)
Equilibrium
C+I
C+I
C
C+I
C
45
0
o
GDP (billions of dollars)
370 390 410 430 450 470 490 510
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-30
Leakages–Injections
Approach
• Utilises the relationship between
leakages and injections back to the
expenditure flow
• 2 sectors: S = I at all levels I = total
investment
• At equilibrium: S = planned
investment
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-31
Saving and Investment
(billions of dollars)
Equilibrium GDP:
Leakages–Injections Approach
S=I
60
40
20
Unplanned
Inventory
Decrease
I
At this level
of GDP
S
I
{
0
–5
S
(S = Ig = $20)
Equilibrium
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP (billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-32
Saving and Investment
(billions of dollars)
Equilibrium GDP:
Leakages–Injections Approach
S=I
60
At this level
of GDP
40
20
(S = I = $20)
Equilibrium
I
0
-5
S
S
{
}
Unplanned
Inventory
Increase
S
I
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP (billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-33
Planned vs Unplanned
Investment
• Investment has two components:
–
I = planned investment as determined by
investment demand schedule
– Iu
= unplanned investment
• At equilibrium: Iu = zero
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-34
Achieving Equilibrium
• Difference in savings and planned
investment causes
• Mismatching of production and
spending causes
• Revision of production plans by firms
until equilibrium is once again
re-established
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-35
S, I & the Paradox of Thrift
• Paradox of thrift:
–
If society attempts to save more, it may end up
actually saving the same amount or even less,
as a result of the multiple decline in equilibrium
GDP caused by the withdrawal of aggregate
expenditure
• For savings to be beneficial it must be
matched by injection, especially I
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-36
Saving and Investment
(billions of dollars)
Equilibrium GDP:
Leakages–Injections Approach
60
S2
40
S1
20
I
S2
0
–5
I
S1
S
370 390 410 430
450
470 490 510
Real domestic product, GDP (billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-37
Next Chapter:
Multipliers, Government
Budgets
and Net Exports
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
6-38