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AGGREGATE EXPENDITURES Frederick University 2014 Aggregate Demand (AD) AD – the quantity of GDP, which the economic agents are planning to buy at every price level, ceteris paribus (Y = const) Aggregate Expenditures АЕ – the expenditures that economic decision makers are planning to make at every level of income, ceteris paribus Planned Spending Real GDP = Nominal GDP AE = C + I + G + X - M Consumption Spending (С) С – the expenditures that households are planning to make at every level of income, ceteris paribus Consumption Spending (С) Y 0 C S Consumption Spending (С) Y 0 C 500 S 500 – consumption spending which does not depend on income, autonomous consumption – С0 (Ca, a) Consumption Spending (С) Y C S 0 500 -500 Consumption Spending (С) Y 0 500 C 500 S -500 C = C0 + (Δ C /ΔY) x Y Δ C /ΔY – the increase in consumption spending, caused by the increase in income – marginal propensity to consume – MPC (mpc, b) C = C0 + MPC x Y Consumption Spending (С) C = C0 + MPC x Y MPC = ¾ = 0,75 If income rises by $100,households increase their consumption spending by $75 and increase their savings by $25 If income rises by $500, С rises by 5 х $75 = $375 C = 500 + 375 = 500 + 0.75 x 500 Y C S 0 500 875 -500 500 Savings (S) Marginal propensity to save – the increase in savings, caused by the increase in income: MPS = Δ S /ΔY If income rises by $100, and households raise their consumption spending by $75, savings increase by $25 MPC + MPS = 1 C+S=Y S = Y – C = Y – (C0 + MPC x Y) = Y - C0 - MPC x Y = - C0 + Y - MPC x Y = - C0 + Y(1 - MPC) S = - C0 + MPS x Y Consumption Spending (С) and Savings (S) Y C S 0 500 -500 500 875 - 375 Consumption Spending (С) and Savings (S) Y = 1000 C = 500 + 0.75 x 1000 Y C S 0 500 -500 500 875 -375 1000 1250 -250 Consumption Spending (С) and Savings (S) Y C S 0 500 -500 500 875 -375 1000 1250 -250 1500 1625 -125 2000 2000 0 2500 2375 125 3000 2750 250 Consumption Spending (С) 2000 Y C S C 0 500 -500 500 875 -375 1000 1250 -250 875 1500 1625 D -125 500 B 375 500 A 2000 2000 0 2500 2375 125 3000 2750 250 0 450 500 2000 Y Factors determining C Households’ income Indirect taxation Propensity to buy imported goods and services Direct taxation Consumers’ expectations Availability of consumer credit Income distribution Living standards Efficiency of market institutions Investment spending I = Gross Private Domestic Investment I – Depreciation = Net Investment Net investment = Purchases of New Equipment + Change in Inventories Fixed Investment = Depreciation + Purchases of New Equipment Net Fixed Investment = Purchases of New Equipment Inventories = Raw Material + Unfinished Production + Finished Goods Factors determining Investment Spending (I) Interest rate (i) Expected future profits (π) Risk Excess capacity Capital-output ratio (α) Technological changes Cost of production Competitiveness of markets Depreciation policies Efficiency of market institutions AE D 2000 C B 875 375 500 500 A 450 0 500 2000 Y AE AE 3500 3000 2500 2000 1500 1000 500 0 0 1000 2000 Y 3000 4000 Injections imports М exports Х Leakages Government purchases G Expenditures on final goods and services Investment І Macroeconomic Equilibrium I+G+X= S+T+M (I - S) = (T - G) + (M - X) taxes Т AE Final goods and services savings S HOUSEHOLDS FIRMS Production factors Primary Income The Circular Flow Macroeconomic Equilibrium Y < AE Reduction of inventories Y Y = AE Y > AE Increase in inventories Y Y = AE The simple multiplier Y 2005 = C2005 + Inj2005 Y2004 = C2004 + Inj2004 Δ Y = ΔC + ΔInj ΔY = C0 2005 +MPCY2005 – C02004 – MPCY2004 + ΔInj ΔY = MPC ΔY + ΔInj ΔY - MPC ΔY = ΔInj ΔY (1-MPC) = ΔInj ΔY = Δ Inj x1/(1-MPC) 1/(1-MPC) = multiplier = К If МРС = 0.5, К = 2 If МРС = 0.75, К = 4 The complete multiplier 1 K= MPS + t x MPC + MPI Multiplier Constraints Factors of production bottlenecks Limited productive capacity Institutions Deriving the Complete Multiplier Y 2005 = C2005 + (I + G + X)2005 - M2005 Y2004 = C2004 + (I + G + X)2004 - M2004 Δ Y = ΔC + ΔInj - ΔM ΔY = C0 2005 +MPC x (Y2005 – t x Y2005) - C02004 – MPC x (Y2004 – t x Y2004) + ΔInj - M0 2005 – MPI x (Y2005 – t x Y2005) - M02004 – MPI x (Y2004 – t x Y2004) + ΔInj ΔY = MPC x Y2005 ( 1– t x) – MPC x Y2004 ( 1 - t) - MPI x Y2005 ( 1– t) – MPI x Y2004 (1– t) ΔY = MPC ( 1 - t) x ΔY – MPI x ΔY + ΔInj ΔY - MPC ( 1 - t) ΔY + MPI x ΔY = ΔInj ΔY [(1-MPC + MPC x t) + MPI] = ΔInj ΔY = Δ Inj :1/(1-MPC + MPC x t + MPI) K = 1/(1-MPC + MPC x t + MPI) = 1/ (MPS + MPT + MPI)