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1 Instructor: MELTEM INCE Expenditures Multipliers: The Keynesian ModelLecture notes 9Instructor: MELTEM INCE
2 Expenditure PlansThe aggregate expenditure model explains fluctuations in aggregate demand by identifying the forces that determine expenditure plans.The components of aggregate expenditure are:1) Consumption expenditure2) Investment3) Government purchases of goods and services4) Net exports (exports minus imports)
3 Expenditure PlansThe main factors that influence consumption and savingare:1) Real interest rate2) Disposable income3) Purchasing power of net assets4) Expected future income
4 Expenditure PlansThe consumption function shows the relationship between consumption expenditure and disposable income.The saving function shows the relationship between saving and disposable income.
5 Planned Disposable consumption Planned income expenditure saving (trillions of 1992 dollars per year)abcdef
6 Consumption and Saving Plans Disposable income is either spent on consumption (C)or saved (S), soYD = C + SThe relationship between consumption expenditure anddisposable income, with other things remaining the same, iscalled the consumption function.The amount of consumption expenditure that takes place whenpeople have zero income is called autonomous consumptionexpenditure.
7 Consumption and Saving Plans 500ConsumptionfunctionfSaving400e(billions of 1995 pounds per year)Consumption expenditureDissaving300dc200ba100100200300400500Disposable income(billions of 1995 pounds per year)
8 Consumption and Saving Plans The relationship between saving and disposable income,with other things remaining the same, is called thesaving function.Negative saving is called dissaving
9 Consumption and Saving Plans function100fSavingeDissavingSaving(billions of 1995 pounds per year)d100200300400500cDisposable income(billions of 1995 pounds per year)b-100a
10 Marginal Propensity to Consume The marginal propensity to consume (MPC) is thefraction of a change in disposable income that isconsumed.MPC= ΔCΔYd
11 f e d c billion b billion a 500 Consumption function MPC= 0.75 400 45o line500ConsumptionfunctionMPC= 0.75f400ebillion(billions of 1992 pounds per year)Consumption expenditure300dbillionc200ba100100200300400500Disposable income(billions of 1992 pounds per year)
12 Marginal Propensity to Save The marginal propensity to save (MPS) is the fraction ofa change in disposable income that is saved.MPS= ΔSΔYd
13 MPC AND MPS ΔC + ΔS = ΔYd MPC + MPS = 1 Because consumption expenditure and saving exhaust disposableincome, the marginal propensity to consume plus the marginalpropensity to save always equals 1.ΔC + ΔS = ΔYdDividing both sides by DYDΔYd ΔYd ΔYdMPC + MPS = 1
14 The Aggregate Expenditure Model Aggregate planned expenditure is planned consumptionexpenditure plus planned investment plus plannedgovernment expenditures plus planned exports minusplanned imports.Planned consumption expenditure and planned importsare influenced — and influence — real GDP
15 The Aggregate Expenditure Model The aggregate expenditure schedule lists aggregate planned expendituregenerated at each level of real GDP.Aggregate planned expenditure increases as real GDP increases.However, only consumption expenditure and imports increase with realGDP.Induced expenditure is the sum of the components of aggregateexpenditure that vary with real GDP.Autonomous expenditure is the sum of the components of aggregateexpenditure that are not influenced by real GDP.
17 (trillions of 1992 dollars) Planned expenditureAggregateConsumption Government plannedReal GDP expenditure Investment purchases Exports Imports expenditure(Y) (C) (I) (G) (X) (M) (AE=C+I+G+X–M)(trillions of 1992 dollars)
18 The Size of the Multiplier The multiplier is the amount by which a change inautonomous expenditure is multiplied to determine thechange in equilibrium expenditure that it generates.Multiplier =Change in equilibrium expenditureChange in autonomous expenditure= = 4£200 billion£50 billion
19 The Multiplier and the Slope of the AE Curve The slope of the AE curve determines the magnitude of the multiplier.The steeper the AE curve, the greater is the increase in induced expenditurethat results from a given increase in real GDP.Multiplier = ΔY =ΔA Slope of AE curveIf the slope of the AE curve is 0.75:Multiplier = = = 4
20 The Algebra of the Multiplier Symbols:Aggregate planned expenditure, AEReal GDP, YConsumption expenditure, CInvestment, IGovernment expenditures, GExports, XImports, MNet taxes, NTDisposable income, YDAutonomous consumption expenditure, aMarginal propensity to consume, bMarginal propensity to import, mMarginal tax rate, tAutonomous expenditure expenditures, A
21 Aggregate Expenditure Aggregate expenditure is the sum of planned amountsof consumption expenditure, investment, governmentexpenditures, and exports minus the planned amount ofimports:AE = C + I + G + X – MWe write the consumption function as:C = a + bYd
22 Equilibrium Expenditure Grouping together terms that involve Y we obtain:AE = [a + I + G + X] + [b(1 – t) – m]YAutonomous expenditure (A)Slope of the AE curve
24 Equilibrium Expenditure Equilibrium expenditure occurs when aggregate plannedexpenditure equals real GDP:AE = YTo calculate equilibrium expenditure and real GDP, wesolve the equation for the AE curve and the 45º line forAE and Y:AE = A + [b(1 – t) – m]Y
25 Equilibrium Expenditure Replace AE with Y in the AE equation to obtain:Y = A + [b(1 – t) – m]Yor