Presentation on theme: "Output and Expenditure in the Short Run"— Presentation transcript:
1 Output and Expenditure in the Short Run Aggregate expenditure (AE) The total amount of spending on the economy’s output:Aggregate ExpenditureAE = C + I + G + NX• Consumption (C)• Planned Investment (I)• Government Purchases of Goods + Services (G)• Net Exports (NX)Actual investment in a year can differ from planned investment: businesses “invest” in unintended inventories if sales fall short of what they expectedMacroeconomic Equilibrium: Aggregate Expenditure = Output (Y)AE = C + I + G + NX = Y
2 Components of Real Aggregate Expenditure, 2006 EXPENDITURE CATEGORYEXPENDITURE(BILLIONS OF 2000 DOLLARS)Consumption$8,091Investment1,946Government1,998Net Exports−618
3 The Aggregate Expenditure Model Adjustments to Macroeconomic EquilibriumActual investment in a year can differ from planned investment: businesses “invest” in unintended inventories if sales fall short of what they expectedIF …THEN …AND …Aggregate expenditure isequal to GDPinventories are unchangedthe economy is in macroeconomic equilibrium.less than GDPinventories riseGDP and employment decrease.Aggregate Expenditure isgreater than GDPinventories fallGDP and employment increase.
4 Real Consumption Expenditure C = $C/CPI FIGURE 11-1Real Consumption, 1979–2006
5 The most important variables that determine the level of consumption: • Current disposable income• Household wealth: Assets minus liabilities• Expected future incomePeople try to keep their consumption fairly steady from year-to-year save for a rainy day• The price levelHigher price level reduces real value of monetary wealth• The interest rateHigh interest rate discourages spending on credit and encourages saving
6 The Relationship between Consumption and Income, 1960– 2006 The Consumption Function: The relation between consumption and disposable incomeMarginal propensity to consume (MPC) The amount by which consumption spending changes when disposable income changes = slope of consumption function.The Relationship between Consumption and Income,1960– 2006Consumption Function
7 The Consumption Function Marginal propensity to consume (MPC) The slope of the consumption function: The amount by which consumption spending changes when disposable income changes.We can also use the MPC to determine how much consumption will change as income changes:Change in consumption = Change in disposable income × MPC
8 The Relationship between Consumption and National Income when net taxes are constant
9 Determining the Level of Aggregate Expenditure in the Economy Income, Consumption, and SavingNational income = Consumption + Saving + TaxesY = C + S + TChange in national income = Change in consumption + Change in saving + Change in taxesIf taxes are always a constant amount, ΔT = 0ΔY = ΔC + ΔS
10 1 = MPC + MPS MPS = 1 - MPC Income, Consumption, and Saving Marginal propensity to save (MPS) The change in saving divided by the change in disposable income.or,1 = MPC + MPSMPS = 1 - MPC
11 MARGINAL PROPENSITY TO CONSUME (MPC) MARGINAL PROPENSITY TO SAVE (MPS) Solved Problem11-2Calculating the Marginal Propensity to Consume and the Marginal Propensity to SaveNATIONAL INCOME AND REAL GDP (Y)CONSUMPTION(C)SAVING(S)MARGINAL PROPENSITY TO CONSUME (MPC)MARGINAL PROPENSITY TO SAVE (MPS)$9,000$8,0001,000—10,0008,6001,4000.60.411,0009,2001,80012,0009,8002,20013,00010,4002,600
12 Determining the Level of Aggregate Expenditure in the Economy Planned Investment (I)Real Investment, 1979–2006
13 Waves of optimism and pessimism The most important variables that determine the level of investment:• Expectations of future profitabilityWaves of optimism and pessimism• Major technology changes: new products & processesThe interest rate• Taxes• Cash flowCurrent capacity utilization
17 Net Exports (NX)The most important variables that determine the level of net exports:• The price level in the United States relative to the price levels in other countries• The growth rate of GDP in the United States relative to the growth rates of GDP in other countries• The exchange rate between the dollar and other currencies
18 Graphing Macroeconomic Equilibrium Learning Objective 11.3Graphing Macroeconomic EquilibriumFIGURE 11-8The Relationship between Planned Aggregate Expenditure and GDP on a 45°-Line Diagram
21 Graphing Macroeconomic Equilibrium Learning Objective 11.3Graphing Macroeconomic EquilibriumShowing a Recession on the 45°-Line DiagramFIGURE 11-11Showing a Recession on the 45°-Line Diagram
22 Planned Aggregate Expendi ture Unplan ned Change in Invent ories Macroeconomic EquilibriumReal GDP(Y)Consump tion(C)Planned Invest ment(I)Govern ment Purchases(G)Net Exports(NX)Planned Aggregate Expendi ture(AE)Unplan ned Change in Invent oriesReal GDP Will …$8,000$6,200$1,500– $500$8,700–$700increase9,0006,8501,500–5009,350–350100007,50010,000be in equili brium110008,15010,650+350decrease120008,80011,300+700Don’t Let This Happen to YOU! Don’t Confuse Aggregate Expenditure with Consumption Spending
24 = Change in autonomous spending that sparks an expansion Learning Objective 11.4The Multiplier EffectAutonomous expenditure An expenditure that does not depend on the level of GDP.Multiplier The increase in equilibrium real GDP in response to increase in autonomous expenditure, e.g.Expenditure multiplier = ΔY/ΔIMultiplier effect The process by which an increase in autonomous expenditure leads to a larger increase in real GDP: ΔY = ΔI + ΔC= Change in autonomous spending that sparks an expansion+Change in consumption spending induced by increasing output and income.
26 Making the ConnectionThe Multiplier in Reverse: The Great Depression of the 1930sThe multiplier effect contributed to the very high levels of unemployment during the Great Depression.YearConsumptionInvestmentNet ExportsReal GDPUnemployment Rate1929$661 billion$91.3 billion$9.4illion$865 billion3.2%1933$541 billion$17.0 billion-$10.2 billion$636 billion24.9%
27 The Multiplier EffectA Formula for the Multiplier
28 Summarizing the Multiplier Effect 1 The multiplier effect occurs both when autonomous expenditure increases and when it decreases.2 The multiplier effect makes the economy more sensitive to changes in autonomous expenditure than it would otherwise be.3 The larger the MPC, the larger the value of the multiplier.4 The formula for the multiplier, 1/(1 − MPC), is oversimplified because it ignores some real-world complications, such as the effect that an increasing GDP can have on taxes, imports, prices and interest rates.
29 The Aggregate Demand Curve The Effect of a Change in the Price Level on Real GDP
30 Aggregate demand curve A curve that shows the relationship between the price level and the level of planned aggregate expenditure, holding constant all other factors that affect aggregate expenditure.
31 K e y T e r m s Aggregate demand curve Aggregate expenditure (AE) Aggregate expenditure modelAutonomous expenditureCash flowConsumption functionInventoriesMarginal propensity to consume (MPC)Marginal propensity to save (MPS)MultiplierMultiplier effect
32 Appendix The Algebra of Macroeconomic Equilibrium 1 Consumption function2 Planned investment function3 Government spending function4 Net export function5 Equilibrium condition
33 Appendix The Algebra of Macroeconomic Equilibrium The letters with bars over them represent fixed, or autonomous, values. So, represents autonomous consumption, which had a value of 1,000 in our original example. Now, solving for equilibrium, we get:Or, Or, Or,
34 Appendix The Algebra of Macroeconomic Equilibrium Remember that is the multiplier. Therefore an alternative expression for equilibrium GDP is:Equilibrium GDP = Autonomous expenditure x Multiplier