1. AE = C + I + G + NX AE = GDP = Y = C + I + G + NX
Output and Expenditure in the Short Run
Aggregate expenditure (AE) The total amount of spending in the economy: the sum of consumption, planned investment, government purchases, and net exports.
AE = C + I + G + NX
Macroeconomic Equilibrium
AE = GDP = Y = C + I + G + NX
Unintended change in inventories:
The Difference between Planned Investment and Actual Investment
In macro-equilibrium, there is no unintended change in
Inventories: Actual Investment = Planned Investment.

2. Adjustments to Macroeconomic Equilibrium
The Relationship between Aggregate Expenditure (AE) and Output (GDP = Y)
IF …
THEN …
AND …
Aggregate expenditure
equals GDP
inventories are unchanged
the economy is in macroeconomic equilibrium.
Aggregate expenditure is
less than GDP
inventories rise
GDP and employment decrease.
Aggregate Expenditure is
greater than GDP
inventories fall
GDP and employment increase.
EXPENDITURE CATEGORY
EXPENDITURE
(BILLIONS OF 2000 DOLLARS)
Consumption
$8,091
Investment
1,946
Government
1,998
Net Exports
−618

3. Determining the Level of Aggregate Expenditure : Consumption Spending (C)
Determinants of C
FIGURE 11-1
• Current disposable income
• Household wealth
• Expected future income
• The price level
• The interest rate

4. The Consumption Function
Relation between real consumption expenditure (C)
and real disposable income (DI)
Slope of consumption function
= Marginal propensity to consume
= MPC

5. Consumption The Consumption Function
The MPC determines how much consumption changes as income changes: or
Change in consumption = Change in disposable income × MPC

6. The Relationship between Consumption and National Income
Disposable income = National income − Net taxes or
National income = GDP = Disposable income + Net taxes C Y

7. Income, Consumption, and Saving
National income = Consumption + Saving + Taxes
Change in national income = Change in consumption
+ Change in saving + Change in taxes
Y = C + S + T
and
ΔY = ΔC + ΔS + ΔT
To simplify, we assume taxes are constant ΔT = 0, so
ΔY = ΔC + ΔS

8. Income, Consumption, and Saving
Marginal propensity to save (MPS) The change in saving divided by the change in disposable income.
or,
1 = MPC + MPS

9. MARGINAL PROPENSITY TO CONSUME (MPC) MARGINAL PROPENSITY TO SAVE (MPS)
Calculating the Marginal Propensity to Consume and the Marginal Propensity to Save
NATIONAL INCOME AND REAL GDP (Y)
CONSUMPTION
(C)
SAVING
(S)
MARGINAL PROPENSITY TO CONSUME (MPC)
MARGINAL PROPENSITY TO SAVE (MPS)
$9,000
$8,000
$1,000 —
10,000
8,600
1,400
0.6
0.4
11,000
9,200
1,800
12,000
9,800
2,200
13,000
10,400
2,600

10. Determining the Level of Aggregate Expenditure in the Economy
Planned Investment
Determinants of Planned Investment Spending
• Expectations of future profitability
Waves of optimism and pessimism
Animal Spirits
• The interest rate
• Cash flow
• Taxes

11. Determining the Level of Aggregate Expenditure in the Economy
Government Purchases: It is what it is
Real Government Purchases, 1979–2006

12. Net exports : Determinants
• The US price level relative to price levels in other countries
• The growth rate of US GDP relative to the growth rates of GDP in other countries
• The exchange rate between the dollar and other currencies
Real Net Exports, 1979–2006

13. Graphing Macroeconomic Equilibrium
The Relationship between Planned Aggregate Expenditure and GDP on a 45°-Line Diagram

14. Graphing Macroeconomic Equilibrium
Macroeconomic Equilibrium on the 45°-Line Diagram

15. Showing a Recession on the 45°-Line Diagram

16. Planned Aggregate Expenditure Unplanned Change in Inventories
A Numerical Example of Macroeconomic Equilibrium
When planned aggregate expenditure is less than output (real GDP), some firms will experience an unplanned increase in inventories. They will then reduce output.
When planned aggregate expenditure is greater than output (real GDP), some firms will experience an unplanned decrease in inventories. They will then increase output.
Real GDP
(Y)
Consumption
(C)
Planned Investment
(I)
Government Purchases
(G)
Net Exports
(NX)
Planned Aggregate Expenditure
(AE)
Unplanned Change in Inventories
Real GDP Will …
$8,000
$6,200
$1,500
– $500
$8,700
–$700
increase
9,000
6,850
1,500
–500
9,350
–350
Increase
10,000
7,500
Equilibrium
11,000
8,150
10,650
+350
decrease
12,000
8,800
11,300
+700
Don’t Let This Happen to YOU! Don’t Confuse Aggregate Expenditure with Consumption Spending

17. = Change in autonomous spending that sparks an expansion
The Multiplier Effect
Autonomous 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/ΔI
Multiplier 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.

18. Suppose MPC = ¾
The Multiplier Effect

19. The Multiplier Effect: MPC = ¾
ADDITIONAL AUTONOMOUS EXPENDITURE (INVESTMENT)
ADDITIONAL INDUCED EXPENDITURE
(CONSUMPTION)
TOTAL ADDITIONAL EXPENDITURE = TOTAL ADDITIONAL GDP
ROUND 1
$100 billion $0
ROUND 2
75 billion
175 billion
ROUND 3
56 billion
231 billion
ROUND 4
42 billion
273 billion
ROUND 5
32 billion
305 billion .
ROUND 10
8 billion
377 billion
ROUND 15
2 billion
395 billion
ROUND 19
1 billion
398 billion n
$400 billion

20. The Multiplier in Reverse: The Great Depression of the 1930s
The multiplier effect contributed to the very high levels of unemployment during the Great Depression.
Year
Consumption
Investment
Net Exports
Real GDP
Unemployment Rate
1929
$661 billion
$91.3 billion
$9.4illion
$865 billion
3.2%
1933
$541 billion
$17.0 billion
-$10.2 billion
$636 billion
24.9%

21. The Multiplier Effect
1 The multiplier effect occurs both when autonomous expenditure increases and when it decreases… like now!
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. It ignores the effects an increasing GDP has on taxes, imports, inflation, and interest rates.

22. The Aggregate Demand Curve
The Effect of a Change in the Price Level on Real GDP…A rise in the price level
reduces net exports
reduces the purchasing power of monetary wealth
reduces real money balances and raises interest rates
higher interest rates appreciate currency and further reduce net exports
A rise in the price level reduces AE and reduces Y

23. Aggregate demand curve A curve that shows the relationship between the price level and the level of planned aggregate expenditure in the economy, holding constant all other factors that affect aggregate expenditure.

24. 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,