Presentation on theme: "AE = C + I + G + NX AE = GDP = Y = C + I + G + NX"— Presentation transcript:
1 AE = C + I + G + NX AE = GDP = Y = C + I + G + NX Output and Expenditure in the Short RunAggregate 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 + NXMacroeconomic EquilibriumAE = GDP = Y = C + I + G + NXUnintended change in inventories:The Difference between Planned Investment and Actual InvestmentIn macro-equilibrium, there is no unintended change inInventories: Actual Investment = Planned Investment.
2 Adjustments to Macroeconomic Equilibrium The Relationship between Aggregate Expenditure (AE) and Output (GDP = Y)IF …THEN …AND …Aggregate expenditureequals GDPinventories are unchangedthe economy is in macroeconomic equilibrium.Aggregate expenditure isless than GDPinventories riseGDP and employment decrease.Aggregate Expenditure isgreater than GDPinventories fallGDP and employment increase.EXPENDITURE CATEGORYEXPENDITURE(BILLIONS OF 2000 DOLLARS)Consumption$8,091Investment1,946Government1,998Net Exports−618
3 Determining the Level of Aggregate Expenditure : Consumption Spending (C) Determinants of CFIGURE 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:orChange in consumption = Change in disposable income × MPC
6 The Relationship between Consumption and National Income Disposable income = National income − Net taxesorNational income = GDP = Disposable income + Net taxesCY
7 Income, Consumption, and Saving National income = Consumption + Saving + TaxesChange in national income = Change in consumption+ Change in saving + Change in taxesY = C + S + TandΔY = ΔC + ΔS + ΔTTo simplify, we assume taxes are constant ΔT = 0, soΔY = 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 SaveNATIONAL 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—10,0008,6001,4000.60.411,0009,2001,80012,0009,8002,20013,00010,4002,600
10 Determining the Level of Aggregate Expenditure in the Economy Planned InvestmentDeterminants of Planned Investment Spending• Expectations of future profitabilityWaves of optimism and pessimismAnimal Spirits• The interest rate• Cash flow• Taxes
11 Determining the Level of Aggregate Expenditure in the Economy Government Purchases: It is what it isReal 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 currenciesReal 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
16 Planned Aggregate Expenditure Unplanned Change in Inventories A Numerical Example of Macroeconomic EquilibriumWhen 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 InventoriesReal GDP Will …$8,000$6,200$1,500– $500$8,700–$700increase9,0006,8501,500–5009,350–350Increase10,0007,500Equilibrium11,0008,15010,650+350decrease12,0008,80011,300+700Don’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 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.
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.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%
21 The Multiplier Effect1 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 levelreduces net exportsreduces the purchasing power of monetary wealthreduces real money balances and raises interest rateshigher interest rates appreciate currency and further reduce net exportsA 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,