Building the Aggregate Expenditures Model 9 C H A P T E R Building the Aggregate Expenditures Model

PRIVATE CLOSED ECONOMY Simplifications... A Closed Economy Defer Government & Taxes Defer Exports and Imports All Saving Is Personal Net Income Abroad Is Zero Aggregate Spending = Consumption and Investment

CONSUMPTION AND SAVING Saving (S) = Disposable Income (DI) - Consumption (C) Households consume most of their disposable income Consumption & saving are directly related to income Consumption Schedule Saving Schedule Breakeven Income

CONSUMPTION AND SAVING schedule C MPC = Slope of C MPC + MPS = 1 DISSAVING 45 o o Disposable Income MPS = Slope of S Saving schedule S Saving SAVING o DISSAVING S Disposable Income

CONSUMPTION AND SAVING APC Consumption / Disposable Income APS Saving / Disposable Income MPC Change in Consumption Change in Disposable Income MPS Change in Saving Change in Disposable Income

GLOBAL PERSPECTIVE Average Propensities to Consume, Selected Nations, 1999 .80 .85 .90 .95 1.0 Canada United States Netherlands United Kingdom Germany Italy Japan France .986 .976 .972 .940 .907 .873 .869 .842 Statistical Abstract of the United States, 2000

NONINCOME DETERMINANTS OF CONSUMPTION AND SAVING Wealth Wealth Effects Expectations Taxation Household Debt

TERMINOLOGY, SHIFTS, & STABILITY Schedule Shifts Stability Graphically…

TERMINOLOGY, SHIFTS, & STABILITY C1 C0 Increases in Consumption Means… Consumption 45 o o Disposable Income A Decrease In Saving S0 S1 Saving o Disposable Income

TERMINOLOGY, SHIFTS, & STABILITY C0 C2 Decreases in Consumption Means… Consumption 45 o o Disposable Income S2 An Increase In Saving S0 Saving o Disposable Income

INVESTMENT Graphically presented... Expected Rate of Return, r Real Interest Rate, i Inverse relationship between Investment demand and the expected rate of return Graphically presented...

and interest rate, i (percents) Expected rate of return, r, INVESTMENT 16 14 12 10 8 6 4 2 INVESTMENT DEMAND CURVE and interest rate, i (percents) Expected rate of return, r, I D 5 10 15 20 25 30 35 40 Investment (billions of dollars)

SHIFTS IN INVESTMENT DEMAND Acquisition, Maintenance, and Operating Costs Business Taxes Technological Change Stock of Capital Goods on Hand Expectations

GLOBAL PERSPECTIVE Gross Investment Expenditures as a Percentage of GDP, Selected Nations 40% 30% 20% 10% 0% Germany France United States Canada Mexico Kingdom Sweden Japan South Korea Source: World Bank

INVESTMENT DEMAND & SCHEDULE Real Domestic Product, GDP Curve Investment Schedule Ig 20 (billions of dollars) Investment Expected rate of return, r, and real interest rate, i (percents) 8 20 20 I D 20 Investment (billions of dollars) Real Domestic Product, GDP (billions of dollars)

INSTABILITY OF INVESTMENT Durability of Capital and Variability of Expectations Irregularity of Innovation Volatility of Investment

GDP = C + Ig EQUILIBRIUM GDP Real Domestic Output Aggregate Expenditures Schedule Equilibrium GDP GDP = C + Ig Saving and Planned Investment are Equal Leakage Injection No Unplanned Changes in Inventories Actual Investment

EQUILIBRIUM GDP Ig = $20 Billion C =$450 Billion (C + I g = GDP) $530 510 490 470 450 430 410 390 370 Equilibrium C Ig = $20 Billion Private spending, C + I g (billions of dollars) C =$450 Billion 45 o o 370 390 410 430 450 470 490 510 530 550 Real domestic product, GDP (billions of dollars)

Say’s Law EQUILIBRIUM GDP Ig = $20 Billion C =$450 Billion (C + I g = GDP) C + Ig $530 510 490 470 450 430 410 390 370 Equilibrium C Say’s Law Ig = $20 Billion Private spending, C + I g (billions of dollars) C =$450 Billion 45 o o 370 390 410 430 450 470 490 510 530 550 Real domestic product, GDP (billions of dollars)

Chapter Conclusions EQUILIBRIUM GDP Ig = $20 Billion C =$450 Billion (C + I g = GDP) C + Ig $530 510 490 470 450 430 410 390 370 Equilibrium C Ig = $20 Billion Private spending, C + I g (billions of dollars) C =$450 Billion 45 o o 370 390 410 430 450 470 490 510 530 550 Real domestic product, GDP (billions of dollars)

KEY TERMS consumption schedule saving schedule break-even income average propensity to consume (APC) average propensity to save (APS) marginal propensity to consume (MPC) marginal propensity to save (MPS) wealth effect expected rate of return real interest rate investment demand curve planned investment investment schedule aggregate expenditures schedule equilibrium GDP 45 degree line leakage injection unplanned changes in inventories actual investment BACK END Copyright McGraw-Hill/Irwin, 2002

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