Condensed Chapter 9 Schiller Component Parts of GDP?

What allows GDP to grow? Consumption increases Investment increases Government spending increases Exports exceed Imports.

What is Disposable Income Yd Amount of money we have to spend after taxes. 2 Things can do with money? Yd = C + S = 1

Some Simplifying Assumptions in a Keynesian Model Consumption + saving  disposable income Saving  disposable income – consumption

The Proportion of Disposable Income spent on Consumer goods and services = APC Average Propensity to Consume (APC) o Real consumption divided by real disposable income o The proportion of total disposable income that is consumed APC = Real consumption Real disposable income

Work this problem If: Disposable income = $40,000 Consumption is $30,000 What is the APC?

Answer 30,000 / 40,000= ¾ =.75 = APC

What is APS? Remember Consumption + Savings = 1 So without working the problem, you already know that savings is.25 But to find the formula – $30,000 - $40,000 = $10,000 Divide 10,000 / $40,000 = l/4 =.25

Another problem for practice Disposable income = $20,000 APS = $1,500 What is APC? Subtract $1,500 from $20,000 and you get $18,500 Divide $18,500/$20,000 =.925 = APC Divide $1,500 / $20,000 =.075 = APS = 1

Average Propensity to Save (APS) o Real saving divided by real disposable income (DI) o Saved proportion of real DI APS = Real saving Real disposable income

MPC = Change in real consumption Change in real disposable income When you think of Marginal, think change from one number to another. Marginal Propensity to Consume (MPC) o The ratio of the change in real consumption to the change in real disposable income

Marginal Propensity to Consume How much will consumption change in response to change in disposable income? Change in Consumption/Change in Income ▲C ▲Yd

Problem to solve YearIncomeConsumption 1998$30,000$23, $40,000$31,000 Answer ▲ Income = $10,000 ▲ consumption = $8,000 8,000/10,000 =.8 MPC MPS = $2,000/$10,000 =.2

The Multiplier The Multiplier: -- The multiple by which an initial change in spending will alter total expenditure after an infinite number of spending cycles; n An increase in spending by one party increases the income of others. Thus, an increase in spending can expand output by a much larger amount. n The multiplier is the number by which the initial change in spending is multiplied to obtain the total amplified increase in income. n The size of the multiplier increases with the marginal propensity to consume (MPC).

In evaluating the importance of the multiplier, one should remember : n taxes and spending on imports will dampen the size of the multiplier; n it takes time for the multiplier to work; and, n the amplified effect on real output will be valid only when the additional spending brings idle resources into production without price changes. The Multiplier

Keynes rejected the classical notion of self- adjustment, (????) and he predicted things would get worse once a spending shortfall emerged. Example: Business expectations of future sales worsens. Business investment is cut back. Unsold capital goods begins to pile up (includes office equip. machinery, airplanes, etc.) *this is an “undesired” change… Worsened sales expectations causes decline in investment spending that shifts the AD curve to the left leading to pileups of unwanted inventory.

Multiplier Formula Multiplier is ______1_____ 1 – MPC When money is spent by someone, it becomes someone else’s income. When someone spends a dollar, perhaps someone who received that dollar would spend 80 cents..next person would spend 64 cents …If you add up the spending created by that one dollar, it will add up to four or five times that dollar… hence “the multiplier”

The multiplier principle applies in reverse also. (decrease, yields reduction) (money in shoe box ) Marginal Propensity to Consume is the key The multiplier builds on the principle that one individual’s expenditure becomes the income of another. * Income increases- we spend some on “more stuff” In turn consumption expenditures on “stuff” will generate additional income for others who will spend part of their income on “stuff” also. There is a direct correlation between expenditure multiplier and MPC.

The Multiplier Process 1. $100 billion in unsold goods appear 3. Income reduced by $100 billion4. Consumption reduced by $75 billion 5. Sales fall $75 billion 6. Further cutbacks in employment or wages 7. Income reduced by $75 billion more 8. Consumption reduced by $56.25 billion more Factor markets Product markets Business firms Households 9. And so on 2. Cutbacks in employment or wages

E xpenditure S tage A dditional I ncome ( Dollars ) M arginal P ropensity To C onsume A dditional C onsumption ( Dollars ) For simplicity (here) it is assumed that all additions to income are either spent domestically or saved. 1,000, , , , , , , , ,113 75, , , , , , , , , ,113 75,085 56, ,939 Round 1 Round 2 Round 3 Round 4 Round 5 Round 6 Round 7 Round 8 Round 9 Round 10 3/4 Total4,000,0003,000,0003/4 All Others The Multiplier Principle The multiplier concept is fundamentally based upon the proportion of additional income that households choose to spend on consumption: the marginal propensity to consume (here assumed to be 75%  3/4). Here, a $1,000,000 injection is spent, received as payment, saved and spent, received as payment, saved and spent … etc. … until... effectively, $4 million is spent in the economy.