AGGREGATE EXPENDITURES Frederick University 2014

Aggregate Demand (AD) AD – the quantity of GDP, which the economic agents are planning to buy at every price level, ceteris paribus (Y = const)

Aggregate Expenditures АЕ – the expenditures that economic decision makers are planning to make at every level of income, ceteris paribus Planned Spending Real GDP = Nominal GDP AE = C + I + G + X - M

Consumption Spending (С) С – the expenditures that households are planning to make at every level of income, ceteris paribus

Consumption Spending (С) YCS 0

YCS – consumption spending which does not depend on income, autonomous consumption – С 0 (C a, a)

Consumption Spending (С) YCS

Consumption Spending (С) YCS C = C 0 + ( Δ C /ΔY) x Y Δ C /ΔY – the increase in consumption spending, caused by the increase in income – marginal propensity to consume – MPC (mpc, b) C = C 0 + MPC x Y

Consumption Spending (С) C = C 0 + MPC x Y MPC = ¾ = 0,75 If income rises by $100,households increase their consumption spending by $75 and increase their savings by $25 If income rises by $500, С rises by 5 х $75 = $375 C = = x 500 YCS

Savings (S) Marginal propensity to save – the increase in savings, caused by the increase in income: MPS = Δ S /ΔY If income rises by $100, and households raise their consumption spending by $75, savings increase by $25 MPC + MPS = 1 C + S = Y S = Y – C = Y – ( C 0 + MPC x Y) = Y - C 0 - MPC x Y = - C 0 + Y - MPC x Y = - C 0 + Y(1 - MPC) S = - C 0 + MPS x Y

Consumption Spending (С) and Savings (S) YCS

Consumption Spending (С) and Savings (S) Y = 1000 C = x 1000 YCS

Consumption Spending (С) and Savings (S) YCS

Consumption Spending (С) YCS C Y C = Y 0 A B D

Factors determining C Households’ income Indirect taxation Propensity to buy imported goods and services Direct taxation Consumers’ expectations Availability of consumer credit Income distribution Living standards Efficiency of market institutions

Investment spending I = Gross Private Domestic Investment I – Depreciation = Net Investment Net investment = Purchases of New Equipment + Change in Inventories Fixed Investment = Depreciation + Purchases of New Equipment Net Fixed Investment = Purchases of New Equipment Inventories =  Raw Material  + Unfinished Production  + Finished Goods

Factors determining Investment Spending (I) Interest rate (i) Expected future profits (π) Risk Excess capacity Capital-output ratio (α) Technological changes Cost of production Competitiveness of markets Depreciation policies Efficiency of market institutions

AE 45 0 C Y A B D C AE = C + I + G + X - M

AE

HOUSEHOLDS FIRMS Expenditures on final goods and services Primary Income imports М taxes Т savings S exports Х Government purchases G Investment І Leakages Injections Production factors Final goods and services The Circular Flow AE Macroeconomic Equilibrium I + G + X = S + T + M (I - S) = (T - G) + (M - X)

Macroeconomic Equilibrium Y < AE Reduction of inventories Y Y = AE Y > AE Increase in inventories Y Y = AE

The simple multiplier Y 2005 = C Inj 2005 Y 2004 = C Inj 2004 Δ Y = ΔC + ΔInj ΔY = C MPCY 2005 – C – MPCY ΔInj ΔY = MPC ΔY + ΔInj ΔY - MPC ΔY = ΔInj ΔY (1-MPC) = ΔInj ΔY = Δ Inj x1/(1-MPC) 1/(1-MPC) = multiplier = К If МРС = 0.5, К = 2 If МРС = 0.75, К = 4

The complete multiplier 1 K = MPS + t x MPC + MPI

Multiplier Constraints Factors of production bottlenecks Limited productive capacity Institutions

Deriving the Complete Multiplier Y 2005 = C (I + G + X) M 2005 Y 2004 = C (I + G + X) M 2004 Δ Y = ΔC + ΔInj - ΔM ΔY = C MPC x (Y 2005 – t x Y 2005 ) - C – MPC x (Y 2004 – t x Y 2004 ) + ΔInj - M – MPI x (Y 2005 – t x Y 2005 ) - M – MPI x (Y 2004 – t x Y 2004 ) + ΔInj ΔY = MPC x Y 2005 ( 1– t x) – MPC x Y 2004 ( 1 - t) - MPI x Y 2005 ( 1– t) – MPI x Y 2004 (1– t) ΔY = MPC ( 1 - t) x ΔY – MPI x ΔY + ΔInj ΔY - MPC ( 1 - t) ΔY + MPI x ΔY = ΔInj ΔY [(1-MPC + MPC x t) + MPI] = ΔInj ΔY = Δ Inj :1/(1-MPC + MPC x t + MPI) K = 1/(1-MPC + MPC x t + MPI) = 1/ (MPS + MPT + MPI)