1. Output and Expenditure in the Short Run
Aggregate expenditure (AE) The total amount of spending on the economy’s output:
Aggregate Expenditure
AE = C + I + G + NX
• Consumption (C)
• Planned Investment (I)
• Government Purchases of Goods + Services (G)
• Net Exports (NX)
Actual investment in a year can differ from planned investment: businesses “invest” in unintended inventories if sales fall short of what they expected
Macroeconomic Equilibrium: Aggregate Expenditure = Output (Y)
AE = C + I + G + NX = Y

2. Components of Real Aggregate Expenditure, 2006
EXPENDITURE CATEGORY
EXPENDITURE
(BILLIONS OF 2000 DOLLARS)
Consumption
$8,091
Investment
1,946
Government
1,998
Net Exports
−618

3. The Aggregate Expenditure Model
Adjustments to Macroeconomic Equilibrium
Actual investment in a year can differ from planned investment: businesses “invest” in unintended inventories if sales fall short of what they expected
IF …
THEN …
AND …
Aggregate expenditure is
equal to GDP
inventories are unchanged
the economy is in macroeconomic equilibrium.
less than GDP
inventories rise
GDP and employment decrease.
Aggregate Expenditure is
greater than GDP
inventories fall
GDP and employment increase.

4. Real Consumption Expenditure C = $C/CPI
FIGURE 11-1
Real Consumption, 1979–2006

5. The most important variables that determine the level of consumption:
• Current disposable income
• Household wealth: Assets minus liabilities
• Expected future income
People try to keep their consumption fairly steady from year-to-year  save for a rainy day
• The price level
Higher price level reduces real value of monetary wealth
• The interest rate
High interest rate discourages spending on credit and encourages saving

6. The Relationship between Consumption and Income, 1960– 2006
The Consumption Function: The relation between consumption and disposable income
Marginal propensity to consume (MPC) The amount by which consumption spending changes when disposable income changes = slope of consumption function.
The Relationship between Consumption and Income,
1960– 2006
Consumption Function

7. The Consumption Function
Marginal propensity to consume (MPC) The slope of the consumption function: The amount by which consumption spending changes when disposable income changes.
We can also use the MPC to determine how much consumption will change as income changes:
Change in consumption = Change in disposable income × MPC

8. The Relationship between Consumption and National Income
when net taxes are constant

9. Determining the Level of Aggregate Expenditure in the Economy
Income, Consumption, and Saving
National income = Consumption + Saving + Taxes
Y = C + S + T
Change in national income = Change in consumption + Change in saving + Change in taxes
If taxes are always a constant amount, ΔT = 0
ΔY = ΔC + ΔS

10. 1 = MPC + MPS MPS = 1 - MPC Income, Consumption, and Saving
Marginal propensity to save (MPS) The change in saving divided by the change in disposable income.
or,
1 = MPC + MPS
MPS = 1 - MPC

11. MARGINAL PROPENSITY TO CONSUME (MPC) MARGINAL PROPENSITY TO SAVE (MPS)
Solved Problem
11-2
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

12. Determining the Level of Aggregate Expenditure in the Economy
Planned Investment (I)
Real Investment, 1979–2006

13. Waves of optimism and pessimism
The most important variables that determine the level of investment:
• Expectations of future profitability
Waves of optimism and pessimism
• Major technology changes: new products & processes
The interest rate
• Taxes
• Cash flow
Current capacity utilization

14. The “new” information economy of the 1990s

15. Government Purchases (G)
Real Government Purchases, 1979–2006

16. Net Exports (NX)
Real Net Exports, 1979–2006

17. Net Exports (NX)
The most important variables that determine the level of net exports:
• The price level in the United States relative to the price levels in other countries
• The growth rate of GDP in the United States relative to the growth rates of GDP in other countries
• The exchange rate between the dollar and other currencies

18. Graphing Macroeconomic Equilibrium
Learning Objective 11.3
Graphing Macroeconomic Equilibrium
FIGURE 11-8
The Relationship between Planned Aggregate Expenditure and GDP on a 45°-Line Diagram

19. Graphing Macroeconomic Equilibrium

20. Graphing Macroeconomic Equilibrium

21. Graphing Macroeconomic Equilibrium
Learning Objective 11.3
Graphing Macroeconomic Equilibrium
Showing a Recession on the 45°-Line Diagram
FIGURE 11-11
Showing a Recession on the 45°-Line Diagram

22. Planned Aggregate Expendi ture Unplan ned Change in Invent ories
Macroeconomic Equilibrium
Real GDP
(Y)
Consump tion
(C)
Planned Invest ment
(I)
Govern ment Purchases
(G)
Net Exports
(NX)
Planned Aggregate Expendi ture
(AE)
Unplan ned Change in Invent ories
Real GDP Will …
$8,000
$6,200
$1,500
– $500
$8,700
–$700
increase
9,000
6,850
1,500
–500
9,350
–350
10000
7,500
10,000
be in equili brium
11000
8,150
10,650
+350
decrease
12000
8,800
11,300
+700
Don’t Let This Happen to YOU! Don’t Confuse Aggregate Expenditure with Consumption Spending

23. The Multiplier Effect

24. = Change in autonomous spending that sparks an expansion
Learning Objective 11.4
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.

25. The Multiplier Effect in Action
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

26. Making the Connection
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%

27. The Multiplier Effect
A Formula for the Multiplier

28. Summarizing the Multiplier Effect
1 The multiplier effect occurs both when autonomous expenditure increases and when it decreases.
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 because it ignores some real-world complications, such as the effect that an increasing GDP can have on taxes, imports, prices and interest rates.

29. The Aggregate Demand Curve
The Effect of a Change in the Price Level on Real GDP

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

31. K e y T e r m s Aggregate demand curve Aggregate expenditure (AE)
Aggregate expenditure model
Autonomous expenditure
Cash flow
Consumption function
Inventories
Marginal propensity to consume (MPC)
Marginal propensity to save (MPS)
Multiplier
Multiplier effect

32. Appendix The Algebra of Macroeconomic Equilibrium
1 Consumption function
2 Planned investment function
3 Government spending function
4 Net export function
5 Equilibrium condition

33. 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,

34. Appendix The Algebra of Macroeconomic Equilibrium
Remember that is the multiplier. Therefore an alternative expression for equilibrium GDP is:
Equilibrium GDP = Autonomous expenditure x Multiplier