Presentation on theme: "Aggregate expenditure"— Presentation transcript:
1 Aggregate expenditure Autonomous versus induced expenditureThe consumption functionThe theory of investmentGovernment purchase functionThe net export function
2 Autonomous versus induced Expenditure Autonomous expenditure: The components of aggregate expenditure that do not change when real GDP changes.Induced expenditure: The components of aggregate expenditure that change when real GDP changes.
3 The consumption function The consumption function reveals the relationship between consumption and disposable income, other things constant.
4 Disposable income, consumption, and saving in US
6 Keynes’s fundamental law of consumption People show a tendency, as a rule and on average, to increase their consumption when their income increases—but not by as much as the increase in income.
7 Marginal propensities to consume (MPC) and save (MPS) MPC: The fraction of the change in income that is spent on consumption.Keynes’s fundamental law implies that:MPS: The fraction of the change in income that is saved
8 The consumption function 1234576891011Real consumption (trillions of dollars)CThe consumption function, C, shows the relationship between consumption and disposable income, other things constant.1234576891014131211Real disposable income (trillions of dollars)
9 Marginal propensities to consume and save Real consumption (trillions of dollars)(a) Consumption function(b) Saving functionReal saving (trillions of dollars)MPC=∆C/∆DI=0.4/0.5=4/5MPS=∆S/∆DI=0.1/0.5=1/5bd∆C=0.4ac∆S=0.1∆DI=0.5∆DI=0.5Real disposable income (trillions of dollars)The slope of the C function equals the marginal propensity to consume.For the straight-line C function in (a), the slope is the same at all levels of income and is given by the change in consumption divided by the change in disposable income that causes it: MPC=4/5.The slope of the S function in (b) equals the marginal propensity to save, MPS=1/5.
10 Determinants of consumption Disposable IncomeNet WealthConsumptionInterest RatesExpectations
11 Shifts of the consumption function Real consumptionCAn upward shift, such as from C to C’’, can be caused by an increase in net wealth, a decrease in the price level, an favorable change in consumer expectations, or a decrease in the interest rate.C’Real disposable incomeA downward shift of the consumption function, such as from C to C’, can be caused by a decrease in net wealth, an increase in the price level, an unfavorable change in consumer expectations, or an increase in the interest rate.
16 Theory of InvestmentWhy do firms purchase things like new offshore drilling platforms, food processing plants, or bulldozers? Because they expect they can make a profit by doing so.
17 Investment Function Let Where: I is gross investment is the expected profit of investment; andr is the interest rate.
18 The Investment Decision Acquisition cost of a tractor–trailer rig $150,000.00Useful life yearsExpected (extra) sales revenue per year from the use of the asset ,000.00Expected costs per year to operate the asset . . $180,000.00Diesel fuel $38, Driver salary & benefits , Depreciation , Repairs (including tires) , Misc. (fees, fines, etc.) 5,000Expected net sales revenue per year from the use of the asset $20,000.00
19 Computing expected profit () To compute expected profit in percentage terms:Thus we have:
20 We would consider the tractor-trailer rig a sound investment if the interest rate were less than 13.7 percent.
21 Rates of return on golf carts and the opportunity cost of funds 5810152025Nominal interest rate (percent)An individual firm invests in any project with a rate of return that exceeds the market interest rate.At an interest rate of 8%, Hacker Haven purchases three golf carts, investing $6,000.Expected rateof returnMarket rateof interest$2,000$4,000$6,000$8,000$10,000Investment
22 Investment demand curve for the economy 6810Nominal interest rate (percent)The investment demand curve for the economy sums the investment demanded by each firm at each interest rate.At lower interest rates, more investment projects become profitable for individual firms, so total investment in the economy increases.D0.91.01.1Investment(trillions of dollars)
23 Investment functionA decrease in the interest rate or more upbeat business expectations would increase investment at every level of income, as shown by the upward shift from I to I’’.0.91.01.1Investment (trillions of dollars)I’’IAn increase in the interest rate or less favorable business expectations would decrease investment at every level of income, as shown by the downward shift from I to I’.I’2.04.06.08.010.0Real disposable income(trillions of dollars)12.014.0Investment is assumed to be independent of income, as shown by horizontal lines. Thus, investment is assumed to be autonomous.
24 Annual percentage change in US real GDP, consumption, and investment
25 Government purchase function Because government purchases are controlled by public officials, we treat them as autonomous—that is, determined independent of income
26 Net export function-420-400-380Net exports (billions of dollars)2.04.06.08.010.0Real disposable income(trillions of dollars)12.014.0A decrease in the value of the dollar would increase net exports at each level of income, as shown by the shift up to X’’-M’’.X’’-M’’X-MX’-M’An increase in the value of the dollar relative to other currencies would decrease net exports at each level of income, as shown by the shift down to X’-M’.Net exports here are assumed to be independent of disposable income, as shown by the horizontal lines. X-M is the net export function when autonomous net exports equal -$400 billion.
27 US spending components as percentages of GDP since 1959