1. Consumption, Savings, and Aggregate Expenditures

2. Do you agree or disagree with the following?
If income remains constant, when consumption increases savings must decrease.
If income increases, savings decreases and if income decreases, savings increases.
If consumption increases, ceteris paribus, GDP will increase.
If GDP rises, unemployment rises.
Consumption can be greater than income.

3. Consumption and Saving
Largest component of AE is C
DI = C + S
If DI ↑, C ↑ and S ↑ ; if DI ↓, C ↓ and S ↓
C can be > DI; S can be negative
If AE ↑, GDP ↑ and unemployment ↓
If AE ↓, GDP ↓ and unemployment ↑

4. APC, APS, MPC, and MPS
APC = C / Income = % of income people are likely to consume
APS = S / Income = % of income people are likely to save
APC + APS = 1
MPC = ∆C / ∆Income
MPS = ∆Savings / ∆Income
MPC + MPS = 1

5. Investment
If business expects to be able to produce $1100 worth of goods from $1000 machine, r = 10% ($100/$1000)
If MB>=MC, they’ll invest so…
r>=i
If r = 10%, nominal i = 12%, inflation = 5%, they’ll invest until nominal i = 15%

6. i
I = $20 8%
Real interest rate 8% ID
I ($) 20

7. I I GDP ($) 45o I = $20 billion I is constant b/c
it depends on r and i,
not GDP 20 I
GDP ($)

8. AE
I = $20 billion
45o
C + I C
470
450
GDP ($)
470

9. AE
I = $20 billion
45o C
470
450
GDP ($)
470

10. The Simple Spending Multiplier
Multiplier = (change in real GDP)/(change in spending) OR
Change in GDP = Multiplier x (change in spending)
Multiplier = 1/MPS OR 1/(1-MPC)

11. The Multiplier and GDP
MPS = .20; consumption increases by $10 billion; what is the increase to GDP?
$50 billion ($10 B x (1/.20)) = $10 B x 5
MPS = .25; income increases by $20 billion; what is the increase to GDP?
Consumption increases by .75 x $20 B = $15 B; GDP increases by $60 B ($15 B x 4)
If MPS falls to .20, how does that change the increase to GDP?
C ↑ by .80 x $20 B = $16 B; GDP ↑ by $80 B ($16 B x 5)

12. AE C + I GDP ($) If net exports > 0 45o If net exports < 0
C + I + Xn
C + I
490
C + I + Xn
GDP ($)
490

13. 45o AE
I = $20 billion
C+I+Xn
C+I+Xn+G
C + I C
GDP ($)

14. Net Exports Positive Xn increase AE and negative Xn decrease AE
Appreciation – value of currency rises against another
Depreciation – value of currency falls against another
Ex: $1.50 = 1 Euro;
Appreciation -- $1 = 1 Euro ($1.50 = 1.5 Euros)
Depreciation -- $2 = 1 Euro

15. Net Exports
If $ appreciates, U.S. goods more expensive (costs more foreign currency) – X falls
$ appreciates – foreign goods are cheaper; M rises so net exports fall
If $ depreciates, U.S. goods cheaper (costs less foreign currency) – X rises
$ depreciates – foreign goods more expensive (costs more $) so M falls; net exports rises

16. Government Purchases More purchases increase AE; fewer reduce AE
∆ in G have a greater effect on GDP than ∆ in taxes do
Ex: MPS = .20; G ↑ by $20 B; GDP ↑ by $100 B ($20 B x 5)
MPS = .20; taxes fall by $20 B; C ↑ by $16 B ($20 B x .80); GDP ↑ by $80 B ($16 B x 5)
Some of the tax cut is saved and doesn’t affect GDP

17. Balanced Budget Multiplier
Taxes and G change in the same direction by the same amount; i.e. -- $20 B
GDP will change by the same amount in the same direction; i.e. -- $20 B
Balanced budget multiplier is 1 (1 x ∆ in G and T)
If G and T fall by $20 B, GDP will fall by $20 B

18. Leakages – pull $ out of the economy: savings, taxes, imports
Injections – inject $ into the economy: investment, government, exports
Recessionary gap – the amount that AE must increase to pull GDP up to full-employment GDP
Inflationary gap – the amount that AE must fall to bring GDP back down to full-employment GDP

19. The Simple Spending Multiplier
Multiplier = (change in real GDP)/(change in spending) OR
Change in GDP = Multiplier x (change in spending)
Multiplier = 1/MPS OR 1/(1-MPC)

20. Practice – What happens to GDP?
Income goes up by $5 M. MPC = 0.8
Investment falls by $40 B. MPS = 0.1
Government purchases falls by $100 B. MPC = 0.75
The dollar appreciates causing net exports to change by $25 B. MPS = 0.2
The dollar depreciates causing net exports to change by $10 B. MPS = 0.33
Taxes fall by $50 B. MPC = 0.8
Taxes and government purchases increase by $25 B. MPC = 0.25

21. Answers GDP increases by $20 B. GDP falls by $400 B.