3 views

Uploaded by fardin222

- ECO403z - 1st Hourly (KEY) MACRO ECONOMICS
- Keynesian Print
- macro economics
- 0By6In2KOjqktanMwd2tuV2RSX28.pdf
- Gdp
- Sarkozy Attacks Focus on Economic Growth
- Middle Income Trap
- Economist Insights 2013 08 052
- Consumption
- Five Decades of Andhra Pradesh
- Untitled 9
- Aggregate Demand and Supply
- Keynesian Aggregate Mode1 PDF
- TERM 1 TEST
- Chapter 12 Study Guide Economics Aggregate Expenditure
- PPT 3.docx
- Reseach on Household Energy in Fiji from the 1980s by Suliana Siwatibau
- Day 1 Session 1 Introduction Background Paper - Basics of National Accounts
- Jamaica recently proposed a fiscal stimulus programme of just over J
- Chap 009

You are on page 1of 9

CHAPTER

25

Explain how expenditure plans are determined when the price level is fixed Explain how equilibrium real GDP is determined when the price level is fixed Explain the expenditure multiplier when the price level is fixed Explain the relationship between aggregate expenditure and aggregate demand and explain the multiplier when the price level changes

Keynesian model describes the economy in the very short run when prices are fixed. Fixed prices have two implications for the economy as a whole: 1 B Because each fi price i fi d the price l h firms i is fixed, h i level i l is fixed. 2 Because demand determines the quantities that each firm sells, aggregate demand determines the aggregate quantity of goods and services sold, which equals real GDP.

Keynesian Model The idea that aggregate demand determines real GDP is the basis of the Keynesian model. The Keynesian model is a model of the economy that determines real GDP in the very short run, when the price level is fixed.

Expenditure Plans The components of aggregate expenditure sum to real GDP (which is also equal to AD as we have seen). That is,

Consumption Function and Saving Function Consumption expenditure is influenced by many factors but the most direct one is disposable income. Disposable income is aggregate income or real GDP, Y, minus net taxes, T. Call disposable income YD. The equation for disposable income is

Y=C+I+G+XM

Aggregate planned expenditure is equal to planned consumption expenditure plus planned investment plus planned government expenditure plus planned exports minus planned imports.

YD = Y T

Pearson Education 2008

6/14/2010

Disposable income is either spent on consumption goods and services, C, or saved, S. That is,

YD = C + S.

The relationship between consumption expenditure and disposable income, other things remaining the same, is the consumption function C = f(YD) The relationship between saving and disposable income, other things remaining the same, is the saving function S = f(YD)

Pearson Education 2008

When consumption expenditure exceeds disposable income there is income, negative saving (dissaving). When consumption expenditure is less than disposable income, there is saving.

Marginal Propensities to Consume and Save The marginal propensity to consume (MPC) is the fraction of a change in disposable income spent on consumption. It is calculated as the change in consumption expenditure, C, divided by the change in disposable income, YD, that brought it about. That is,

MPC is the slope of the consumption function. Along this consumption function, function when disposable income increases by 200 billion, consumption expenditure increases by 150 billion. The MPC is 0.75.

MPC = C YD

MPS is the slope of the saving function. Along this saving function, when disposable income increases by 200 billion, saving increases by 50 billion. The MPS is 0.25.

The marginal propensity to save (MPS) is the fraction of a change in disposable income that is saved. g g, , y It is calculated as the change in saving, S, divided by the change in disposable income, YD, that brought it about. That is,

MPS = S YD

6/14/2010

The MPC plus the MPS equals 1. To see why, note that, YD = C + S (remember?). So,

Other Influences on Consumption and Saving The other influences on consumption expenditure and saving are the real interest rate, wealth, and expected future income. A fall in the real interest rate, an increase in wealth or an increase in expected future income shifts the consumption function upward and the saving function downward.

Pearson Education 2008

C + S = YD.

Divide this equation by YD to obtain,

Consumption as a Function of Real GDP

Import Function The marginal propensity to import is the fraction of an increase in real GDP spent on imports. imports For example, if a 100 billion increase in real GDP increases imports by 20 billion, then the marginal propensity to import is 0.2.

C = f(YD), we learnt. Y T = YD

Disposable income changes when either real GDP changes or net taxes change change. If tax rates dont change, real GDP is the only influence on disposable income. So consumption expenditure is a function of real GDP. We use this relationship to determine real GDP when the price level is fixed.

Pearson Education 2008

To understand how real GDP is determined when the price level is fixed, we must understand how aggregate demand is determined. Aggregate demand is determined by aggregate expenditure plans. Aggregate planned expenditure is planned consumption expenditure plus planned investment plus planned government expenditure plus planned exports minus planned imports.

Weve seen that planned consumption expenditure and planned imports are influenced by real GDP. When real GDP increases, planned consumption expenditure and planned imports increase. Planned investment plus planned government expenditure plus planned exports are not influenced by real GDP.

6/14/2010

Aggregate Planned Expenditure and Real GDP Figure 25.4 shows how the aggregate expenditure curve (AE) is built from its components.

The relationship between aggregate planned expenditure y gg g and real GDP can be described by an aggregate expenditure schedule, which lists the level of aggregate expenditure planned at each level of real GDP.

Actual Expenditure, Planned Expenditure, and Real GDP Actual aggregate expenditure is always equal to real GDP. Aggregate planned expenditure may differ from actual aggregate expenditure because firms can have unplanned changes in inventories or stocks. Equilibrium Expenditure Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP.

Pearson Education 2008

Consumption expenditure minus imports, which varies with real GDP, is induced expenditure. The sum of investment, government expenditure and investment expenditure, exports, which does not vary with GDP, is autonomous expenditure. (Consumption expenditure and imports can have an autonomous component.)

Equilibrium occurs at the point at which the aggregate expenditure curve crosses th 45 li the line in part (a). Equilibrium occurs when there are no unplanned changes in inventories or stocks in part (b).

Convergence to Equilibrium If aggregate planned expenditure exceeds real GDP (the AE curve is above the 45 line), there is an unplanned decrease in stocks. To restore stocks, firms hire workers and increase production. Real GDP increases.

6/14/2010

If aggregate planned expenditure is less than real GDP (the AE curve is below the 45 line), there is an unplanned increase in stocks. To reduce stocks, firms fire workers and decrease production. Real GDP decreases.

If aggregate planned expenditure equals real GDP (the AE curve intersects the 45 line), there is no unplanned change in stocks. So firms maintain their current production. Real GDP remains constant.

The Multiplier

The Multiplier

The Basic Idea of the Multiplier An increase in investment (or any other component of autonomous expenditure) increases aggregate expenditure and real GDP. The increase in real GDP leads to an increase in induced expenditure. The increase in induced expenditure leads to a further increase in aggregate expenditure and real GDP. So real GDP increases by more than the initial increase in autonomous expenditure.

Pearson Education 2008 Pearson Education 2008

The multiplier is the amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real GDP.

The Multiplier

Figure 25.6 illustrates the multiplier. An increase in autonomous expenditure brings an unplanned decrease in stocks. So firms increase production and real GDP increases to a new equilibrium.

The Multiplier

Why Is the Multiplier Greater than 1? The multiplier is greater than 1 because an increase in autonomous expenditure induces further increases in aggregate expenditure. The Size of the Multiplier The size of the multiplier is the change in equilibrium expenditure divided by the change in autonomous expenditure.

6/14/2010

The Multiplier

The Multiplier and the Slope of the AE Curve The slope of the AE curve determines the magnitude of the multiplier:

The Multiplier

To see why the multiplier = 1 (1 Slope of AE curve), begin with the fact that:

Y = N + A

But

If the change in real GDP is Y, the change in autonomous expenditure is A, and the change in induced expenditure is N, then

Slope of AE curve = N Y

so,

N = (Slope of AE curve x Y)

and

Multiplier = Y A

Y = (Slope of AE curve x Y) + A

Pearson Education 2008 Pearson Education 2008

The Multiplier

Because

The Multiplier

The multiplier is

Y = (Slope of AE curve x Y) + A

you can see that Y - (Slope of AE curve x Y) = A

Y A

So, divide both sides of the equation,

(1 Slope of AE curve) x Y = A

and

Y = A (1 Slope of AE curve)

by A to obtain

Y = A (1 Slope of AE curve)

Y A = 1 (1 Slope of AE curve)

The Multiplier

With the numbers in Figure 25.6, the slope of the AE curve is 0.75, so the multiplier is

The Multiplier

Imports and Income Taxes Both imports and income taxes reduce the size of the multiplier multiplier. Figure 25.7 shows how. In part (a) with no taxes or imports, the slope of the AE curve is 0.75 and the multiplier is 4.

Y A = 1 (1 0.75) = 1 (0.25) = 4.

When there are no income taxes and no imports, the p , slope of the AE curve equals the marginal propensity to consume, so the multiplier is

Multiplier = 1 (1 MPC).

But 1 MPC = MPS, so the multiplier is also

Multiplier = 1 MPS.

Pearson Education 2008

6/14/2010

The Multiplier

In part (b), with taxes and imports, the slope of the AE curve is 0.5 and the multiplier is 2.

Y = I + bI + b2I + b3I + b4I + b5I + . (where b = slope of AE curve). Multiply by b to obtain bY = bI + b2I + b3I + b4I + b5I + . bn approaches zero as n becomes large so b(n + 1) also approaches zero. zero Subtract the second equation from the first to obtain Y bY = I, or (1 b) Y = I, so that Y = I (1 b). Y = I 1/(1 b).

Pearson Education 2008 Pearson Education 2008

Aggregate Expenditure and Aggregate Demand The aggregate expenditure curve is the relationship between aggregate planned expenditure and real GDP, with all other influences on aggregate planned expenditure remaining the same. The aggregate demand curve is the relationship between the quantity of real GDP demanded and the price level, with all other influences on aggregate demand remaining the same.

Deriving the Aggregate Demand Curve When the price level changes, a wealth effect and substitution effects change aggregate planned expenditure and change the quantity of real GDP demanded. Figure 25.9 on the next slide illustrates the effects of a change in the price level on the AE curve, equilibrium expenditure, and the quantity of real GDP demanded.

In Figure 25.9(a), a rise in price level from 105 to 125 shifts the AE curve from AE0 downward to AE1 and decreases the equilibrium expenditure from 1,300 billion to 1,200 billion.

6/14/2010

In Figure 25.9(b), the same rise in the price level that lowers equilibrium expenditure brings a movement along the AD curve from point B to point A.

A fall in price level from 105 to 85 shifts the AE curve from AE0 upward to AE2 and increases equilibrium expenditure from 1,300 billion to 1,400 billion.

The same fall in the price level that increases equilibrium expenditure brings a movement along the AD curve to from point B to point C.

Points A, B, and C on the AD curve correspond to the equilibrium expenditure points A, B, and C at the intersection of the AE curve and the 45 line.

Changes in Aggregate Expenditure and Aggregate Demand Figure 25.10 illustrates the effects of an increase in investment. i t t The AE curve shifts upward and the AD curve shifts rightward by an amount equal to the change in investment multiplied by the multiplier.

Pearson Education 2008

6/14/2010

The increase in investment shifts the AE curve upward and shifts the AD curve rightward. With no change in the price level, real GDP would increase to 1,500 billion at point B.

But the price level rises. The AE curve shifts downward. Equilibrium expenditure decreases to 1,430 billion As the price level rises, real GDP increases along the SAS curve to 1,430 billion. The multiplier in the short run is smaller than when the price level is fixed.

Figure 25.12 illustrates the long-run effects. At point C, there is an inflationary gap. The money wage rate starts to rise and the SAS curve starts to shift leftward.

The money wage rate will continue to rise and the SAS curve will continue to shift leftward until real leftward, GDP equals potential real GDP. In the long run, the multiplier is zero.

- ECO403z - 1st Hourly (KEY) MACRO ECONOMICSUploaded byammara_786
- Keynesian PrintUploaded byserene1989
- macro economicsUploaded byVivek Mishra
- 0By6In2KOjqktanMwd2tuV2RSX28.pdfUploaded bypkssteja
- GdpUploaded byapi-3728485
- Sarkozy Attacks Focus on Economic GrowthUploaded byCocindau Monica
- Middle Income TrapUploaded byPutri Rizky Dwisumarti
- Economist Insights 2013 08 052Uploaded bybuyanalystlondon
- ConsumptionUploaded byLawrence Jiang
- Five Decades of Andhra PradeshUploaded bylajipathirai
- Untitled 9Uploaded byErsin Tukenmez
- Aggregate Demand and SupplyUploaded byApMacro
- Keynesian Aggregate Mode1 PDFUploaded byRashard Alexander
- TERM 1 TESTUploaded byMmapontsho Tshabalala
- Chapter 12 Study Guide Economics Aggregate ExpenditureUploaded byMonica Abreu
- PPT 3.docxUploaded byPurmanRayTarsil
- Reseach on Household Energy in Fiji from the 1980s by Suliana SiwatibauUploaded byPapers and Powerpoints from UNTL-VU Joint Conferenes in Dili
- Day 1 Session 1 Introduction Background Paper - Basics of National AccountsUploaded byFlorentina Viorica
- Jamaica recently proposed a fiscal stimulus programme of just over JUploaded byWessel Brissett
- Chap 009Uploaded by092994
- CommercialConnections Summer17 Issue FINAL WebUploaded byNational Association of REALTORS®
- New ZealandUploaded byCarlos Landaverde Alquicirez
- CEA State of the Economy August 2008Uploaded bysouleymane2013
- Sylebus MbaUploaded byAwanish Kumar Singh
- Concept of Economic Development (1)Uploaded bysumit sharma
- aUploaded byWashingtong
- RIO10 IND Egypt EngUploaded bySaad Motawéa
- Untitled14.PDFUploaded byErsin Tukenmez
- GDP_C02Uploaded byNaga Manasa K
- Determinants of Foreign Direct Investment in ServicesUploaded byloredanam1986

- Warachka - Disney YenUploaded byarunzexy
- Business Stratedgy ITUploaded byJagdish Arora
- 68-127-1-SMUploaded bylearnoracle19
- Environmental Economic -vol2Uploaded bybluesky062
- KESC Fifth Power (Sector Loan) Project (Loan 925-PAK).PfUploaded byIndependent Evaluation at Asian Development Bank
- soeren_skov_hansen.pdfUploaded byjojo
- POM Quiz FinalUploaded byMarie Gonzales
- IRENA Solar PV Costs Africa 2016Uploaded bymichael_obeng_4
- DemandUploaded byCharuta Jagtap Tekawade
- Freespan Analysis, Correction Method Saves Time on North Sea Project - Oil & Gas JournalUploaded byPavan Ray
- LPMC - Nomination Letter for Handrails and Balustrades - GS SteelUploaded byDeepum Hallooman
- Gainesboro_Machine_Tools_Corporation.pdfUploaded bySaad Hassan
- Partnership Dissolution - DiscussionUploaded byIñego Begdorf
- 76e9442b Eztravaganzza WarehouseUploaded byMario Villaseñor
- AKC Steel Industries-VizagUploaded byMytreyi Atluri
- Organizational Design & Analysis Case11 Southwest Team2Uploaded byMuhammad Kashif
- Sap Fico Theory-newUploaded byAbhijeet Singh
- benchmarking-internal-powe-rmarkets.pdfUploaded bysunata
- Economics Project: The Impact of Taxation on EconomyUploaded byAssignment Prime
- Power Plant PerformanceUploaded by95113309
- Indias Goods and Services Tax a PrimerUploaded bysamrat_dhar_1
- Assessing Sovereign Default RiskUploaded bykunalwarwick
- Diminishing ReturnsUploaded byMarto Fe
- India vs ChinaUploaded byMayank Kumar
- e ChapterUploaded byNewsBharati
- Valez Setup 2Uploaded byRodrigo Reis
- Larsen & ToubroUploaded bynit111
- SAP Currency ManagementUploaded byHeamanth Kkumar Chiittibomma
- PAk Suzuki Motor (Sundus Shehzadi)Uploaded bySûñdûs Shêhzãdî
- Time Value of Money ExerciseUploaded byNicholas Lau