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    KENESIAN EQUATION

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    KENESIAN EQUATION

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    © All Rights Reserved
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    9 views15 pages

    13 EXPENDITURE MULTIPLIERS - THE KEYNESIAN MODEL - Chapter. Key Concepts - PDF

    Uploaded by

    Faris Khalid
    KENESIAN EQUATION

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    © All Rights Reserved
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    of 15
    13 EXPENDITURE Il Fixed Prices and Expenditure Plans In che very shore run firms do not change their prices and they sell the amounc that is demanded. Asa result The price level is fixed. ¢ GDP is determined by aggregate demand. Aggregate planned expenditure isthe sum of planned consumption expenditure, planned investment. planned government purchases, and planned exports minus planned imports. GDP and aggregate planned expendicures have a wor way link: An increase in real GDP increases aggregate planned expenditures, and an increase in aggregate expenditures increases real GDP. Consumption expenditure, C, and saving, 5; depend on disposable income (disposable income, YD. isi come minus taxes plus transfer payments), the rea terest rate, wealth, and expected farure income. The consumption function isthe relationship be- ‘ovcen consumption expenditure and disposable in- come. Figure 13.1 illustrates consumption function 4 Theamount of consumption when disposable in- come is zero (SI trillion in Figure 13.1) sealed ausonomous consumption. Consumption above this amount is called induced consumption The marginal propensity to consume, MPC, is the fraction of a change in disposable income tha is ‘consumed, or MPC ac where A means aYD “change in.” * This is Chapter 29 in Economies. 191 MULTIPLIERS: THE KEYNESIAN MODEL* FIGURE 13. =z fo eam z b 1 & 4 ; § 23s Dic income iso 2000 dol 4 The lope of the consumprionFanetion quae the MPC. The slope ofthe U.S. consumption function is about 0.9. ‘Changes inthe real interest rate, wealth, or pected future income shife the consumption Fune- Consumption varies when teal GDP changes because changes in real GDP change disposable income. ‘The saving function isthe relationship between ssving and disposable income. The marginal propensity to save, MPS, isthe fraction of a change in disposable as AyD ‘The sum of the MPC plus MPS equals 1 Domestic imports are determined in the shore ean mainly by U.S. GDP. The marginal propensity to import isthe fraction of an inerease in real GDP spent con imports income thacis saved, or MP! 192 lm Real GDP with a Fixed Price Level FIGURE 13.2 Aggregate Expenditure 45° A ae ee 0 NW fool GOP rllions of 2000 ders), The aggregate planned expendicuce schedule shows how aggregace expenditure depends on teal GDP. The aggregate expenditure eure plots che aggregate pinned expenditure schedule. Figure 13.2illastrates an aggre gate expenditure eurve, AE = C+ 1+ G + NX, where 'NXis exports minus impor. + Induced expenditure i the sum of the compo nents of aggregate expenditure chat change with Gop. 4+ Autonomous expendirare is the sum of the com- ponents of aggregate expenditure that do noe change when rel GDD changes. In Figure 132 conomous expendinure is $8 elon Equilibrium expenditure is che level of aggregate ex- pendirase chat occurs when aggregate planned expendi ture equals real GDP. In Figure 13.2 the equilibrium ‘expenditure isthe point at which the 45° line cross the AF line, or $10 tillion. 4 Freal GDP exceeds equilibrium expendiure, un- planned inventories accumulate; if real GDP is ess shan equilibrium expenditure, inventories are drawn down in an unplanned manner. 1 The Multiplier A change in autonomous expenditure creates an addi- sional change in induced expendicure. The mul the amount by which a change in autonomous ex- penditute is multiplied to determine the change in CHAPTER 13 (29) cquilbsiuon expendinare and real GDP. he suulipier is ager than .0 because a change in autonomous ex penditure also changes induced expendicut. 4 With no income axes or imports, che multiplier 1 or, equivalently, 7 MPS Income taxes and imports shrink the multiplier. Imports and income taxes reduce the slope of the AE curve, With them the multiplier equals 1 lope of the AE cares) A business cycle expansion occurs when autono. ‘mous expenditure increases and the multiplier ef- fect increases equilibrium expendicure; a business ‘eyele recession oceurs when autonomous expendli- ture decreases. Ml The Multiplier and the Price Level The aggregate expenditure curve (AE) shows the sela- tionship between aggregate planned expenditure and dlisposable income; de aggregate demand curve (AD) shows the relaionship berween the aggregate quantity ‘of goods demanded and the price level. The AD curve is derived from the AE eurve. Am increase in the price level shifts the AE curve dowaward and equilibrium expenditure decreases FIGURE 13.3 Increase in the Price Level and the AE Curve @ 9 wo Nw Real GOP Willons of 2000 dello) © Figure 13.3 illustrates this effecr: Whea the price level rises from 130 to 170, the AF curve shifts EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL 193 from AE, © AB, and equ creases from $10 t0 $8 ibium expenditure de- Figure 13.3 shows chat, when the price level is 130, the aggregate quantity demanded is $10 trillion and, when the price level is 170, the aggregace ‘quantity demanded is $8 tillion, These are «wo points on the AD curve in Figure 13.4. FIGURE 13.4 Increase in the Price Level and the AD Curve “AD 8 9 0 oN wD Real GOP (vlions of 2000 dees} ‘¢ An increase inthe price level leads to 2 movement along the aggrogare demand curve. Figure 13.4 shows how an inerease in the price level from 130 10 170 lead to.a movement along the AD curve from point «to point &, The AD curve does not shift in response to a change in the price level. ¢ The AD curve shifts when autonomous expendi- tue changes for any season other than a change in the price evel. For instance, a change in investment cor government purchases shifts the AD curve. The size of the shift in the AD curve equals the ‘multiplier cimes the change in autonomous expen: livre, Figure 13.5 shows this result, where the AD curve shifts rightward and che multiplied change in ‘equilibrium expenditure is equal to the length of the double-headed arrow, $2 tillion, The change in real GDP is ess than the shift in the AD curve, In Figure 13.5 the shift in the AD curve is $2 ailion. ‘The increase in the price level reduces the inerease in GDP: in the short run, seal GDP in the figure increases by only $1 willion FIGURE 13.5 Increase in Aggregate Demand AD, ‘AD @ 9 0 12 eal GDP (hillons of 2000 dears In the long mn, real GDP etuens ro potential seal GDP and does aot change as a result of a change in segregate demand. In the long run, the multiplier PRs 1. AUTONOMOUS AND INDUCED EXPENDITURE: ‘Autonomous expenditure is independent of ‘changes in real GDP, whereas induced expenditure varies as eal GDP changes. In general, a change in ‘autonomous expenditure creates a change in teal GDP, which in curn creates a change in induced ‘expenditure. The induced changes are at the heart ‘ofthe multiplier effect. 2. THE INTUITION oF THE MULTIPLIEE ‘cept of the multiplier i very important. An initial increase in autonomous expenditure, sich as in- ‘vest-ment, increases real GDP dlrectly, but that is rot the end of the story. The initial increase in real GDP generates an increase in induced expenditure, ‘which further increases real GDP and thus creates further increases in (induced) expenditure. Induced ‘expendiire accurs because the increate in real GDP created by the increase in autonomous ex- penditute raises disposable income. For instance, an increase in investment purchases of computers raises the incomes of workers who are hited ro manufacture the additional computers. Then, the The con- 194 increate in disposable income increases these work: cs’ (induced!) consumption expendivure. 3. THE MULTIPLIER aND THE AGGREGATE SUPPLY CURVE: The mulplir shows the change in equi- librium expenditure. So, if he multplice is 5.0 and Jnvestment (a component of auronomous expendi- tue) increases by $10 Billion, the equilibrium ex- penditure increases by $50 billion However, am increase inthe equilibrium expendi- ‘ure of $50 billion does not necessarily mean that equilibrium seal GDP also increases by $50 billion The change in equilibrium real GDP depends on the interaction of aggregate demand and ageregate supply. The $50 billion increase in equlbriums ex- penditure implies thatthe AD curve shifts right- ward by $50 billion, but this shift is one par of the picture. Depending on the aggregate supply curve, seal GDP could increase by an amount close w $50 Villon ithe SAS curve is zlaively fat) or by an ammount les than $50 bilin (how mucl les de- pends onthe steepness ofthe SAS curve) I True/False and Expl Fixed Prices and Expenditure Plans 1. A change in disposable income shifts the consump- tion function 2. The marginal propensity to consume equals con- sumption divided by disposable income. 3. The sum ofthe marginal propensity to consume and the marginal propensity to save equals 1 Real GDP with a Fixed Price Level 4, When real GDP increases, induced expendieure increases along the AF curve. 5. Planned aggregate expenditure can be different than the actual aggregate expenditure. 6. Equilibrium expenditure occurs when aggregate planned expenditure equals eal GDP. 7. When aggregate planned expenditure exceeds rel GDP, inventories rise more than planned. ‘The Multiplier 8, An increase in autonomous expenditure leads to an induced increase in consumption expendivure, CHAPTER 13 (29) 1 9. The muliplice equals —— Pie eS T= MPS) 10, The lrg the marginal propensity to consume, the smaller the multiplier. LL. Ifthe marginal propensity ro consume is 0.8 and. there are no income taxes nor imports the mult- plier equals 5.0. ‘The Multiplicr and the Price Level 12, An inerease in investment shifs the AP curve up- ‘ward and the AD curve tigheward 15. In the shore run, an increase in investment expen- inure of S1 billion increases equilibrium GDP by more chan $1 billion. 14, Inthe long run, an increase in investment expendi- ‘ure of $1 billion increases equilibrium GDP by more than SI billion. 1 Multiple Choice Fixed Prices and Expenditure Plans Use Figure 13.6 for the next question, FIGURE 13.6 ‘Multiple Choice Question 1 1 2 9 4 6 Disposable incame (ilns of 2000 dlrs] 1, What is the marginal propensity to consume, MPC, in Figure 13.62 a. 100, b, 0.90. 007. 4. $3.uillion EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL The fisction of a change in disposable income saved is called the marginal propensity to consume. i, the marginal propensity to save. the marginal tax rate. d. none of the above. . The MPC plus MPS equals ad bo. anumber between 1 and 0, d. anumber not between 0 and 1. Consumption expenditure increases when fa the interest rate Bb, the price level «ral GDP d. saving Which of the following increases the amount a houschold saves? a. A decreate in the household's current disposable b, An increate in the houschold’s expected future [An increase in the houschold’s net taxes, d. A decrease in the houschold’s expected future ‘Which of the following shifis the consumption function downward? a. Am increase in current disposable income. bb Am increase in future expected income. An increase in wealth dd. A decrease in wealth. An increase in expected future income __con- sumption expenditure and saving by. incresses; decreases decreases, incresses 4. decreases, decreases 195 Real GDP with a Fixed Price Level 8. The aggregate expenditure curve shows the relation ship between aggregace planned expendicure and a. government purchases b. real GDP, ce the interest rat, 1d. the price level 9. Auronomous expendinuce is NOT ingluenced by a. the interest rate. b. taxes real GDP. 4. any variable 10, Ifunplanned inventories rise, aggregate planned ‘expenditure is 4. greater than real GDP and firms increase thei upor. b. greater than real GDP and firms decrease their output. ce. less than real GDP and output. 4d. less than real GDP and firms decrease their output. 11. Tfaggregate planned expenditure exceeds real GDP, in the shore run, 4. aggregate planned expenditure will increase. b. real GDP will increase.

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