Spending by Individuals,

Firms, and Governments on

Real Goods and Services

Chapter 12

Framework for Macroeconomic

Analysis
Focus

on the Short Run

Analysis in Real Versus Nominal Terms
Treatment of the Foreign Sector

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Outline for Macroeconomic

Analysis
Fixed Price Assumption
Market and
Expenditure for
Real Goods and
Services
(Chapter 12)
Money Market:
Supply and
Demand for
Money
(Chapter 13)

Flexible Price Assumption

Aggregate
Demand Curve
(Chapter 14)

Aggregate
Supply Curve
(Chapter 14)
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Model of
Aggregate
Demand and
Aggregate
Supply
(Chapter 14)

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Aggregate Expenditure
The

sum of personal consumption expenditure,

investment expenditure, government
expenditure, and net export expenditure in a
given period of time.
E = C + I + G + (X M)

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05/16/15

Personal Consumption Expenditure

The

amount of spending by households on

durable goods, nondurable goods, and
services in a given period of time.

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Consumption Function
The

fundamental relationship in
macroeconomics that assumes that household
consumption spending depends primarily on the
level of disposable income (net of taxes) in the
economy, all other variables held constant.
C = f(Yd), where
Yd = disposable, or after-tax income

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Marginal Propensity to Consume

(MPC)
The

additional consumption spending

generated by an additional amount of real
income, assumed to take a value less than 1.
MPC = C/Yd or C/(Y - TP)

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Saving Function
The

amount of disposable income that

households do not spend on the consumption
of goods and services.
S = Yd - C

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Marginal Propensity to Save (MPS)

The

additional household saving generated by

an additional amount of real income, which
equals 1 - MPC.
MPS = S/Yd or S/(Y TP) = 1 - MPC

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Other Factors Affecting the Level of

Consumption Spending
Personal

taxes
Real interest rate
Consumer confidence
Existing stock of wealth
Availability of consumer credit
Stock of consumer debt outstanding

10

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Consumption Function - Graphical

C

C2

C1
Y

C0

11

Y1

Y2

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Y
05/16/15

Gross Private Domestic Investment

Expenditure
The

total amount of spending on nonresidential

structures, equipment, and software;
residential structures; and business inventories
in a given period of time.

12

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Determinants of Gross Private

Domestic Investment
Level of real income and output in the economy
Real interest rates
Business taxes
Expected Profits and Business Confidence
Capacity utilization rates
Residential Investment Spending
Inventory Investment

13

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Government Expenditure
The

total amount of spending by federal, state,

and local governments on consumption outlays
for goods and services, depreciation charges
for existing structures and equipment, and
investment capital outlays for newly acquired
structures and equipment in a given period of
time.

14

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Determinants of the Level of

Government Expenditures
Government

expenditure policy is determined

by the legislative and executive institutions at
all levels of government.

15

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Net Export Expenditure

The

difference between export spending on

domestically produced goods and services by
individuals in other countries and import
spending on foreign produced goods and
services by domestic residents in a given
period of time.

16

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Determinants of the Level of Net

Export Expenditures
Relative

economic growth rates around the

world.
Currency exchange rates.
Relative interest rates.

17

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Aggregate Expenditure Function

E = E0 + (c1 + i1 - m1)Y
where
E = aggregate expenditure
E0 = sum of all autonomous expenditure
components
c1 = marginal propensity to consume
i1 = marginal propensity to invest
m1 = marginal propensity to import
Y = real income

18

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Aggregate Expenditure Function

Graphical Treatment
E
E
Slope = c1 + i1 m1
E0

19

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05/16/15

Equilibrium Level of Income and

Output
The

equilibrium level of income and output is

that level of income at which the desired
spending by all sectors of the economy just
equals the value of the aggregate output
produced and the income received from that
production.
E=Y

20

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05/16/15

Equilibrium Level of Income and

Output - Graphical
E

E1

EE

Slope = c1,
assuming
i1 = m 1 = 0

E0

45o
YE

21

Equilibrium is that level of real

income,YE, where the aggregate
expenditure line, E1 , crosses
the 45 line.

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Disequilibrium Level Income and

Output Adjustment
Relationship of E to Y

22

Inventories

Output Adjustment

E>Y

Unexpected decrease in
Output increases
inventories

E=Y

Inventories are at
expected level

Output equilibrium

E<Y

Unexpected increase in
inventories

Output decreases

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The Multiplier
The

multiple change in income and output that

results from a change in autonomous
expenditure.
m = Y E = 1 1- MPC

23

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Interest Rates and Aggregate

Expenditures
The

interest-related expenditure (IRE) function

shows planned consumption and investment
spending as a function of the real interest rate,
all else held constant.

24

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Interest Rates and Aggregate

Expenditures
r

E
B

r1

E(r2)

E(r1)
A
B

r2

IRE = f(r)
45o
IRE1

25

IRE2

IRE

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Y1

Y2

Y
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