Aggregate Expenditure,

Equilibrium Output,
Unemployment,
and Inflation
Robin R. Santos, MBA
BAE103 Macroeconomics
Learning Objectives

 Understand how macroeconomic equilibrium is determined in the

aggregate expenditure model.
 Discuss the determinants of the four components of aggregate
expenditure
 Define the marginal propensity to consume and the marginal
propensity to save.
 Define the multiplier effect and use it to calculate changes in
equilibrium GDP
 Aggregate Expenditure in the Short Run

Aggregate expenditure (AE) - The total amount of spending in the economy. The
sum of consumption, planned investment, government purchases, and net exports.

Aggregate expenditure model - A macroeconomic model that focuses on the

relationship between total spending and real GDP, assuming the price level is
constant
 In any particular year, the level of GDP is determined mainly by the level of AE that
have several components
Aggregate Expenditure
Aggregate Demand Curve
Shift in Aggregate Demand
Aggregate Supply Curve
Shift in Aggregate Supply
Macroeconomic Equilibrium

 For the economy as a whole, macro equilibrium occurs where total spending
equals to total production, that is,
Keynesian Consumption Function

 Keynes focused his analysis on Total Expenditures in the economy

 Consumption function, or Keynesian consumption function, is an

economic formula that represents the functional relationship between
total consumption and gross national income
 The Consumption Function

Autonomous Consumption: portion of consumption that is not related to

income

Disposable income: The amount of money that households have

available for spending and saving after income taxes have been
accounted for.
DI = Total income – Taxes

Marginal propensity to consume (MPC): The slope of the consumption

function: the amount by which consumption spending increases when
disposable income increases:
 Unemployment and the Unemployment Rate

 Employed: works full-time or part-time

 Unemployed: unemployed but is actively seeking employment
 Out of the labor force: unemployed and is not actively seeking
employment
 Full-time students, unpaid homemakers, retirees, and people
unable to work because of disabilities
 Discouraged job seekers who have given up searching for
employment
Unemployment and the Unemployment Rate

 Measuring Unemployment

Unemployed
Out of
the
Employed Labor
Force

 Labor force = employed + unemployed

 Unemployment rate = unemployed / labor force
 Participation rate = labor force / working age*
 Working age = labor force + Out of labor
Types of Unemployment

 Frictional unemployment - Short-term

unemployment that is associated with the process of
matching workers with jobs.
 Structural unemployment is long-term, chronic
unemployment in a well-functioning economy due to
 Lack of skills, language barriers, or discrimination
 Cyclical unemployment is the increase in
unemployment during economic slow-downs
(recessions)
 Costs of Unemployment

 Unemployment imposes:
 Economic costs
 Lost wages and production
 Decreased taxes and increased transfers
 Psychological costs
 Individual self-esteem
 Family stress of decreased income and increased uncertainty
 Social costs
 Potential increases in crimes and social problems
 Anger, frustration, and despair may result in social rebellion
 Unemployment and Wages:
Supply and Demand in The Labor Market

 Supply and demand analysis can be used to find the price of

labor (real wages) and the quantity (employment)
 Analysis will consider the number of workers employed, not
work-hours per year
 Labor market is an input market
 Firms buy labor to produce goods and services
 Macroeconomics look at aggregate levels of employment and
real wages
 Microeconomics looks at wage determination for a category of
workers
Demand Curve for Labor

 If wage is $60,000,
MCC will hire 3

Wage ($000s)
workers 60

 At $50,000, MCC 50

hires 5 workers
Labor
 The lower the wage, the Demand
3 5
more workers employed Employment
The Supply of Labor

Labor
Supply

Real Wage

The labor supply curve

slopes up because the
higher the real wage,
the more people are
willing to work

Employment
Minimum Wage Legislation
Unemployment

Wmin S

Wage ($/hour)
 Minimum wage above W
equilibrium creates
unemployment D

 L1 workers earn more L1 L0

Employment

 (L0 – L1) are unemployed

 Measuring the Price Level

 Consumer Price Index (CPI) is a measure of changes

in prices
 CPI measures
The cost of a standard basket of goods and
services in a given year
Relative to the cost of the same basket of goods
and services in the base year
Base year changes periodically
Calculating the CPI
2000 Spending Monthly Cost in 2000
Rent (2 bedroom apartment) $500
Sandwiches (60 at $2 each) 120
Taxi rides (10 at $6 each) 60
Monthly expenditures $680

2005 Spending Monthly Cost in 2005

Rent (2 bedroom apartment) $630
Sandwiches (60 at $2.50 each) 150
Taxi rides (10 at $7 each) 70
Monthly expenditures $850

Cost of base-year basket of goods and services in current year

CPI =
Cost of base-year basket of goods and services in base year

CPI = (850 / 680)= 1.25

 Inflation Year CPI Inflation
2003 1.840
 The rate of inflation is the 2004 1.889 2.7%
annual percentage change 2005 1.953 3.4%
in the price level 2006 2.016 3.2%
 Inflation in 2004 2007 2.073 2.8%
(1.889 – 1.840) / 1.840
= 0.027 = 2.7% Year CPI Inflation
 How is inflation in the 1930s 1929 0.151
different since 2003? 1930 0.167 –2.3%
1931 0.152 –9.0%
 Inflation rates are negative
1932 0.137 –9.9%
 Negative inflation = Deflation 1933 0.130 –5.1%
 Demand Pull
 Aggregate demand growing faster than aggregate supply (growth too rapid)

If the economy is at
or close to full
employment, then
an increase in AD
leads to an increase
in the price level
Cost push inflation

 Shortage of supply of labor, raw materials, or

capital drives up prices.

 Wages
 Taxes
 Raw Material
Cost Push
Expansion of Money Supply

 If
the Central Bank prints more money, you
would expect to see a rise in inflation.
 Ifthere is more money chasing the same
amount of goods, then prices will rise.
 Hyperinflation is usually caused by an extreme
increase in the money supply.
Recessions and Expansions

 Recession(or contraction) is a period in which

the economy is growing at a rate below normal
Depression a particularly severe recession
Commonly held to be 2 or more consecutive
quarters of negative GDP growth
1930s was worldwide
US recessions of 1973 – 1975 and 1981 –
1982
Recessions and Expansions

A peak is the beginning of a

recession
High point of the business cycle
A trough is the end of a recession
Low point of the business cycle
Recessions and Expansions
Recessions and Expansions
Recession and Depression

 The most significant human problem associated

with recessions (and their larger, uglier cousins,
depressions) is that a slowdown in production
means that firms need to lay off or fire some of
the workers they have.

 In addition, even those who keep their jobs are

likely to find that wage raises are minimal
REFERENCES

 Philippine Statistics Authority (2017). National Accounts in first

half of 2017. http://psa.gov.ph/nap-press-release

 Bangko Sentral ng Pilipinas (2017). Exchange Rate Bulletin.

http://www.bsp.gov.ph/statistics/sdds/ExchRate.htm

 Frank, Robert H. et al. (2015). Principles of Economics. Penn

Plaza, New York. McGrawHill Education.

 McEachern, William A. (2012). Macroeconomics: A Contemporary

Introduction. Victoria, AUS SouthWestern CEngage Learning.