Chapter 10 aggregate expenditures
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ECONOMICS: EXPLORE & APPLY by Ayers and Collinge. Chapter 10 “Aggregate Expenditures”. Learning Objectives. Summarize the perspective of Keynesian and Keynesian economics. Illustrate the income-expenditure. Explain the adjustment process to an expenditure equilibrium.

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Chapter 10 “Aggregate Expenditures”

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Chapter 10 aggregate expenditures

ECONOMICS: EXPLORE & APPLYby Ayers and Collinge

Chapter 10“Aggregate Expenditures”


Learning objectives

Learning Objectives

  • Summarize the perspective of Keynesian and Keynesian economics.

  • Illustrate the income-expenditure.

  • Explain the adjustment process to an expenditure equilibrium.

  • Describe how new spending can have a ripple effect throughout the economy.


Learning objectives1

Learning Objectives

  • Distinguish the types of multipliers in the Keynesian model.

  • Graph the relationship of the income-expenditure model to aggregate demand.

  • (E&A) Compare economic analyses of the Great Depression.


10 1 in the long run we are all dead

10.1“IN THE LONG RUN, WE ARE ALL DEAD”

  • Keynes chose to ignore long-run tendencies toward full employment.

  • In his view the problems of unemployment could be solved only if people and government would buy more goods and services.

    • Consumption spending is 70% of GDP, and it motivates investment spending.

  • The Keynesian model is based around understanding how much spending is likely to occur at different levels of spending, and how government can influence that spending to ensure full employment.


10 2 the income expenditure model

Aggregate National Income

=

Aggregate National Output

10.2THE INCOME-EXPENDITURE MODEL

“One person’s spending is another

person’s income.”


The income expenditure model

The Income –Expenditure Model

  • The aggregate expenditures function tells what the economy’s planned spending will be at each level of real GDP.

  • There will be only one GDP that does match up planned spending and actual spending.

  • That GDP occurs at the expenditure equilibrium, where the AE function and the 45-degree line intersect.


The income expenditure model1

#2 The 4-degree line

shows expenditures by repeating to the

vertical axis the real

GDP listed on the horizontal axis.

#3 At the equilibrium

value of GDP, actual

spending equals planned

spending .

#1 The aggregate

expenditure function

shows how much the

economy plans to

spend at each possible

GDP

The Income –Expenditure Model

45o: Spending=production

Aggregate Expenditure Function

Expenditures

$10 trillion

$5 trillion

$10

trillion

Real GDP

(income)


Components of aggregate expenditures

Components of Aggregate Expenditures

  • Spending can be divided into two types:

    • Autonomous spending: spending that would occur even if people had no income.

    • Induced spending: spending that depends upon income.


Components of aggregate expenditures1

Components of Aggregate Expenditures

  • Autonomous spending includes both investments and goods.

    • Draw upon previous wealth and savings.

    • College students with no earnings drawing down their parents bank accounts to pay for room and board at school.

  • Graphically, autonomous spending is a positive amount that shows up as a horizontal line.


Components of aggregate expenditures2

Components of Aggregate Expenditures

  • Since induced spending is entirely dependent upon income, graphically it starts at zero starts at zero and GDP rises from there.

  • When autonomous spending and induced spending are added together, the result is an aggregate expenditure function that has both a positive vertical intercept, and a positive slope.


Aggregate expenditures

Aggregates expenditures includes

both autonomous and induced spending.

Aggregate Expenditure Function

Induced spending

Autonomous spending

Aggregate Expenditures

Expenditures

$10 trillion

$5 trillion

0

$10

trillion

Real GDP

(income)


Components of aggregate expenditures3

Components of Aggregate Expenditures

  • The components of aggregate expenditures are merely the components of GDP.

    GDP = C + I + G + (X-M)

  • The consumption function because of autonomous spending has a positive vertical intercept.

  • From there, it slopes upward because of the marginal propensity to consume (mpc).


Mpc and mps

MPC and MPS

  • The marginal propensity to consume (MPC) is the fraction of additional income that people spend.

  • The marginal propensity to save (MPS) is the fraction of additional income that people save.

MPC + MPS = 1


The aggregate expenditures function

The Aggregate Expenditures Function

  • Investment and government purchases are of roughly comparable size.

  • If planned government purchases and investment spending are assumed to be completely autonomous, they will be constant as GDP changes.

  • For this reason, the slope of the AE function and the consumption function are the same.


Modeling the expenditure equilibrium

Modeling the Expenditure Equilibrium

  • When the economy is not at equilibrium, actual GDP and planned spending differ.

  • Unintended inventory changes show up as the difference between planned and actual investment.


Modeling the expenditure equilibrium1

Modeling the Expenditure Equilibrium

Expenditure equilibrium:

aggregate expenditures = actual GDP

where

Aggregate expenditures: consumption + planned investment

government + net exports

and

GDP = consumption + actual investment

+ government +net exports

which

implies

Expenditure equilibrium:

planned investment = actual investment


Modeling the expenditure equilibrium2

Output decreases

but at a decreasing rate.

Modeling the Expenditure Equilibrium

45o: Spending=production

#1 if the economy

starts here

#2 A progression of inventory

buildups less production leads to

the expenditures equilibrium

here.

Expenditures

Aggregate Expenditure Function

Real GDP

(income)


10 3 changing the expenditure equilibrium

10.3CHANGING THE EXPENDITURE EQUILIBRIUM

  • When there are changes in autonomous spending, the changes are magnified by the multiplier effect.

  • Adding autonomous spending causes a higher GDP, which causes more induced spending.

  • That’s because money that one person spends autonomously adds to income of others, which in turn induces them to buy more output.

  • At each stage in this cycle, however, some income is saved, thus eventually bringing the cycle to a halt.


The multiplier effect

The expenditure

equilibrium moves

higher

Increase in autonomous expenditures

Increase in GDP

The Multiplier Effect

Aggregate

expenditure

function

Expenditures

The multiplier effect causes a small increase in autonomous expenditures to have a much larger effect on GDP.

Real GDP

(income)


The multiplier effect1

The Multiplier Effect

  • The strength of the multiplier effect depends upon the proportion of income that is devoted to consumption.

  • To the extent that people save their incomes, savings represents a leakage out of the multiplier process.

  • A negative value for savings means that there is dissaving – spending out of existing savings.


Spending depends upon the marginal propensity to consume mpc

Spending Depends upon the Marginal Propensity to Consume (mpc):


The expenditure multiplier

The Expenditure Multiplier

Expenditure multiplier = 1/mps

or

1/(1-MPC)

 Autonomous spending x 1/mps

=

 Expenditure equilibrium


The multiplier effect2

The Multiplier Effect

  • The multiplier is multiplied by a change in autonomous spending to reveal the change in equilibrium GDP.

  • There must be some idle resources for the multiplier effect to occur.

  • Keynesian multiplier analysis assumes a constant price level.


Recession and inflation within the income expenditure model

Recession and Inflation within the Income-Expenditure Model

  • If the expenditure equilibrium lies below full-employment GDP, it is called an unemployment equilibrium.

  • Along with the unemployment equilibrium comes an output gap, in which actual GDP falls below full-employment GDP.

    • At an unemployment equilibrium, there is to little spending for the economy to achieve full employment GDP.


Recession and inflation within the income expenditure model1

Recession and Inflation within the Income-Expenditure Model

The shortfall

in spending

is called a

recessionary gap.

  • If the expenditure equilibrium lies below full-employment GDP, it is called an unemployment equilibrium.

  • Along with the unemployment equilibrium comes an output gap, in which actual GDP falls below full-employment GDP.

    • At an unemployment equilibrium, there is to little spending for the economy to achieve full employment GDP.


Recession and inflation within the income expenditure model2

Recession and Inflation within the Income-Expenditure Model

  • If the expenditure equilibrium occurs past the full-employment GDP, multiplier analysis does not apply, because inflation will not allow it to stay there.

  • This possibility is referred to as an inflationary gap, which is the excess of the aggregate expenditure function above that consistent with a full employment equilibrium.


Making policy with multipliers

Making Policy with Multipliers

  • Keynesian analysis suggest that govern can use taxes to stimulate the economy.

  • However people might save some of their higher after tax income rather than spend it. The tax multiplier, which is the expansionary, or contractionary effect of a tax cut, or increase would be less than the multiplier by the amount of the initial round of spending.


Making policy with multipliers1

Making Policy with Multipliers

Tax Multiplier = -mpc/(1-mpc)


Balanced budget multiplier

Balanced Budget Multiplier

  • Keynesians view extra government spending as the most effective policy to cure a recession.

  • The balanced-budget multiplier combines the expenditure multiplier for an increase in government spending and the tax multiplier because taxes would increase to finance that spending.


Making policy with multipliers2

Making Policy with Multipliers

Balanced Budget Multiplier =

1/(1-mpc) – mpc/(1-mpc)=

(1-mpc)/(1-mpc)=1


10 4 aggregate demand

Aggregate Expenditures with lower price level P1

Aggregate Expenditures with higher price level P2

P2

P1

Aggregate Demand

GDP2

GDP1

10.4 AGGREGATE DEMAND

45o: Spending=production

Expenditures

Actual Real GDP (income)

Price Level

Real GDP


10 5 explore apply the great depression

10.5 EXPLORE & APPLYThe Great Depression

  • The 1920’s era of prosperity peaked in early 1929.

    • A few months later the stock market crashed.

    • The Great Depression began and did not end for over a decade.

  • Keynesian aggregate expenditure analysis can be used to describe the depression and the policy action to correct it.


Terms along the way

income-expenditures model

aggregate expenditures

aggregate expenditures function

expenditure equilibrium

autonomous spending

induced spending

consumption function

marginal propensity to consume

marginal propensity to save

Terms Along the Way


Terms along the way1

multiplier effect

expenditure multiplier

unemployment equilibrium

output gap

recessionary gap

inflationary gap

tax multiplier

balanced budget multiplier

Terms Along the Way


Test yourself

Test Yourself

  • John Maynard Keynes offered a long-run perspective on the macro-economy in the general theory.

  • If you had no income you could still engage in induced spending.

  • The marginal propensity to consume must be 1 or less.

  • An expenditure equilibrium occurs where the aggregate expenditure function intersects the vertical axis.

  • An injection of new autonomous spending will leave equilibrium real GDP unchanged when the marginal propensity to save equals 0.5.


Test yourself1

Test Yourself

2.Suppose actual spending equals planned spending. Then we can say

  • the economy is at an expenditure equilibrium.

  • real GDP is the most it can possibly be.

  • autonomous spending equals zero.

  • aggregate demand has shifted to the left.


Test yourself2

Test Yourself

3.In the income expenditures model the 45-degree line shows

  • the amount of autonomous spending.

  • the amount of induced spending.

  • the expenditure multiplier.

  • that the economy’s expenditures are actually the same as its output. .


Test yourself3

Test Yourself

4.Aggregate expenditures include all of the following except

  • consumption.

  • planned investment.

  • net exports.

  • unintended changes in business inventories.


Test yourself4

Test Yourself

5.The marginal propensity to consume equals

  • the fraction of their total income that people consume.

  • the fraction of additional income that people consume.

  • the fraction of their savings that people plan to spend within the next year.

  • one in most cases..


Test yourself5

Test Yourself

6.The paradox of thrift, if true suggest that people should

  • save more.

  • spend more.

  • vote more often.

  • spend the same amount of money, but spend it more wisely.


Chapter 10 aggregate expenditures

The End!

Next Chapter 11

“Fiscal Policy in Action"


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