14. Aggregate Expenditure. CHAPTER. C H A P T E R C H E C K L I S T. When you have completed your study of this chapter, you will be able to. 1 Distinguish between autonomous expenditure and induced expenditure and explain how real GDP influences expenditure plans.
When you have completed your study of this chapter, you will be able to
Autonomous expenditure is the components of aggregate expenditure that do not change when real GDP changes.
Autonomous expenditure equals investment plus government expenditure plus exports plus the components of consumption expenditure and imports that are not influenced by real GDP.
Induced expenditureis the components of aggregate expenditure that change when real GDP changes.
Induced expenditure equals consumption expenditure minus imports (excluding the elements of consumption expenditure and imports that are part of autonomous expenditure).
Figure 14.1 shows the consumption function.
Each dot corresponds to a column of the table.
Point A shows that autonomous consumption is $1.5 trillion.
As disposable income increases, consumption expenditure increases—induced consumption.
Along the 45° line, consumption expenditure equals disposable income.
1.When the consumption function is above the 45° line, saving is negative (dissaving occurs).
3.At the point where the consumption function intersects the 45° line, all disposable income is consumed and saving is zero.
2.When the consumption function is below the 45° line, saving is positive.
Change in disposable income14.1 EXPENDITURE PLANS AND REAL GDP
Figure 14.2 shows how to calculate the marginal propensity to consume.
1. A $2 trillion change in disposable income brings
2.A $1.5 trillion change in consumption expenditure, so...
3. The MPC is $1.5 trillion ÷ $2.0 = 0.75.
Figure 14.3 shows shifts in the consumption function.
2. Consumption expenditure decreases and the consumption function shifts downward if
Figure 14.4 shows the AE curve.
Aggregate expenditure is the sum of
Government expenditure (G),
Consumption expenditure (C)
minus Imports (M).
Figure 14.5 shows equilibrium expenditure.
1. When aggregate planned expenditure exceeds real GDP, an unplanned decrease in inventories occurs.
2. When aggregate planned expenditure is less than real GDP, an unplanned increase in inventories occurs.
3. When aggregate planned expenditure equals real GDP, there are no unplanned inventories and real GDP remains at equilibrium expenditure.
When investment increases, aggregate expenditure and real GDP also increase.
But the increase in real GDP is larger than the increase in investment.
The multiplier is the amount by which a change in any component of autonomous expenditure is magnified or multiplied to determine the change that it generates in equilibrium expenditure and real GDP.
Figure 14.6 illustrates the multiplier.
1.A $0.5 trillion increase in investment shifts the AE curve upward by $0.5 trillion from AE0 to AE1.
2.Equilibrium expenditure increases by $2 trillion from$9 trillion to $11 trillion.
3.The increase in equilibrium expenditure is 4 times the increase in investment, so the multiplier is 4.
Change in autonomous expenditure14.3 THE EXPENDITURE MULTIPLIER
But the change in consumption expenditure is determined by the change in real GDP and the marginal propensity to consume.
C = MPCY
Now substitute MPCY for C in the equation at the top of the screen
Y = MPCY + I
(1 – MPC)14.3 THE EXPENDITURE MULTIPLIER
Now solve for Y as
(1 – MPC) Y = I
Rearrange to get
(1 – MPC)
(1 – MPC)
(1 – 0.75)14.3 THE EXPENDITURE MULTIPLIER
Now, divide both sides of the by the I to give
When MPC is 0.75, so the multiplier is
(1 – Slope of AE curve)14.3 THE EXPENDITURE MULTIPLIER
Figure 14.7 shows the multiplier and the slope of the AE curve.
With no imports and income taxes, the slope of the AE curve equals the marginal propensity to consume, which in this example is 0.75.
A $0.5 trillion increase in investment increases real GDP by $2 trillion. The multiplier is 4.
With imports and income taxes, the slope of the AE curve is less than the marginal propensity toconsume.
In this example, the slope of the AE curve is 0.5.
A $0.5 trillion increase in investment increases real GDP by $1 trillion. The multiplier is 2.
Business-Cycle Turning Points
The forces that bring business-cycle turning points are the swings in autonomous expenditure such as investment and exports.
The mechanism that gives momentum to the economy’s new direction is the multiplier.
An expansion is triggered by an increase in autonomous expenditure that increases aggregate planned expenditure.
At the moment the economy turns the corner into expansion, aggregate planned expenditure exceeds real GDP.
In this situation, firms see their inventories taking an unplanned dive.
The expansion now begins.
To meet their inventory targets, firms increase production, and real GDP begins to increase.
This initial increase in real GDP brings higher incomes, which stimulate consumption expenditure.
The multiplier process kicks in, and the expansion picks up speed.
Figure 14.8 shows the connection between the AE curve and the AD curve.
When the price level is 110, the AE curve is AE0.
Equilibrium expenditure is $10 trillion at point B.
The quantity of real GDP demanded at the price level of 110 is $10 trillion—one point on the AD curve.
When the price level falls to 90, the AE curve shifts upward to AE1.
Equilibrium expenditure increases to $11 trillion at point C.
The quantity of real GDP demanded at the price level of 90 is $11 trillion—a movement along the AD curve to point C.
When the price level rises to 130, the AE curve shifts downward to AE2.
Equilibrium expenditure decreases to $9 trillion at point A.
The quantity of real GDP demanded at the price level of 130 is $9 trillion—a movement along the AD curve to point A.