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Fluctuating Demand at Cisco Systems

Fluctuating Demand at Cisco Systems. Learning Objectives. In this chapter, we will explore the reasons for changes in aggregate expenditures and how these changes affect the level of total production in the economy. Output and Expenditure in the Short Run.

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Fluctuating Demand at Cisco Systems

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  1. Fluctuating Demand at Cisco Systems Learning Objectives In this chapter, we will explore the reasons for changes in aggregate expenditures and how these changes affect the level of total production in the economy.

  2. Output and 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.

  3. Learning Objective 23.1 The Aggregate Expenditure Model Aggregate expenditure model A macroeconomic model that focuses on the relationship between total spending and real GDP, assuming that the price level is constant. Aggregate Expenditure • Consumption (C) • Planned Investment (I) • Government Purchases (G) • Net Exports (NX)

  4. Learning Objective 23.1 The Aggregate Expenditure Model Aggregate Expenditure Aggregate expenditure = Consumption + Planned investment + Government purchases + Net exports or: AE = C + I + G + NX

  5. Learning Objective 23.1 The Aggregate Expenditure Model The Difference between Planned Investment and Actual Investment Inventories Goods that have been produced but not yet sold. Macroeconomic Equilibrium Aggregate expenditure = GDP

  6. Learning Objective 23.1 The Aggregate Expenditure Model Adjustments to Macroeconomic Equilibrium Table 23-1 The Relationship between Aggregate Expenditure and GDP

  7. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Table 23-2 Components of Real Aggregate Expenditure, 2007

  8. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Consumption FIGURE 23-1 Real Consumption, 1979–2007

  9. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Consumption The following are the five most important variables that determine the level of consumption: • Current disposable income • Household wealth • Expected future income • The price level • The interest rate

  10. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Consumption Current Disposable Income The most important determinant of consumption is the current disposable income of households. Household Wealth Consumption also depends on the wealth of households. A household’s wealth is the value of its assets minus the value of its liabilities.

  11. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Consumption Expected Future Income Consumption also depends on expected future income. Most people prefer to keep their consumption fairly stable from year to year, even if their income fluctuates significantly. The Price Level The price level measures the average prices of goods and services in the economy. Consumption is affected by changes in the price level. The Interest Rate When the interest rate is high, the reward to saving is increased, and households are likely to save more and spend less.

  12. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Consumption The Consumption Function FIGURE 23-2 The Relationship between Consumption and Income,1960– 2007

  13. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Consumption The Consumption Function Consumption function The relationship between consumption spending and disposable income. Marginal propensity to consume (MPC) The slope of the consumption function: The amount by which consumption spending changes when disposable income changes.

  14. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Consumption The Consumption Function We can also use the MPC to determine how much consumption will change as income changes: or Change in consumption = Change in disposable income × MPC

  15. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy The Relationship between Consumption and National Income Disposable income = National income − Net taxes We can rearrange the equation like this: National income = GDP = Disposable income + Net taxes

  16. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy The Relationship between Consumption and National Income FIGURE 23-3 The Relationship between Consumption and National Income

  17. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Income, Consumption, and Saving National income = Consumption + Saving + Taxes Change in national income = Change in consumption + Change in saving + Change in taxes Y = C + S + T and To simplify, we can assume that taxes are always a constant amount, in which case ΔT = 0, so the following is also true: • ΔY = ΔC + ΔS

  18. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Income, Consumption, and Saving Marginal propensity to save (MPS) The change in saving divided by the change in disposable income. or, 1 = MPC + MPS

  19. Learning Objective 23.2 23-2 Solved Problem Calculating the Marginal Propensity to Consume and the Marginal Propensity to Save

  20. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Planned Investment FIGURE 23-4 Real Investment, 1979–2007

  21. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Planned Investment The four most important variables that determine the level of investment are: • Expectations of future profitability • The interest rate • Taxes • Cash flow

  22. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Planned Investment Expectations of Future Profitability The optimism or pessimism of firms is an important determinant of investment spending. The Interest Rate A higher real interest rate results in less investment spending, and a lower real interest rate results in more investment spending.

  23. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Planned Investment Taxes Firms focus on the profits that remain after they have paid taxes. Cash Flow Cash flow The difference between the cash revenues received by a firm and the cash spending by the firm.

  24. Learning Objective 23.2 MakingtheConnection • Cisco Rides the Roller Coaster of Information Technology Spending

  25. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Government Purchases FIGURE 23-5 Real Government Purchases, 1979–2007

  26. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Net Exports FIGURE 23-6 Real Net Exports, 1979–2007

  27. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Net Exports The following are the three most important variables that determine the level of net exports: The price level in the United States relative to the price levels in other countries The growth rate of GDP in the United States relative to the growth rates of GDP in other countries The exchange rate between the dollar and other currencies

  28. Learning Objective 23.2 Determining the Level of Aggregate Expenditure in the Economy Net Exports The Price Level in the United States Relative to the Price Levels in Other Countries If inflation in the United States is lower than inflation in other countries, prices of U.S. products increase more slowly than the prices of products of other countries. The Growth Rate of GDP in the United States Relative to the Growth Rates of GDP in Other Countries When incomes in the United States rise more slowly than incomes in other countries, net exports will rise. The Exchange Rate Between the Dollar and Other Currencies As the value of the U.S. dollar rises, the foreign currency price of U.S. products sold in other countries rises, and the dollar price of foreign products sold in the United States falls.

  29. Learning Objective 23.3 Graphing Macroeconomic Equilibrium FIGURE 23-7 An Example of a 45°-Line Diagram

  30. Learning Objective 23.3 Graphing Macroeconomic Equilibrium FIGURE 23-8 The Relationship between Planned Aggregate Expenditure and GDP on a 45°-Line Diagram

  31. Learning Objective 23.3 Graphing Macroeconomic Equilibrium FIGURE 23-9 Macroeconomic Equilibrium on the 45°-Line Diagram

  32. Learning Objective 23.3 Graphing Macroeconomic Equilibrium FIGURE 23-10 Macroeconomic Equilibrium

  33. Learning Objective 23.3 Graphing Macroeconomic Equilibrium Showing a Recession on the 45°-Line Diagram FIGURE 23-11 Showing a Recession on the 45°-Line Diagram

  34. Learning Objective 23.3 Graphing Macroeconomic Equilibrium The Important Role of Inventories Whenever planned aggregate expenditure is less than real GDP, some firms will experience an unplanned increase in inventories.

  35. Learning Objective 23.2 MakingtheConnection • Business Attempts to Control Inventories, Then . . . and Now Dell Computer uses supply chain management to keep its inventory low.

  36. Learning Objective 23.3 Graphing Macroeconomic Equilibrium A Numerical Example of Macroeconomic Equilibrium Table 23-3 Macroeconomic Equilibrium Don’t Let This Happen to YOU!Don’t Confuse Aggregate Expenditure with Consumption Spending

  37. Learning Objective 23.3 23-3 Solved Problem Determining Macroeconomic Equilibrium Planned aggregate expenditure (AE) = Consumption (C) + Planned investment (I) + Government (G) + Net exports (NX) Unplanned change in inventories = Real GDP (Y) − Planned aggregate expenditure (AE)

  38. Learning Objective 23.4 The Multiplier Effect FIGURE 23-12 The Multiplier Effect

  39. Learning Objective 23.4 The Multiplier Effect Autonomous expenditure An expenditure that does not depend on the level of GDP. Multiplier The increase in equilibrium real GDP divided by the increase in autonomous expenditure. Multiplier effect The process by which an increase in autonomous expenditure leads to a larger increase in real GDP.

  40. Learning Objective 23.4 The Multiplier Effect Table 23-4 The Multiplier Effect in Action

  41. Learning Objective 23.4 MakingtheConnection • The Multiplier in Reverse: The Great Depression of the 1930s The multiplier effect contributed to the very high levels of unemployment during the Great Depression.

  42. Learning Objective 23.4 The Multiplier Effect A Formula for the Multiplier

  43. Learning Objective 23.4 The Multiplier Effect Summarizing the Multiplier Effect 1 The multiplier effect occurs both when autonomous expenditure increases and when it decreases. 2 The multiplier effect makes the economy more sensitive to changes in autonomous expenditure than it would otherwise be. 3 The larger the MPC, the larger the value of the multiplier. 4 The formula for the multiplier, 1/(1 − MPC), is oversimplified because it ignores some real-world complications, such as the effect that an increasing GDP can have on imports, inflation, and interest rates.

  44. Learning Objective 23.4 23-4 Solved Problem Using the Multiplier Formula

  45. Learning Objective 23.4 23-4 Solved Problem Using the Multiplier Formula (continued)

  46. Learning Objective 23.5 The Aggregate Demand Curve FIGURE 23-13 The Effect of a Change in the Price Level on Real GDP

  47. Learning Objective 23.5 The Aggregate Demand Curve FIGURE 23-14 The Aggregate Demand Curve Aggregate demand curve A curve that shows the relationship between the price level and the level of planned aggregate expenditure in the economy, holding constant all other factors that affect aggregate expenditure.

  48. Consumer Spending and Business Inventories Send Positive Signals about GDP LOOK An Inside Economy Slows but May Hold Seeds of Growth A decrease in aggregate expenditure causes an unplanned increase in inventories and a decrease in real GDP.

  49. K e y T e r m s Aggregate demand curve Aggregate expenditure (AE) Aggregate expenditure model Autonomous expenditure Cash flow Consumption function Inventories Marginal propensity to consume (MPC) Marginal propensity to save (MPS) Multiplier Multiplier effect

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