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Unit Four: Aggregate Model

Unit Four: Aggregate Model. Topic: Aggregate Expenditures, Propensities and the Multipliers. Learning Targets. I will be able to explain the significance of the aggregate expenditures model and the impact of spending on the economy.

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Unit Four: Aggregate Model

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  1. Unit Four: Aggregate Model Topic: Aggregate Expenditures, Propensities and the Multipliers

  2. Learning Targets • I will be able to explain the significance of the aggregate expenditures model and the impact of spending on the economy. • I will be able to explain the leakages and injections in the circular flow model. • I will be able to explain how GDP gaps occur in an economy.

  3. Things to remember… • Economic growth occurs when we have new and/or better resources. • People who BORROW money like LOW interest rates. • People who SAVE money like HIGH interest rates. • Saved money becomes loans (which becomes investment). • GDP = C + Ig + G (+ Xn) • ↑ Ig => ↑ resources/capital stock => ↑ GDPr => economic growth (PPC shifts right)

  4. Aggregate Expenditures • Def: old-school model of the economy; is the basis of current economic theory; shows the total spending in the economy. • AE = C + Ig + G (+ Xn) • All factors are dependent on income/output in the economy.

  5. Consumption • C is the most sensitive to income (and interest rate) changes, but remains relatively stable. • There will ALWAYS be some C in the economy (everyone has to buy food, shelter, etc.) EVEN IF there is LITTLE income. • Households either CONSUME or SAVE; if they CONSUME more than their INCOME, they have DISSAVINGS. • More dissavings at lower incomes; more savings at higher incomes.

  6. Determinants of Consumption • Disposable income • Wealth • Price level • Interest rates

  7. Propensities • Def: what people usually do; inclinations. AVERAGE PROPENSITIES: APC = C / disposable income APS = S / disposable income APC + APS = 1

  8. Practice • The APC is 0.7. What is the APS? • Total income = $100; total consumption = $80. • What is the APC? • What is the APS? • Total income = $100; total consumption = $120. • What is the APC? • What is the APS?

  9. Propensities MARGINAL PROPENSITIES (what we do with extra income): MPC = Δ C / Δ disposable income MPS = Δ S / Δ disposable income MPC + MPS = 1

  10. Practice • The MPC is 0.5. What is the MPS? • With an income of $1000, consumption is $800. With an income of $1200, consumption is $900. • What is the MPC? • What is the MPS?

  11. Investment • Components: additions to resource base; increase in inventories (unplanned); residential construction (houses); depreciation; education • Interest rates determine the quantity of investment; businesses take out loans at LOWER INTEREST RATES in order to INCREASE investment (quantity of loanable funds demanded increases). • Increases in investment => economic growth because resource base increases

  12. Investment • Ig varies the MOST and is the most UNSTABLE because of: • Interest rates change often because of fiscal and monetary policy, etc. • Taxes • Expectations of inflation, etc.

  13. Government Expenditures and Net Exports • Both are relatively stable. • Remember: G revenue comes from taxes (T) • Fiscal policy – gov’t use of taxing and spending to influence the economy.

  14. The Multiplier Effect • Def: a change in any component of AE leads to a larger change in total output (GDPr). • Spending/Investment multiplier: use any time there is a change in C, Ig, or G. • (Change in C, Ig or G) times the multiplier = the change in GDPr. • Two ways to find the spending multiplier: 1 / MPS 1 / (1-MPC)

  15. Practice • The MPS is 0.2. What is the value of the spending multiplier? • The MPC is 0.7. What is the value of the spending multiplier? • If the spending multiplier is 0.5, and spending increases by $100, then by how much will GDPr change?

  16. The Multiplier Effect • Tax multiplier: use when there is a change in lump-sum taxes. • Change in taxes times tax multiplier = change in GDPr. • Two ways to find the tax multiplier: -MPC / (1-MPC) -MPC/MPS • REMEMBER THAT IT IS NEGATIVE!

  17. Practice • The MPC is 0.8. What is the tax multiplier? • The MPC is 0.5. What is the tax multiplier? • If the tax multiplier is -3, and taxes increase by $100, then by how much will GDPr change?

  18. LEAKAGES Def: things that “fall out” of spending in the economy. Savings Taxes Imports INJECTIONS Def: things that “fall into” spending in the economy. Investment Government spending Exports Leakages and Injections

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