
C hapter 22. Equilibrium National Income. Economic Principles. Aggregate expenditure The equilibrium level of national income The relationship between saving and investment The income multiplier. Economic Principles. The relationship between aggregate expenditure and aggregate demand
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Equilibrium National Income
Gottheil - Principles of Economics, 4e
Gottheil - Principles of Economics, 4e
Equilibrium price is determined by the equal contribution of both demand and costs of production. In particular, it is their interaction that determines equilibrium price.
Gottheil - Principles of Economics, 4e
Similarly, the interaction of aggregate expenditure and aggregate supply contribute to equilibrium national income. In this case, however, aggregate expenditure plays a stronger role than aggregate supply.
Gottheil - Principles of Economics, 4e
Aggregate expenditure
Gottheil - Principles of Economics, 4e
Recall that the amount of consumer income spent on consumption and saving is represented by:
Y = C + S
Gottheil - Principles of Economics, 4e
And recall that the amount of production goods and investment goods produced by producers is represented by:
Y = C + Ii
where the subscript i indicates intended as distinct from actual.
If, by chance, what producers intend to produce for consumption turns out to be precisely what consumers intend to consume, the match between intended investment and savings is written as:
Ii = S
Gottheil - Principles of Economics, 4e
The I = S equation describes the economy in macroequilibrium. No excess demand or supply exists. Aggregate expenditure equal aggregate supply.
Gottheil - Principles of Economics, 4e
The national economy, if not already in equilibrium, is always moving toward it.
Gottheil - Principles of Economics, 4e
Equilibrium level of national income
Gottheil - Principles of Economics, 4e
Unwanted inventories
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Actual investment (Ia)
Gottheil - Principles of Economics, 4e
EXHIBIT 1 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN Y = $900 BILLION
Gottheil - Principles of Economics, 4e
Suppose the economy is at Y = $900 billion, autonomous consumption = $60 billion, MPC = 0.80 and producers’ intended investment is $100 billion.
Gottheil - Principles of Economics, 4e
1. What are consumers’ consumption expenditures and savings in Exhibit 1?
Gottheil - Principles of Economics, 4e
1. What are consumers’ consumption expenditures and saving in Exhibit 1?
Gottheil - Principles of Economics, 4e
2. What is intended production by producers?
Gottheil - Principles of Economics, 4e
3. What is the difference between consumers’ consumption expenditures and producers’ intended production?
Gottheil - Principles of Economics, 4e
3. What is the difference between consumers’ consumption expenditures and producers’ intended production?
Gottheil - Principles of Economics, 4e
3. What is the difference between producers’ intended production and consumers’ consumption expenditures?
Gottheil - Principles of Economics, 4e
EXHIBIT 2 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN Y = $700 BILLION
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Suppose national income changes to Y = $700 billion, but MPC, autonomous consumption and intended investment all remain the same.
Gottheil - Principles of Economics, 4e
1. What are consumers’ consumption expenditures?
Gottheil - Principles of Economics, 4e
2. What is intended production by producers?
Gottheil - Principles of Economics, 4e
3. What is the difference between consumers’ consumption expenditures and producers’ intended production?
Gottheil - Principles of Economics, 4e
3. What is the difference between consumers’ consumption expenditures and producers’ intended production?
Gottheil - Principles of Economics, 4e
3. What is the difference between consumers’ consumption expenditures and producers’ intended production?
Gottheil - Principles of Economics, 4e
EXHIBIT 3 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN Y = $800 BILLION
Gottheil - Principles of Economics, 4e
What is the difference between production and consumers’ expenditures in Exhibit 3?
Gottheil - Principles of Economics, 4e
Aggregate expenditure curve (AE)
Gottheil - Principles of Economics, 4e
Aggregate expenditure curve (AE)
Gottheil - Principles of Economics, 4e
Gottheil - Principles of Economics, 4e
EXHIBIT 4A THE EQUILIBRIUM LEVEL OF NATIONAL INCOME
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EXHIBIT 4B THE EQUILIBRIUM LEVEL OF NATIONAL INCOME
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At a national income of $700 billion, aggregate expenditure is ____ the national income in panel a of Exhibit 4.
i. Greater than
ii. Less than
Gottheil - Principles of Economics, 4e
At a national income of $700 billion, aggregate expenditure is ____ the national income in panel a of Exhibit 4.
i. Greater than
ii. Less than
Gottheil - Principles of Economics, 4e
As long as the consumption function and the investment demand function remain unchanged, there is no reason to suppose that the level of national income would move away from equilibrium.
Gottheil - Principles of Economics, 4e
Functions do change, however.
Gottheil - Principles of Economics, 4e
EXHIBIT 5 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN INVESTMENT INCREASES TO $130 BILLION AND Y = $800 BILLION
Gottheil - Principles of Economics, 4e
What happens to the equilibrium level of national income when intended investment increases in Exhibit 5?
Gottheil - Principles of Economics, 4e
What happens to the equilibrium level of national income when intended investment increases in Exhibit 5?
Gottheil - Principles of Economics, 4e
What happens to the equilibrium level of national income when intended investment increases in Exhibit 5?
Gottheil - Principles of Economics, 4e
EXHIBIT 6A DERIVING EQUILIBRIUM AT Y = $950 BILLION
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EXHIBIT 6B DERIVING EQUILIBRIUM AT Y = $950 BILLION
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What is the equilibrium level of national income when intended investment increases to $130 billion in Exhibit 6?
Gottheil - Principles of Economics, 4e
The formula Y = (a + bY) + Iican be used to calculate equilibrium national income when specific values for autonomous consumption, MPC and intended investment are known.
Gottheil - Principles of Economics, 4e
While consumption spending, MPC, and autonomous consumption have all remained relatively stable over time, investment spending has been volatile.
Gottheil - Principles of Economics, 4e
Economists identify changes in aggregate expenditure, in particular investment spending, as the key to our understanding of why national income changes.
Gottheil - Principles of Economics, 4e
Income multiplier
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The size of the multiplier depends on the marginal propensity to consume. An initial change in investment sets in motion a chain of events that creates a larger change in national income.
Gottheil - Principles of Economics, 4e
For example, suppose a business owner decides to invest $1,000 in a new technology. The producer of the technology receives an increase in income of $1,000. If MPC = 0.80, the technology producer’s consumption spending increases by $800.
Gottheil - Principles of Economics, 4e
Suppose the $800 is then spent on a custom-made water bed. The carpenter that makes the water bed receives $800 of additional income. Based on MPC, we know that she will spend $640 and save the rest. The chain of events continues.
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EXHIBIT 7 THE MAKING OF THE INCOME MULTIPLIER
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The additions to national income in Exhibit 7 become _____ as economic activity progresses through successive rounds.
i. Smaller and smaller
ii. Bigger and bigger
Gottheil - Principles of Economics, 4e
The additions to national income in Exhibit 7 become _____ as economic activity progresses through successive rounds.
i. Smaller and smaller. For example, in round 2, $800 is added. In round 3, $640 is added.
ii. Bigger and bigger
Gottheil - Principles of Economics, 4e
The formula to determine the income multiplier is written:
1/(1 - MPC).
Since (1 - MPC) = MPS, the formula can be written:
1/MPS.
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For example, for a $1,000 change in investment, when MPC = 0.80, the income multiplier is:
1/(1 - 0.80) = 1/(0.2) = 5.
A $1,000 investment leads to a $5,000 change in national income.
Gottheil - Principles of Economics, 4e
Just as increases in aggregate expenditure stimulate the economy, cuts in aggregate expenditure drag it down.
Gottheil - Principles of Economics, 4e
Changes in the price level shift the AE curve, creating changes in the equilibrium level of national income. As the price level decreases, national income increases.
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What happens to the equilibrium national income when the price level decreases from AE100to AE75?
Gottheil - Principles of Economics, 4e
EXHIBIT 9 THE MULTIPLIER EFFECT IN THE AE AND AD MODELS OF INCOME DETERMINATION
If aggregate expenditure increases but the price level remains the same, what happens to aggregate demand?
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Some people believe that putting a higher percentage of their income into saving will provide greater economic security. This is not necessarily the case, however. By trying to save more, people may actually end up saving less, or at least saving no more.
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The paradox of thrift
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The intention to save more causes the saving curve to shift upwards. Saving then becomes greater than intended investment (S > Ii). The equilibrium level of national income falls.
Gottheil - Principles of Economics, 4e
Gottheil - Principles of Economics, 4e
1. What happens to national income and saving when the saving curve shifts from S to S′ in panel a of Exhibit 10?
Gottheil - Principles of Economics, 4e
2. What happens to national income and saving in panel b when the saving curve shifts from S to S′?
Gottheil - Principles of Economics, 4e
2. What happens to national income and saving in panel b when the saving curve shifts from S to S′?
Gottheil - Principles of Economics, 4e
2. What happens to national income and saving in panel b when the saving curve shifts from S to S′?
Gottheil - Principles of Economics, 4e
Increased saving is not always detrimental to our economic health. If accompanied by increased investment, increased saving is both inevitable and desirable.
Gottheil - Principles of Economics, 4e