Final exam of macroeconomics
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chiang4e_ch08pt1rev.pptxCHAPTER 19 SLIDE 1
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Aggregate Expenditures
SLIDES CREATED BY ERIC CHIANG
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Name the components of aggregate spending.
Analyze the relationship between consumption and income using a basic aggregate expenditures graph.
Analyze consumption and saving using marginal propensity to consume (MPC) and marginal propensity to save (MPS).
Describe the determinants of consumption, saving, and investment.
Determine macroeconomic equilibrium in the simple aggregate expenditures model of the private domestic economy.
CHAPTER OBJECTIVES
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SLIDE 2
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THE GREAT DEPRESSION
SLIDE 3
The prolonged downturn challenged the classical perspective:
John Maynard Keynes argued that government has an important role in stabilizing a distressed economy.
Keynesians argued that prices and wages were sticky, or slow to adjust.
Keynes published The General Theory… in 1936.
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JOHN MAYNARD KEYNES (1883–1946)
Known as the father of macroeconomics.
Launched a critique of classical economics by focusing on spending as the key to growth.
His writings still influence economic policy (e.g., stimulus policies).
SLIDE 4
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EXPLAINING BUSINESS CYCLES
SLIDE 5
We want to explain the short-run fluctuations in the business cycle:
The Short-Run or Keynesian Model
The PPF and the LRAS remain constant in the short run
Wages and Prices are Sticky
CHAPTER 20
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A TYPICAL BUSINESS CYCLE
SLIDE 6
Trend
Peak
Peak
Trough
Recession
Recovery
REAL GDP
TIME
CONTRACTION
EXPANSION
CHAPTER 16
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EXPLAINING BUSINESS CYCLES
PPFA
Short-run expansion is shown as a movement toward a PPF. Recessions leave the economy inside the PPF.
SHORT-RUN EXPANSION
SLIDE 7
a
b
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EXPLAINING BUSINESS CYCLES
SLIDE 8
The Circular Flow Model:
Short-run expansions and contractions can be explained by changes in expenditures in the product market.
CHAPTER 20
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Expanded Model
Resource Market
Product Market
Consumption
Gross Domestic Product
Wages, Rent, Interest, and Profit
Gross Domestic Income
Saving
Investment
Government
Sector
Government Purchases
Transfer Payments
Taxes
CIRCULAR FLOW DIAGRAM
Foreign Sector
Imports
Exports
Govt.
Deficit/Surplus
Financial Market
Business
Households
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EXPLAINING BUSINESS CYCLES
SLIDE 10
The Aggregate Demand and Aggregate Supply Model:
Output, employment, and prices are determined by the interaction of total spending and production in the economy.
The Keynesian model explains short-run changes as a change in AD.
CHAPTER 20
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EXPLAINING BUSINESS CYCLES
SLIDE 11
0
SRAS
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
Short-run macroeconomic equilibrium occurs where ad and sras intersect.
Pe
AD1
e
Qf
LRAS
When AD is too low there is a recession (a recessionary gap in output).
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AD2
a
P1
Q1
The Keynesian Model
SLIDE 12
Keynesians explain changes in AD by looking at the expenditures on goods and services:
Increases in expenditures will increase AD.
Decreases in expenditures will decrease AD.
What causes the changes in expenditures?
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SLIDE 13
MOLIMA/DREAMSTIME.COM
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AGGREGATE EXPENDITURES
SLIDE 14
Consist of the components of GDP that are measured by spending:
GDP = AE = C + I + G + (X − M)
Consumption (C) is the largest component, representing nearly 70% of GDP. Consumption is the key factor in the AE model.
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IN A CLOSED ECONOMY, CONSUMPTION IS THE PORTION OF INCOME NOT SAVED: INCOME = C + S.
SLIDE 15
YURI ARCURS/AGE FOTOSTOCK
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KEYNESIAN CONSUMPTION FUNCTION
SLIDE 16
Consists of autonomous consumption and induced consumption:
C = A + MPC(Yd)
Autonomous consumption does not depend on income, while induced consumption depends positively on income.
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KEYNESIAN CONSUMPTION FUNCTION
SLIDE 17
3
4
CONSUMPTION (thousands)
INCOME (thousands)
5
4
5
6
3
2
1
2
1
6
Y = C + S
C
a
Saving is negative to the left of point a and positive to the right of point a.
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SLIDE 18
KEYNESIAN CONSUMPTION FUNCTION
Consumption spending grows as income grows but not as fast.
As income rises, savings rise as a percentage of income.
Classical economists believe that interest rates determine saving, while Keynesians believe that income determines saving.
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SAVING
SLIDE 19
Consists of autonomous consumption and induced saving:
S = -A + MPS(Yd)
Autonomous consumption reduces saving, while induced saving depends positively on income.
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SLIDE 20
CONSUMPTION AND SAVING
We can show these relationships in a table. Suppose that A = $500 MPC = 3/4 and MPS = 1/4
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| Yd | C | S |
| $0 | $500 | -$500 |
| 1,000 | 1,250 | -250 |
| 2,000 | 2,000 | 0 |
| 3,000 | 2,750 | 250 |
| 4,000 | 3,500 | 500 |
| 5,000 | 4,250 | 750 |
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AVERAGE PROPENSITY TO CONSUME (APC) AND SAVE (APS)
APC
PERCENTAGE OF INCOME THAT IS USED FOR CONSUMPTION (C / Y)
APS
PERCENTAGE OF INCOME THAT IS SAVED (S / Y)
SLIDE 21
Because Y = C + S, APC + APS = 1.
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MARGINAL PROPENSITY TO CONSUME (MPC) AND SAVE (MPS)
MPC
THE CHANGE IN CONSUMPTION GIVEN A CHANGE IN INCOME (ΔC/ΔY)
MPS
SLIDE 22
Because Y = C + S, MPC + MPS = 1
THE CHANGE IN SAVING GIVEN A CHANGE IN INCOME (ΔS/ΔY)
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SLIDE 23
CONSUMPTION AND SAVING
We can show these relationships in a table. Suppose that A = $500 MPC = 3/4 and MPS = 1/4
CHAPTER 19
| Yd | C | S | APC | APS | MPC | MPS |
| $0 | $500 | -$500 | - | - | - | - |
| 1,000 | 1,250 | -250 | 1.25 | -0.25 | 0.75 | 0.25 |
| 2,000 | 2,000 | 0 | 1.00 | 0 | 0.75 | 0.25 |
| 3,000 | 2,750 | 250 | 0.92 | 0.08 | 0.75 | 0.25 |
| 4,000 | 3,500 | 500 | 0.88 | 0.12 | 0.75 | 0.25 |
| 5,000 | 4,250 | 750 | 0.85 | 0.15 | 0.75 | 0.25 |
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OTHER DETERMINANTS OF CONSUMPTION
SLIDE 24
Income is the principal determinant of consumption and saving, but other factors can shift the consumption and saving schedules:
Wealth
Expectations about future prices and income
Household debt
Taxes
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INVESTMENT IS SPENDING BY BUSINESSES THAT ADDS TO THE PRODUCTIVE CAPACITY OF THE ECONOMY.
SLIDE 25
FRENC/DREAMSTIME.COM
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THE INSTABILITY OF INVESTMENT
SLIDE 26
Gross private domestic investment is much more volatile than consumption spending.
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INVESTMENT DEMAND
SLIDE 27
Spending by businesses is known as Planned Investment.
total I = planned I + unplanned I
For simplicity, we assume that planned investment does not depend on income.
Planned Investment is autonomous.
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INVESTMENT DEMAND
SLIDE 28
Investment levels depend primarily on the rate of return on capital.
Investments earning a high rate of return are those undertaken first.
Interest rates also affect investment because most business investment is financed.
As interest rates fall, investment rises.
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OTHER DETERMINANTS OF INVESTMENT
SLIDE 29
Investment demand also depends on:
expectations about future revenues and return on investment.
technological change.
operating costs.
capital goods on hand.
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AGGREGATE INVESTMENT SCHEDULE
SLIDE 30
3
4
INVESTMENT SPENDING (I)
INCOME (Y)
5
I0
2
1
6
I
Investment spending is autonomous (independent) of income.
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SIMPLE AGGREGATE EXPENDITURES MODEL
HOW MUCH WILL THE ECONOMY PRODUCE?
WHAT IS THE MACROECONOMIC EQUILIBRIUM?
WHAT CHANGES THE EQUILIBRIUM?
SLIDE 31
Leaving out the government and foreign sectors, we ask the following questions:
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SLIDE 32
THE TWO COMPONENTS IN THE SIMPLE AE MODEL (AE = C + I)
CONSUMPTION
ALMOST 70% OF AGGREGATE SPENDING: LARGE AND STABLE
INVESTMENT
ABOUT 15% OF AGGREGATE SPENDING: VOLATILE AND SENSITIVE TO ECONOMIC CONDITIONS
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MACROECONOMIC EQUILIBRIUM
SLIDE 33
The economy is at equilibrium where income (Y)equals planned spending (AE):
Y = C + IP
There is no unplanned investment; business inventories are at their desired levels.
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MACROECONOMIC EQUILIBRIUM
SLIDE 34
Or the economy is at equilibrium where injections of spending (investment) equal withdrawals (saving):
I = S
At this point, there is no reason for the economy to change its level of output or income.
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SLIDE 35
MACROECONOMIC EQUILIBRIUM
We can show the macroeconomic equilibrium in a table of spending and saving.
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| Y | C | S | I | AE |
| $0 | $500 | -$500 | $250 | $750 |
| 1,000 | 1,250 | -250 | 250 | 1,500 |
| 2,000 | 2,000 | 0 | 250 | 2,250 |
| 3,000 | 2,750 | 250 | 250 | 3,000 |
| 4,000 | 3,500 | 500 | 250 | 3,750 |
| 5,000 | 4,250 | 750 | 250 | 4,500 |
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SLIDE 36
MACROECONOMIC EQUILIBRIUM
If investment increases by $250, the macroeconomic equilibrium increases by $1,000.
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| Y | C | S | I | AE |
| $0 | $500 | -$500 | $500 | $750 |
| 1,000 | 1,250 | -250 | 500 | 1,500 |
| 2,000 | 2,000 | 0 | 500 | 2,250 |
| 3,000 | 2,750 | 250 | 500 | 3,000 |
| 4,000 | 3,500 | 500 | 500 | 3,750 |
| 5,000 | 4,250 | 750 | 500 | 4,500 |
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SLIDE 37
AGGREGATE EXPENDITURES
INCOME (Y)
3,500
4,000
4,500
3,000
250
100
4,000
Y = AE
AE = C + I0
a
Point a in both panels represents zero saving (income equals consumption). If AE rises by $100, equilibrium income rises by $400, where S = I.
SIMPLE AGGREGATE EXPENDITURES MODEL
C
0
SAVING & INVESTMENT
f
e
a
e
S
I0
500
5,000
5,500
4,500
5,000
3,500
4,000
4,500
5,000
3,500
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MACROECONOMIC EQUILIBRIUM
SLIDE 38
Algebraically, macroeconomic equilibrium is given by the following equation:
Y = (1/(1-MPC))(A + IP)
When MPC = .75, A = $500, and IP = $250, the equilibrium level of output is $3,000.
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MACROECONOMIC EQUILIBRIUM
SLIDE 39
A change in autonomous consumption or planned investment causes a change in production:
ΔY = (1/(1-MPC))(ΔSpending)
When MPC = .75, a $250 increase in planned investment will increase production by $1,000.
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IF THE MPC = 0.8 AND INCOME RISES BY $5,000, WHAT IS THE INCREASE IN CONSUMPTION?
B
C
A
$625
$1,000
$4,000
D
E
$5,000
$6,250
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SLIDE 40
Answer: C
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IF THE MPC = 0.8 AND INCOME RISES BY $5,000, WHAT IS THE INCREASE IN CONSUMPTION? (Answer)
B
C
A
$625
$1,000
$4,000 (Correct Answer)
D
E
$5,000
$6,250
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SLIDE 41
Answer: C
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EXPLAIN HOW THE RECOVERY IN NEW HOUSING CONSTRUCTION WILL AFFECT THE ECONOMY AS A RESULT OF THE MULTIPLIER EFFECT.
PRACTICE QUESTION
SLIDE 42
SUE ASHE/SHUTTERSTOCK
CHAPTER 19
Answer: As the housing industry recovers, construction of new homes will boost investment, an important component of AE. This injection into the economy will generate even more spending, up to the amount of investment times the multiplier. As a result, spending on homes will spur other economic activity, raising incomes.
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WHICH OF THE FOLLOWING STATEMENTS CONCERNING CONSUMPTION IS INCORRECT?
B
C
A
WEALTHY PEOPLE CONSUME MORE THAN OTHER PEOPLE.
EXPECTATIONS ABOUT FUTURE PRICES AFFECT CONSUMPTION.
TAX INCREASES REDUCE CONSUMPTION.
D
SAVINGS RATES DECREASE AS INCOME INCREASES.
SLIDE 43
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Answer: D
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WHICH OF THE FOLLOWING STATEMENTS CONCERNING CONSUMPTION IS INCORRECT?
(Answer)
B
C
A
WEALTHY PEOPLE CONSUME MORE THAN OTHER PEOPLE.
EXPECTATIONS ABOUT FUTURE PRICES AFFECT CONSUMPTION.
TAX INCREASES REDUCE CONSUMPTION.
D
SAVINGS RATES DECREASE AS INCOME INCREASES. (Correct Answer)
SLIDE 44
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Answer: D
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END OF CHAPTER
SLIDES CREATED BY ERIC CHIANG
CHAPTER 19
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