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Lecture notes

Lecture notes. Prepared by Anton Ljutic. CHAPTER SIX. Aggregate Expenditure. This Chapter Will Enable You to:. Distinguish between autonomous and induced expenditures Understand the concept of expenditures equilibrium

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Lecture notes

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  1. Lecture notes Prepared by Anton Ljutic

  2. CHAPTER SIX Aggregate Expenditure

  3. This Chapter Will Enable You to: • Distinguish between autonomous and induced expenditures • Understand the concept of expenditures equilibrium • Explain what factors can affect spending and how they can affect income • Describe how small changes in spending have a large effect on national income • See the significance of the Keynesian revolution

  4. Quick review/definitions • GDP = national income = Y • AE = aggregate expenditure = • Question: does AE always equal Y? C + I + G + Xn

  5. The Expenditure Model (I) • Autonomous spending • The portion of total spending that is independent of the level of income • Induced spending • The portion of spending that depends on the level of income • Aggregate expenditures = autonomous + induced

  6. The Expenditure Model (II) • Marginal propensity to expend • The ratio of the change in aggregate expenditure that results from a change in income • Marginal leakage rate • The rate of change of leakages that result from a change in income MPE =  aggregate expenditures /  income MLR =  total leakages /  income MLR = 1 - MPE

  7. The Tax Function and Disposable Income • It shows the relationship between taxes and income • Marginal tax rate • The ratio of the change in taxation as a result of a change in income • To calculate it, you divide the change in taxes by the change in income • Disposable income • It is national income minus taxes (Y - T) • Total taxes = autonomous taxes + induced taxes

  8. The Consumption Function • Autonomous consumption • The portion of consumer spending that is independent of the level of income • Induced consumption • The portion of consumer spending that is dependent on the level of income • Marginal propensity to consume • The ratio of the change in consumption to the corresponding change in income MPC =  consumption /  income

  9. The Saving Function • S = Yd – C • Yd = C + S • Marginal propensity to save (MPS) • The change in savings as a result of a change in disposable income or national income MPS =  saving /  income

  10. The Consumption Function • As disposable income rises, • consumption also rises • The slope of the consumption • function is the MPC C C Autonomous consumption Income

  11. The Saving Function S S The slope of the saving function is the MPS Income

  12. The Investment and Government Spending Functions NOTE: Model assumes that both Investment and Government spending functions are autonomous I & G G Figure 6.2 I Income

  13. Exports, Imports and the Net Export Function • Net Exports • It is assumed that exports are autonomous whereas imports are directly related to national income • Marginal propensity to import (MPM) • The change in imports as a result of a change in national income • Balance of trade • The value of a country’s export of goods and services less the value of imports MPM =  imports (IM) /  income (Y)

  14. Expenditure Equilibrium • …is that level of income (and production) at which there is neither a surplus nor a shortage of goods and unplanned investment is zero • Unplanned investment: the amount of unintended build-up or run-down of business inventories (= Y-AE)

  15. The Aggregate Expenditure Function • The slope of the aggregate • expenditure function is the MPE • It is equal to the slope of the consumption function (MPC) minus the slope of the net export function (MPM) AE AE C Xn Figure 6.4 Income

  16. Expenditure Equilibrium (Graph) AE=Y AE Surplus AE Figure 6.5 Shortage T + S + IM Y G + I + X Y

  17. The Net Export Function Figure 6.3 X, IM IM X Income + Trade XN=X-IM -

  18. From Income to Disposable Income • Disposable income • It is national income minus total taxes (Y - T) • Total taxes = autonomous taxes + induced taxes • Marginal tax rate • The ratio of the change in taxation as a result of a change in income MTR =  taxes /  income

  19. Where Income Goes MPC = (1 – MTR) x MPCD MPCD =  consumption /  disposable income MPE = MPC - MPM

  20. Autonomous and Induced Spending (I) Y=AE AE AE  Spending (effect) Figure 6.7A  Income (cause) Y

  21. Autonomous and Induced Spending (II) Y=AE  Autonomous spending (cause) AE AE • Level of Spending (effect) Figure 6.7B Y

  22. A Change in Autonomous Consumption • Changes in wealth • Wealth effect • The effect of a change in wealth on consumption spending • Changes in the price level • Real-balances effect • The effect that a change in the value of real balances has on consumption spending. The value of real balances is affected by changing price levels • Changes in the age of consumer durables • Changes in consumer expectations

  23. A Change in Investment • Interest rates • Purchase price, installation, maintenance and operating costs of capital goods • The age of capital goods • Business expectations • Government regulations

  24. A Change in Government Spending • Tax revenues • Interest rates • Social and cultural standards • Voters’ expectation • Budget philosophies • Political considerations

  25. A Change in Autonomous Net Exports • Comparative price levels • The value of exchange rates • Exchange rates • The value of a country’s currency in relation to foreign currencies • Income levels abroad

  26. The Model’s Algebra • Assume: C = 170 + 0.75 YD and T = 160 + 0.2 Y C = 50 + 0.6 Y I = 250 G = 400 XN = 100 – 0.1 Y

  27. The Multiplier (I) • The effect on income of a change in autonomous spending • The value of the multiplier depends on the MPE • In general, a one dollar increase in autonomous spending will lead to more than a dollar increase in income

  28. The Multiplier (II) AE Y=AE AE2 AE1 Shortages Figure 6.8 cause result Income

  29. The Multiplier (III) • An increase in investment will lead to an increase in income, which will in turn lead to an increase in consumption Multiplier =  income /  autonomous expenditures Multiplier = 1 / (1 – MPE) or 1 / MLR or 1 / MPC - MPM The higher the MPE, the higher the multiplier.

  30. The Model’s Algebra • Assume: C = 50 + 0.6 Y I = 250 G = 400 XN = 100 – 0.1 Y • Then… AE = Y = C + I + G + XN = 50 + 0.6Y + 250 + 400 + 100 – 0.1Y 0.5Y = 800 Y = 1600

  31. Summing up (I) • Income will increase if one of the following increases: • Autonomous consumption • Investment • Exports • Government spending • Income will increase if one of the following decreases: • Autonomous taxes • Autonomous imports

  32. Summing up (II) • The value of the multiplier will increase if any of the following decreases: • Marginal propensity to save (MPS or MPSD) • Marginal tax rate • Marginal propensity to import

  33. A Look at Keynesian Revolution • The Great Depression and the low employment equilibrium due to shortage in purchasing power • Keynes’ prescription: that the government borrow and spend, increasing autonomous expenditures and boosting incomes (and therefore purchasing power and consumption)

  34. Derivation of the Aggregate Demand Curve AE3 AE1 AE AE2 Y P2 P1 P3 AD Y2 Y1 Y3

  35. Chapter Summary:What to Study and Remember • A change in expenditure can be autonomous or induced • Expenditures are in equilibrium when they equal income and there is no unplanned investment • Many factors can affect spending and therefore income. Can you list and explain them? • Describe how small changes in spending have a large effect on national income • Summarized the significance of the Keynesian revolution

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