SPENDING AND OUTPUT IN THE SHORT RUN

1. SPENDING AND OUTPUT IN THE SHORT RUN Chapter 11

2. Planned Aggregate Expenditure---PAE PAE—The economy’s total planned spending on final goods and services.

3. PAE PAE = C + IP + G + NX

4. Definitions Y = GDP C = consumption I = investment spending IP = planned investment = investment demand

5. Definitions G = government spending = goverment purchases of goods and services NX = net exports = exports – imports T = tax receipts

6. Definitions (Y – T) = disposable income (DI) = after tax income r = real rate of interest

7. Definitions the portion of C that is not related to (Y - T) is intended to capture factors other than disposable income that affect consumption (think of this as autonomous consumption) C = + mpc(Y-T)

8. Consumption Function C = f [(Y-T), wealth, P, expectations, r]

9. Consumption Function The consumption function shows the relationship between consumption (C) and disposable income (Y-T).

10. The Consumption Function

11. Shifts in the Consumption Function 1) wealth 2) P 3) expectations 4) r

12. Wealth is the value of all assets owned by households minus liabilites.

13.  wealth

14.  P

15. Expectations - consumer confidence

16. r - r is the cost of borrowing. An increase in r increases the real cost of borrowing and therefore increases the cost of consumer goods.  r  C  r  C

17.  r

18. The C function and tax changes. When we draw the consumption function (Y – T) is on the axis. Because (Y – T) is on the axis, a change in T is simply a change in (Y - T). Hence, a change in T will lead to a movement along the C function.

19.  T

20. We could also draw the C function in terms of Y. In this case, changes in T will shift the C function.  T  (Y – T)  C

21.  T

22. Investment I = investment spending = business spending of capital goods, including additions to inventories IP = planned investment = business spending of capital goods, including planned additions to inventories

23. Investment IUNPLANNED = unplanned investment = unplanned additions to inventories

24. Investment Investment = IP + IUNPLANNED

25. The Planned Investment Function IP = f(r,price of capital goods, technology, T of capital)

26. IP function The IP function shows the relationship between IP and r.

27. IP function

28. Shifts in the IP function 1) the price of capital goods 2) technology 3) Taxation (T) of capital

29.  P of capital

30.  Technology

31.  T

32. Government Spending G = government spending G = G (totally autonomous)

33. Net Exports NX = EX – IM = f [(Y-T), e, relative price level]

34. Exports EX = f (foreign income) = autonomous with respect to the U.S. Exports are not a function of U.S. variables.

35. Imports IM = f [(Y-T), exchange rate(e), relative price level]

36. IM function The IM function shows the relationship between changes in IM and disposable income (Y-T)

37. IM function

38. Shifts in the IM function 1) e 2) relative price level

39.  e e - price of one currency in terms of another.  price of the $. This makes foreign goods more expensive in the U.S.  IM  IM function shifts downward.

40.  e

41. Relative Price Level  foreign price level relative to the U.S. price level.  foreign goods relative cheaper.  IM  IM function shifts upward.

42.  Relative Price Level

43. Net Exports NX = EX – IM = f [(Y-T), e, relative price level]

44. NX Function The NX function shows the relationship between NX and disposable income (Y-T).

45. NX function

46. Shifts in the NX function 1) e 2) relative price level

47. The NX function can also be drawn in terms of Y.

48. NX function

49. PAE C = f[(Y-T), wealth, P, expectations, r] IP = f (r, price of capital goods, technology, T of capital) G = G (autonomous) NX = f [(Y-T), e, relative price level]

50. PAE PAE = C + IP + G + NX PAE = f (Y, T, wealth, P, expectations, r, G, P of capital, technology, e, relative price level)