Chapter Twenty Four

1. Chapter Twenty Four Aggregate Expenditure and Equilibrium Output

2. Income, Consumption, and Saving (Y, C, and S) Saving = Income - Consumption S = Y - C

3. The Role of Income Disposable Income: The current income you receive in your paycheck, after you pay taxes. Expected Future Income: The income you expect to receive in the future

4. The Role of Income Higher Consumption Higher Income

5. Income = Consumption + Savings Y = C + S Savings Income Consumption

6. Consumption Schedule Income 0 1000 2000 3000 4000 Consumption 500 1250 2000 2750 3500 Assuming Taxes=0

7. Consumption Schedule Income 0 1000 2000 3000 4000 Consumption 500 1250 2000 2750 3500 Saving -500 -250 0 250 500 + =

8. Graphing the Consumption Function Consumption 45o line 4000 3000 2000 1000 1000 2000 3000 4000 Household Income

9. Graphing the Consumption Function Consumption Consumption Household Income

10. D C Slope= D Y Slope of the Consumption Function Consumption C DC DY 45o Household Income

11. Slope of the Consumption Function Consumption Slope = 0.75 C DC = 750 DY = 1000 45o Household Income

12. The Consumption FunctionC = 500 + .75*Income People buy goods even when their income is zero 75% of each dollar of income is consumed 25% of each dollar is saved 0.75 is the Marginal Propensity to Consume (MPC)

13. MPC and MPS The marginal propensity to consume (MPC)is that fraction of a change in income that is consumed or spent. The marginal propensity to save (MPS) is that fraction of a change in income that is saved.

14. Savings Savings = Income - Consumption MPS: marginal propensity to save MPS = 1 - MPC

15. Consumption & Saving Consumption Consumption Function S Y C 45o Household Income

16. Increase in MPC An increase in the MPC increases the slope of the consumption function...

17. Increase in MPC Consumption Consumption Function 45o Household Income

18. Increase in the Constant An increase in the constant shifts the entire consumption function upward, parallel to the original.

19. Increase in the Constant Consumption Consumption Function 45o Household Income

20. What Determines the Level of Planned Investment? Real interest rates Expected future profits

21. What Determines the Level of Planned Investment? Lower Interest Rates More Investment (I) Higher Expected Future Profits

22. Actual Investment Actual Investment = Planned Investment + Inventories Inventories = Production - Sales

23. Inventory Adjustment Consumers buy more than firms planned Inventories fall Actual Investment falls short of Planned Investment

24. Output Adjustment Inventories are lower than desired Firms will increase production Output will rise

25. Inventory Adjustment Planned Investment Output C <

26. Inventory Adjustment Actual Investment Output C =

27. Inventory Adjustment Change in Inventories Planned Investment = Actual Investment Inventories decline by the difference between planned investment and actual investment.

28. Inventory Adjustment Consumers buy less than firms planned Inventories rise Actual Investment exceeds Planned Investment

29. Output Adjustment Inventories are higher than desired Firms will decrease production Output will fall

30. Inventory Adjustment Output Planned Investment > C

31. Inventory Adjustment Actual Investment Output = C

32. Inventory Adjustment Change in Inventories Planned Investment = Actual Investment Inventories increase by the difference between planned investment and actual investment.

33. Aggregate Expenditures Schedule Income Y 0 1000 2000 3000 4000 Consumption 500 1250 2000 2750 3500 Planned Investment 50 50 50 50 50 Agg. Expend. C + I 550 1300 2050 2800 3550

34. Aggregate Expenditures = C + I Planned Aggregate Expenditures AE = C + I C I 45o Aggregate Income, Y

35. Output > Aggregate Expenditures Planned Aggregate Expenditures AE = C + I Unplanned rise in inventories. Output falls. 550 500 45o Aggregate Income, Y

36. Output < Aggregate Expenditures Planned Aggregate Expenditures Unplanned fall in inventories. Output rises. AE = C + I 550 500 45o Aggregate Income, Y

37. Planned Aggregate Expenditures Output = Aggregate Expenditures Equilibrium AE = C + I 550 Planned Investment = Actual Investment Output does not change. 500 45o Aggregate Income, Y

38. Income Identities C + S + T = Y (household budget) C + I = AE (planned expenditure) AE = Y (equilibrium)

39. In equilibrium... C + S = Y C + I = AE AE = Y S = I

40. Adjustment to Equilibrium Expenditures C + I 2400 C 2200 I = 100 C = 2300 Y = 2400 S = 100 2000 45o Aggregate Income, Y 2000 2200 2400

41. Adjustment to Equilibrium Expenditures C + I 2400 C 2200 I = 50 C=2150 Y= 2200 S = 50 2000 45o Aggregate Income, Y 2000 2200 2400

42. Adjustment to Equilibrium- C & S - Aggregate Planned Expenditures Savings = -600 + .25Y Consumption=600+.75Y 600 45o Aggregate Income, Y

43. Adjustment to EquilibriumAE < Y and S > I Expenditures AE = C + I Investment=$50 Savings Consumption=600+.75Y 650 600 45o Aggregate Income, Y

44. Adjustment to EquilibriumAE < Y AE = C + I Expenditures Actual Inventories exceed Planned Inventories 650 600 45o Aggregate Income, Y $3000

45. When AE < Y, Output is too High... Firms produce more than consumers and firms want to buy Inventories accumulate Actual inventories exceed planned inventories Firms will cut back on production

46. Adjustment to EquilibriumAE > Y Expenditures AE = C + I 650 600 Actual Inventories less than Planned Inventories $800 Aggregate Income, Y

47. When AE > Y, Output is too Low... Firms produce less than consumers and firms want to buy Inventories decline Actual inventories are less than planned inventories Firms will increase on production

48. Adjustment to EquilibriumAE = Y Expenditures AE = C + I Actual Inventories equal Planned Inventories 650 600 $2600 Aggregate Income, Y

49. When AE = Y, Equilibrium... Equilibrium income: the level at which C+I = Y Planned Inventories = Actual Inventories

50. The Simple Model and the Multiplier • C = 500 + 0.75*Y • I = 50 Equilibrium: C + I = Y 2200 = Y