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Chapter 22

Chapter 22. DERIVING equilibrium National Income. Economic Principles. Aggregate expenditure The equilibrium level of national income The relationship between saving and investment The income multiplier. Economic Principles.

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Chapter 22

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  1. Chapter 22 DERIVING equilibrium National Income Gottheil — Principles of Economics, 7e

  2. Economic Principles • Aggregate expenditure • The equilibrium level of national income • The relationship between saving and investment • The income multiplier Gottheil — Principles of Economics, 7e

  3. Economic Principles • The relationship between aggregate expenditure and aggregate demand • The paradox of thrift Gottheil — Principles of Economics, 7e

  4. Equilibrium National Income 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, 7e

  5. Equilibrium National Income 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, 7e

  6. Interaction Between Consumers and Producers Aggregate expenditure • Spending by consumers on consumption goods, spending by businesses on investment goods, spending by government, and spending by foreigners on net exports. Gottheil — Principles of Economics, 7e

  7. Interaction Between Consumers and Producers Recall that the amount of consumer income spent on consumption and saving is represented by: Y = C + S Gottheil — Principles of Economics, 7e

  8. Interaction Between Consumers and Producers 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. Gottheil — Principles of Economics, 7e

  9. Interaction Between Consumers and Producers 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, 7e

  10. Interaction Between Consumers and Producers The I = S equation describes the economy in macroequilibrium. No excess demand or supply exists. Aggregate expenditure equal aggregate supply. Gottheil — Principles of Economics, 7e

  11. The Economy Moves Toward Equilibrium The national economy, if not already in equilibrium, is always moving toward it. Gottheil — Principles of Economics, 7e

  12. The Economy Moves Toward Equilibrium Equilibrium level of national income • C + Ii = C + S, where saving equals intended investment. Gottheil — Principles of Economics, 7e

  13. The Economy Moves Toward Equilibrium Unwanted inventories • Goods produced for consumption that remain unsold. Gottheil — Principles of Economics, 7e

  14. The Economy Moves Toward Equilibrium Actual investment (Ia) • Investment spending that producers actually make, which is, intended investment (investment spending that producers intend to undertake) plus or minus unintended changes in inventories. Gottheil — Principles of Economics, 7e

  15. EXHIBIT 1 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN Y = $900 BILLION Gottheil — Principles of Economics, 7e

  16. Exhibit 1: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $900 Billion 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, 7e

  17. Exhibit 1: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $900 Billion 1. What are consumers’ consumption expenditures and savings in Exhibit 1? • If Y = C + S and C = a + bY, then consumption expenditures (C) = $60 billion + 0.8 ($900 billion) = $780 billion. Gottheil — Principles of Economics, 7e

  18. Exhibit 1: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $900 Billion 1. What are consumers’ consumption expenditures and saving in Exhibit 1? • If S = Y – C, then saving (S) = $900 billion – $780 billion = $120 billion. Gottheil — Principles of Economics, 7e

  19. Exhibit 1: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $900 Billion 2. What is intended production by producers? • If C = Y - Iiand Ii= $100 billion, thenintended production= $900 billion - $100 billion = $800 billion. Gottheil — Principles of Economics, 7e

  20. Exhibit 1: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $900 Billion 3. What is the difference between consumers’ consumption expenditures and producers’ intended production? • Producers’ intended production ($800 billion) – consumers’ consumption expenditures ($780 billion) = $20 billion. Gottheil — Principles of Economics, 7e

  21. Exhibit 1: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $900 Billion 3. What is the difference between consumers’ consumption expenditures and producers’ intended production? • The $20 billion difference is described as unwanted inventories and must be absorbed as investment. Gottheil — Principles of Economics, 7e

  22. Exhibit 1: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $900 Billion 3. What is the difference between producers’ intended production and consumers’ consumption expenditures? • Producers’ actual investment ($120 billion) ends up being greater than what they had intended to invest ($100 billion). Gottheil — Principles of Economics, 7e

  23. EXHIBIT 2 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN Y = $700 BILLION Gottheil — Principles of Economics, 7e

  24. Exhibit 2: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $700 Billion Suppose national income changes to Y = $700 billion, but MPC, autonomous consumption and intended investment all remain the same. Gottheil — Principles of Economics, 7e

  25. Exhibit 2: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $700 Billion 1. What are consumers’ consumption expenditures? • C = $60 billion + 0.8 ($700 billion) = $620 billion Gottheil — Principles of Economics, 7e

  26. Exhibit 2: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $700 Billion 2. What is intended production by producers? • C = $700 billion – $100 billion = $600 billion Gottheil — Principles of Economics, 7e

  27. Exhibit 2: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $700 Billion 3. What is the difference between consumers’ consumption expenditures and producers’ intended production? • Consumers’ consumption ($620 billion) – Producers’ production ($600 billion) = $20 billion Gottheil — Principles of Economics, 7e

  28. Exhibit 2: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $700 Billion 3. What is the difference between consumers’ consumption expenditures and producers’ intended production? • The $20 billion difference must be converted from intended investment to consumption goods to meet demand. Gottheil — Principles of Economics, 7e

  29. Exhibit 2: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $700 Billion 3. What is the difference between consumers’ consumption expenditures and producers’ intended production? • Actual investment ends up being less than intended investment. Gottheil — Principles of Economics, 7e

  30. EXHIBIT 3 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN Y = $800 BILLION Gottheil — Principles of Economics, 7e

  31. Exhibit 3: Consumers’ and Producers’ Intentions and Activities, by Stages, When Y = $800 Billion What is the difference between production and consumers’ expenditures in Exhibit 3? • Production and consumption are equal at $700 billion. The economy is in equilibrium. Gottheil — Principles of Economics, 7e

  32. Equilibrium National Income Aggregate expenditure curve (AE) • A curve that shows the quantity of aggregate expenditures at different levels of national income or GDP. Gottheil — Principles of Economics, 7e

  33. Equilibrium National Income Aggregate expenditure curve (AE) • The intersection of the 45° income curve and AE identifies the economy’s equilibrium position. Gottheil — Principles of Economics, 7e

  34. Equilibrium National Income • When Ii > S, producers hire more workers to replace depleted inventories. Y increases and continues to increase until Ii = S. • When S > Ii, inventories build up and producers lay off workers. Y decreases until Ii = S. Gottheil — Principles of Economics, 7e

  35. EXHIBIT 4A THE EQUILIBRIUM LEVEL OF NATIONAL INCOME Gottheil — Principles of Economics, 7e

  36. EXHIBIT 4B THE EQUILIBRIUM LEVEL OF NATIONAL INCOME Gottheil — Principles of Economics, 7e

  37. Exhibit 4: The Equilibrium Level of National Income 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, 7e

  38. Exhibit 4: The Equilibrium Level of National Income 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, 7e

  39. Changes in Investment Change National Income Equilibrium 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, 7e

  40. Changes in Investment Change National Income Equilibrium Functions do change, however. Gottheil — Principles of Economics, 7e

  41. EXHIBIT 5 CONSUMERS’ AND PRODUCERS’ INTENTIONS AND ACTIVITIES, BY STAGES, WHEN INVESTMENT INCREASES TO $130 BILLION AND Y = $800 BILLION Gottheil — Principles of Economics, 7e

  42. Exhibit 5: Consumers’ and Producers’ Intentions and Activities, by Stages, when Investment Increases to $130 Billion and Y = $800 Billion What happens to the equilibrium level of national income when intended investment increases in Exhibit 5? • When intended investment increases, the supply of consumption goods decreases to $670 billion. Gottheil — Principles of Economics, 7e

  43. Exhibit 5: Consumers’ and Producers’ Intentions and Activities, by Stages, when Investment Increases to $130 Billion and Y = $800 Billion What happens to the equilibrium level of national income when intended investment increases in Exhibit 5? • Consumers’ consumption expenditures remain at $700 billion. Consumers’ demand is greater than producers’ production. Gottheil — Principles of Economics, 7e

  44. Exhibit 5: Consumers’ and Producers’ Intentions and Activities, by Stages, when Investment Increases to $130 Billion and Y = $800 Billion What happens to the equilibrium level of national income when intended investment increases in Exhibit 5? • In an effort to meet consumers’ demand, producers hire more workers and national income increases. The equilibrium also increases. Gottheil — Principles of Economics, 7e

  45. EXHIBIT 6A DERIVING EQUILIBRIUM AT Y = $950 BILLION Gottheil — Principles of Economics, 7e

  46. EXHIBIT 6B DERIVING EQUILIBRIUM AT Y = $950 BILLION Gottheil — Principles of Economics, 7e

  47. Exhibit 6: Deriving Equilibrium at Y = $950 Billion What is the equilibrium level of national income when intended investment increases to $130 billion in Exhibit 6? • The equilibrium level increases to $950 billion, where Ii = S. Gottheil — Principles of Economics, 7e

  48. Changes in Investment Change National Income Equilibrium 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, 7e

  49. The Income Multiplier While consumption spending, MPC, and autonomous consumption have all remained relatively stable over time, investment spending has been volatile. Gottheil — Principles of Economics, 7e

  50. The Income Multiplier 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, 7e

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