1 / 31

Chapter Six Output, Aggregate Expenditure, and Aggregate Demand

Chapter Six Output, Aggregate Expenditure, and Aggregate Demand. Macroeconomics by Curtis, Irvine, and Begg Canadian Edition, McGraw-Hill Ryerson, 2007. Learning Outcomes. This chapter explains Aggregate demand and output in the short run The consumption, saving, and investment functions

rance
Download Presentation

Chapter Six Output, Aggregate Expenditure, and Aggregate Demand

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter SixOutput, Aggregate Expenditure, and Aggregate Demand Macroeconomics by Curtis, Irvine, and Begg Canadian Edition, McGraw-Hill Ryerson, 2007

  2. Learning Outcomes This chapter explains • Aggregate demand and output in the short run • The consumption, saving, and investment functions • Aggregate expenditure and equilibrium output in the short run • The multiplier • How the marginal propensity to consume affects the multiplier • The paradox of thrift • Equilibrium output and aggregate demand Chapter 6

  3. Aggregate Demand and Output in the short Run • Assumptions • All prices and wages are fixed at a given level • At these prices and wages, there are workers without a job who would like to work and firms have spare capacity they could profitably use Chapter 6.1

  4. AD, AE, and Output when Price is Constant P AE Y = AE AS P0 AE (P0) E Aggregate Expenditure E GDP Deflator Planned Aggregate Expenditure is positively related to real income and output Short run equilibrium: Y = AE A0 AD 45o Y0 Y Y0 Y Real GDP and Income Real GDP and Income Chapter 6.1

  5. Consumption, Saving, and Investment • Without a government or a foreign sector AE = C + I • Consumption Expenditure • Disposable income is the income net taxes and transfers • Consumption function explains consumption expenditure at each level of disposable income Chapter 6.2

  6. The Consumption Function C = C0 + cY C0: autonomous consumption c: MPC = ΔC / ΔY Chapter 6.2

  7. The Consumption Function:A Numerical Example -20 -10 0 10 20 0.2 0.2 0.2 0.2 C = 20 + 0.8 Y Chapter 6.2

  8. The Saving Function:A Numerical Example MPS = 1 - MPC Chapter 6.2

  9. The Saving Function • S = Y – C • S = Y – (C0 + cY) = - C0 + (1 - c)Y = S0 + sY Saving (S) S = -20 + 0.2Y 50 100 0 -10 -20 Real GDP and Income (Y) Chapter 6.2

  10. Investment Expenditure • Investment expenditure is planned additions by business to their stock of physical capital and to inventories • I = I0 • Investment is autonomous I = I0 I0 Real GDP and Income Chapter 6.2

  11. Annual Percent Change in Real Investment and Consumption Expenditures Chapter 6.2

  12. The Aggregate Expenditure Function:A Numerical Example C = 20 + 0.8 Y I = 15 AE = C + I AE = 20 + 0.8 Y + 15 AE = 35 + 0.8 Y Chapter 6.3

  13. Aggregate Expenditure Real Consumption C AE = 35 + 0.8Y 135 C = 20 + 0.8Y 120 I = 15 35 20 50 100 Real GDP and Income Chapter 6.3

  14. Equilibrium Output When wages and prices are fixed • Involuntary excess capacity  Involuntaryunemployment • A short-run equilibrium occurs when aggregate expenditure or planned spending equals the output produced Chapter 6.3

  15. AE = C0 + I0 + cY o 45 The 45o Diagram and Equilibrium Output AE Y=AE AEe E D Aggregate Expenditures B C0 + I0 Y1 Ye Real domestic product, GDP Chapter 6.3

  16. Equilibrium Output • Examples: AE = C + I C = C0 + cY I = I0 • Y = C + I = C0 + cY + I0 • Y – cY = C0 + I0 • Ye = (C0 + I0) / (1 – c) • Examples: C = 20 + 0.8Y I = 15 • AE = 35 + 0.8Y • Y = AE • Y – 0.8Y = 35 • Ye = 35 / (1 – 0.8) = 175 Chapter 6.3

  17. Short-Run Equilibrium • Adjustment towards equilibrium • Unplanned inventory • Output is above equilibrium  unplanned inventory  cutting output • Output is below equilibrium  turning away consumers  raising output • Equilibrium Output and Employment Chapter 6.3

  18. Another Approach:Planned Saving Equals Planned Investment • Since AE = C + I • And Y = C + S • AE = Y  I = S • S = - C0 + (1-c)Y • Example : I = 15, C = 20 + 0.8 Y • S = - 20 + 0.2 Y • So -20 + 0.2 Y = 15 • Y =175 Chapter 6.4

  19. At Equilibrium,Planned Saving Equals Planned Investment Saving (S) • S = I • -C0 + (1-c)Y = I0 • Ye = (C0 + I0) / (1 – c) S = -C0 + (1-c)Y I = I0 0 Note: Planned versus Actual Ye Y2 - C0 Real GDP and Income (Y) Chapter 6.4

  20. AE’ AE o 45 The Multiplier:Changes in AE and Equilibrium Output AE Y=AE E Aggregate Expenditures ΔI E’ C0 + I0 C0 + I1 ΔY Ye’ Ye Real domestic product, GDP Chapter 6.5

  21. Adjustment to Shifts in Investment Expenditure Chapter 6.5

  22. Multiplier • Consumption Function: C = 20 + 0.8Y • Investment: I = 15 • Aggregate Expenditure: AE = 35 + 0.8Y • Y = AE  Y = 35 + 0.8Y  (1-0.8)Y = 35 • Y = 175. • Suppose investment decline to I = 10 • AE = 30 + 0.8Y  (1-0.8)Y = 30 Y = 150 Chapter 6.5

  23. Multiplier • The Multiplier defines the change in equilibrium output and income caused by a change in autonomous expenditure Chapter 6.5

  24. The Size of the Multiplier Consumption function: C = 20 + 0.8Y Chapter 6.5

  25. Multiplier The Multiplier and the MPS The higher the marginal propensity to save, the larger is the change in saving as a result of a change in income, the smaller the multiplier Chapter 6.5

  26. The Paradox of Thrift Saving (S) S1 + (1-c)Y S0 + (1-c)Y I = Ig 0 Ye1 Ye S1 S0 Real GDP and Income (Y) Chapter 6.6

  27. The Paradox of Thrift • An increase in autonomous saving decreases autonomous consumption • With multiplier effect, equilibrium income declines further than the increase in saving. • The attempt to increase saving results in lower output and income but no change in saving. Chapter 6.6

  28. AE’ AE o 45 Equilibrium Output and Aggregate Demand Y=AE AE AS P0 Aggregate Expenditures ΔA AD’ A1 A0 ΔY AD ΔY Ye Ye’ Ye Ye’ Real domestic product, GDP Real domestic product, GDP Chapter 6.7

  29. Equilibrium Output and Aggregate Demand • Equilibrium output in the AE model determines the position of the AD curve • Any change in autonomous expenditure (ΔA) causes a larger increase in equilibrium output (ΔY) based on the multiplier • As a result, ΔA causes a horizontal shift in AD, which is equal to ΔY by ΔA and the multiplier • Fluctuations in AD and output are caused by fluctuations in autonomous expenditure Chapter 6.7

  30. Chapter Summary • Aggregate demand determines real output and national income in the short run when price is constant • Equilibrium between AE and Y determines AD • AE is planned spending on goods and services • Consumption (C) is a function of disposable income • Autonomous consumption and marginal propensity to consume (MPC) • Saving function, MPS and MPC + MPS = 1 • The economy is in equilibrium when output equals planned spending (Y = AE) Chapter 6

  31. Chapter Summary • Equilibrium output is determined by AE and AD when prices and wages are fixed • When AE exceeds actual output, there is an unplanned fall in inventories • A rise in planned investment is an increase in autonomous expenditure • The multiplier determines the change in equilibrium income caused by a change in autonomous expenditure • The paradox of thrift • The equilibrium output determined by AE = Y determines the position of the AD curve in AD/AS model Chapter 6

More Related