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Aggregate Expenditures

Aggregate Expenditures. Say’s Law: supply creates its own demand Keynes: not all income spent on output produced  underspending unsold inventories up production cut jobs cut underspending Not self-regulating, uninterrupted prosperity Keynesian Economics = Aggregate Expenditure Model.

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Aggregate Expenditures

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  1. Aggregate Expenditures

  2. Say’s Law: supply creates its own demand • Keynes: not all income spent on output produced underspending unsold inventories up production cut jobs cut underspending • Not self-regulating, uninterrupted prosperity • Keynesian Economics = Aggregate Expenditure Model

  3. Keys: • 1) U and I caused by saving and investment decisions • 2) Prices and wages downwardly inflexible • Costs, unions, expectations, tradition • 3) Internal and external factors affect

  4. Simplifications • 1) “Closed economy” • 2) Ignore gov’t for now • 3) All saving personal • 4) Ignore depreciation and net foreign factor income (assume 0) GDP=NI=PI=DI

  5. Consumption and Saving • Saving = “not spending”; DI – C = S • (not same as investment) • DI = S (45 degree line) • Saving and Consumption Schedules • Break-Even Income (DI=C; S=0)

  6. Propensities to Consume and Save • Average propensity to consume: APC = consumption/income; APS = saving/income • APS + APC = 1 • Marginal Propensity to Consume: MPC = change consumption/ change in income • MPS + MPC = 1

  7. Nonincome Determinants of Consumption and Saving • Wealth • Real and financial assets; save to generate wealth; increase w C up and S down • Expectations • Will I have a job tomorrow? Will there by inflation, shortages? • Household Debt • Increase consumption past income; home equity loans and refinancing • Taxation • GDP not equal DI plot C and S against GDP; taxes shift C and S in same direction

  8. Shifts and Stability • Movement from one point to another: change in amount consumed • Shift entire schedule: change in the consumption schedule • Wealth, expectations, and debt shift schedules in opposite directions • Taxes shift both down

  9. Investment • Private spending on new plant, capital equipment, machinery, etc. • Marginal benefit: expected (real) rate of return • Marginal cost: real interest rate on borrow money

  10. Investment Demand Curve • How many dollars’ worth of investment projects have an expected rate of return of… (cummulative) • Financial “price” of investment IR Investment

  11. Shifts • Acquisition, Maintenance, and Operating Costs (of capital goods) • Higher costs lower rate of return • Business Taxes • Reduces rate of return • Tech Changes • Typewriter computer • Stock of Capital Goods on Hand • Excess capacity ID down • Expectations • Expected rate of return

  12. Investment Schedule • The amounts business firms collectively intend to invest at each possible level of GDP • Independent current DI or real output • Simplification: level of GDP may induce more or less investment • Derived from investment demand curve and current real IR

  13. IR Inv 20 8 20 Inv GDP

  14. Instability of Investment • Durability • Indefinite useful life • Irregularity of Innovation • 1920s automobile • Variability of Profits • Current profits predict future • Variability of Expectations • Project current forward, often wrong

  15. Equilibrium GDP • C + I = GDP • Output whose production will create total spending just sufficient to purchase that output • Unintended investment (+) or disinvestment (-) in inventories Surpluses and shortages Total spending (demand) < total output (supply)  GDP down Total spending > total output GDP up

  16. Leakages-Injections Approach • Less direct, explains reason C+Ig≠GDP except at equil. • Saving = leakage (withdrawal from spending) spending < output • Not all output for consumption (capital goods) investment = injection • Leakage > injection C + I <GDP above eq  GDP falls • Injection > leakage C + I >GDP below eq GDP rises • Other injections: Exports and G

  17. Unplanned Inventory increase Unplanned Inventory decrease S S + I E I RGDP

  18. Planned vs. Actual Investment • Planned investment and saving (not necessarily equal) and Actual investment and saving (which are definitionally equal) • Actual= planned + unplanned • Unplanned changes in inventory balance the equation saving and investment

  19. The equality of planned investment and saving determine equilibrium level of GDP • How achieve e GDP?1) Diff S and PI diff production and spending • 2) Diff production plans + spending plans unintended (dis)investment • 3) As long as unintended (dis)investment revise production plans (up or down) • 4) e GDP where 0 (dis)investment

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