Chapter 8: Aggregate Expenditures

Aggregate Expenditures
GDP= AE= C + I + G + (X-M)
Consumer spending, business investment spending, government spending, & net foreign spending (exports – imports)

Some Simplifying Assumptions
1. Simple model of private economy that includes only consumers & businesses
2. Assume all saving is a personal saving as opposed to national saving, which includes business saving & gov. saving
3. B/c Keynes was modeling a depression economy, we follow him in assuming that there is a considerable slack in the economy

Spending by individuals/households on both durable & non-durable goods
Represents roughly 70% of GDP
The 45 degree line inserted represents all points where consumption is equal to disposable income (Yd)
Grows as income grows, but not as fast

Amt. of disposable income not spent
Equal to vertical difference between 45 degree reference line & annual consumption
S=Yd – C

Classical Economists
Assume IR is principal determinant of saving & one of the principal determinants of consumption

Average Propensity to Consume
Percentage of income that is consumed (C/Y)

Average Propensity to Save
Equal to saving divided by income (S/Y); percentage of income saved

APC + APS = 1
APC + APS = 1

Marginal Propensity to Consume
Equal to change in consumption associated with a given change in income
Denoting change by delta symbol
MPC= deltaC/deltaY

Marginal Propensity to Save
Equal to change in saving associated with a given change in income
MPS= deltaS/deltaY

Other Determinants of Consumption & Saving
Wealth, expectations, household debt, taxes

Spending by businesses that adds to the productive capacity of the economy; depends on factors such as its rate of return, level of technology, & business expectations

The Investment Schedule
Same at all income levels; remains unaffected by different levels of income

Keynesian Macroeconomic Equilibrium
Spending injections (investment) are equal to withdrawals (saving) & there are no net inducements for economy to change level of output or income
I + G + X = S + T + M

The Multiple Effect
At equilibrium, what people withdraw from economy is equal to what others are willing to inject into spending system

The Multiplier
Spending changes alter equilibrium income by the spending change times the multiplier; operates in both directions
k= 1/(1-MPC)

Increments of spending, including investment, government spending, & exports

Activities that remove spending from the economy, including saving, taxes, imports

Paradox of Thrift
When investment is positively related to income & households intend to save more, they reduce consumption, income, & output, reducing investment so that the result is that consumers actually end up saving less

Balanced Budget Multiplier
Equal changes in gov. spending & taxation lead to an equal change in income

Recessionary Gap
Increase in aggregate spending needed to bring a depressed economy back to full employment, equal to the GDP gap divided by the multiplier

Inflationary Gap
Spending reduction necessary to bring an overheated economy back to full employment

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