chapter 6

Aggregate Expenditures

• Prepared by Ifeanyi Uzoka, Sheridan College Principles of Macroeconomics

  • Authors: Sayre // Morris // Ghayad

  • Edition: Eleventh Edition

  • Purpose: Overview of aggregate expenditures in macroeconomics.

Learning Objectives

• Describe the marginal propensity to consume (MPC) and the relationship between consumption, saving, investment, and national income.

• Explain the concept of expenditures equilibrium and its implications in economic analysis.

• Explain how the multiplier operates, producing significant changes in national income from minor shifts in spending.

• Discuss the relationship between government budget balance, balance of trade, and national income.

• Derive aggregate demand from aggregate expenditures.

LO1: Consumption, Savings, and Investment Functions

• Production and Income Generation:

  • Production generates income (Y) for households.

    • In a closed, private economy, income is utilized for:

    • Consumption spending (C) on domestically produced goods and services.

    • Savings (S).

• Spending Equation:

  • $Y = C + S$

Key Concepts

• Autonomous Spending:

  • Portion of total spending independent of income levels.

  • Exists even at zero income (essential consumption needs).

• Induced Spending:

  • Portion of spending that is dependent on income levels.

• Total Spending Equation:

  • $ext{Total Spending} = ext{Autonomous Spending} + ext{Induced Spending}$

Consumption and Saving Functions

• Marginal Propensity to Consume (MPC):

  • Ratio defined as the change in consumption ($riangle C$) over the change in income ($riangle Y$).

    • $ext{MPC} = rac{ riangle C}{ riangle Y}$

  • Consumption Function:

    • Defines the relationship between income (Y) and consumption (C).

    • $C = ext{Autonomous Consumption} + ext{Induced Consumption}$

Example: Consumption and Savings Function

• Table 6.1 (National Income, Consumption, and Saving):

  • National Income (Y): 0, 100, 200, 300, 400, 500, 600, 700, 800.

  • Consumption (C): Corresponding values: 50, 125, 200, 275, 350, 425, 500, 575, 650.

  • Saving (S): Corresponding values: -50, -25, 0, 25, 50, 75, 100, 125, 150.

• Consumption Function Example: $C = 50 + 0.75Y$

LO2: Expenditures Equilibrium

• Total Spending in a Closed Private Economy:

  • Comprised of consumption (C) and investment (I):

    • $ext{Aggregate Expenditures (AE)} = C + I$

• Equilibrium Condition:

  • Where total aggregate expenditures equal national income:

    • $AE = Y$

• Marginal Propensity to Expend (MPE):

  • Defined as the change in aggregate expenditure divided by the change in income:

    • $ext{MPE} = rac{ riangle ext{Aggregate Expenditure}}{ riangle Y}$

Deriving Aggregate Expenditures

• Combine consumption and investment functions to determine aggregate expenditure:

  • $C = 50 + 0.75Y$

  • $I = 75$

  • Thus, leading to:

    • $AE = 125 + 0.75Y$

Calculating AE Equilibrium

• Equilibrium condition established as $Y = AE$ results in:

  • $Y = 125 + 0.75Y$, therefore:

    • $0.25Y = 125$

    • $Y = rac{125}{0.25} = 500$

LO3: The Multiplier

• Definition of Multiplier:

  • Represents the change in income relative to a change in autonomous spending:

    • $ext{Multiplier} = rac{ riangle ext{Income}}{ riangle ext{Autonomous Expenditures}}$

  • A one dollar increase in autonomous spending can lead to a more than one dollar increase in income.

Effect of Multiplier on Aggregate Expenditures

• A rise in income induces higher consumption, shifting the aggregate expenditure curve upward.

Example of Multiplier

• Investment Impact:

  • Month 1 begins with an investment of $50 million resulting in an eventual income change upwards of $200 million over several months.

Mathematical Representation of Multiplier

• Calculation leads to:

  • $ext{Multiplier} = rac{200}{50} = 4$

  • More generally represented as:

    • $ext{Multiplier} = rac{1}{ ext{MLR}}$ where MLR is the Marginal Leakage Rate.

LO4: The Complete Expenditure Model

• Incorporation of Government Sector:

  • Government spending is considered autonomous while taxes have autonomous and induced components.

The Government Budget Function:

• Total taxes = autonomous taxes + induced taxes

  • Marginal tax rate defined as:

    • Marginal tax rate = (Taxes / income)

Connection to National Income

• YC where government spending influences aggregate expenditure, represented in tables for clarity.

LO5: Deriving Aggregate Demand

• Price Level Effects on Expenditure:

  • Higher prices lead to decreased aggregate expenditures at new income levels.

  • Movement along the aggregate demand curve reflects these economic principles.

Key Concepts Summary

• Understand the relationship between consumption, saving, investments with national income.

• Grasp the equilibrium concept in expenditures and how the multiplier impacts national income shifts.

• Link governmental budget balances and trade balances to national income growth.