Module 16-18
Module 16 Income and expenditure
The spending multiplier: An INformational Intro
4 assumptions
producers are willing to supply additional outputs at a fixed price, As a result changes in overall spending translate into changes in aggregate output.
We take interest rate as given
we assume that there is no government spending and no taxes
we assume that exports/imports are zero
Marginal propensity to consume/MPC: the increase in consumer spending when disposable income rises by $1 (btwn 0-1)
MPS= Consumer spending/disposable income
Ex: consumer spending gone up by $6 billion, when disposable income goes up by $10 billion. MPC is (0.6)
Marginal Propensity to save or MPS: the increase in household savings when disposable income rises by $1 (1= ______ X 100 billion)
Ex.MPC=0.6 each is $1 in addition disposable income causes $0.60 rise in consumer spending
1st round, rGDP is raised by $100 billion
2nd round, raised by 60 billion (0.6 × 100 billion)
3rd round 36 billion (0.6 x $60 billion)
______ X 100 billion +2.5 X 100 billion = 250 billion
Autonomous change in aggregate spending: an initial rise/fall in aggregate spending that is the cause, not the result of a series of income and spending charges.
Leads to a chain reaction in which the total change in rGDO is equal to the spending multiplier times the initial change in the aggregate spending
Y = 1/(1-MPC) X AAS
Spending Multiplier: the ratio of the total change in the real GDP caused by an autonomous change in aggregate spending to the size of the autonomous change, It indicates the total rise in real GDP that results from each $1 of an initial rise in spending.
Y/AAS = 1/(1-MPC)
Consumption Function: shows how an individual household consumer spending is determined by its current disposable income.
Autonomous consumer spending: the amount the household would spend if its current disposable income was zero.
Aggregate Consumption Function: the relationship for the entire economy
C=A +MPC +Yd
Changes in Aggregate Wealth -
life cycle hypothesis: consumers plan their spending over their lifetime, not just in response to their current disposable income. Someone who has been wealth for a long time is more likely to spend more on consumption.
Planned Investment Spending: the investment spending that firms intend to undertake during a given period.
Depends Negative
On interest rate
On existing production captivity
Depends Positively
On expected future rGDP
Firms hold inventories of goods so that they can satisfy consumer demands quickly
Inventor Investment: the value of the change in the total inventories held in the economy during a given period of time.
Positive-when firms add to their inventories
Negative-When a firm reduces their inventories
Changes in inventories are not deliberate decision but the result of mistakes in forecasts about sales
Unplanned Inventory investment : actual sales are lower than expected, leading to unplanned increase in inventories
Can be - or +
actual Investment Spending: equal to planned investment spending + unplanned inventory investment
I = I unplanned + I planned
Module 17 aggregate Demand
Aggregate demand
Aggregate Demand Curve: a curve that shows the relationship between the aggregate price level and the quantity of a aggregate output demanded by households, firms, the government and the rest of the world
GDP= C+I+G+x-IM
C= consumer spending
I=investment spending
G=Government purchase
X=Export to other countries
Im=IMports
Wealth effect at a change in the aggregate price level: the change in consumer spending caused by altered purchasing power of consumers assets
C falls, when the aggregate price rises, leaving to downward sloping demand curve
Interest rate effect at a change in the aggregate price level: a higher aggregate price level reduced the purchasing power of households and firms money holding
Leading to rise in interest rate s and a fall in investment/consumer spending
the wealth effect of a change in the aggregate price level: The change in consumer spending caused by altered purchasing power of consumers’ assets
C falls, when the aggregate price rises, leaving to downward sloping demand curve
Interest rate effect at a change in the aggregate price level a higher aggregate price level reduced the purchasing power of households’ and firms’ money holding
Leading to a rise in interest rates and a fall in investment spending and consumer spending.
Fiscal Policy: is the use of government purchases of goods and services, government transfers, or tax policy to stabilize the economy.
Monetary Policy: is the central bank’s use of changes in the quantity of money or the interest rate to stabilize the economy.
Aggregate Supply: Introduction and Determinantants
Aggregate supply module 18
Aggregate Supply Curve: shows the relationship between the aggregate price level and the quantity of of aggregate output supplied in the economy
The Short-Run Aggregate Supply Curve
Short-run aggregate supply curve: Shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed.
Upward sloping because normal wages (the dollar amount of the wage paid) are sticky (nominal wage that are slow to fail even in the face of high unemployment and slow to the even in the face of labor shortages) in the short run: a higher aggregate price level leads to higher profit per unit of output and increased aggregate output in the short run
If inflation is expected to be lower… short run aggregate supply increases
If inflation is expected to be higher… short run aggregate supply decreases
The Long Run Aggregate Supply Curve
Long run aggregate supply curve: shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible
All prices, including normania wages are flexible and the economy produces at its Potential output: in the level of eal GDP the economy would produce if all prices including nominal wages, were fully flexible
If aggregate output exceed potential output
Nominal wages will eventually rise in response to low employment and aggregate output will fall
If potential output exceeds actual aggregate output
Nominal wages will eventually fall in response to high unemployment and aggregate output will rise.
Long run aggregate supply curve is vertical at potential output
