Ch 11 Aggregate Expenditure 2023

PowerPoint Presentations Overview

• Title: Macroeconomics Third Canadian Edition

• Authors: Karlan, Morduch, Alam, Wong

• Adapted for Canadian Edition by Andrew Wong (University of Alberta)

Chapter 11: Aggregate Expenditure Overview

Business Cycles

• Economies experience depressions and recessions, characterized by:

  • Availability of labor at prevailing wages, yet inability to find jobs.

  • Firms have excess capacity but no corresponding demand.

  • Results in unemployment, idle resources, accumulating inventories, and significant output declines.

  • Human costs are profound; individuals suffer due to economic downturns.

Key Concepts in Business Cycles

• Spending and production decrease during economic downturns.

• GDP is computed by aggregating total expenditure in the economy:

  • Aggregate Expenditure (Y) = Consumption (C) + Actual Investment (I) + Government Spending (G) + Net Exports (NX)

Consumption

• Constitutes 55% of Canadian GDP (approx. 70% for U.S. GDP).

• Key determinants include:

  1. Current Income - Increases in after-tax income lead to higher consumption (measured by Marginal Propensity to Consume - MPC).

  2. Wealth - Higher wealth correlates with increased consumption.

  3. Expected Future Income - Individuals smooth consumption over time based on income expectations.

  4. Interest Rates - Rates influence saving returns and borrowing costs; real interest rate (r) is calculated by:

     • r = nominal interest rate (i) - inflation (π)

Investment

• Investment refers to expansions in capital assets like machinery, structures, software, and housing.

• Relationships affecting investment:

  • Directly correlates with expected profitability.

  • Increase in borrowing correlates with lower borrowing costs.

  • Negative relationship between interest rates and investment; high taxes can deter investment.

Government Spending

• Influences citizen needs and acts as a lever for fiscal policy to stimulate or restrain the economy.

• Only encompasses direct purchases, excluding transfer payments, which typically correlate negatively with aggregate income.

Net Exports

• Defined as the difference between exported goods/services and imported ones:

  • Factors affecting net exports:

    1. Domestic Income - Increasing domestic income raises consumption and imports, which can reduce net exports.

    2. Foreign Income - Higher foreign income boosts exports.

    3. Real Exchange Rates - Impact the value of domestic goods compared to abroad.

    4. Tastes for Foreign Goods - Changing consumer preferences impact consumption patterns.

    5. Trade Policies - Affect exchange rates and overall trade dynamics on a case-by-case basis.

Aggregate Expenditure

• Composed of autonomous and induced expenditures:

  • Autonomous Expenditure: Not influenced by current income levels.

  • Induced Expenditure: Changes with aggregate income.

Aggregate Expenditure Equilibrium

• Keynes's analysis of the Great Depression highlighted the role of spending inadequacy in creating economic stagnation.

• Prices need adjustment to boost production; failure leads to underutilization of resources.

• Planned vs Actual Investment:

  • Planned Investment: Intended spending by firms on capital.

  • Actual Investment: Real changes in inventories and resources.

  • Unexpected demand changes reflected through inventory discrepancies.

Planned Aggregate Expenditure (PAE)

• PAE can be defined as:

  • PAE = Autonomous sources (A) + (b * National Income (Y))

  • Where A = constant representing non-income factors, and b = sensitivity of spending to changes in income.

Keynesian Equilibrium

• Established when planned aggregate expenditure matches actual output.

• Reflects a stable state where no changes in output desires occur based on inventory levels.

• Gaps can arise between actual and full employment output:

  • Recessionary Gap: Insufficient expenditure for full employment.

  • Inflationary Gap: Excessive expenditure leading to inflation concerns.

Multiplier Effect

• Definition: The increase in overall consumer spending initiated by an initial expenditure.

• Multiplier can be calculated based on the marginal propensity to consume (MPC), significantly enhancing the overall economic output.

• Example Calculation:

  • For MPC (b) = 0.8, the multiplier effect yields:

    • 1/(1-b) = 5, indicating amplified spending impacts.

The Great Multiplier Debate

• Government infrastructure projects aim to boost economic activity during downturns through the multiplier effect's amplification.

• Dissected effects in Canada and the U.S. show varied perceptions of multiplier effectiveness, with implications on crowding out effects during near full employment phases.

Conclusion

• End of Chapter 11; key themes focus on the aggregates that stimulate or hinder economic activity, illustrating the complex dynamics that influence macroeconomic outcomes.