Econ MO 7 Aggregate Expenditure Notes

Module Outline

  • The Keynesian Model:

    • Consumption, Saving, and Disposable Income

    • Consumption and Saving Functions

    • Determinants of Consumption and Saving

    • Planned Investment

    • Aggregate Expenditure and Actual Equilibrium

    • Formula: C + I + G + NX

    • The Multiplier Effect

    • Aggregate Expenditure and Aggregate Demand

Learning Objectives

  1. Explain, measure, and illustrate the relationship between disposable income, consumption, and saving using the Keynesian model in the aggregate expenditure model.

  2. Determine the consumption and savings functions, including marginal and average propensity to consume and save, as well as autonomous consumption and saving using algebraic, tabular, or graphical formats.

  3. Classify and illustrate the determinants of consumption and saving.

  4. Classify and illustrate the function and determinants of planned investment and incorporate planned investment into the aggregate expenditure model.

  5. Apply government spending, lump-sum taxes, and net exports to the aggregate expenditure model to establish and illustrate the actual short-run equilibrium real GDP.

  6. Explain, measure, and illustrate the multiplier and its effects in the aggregate expenditure model.

  7. Identify the relationship between the aggregate expenditure model and the aggregate demand curve.

Learning Objective #1: Relationship Between Disposable Income, Consumption, and Saving

  • Definitions and Relationships:

    • Consumption: Spending on new goods and services.

    • Saving: Income not utilized for consumption; this category is broader than just money in banks and excludes new housing.

  • Primary Determinant of Spending/Saving:

    • Disposable Income (Yd): Defined as Y_d = Y - T

    • Where:

      • Y = GDP

      • T = taxes

    • Explanation: Disposable income is the leftover income after debts are paid at a macro level when considering GDP after taxes.

    • Components: Yd can be either consumed (C) or saved (S), thus Y_d = C + S .

Learning Objective #2: Consumption and Savings Functions


  • Consumption and Saving Functions:

    • These functions provide different ways to understand the aggregate expenditure model:

    • Table Form: Less focus

    • Graph Form: Less focus

    • Algebraic Form: More emphasis on relationships


  • Consumption Function:

    • Demonstrates the relationship between consumption and disposable income:

    • Formula: ext{Spending} = ext{Slope} imes ( ext{Disposable Income}) + ext{Constant}


  • Marginal Propensity to Consume (MPC):

    • Defined as the ratio of the change in consumption to the change in disposable income:

    • ext{MPC} = rac{ ext{Change in Consumption}}{ ext{Change in Real Disposable Income}}

    • This represents the slope of the consumption function and is critical for understanding shifts in these relationships.

    • Example: Rearrangement of MPC definition:

    • ext{Change in C} = ext{MPC} imes ext{Change in Yd}

    • Equivalently expressed as riangle C = ext{MPC} imes riangle Y_d


  • Marginal Propensity to Save (MPS):

    • Defined as the ratio of the change in saving to the change in disposable income:

    • ext{MPS} = rac{ ext{Change in Saving}}{ ext{Change in Real Disposable Income}}

    • Relationship to MPC: ext{MPS} = 1 - ext{MPC}


  • Examples of Consumption and Saving Functions:

    • Given Real Disposable Incomes (Yd):

    • Yd1 = 60,000, Yd2 = 49,000

    • Consumption levels (C1) and (C2):

      • C1 = 48,000, C2 = 42,100

      • Prompting calculation of MPC and MPS.


  • Tabular Example for Consumption and Saving:


      Real Disposable Income (Yd)

      Real Consumption (C)

      Real Saving (S)

      APC

      APS

      MPC

      MPS


      $0

      $6,000

      -$6,000

      1.80

      -0.80

      0.80

      0.20


      $6,000

      $10,800

      -$4,800

      1.30

      -0.30

      0.80

      0.20


      $12,000

      $15,600

      -$3,600

      1.13

      -0.13

      0.80

      0.20


      …

      …

      …

      …

      …

      …

      …

      Learning Objective #3: Determinants of Consumption and Saving

      • Determinants of Consumption Function Shift:

        • Non-income determinants that influence the consumption function include:

        • Cost (Note: price level does not shift aggregate demand directly)

        • Population

        • Wealth (liquidity and credit availability)

        • Expected future income

        • Interest rates

        • Consumer confidence

        • Taxation (Consumption tax expectations)

      • Graphical representation of consumption function changes can depict shifts given these determinants executing positive economic changes.

      Learning Objective #4: Planned Investment Functions

      • Planned Investment:

        • Defined as:

        • Actual Investment = Planned Investment + Unplanned Investment

        • Where: Unplanned Investment = Change in Inventories

        • Inventory:

        • Stock of goods and materials held by businesses for production or future sales.

      • Determinants of Investments:

        • Shifting factors include:

        • Same non-income determinants that impact consumption shifted toward businesses

        • Expectations of future profitability

        • Technological advancements

      • Investment Addition into the Aggregate Expenditure Model:

        • Keynotes:

        • Autonomous component of spending that does not rely on GDP.

        • Investment decisions made with interest rates and production stability in mind during equilibrium.

      Learning Objective #5: Influence of Government Spending and Exports

      • Government Influence on Aggregate Expenditure:

        • Government (G) expenditure components in the model include federal, state, and local levels, excluding transfer payments as they're not considered autonomous.

        • Lump-Sum Tax (T):

        • Defined as taxes that are constant regardless of income; categorized as autonomous.

      • Foreign Sector Influence:

        • Net exports (NX), defined as:

        • NX = ext{Exports} - ext{Imports}

        • These are autonomous elements dependent on international economic relations.

      Learning Objective #6: Multiplier Effect

      • Understanding the Multiplier Effect:

        • Describes how an initial investment can create a larger final impact on GDP. Example given of:

        • An extra 150 of investment leading to a GDP increase of 416.67 through the autonomous spending multiplier.

      • Multiplier Formula:

        • ext{Multiplier} = rac{1}{1 - ext{MPC}} = rac{1}{ ext{MPS}}

      • Equation for Change in Equilibrium Income:

        • ext{Change in Equilibrium Income (Real GDP)} = ext{Multiplier} imes ext{Change in Level of Real Autonomous Spending}

      • Examples of Calculations:

        • Integrating the consumption functions and expenditure levels into the multiplier calculations to ascertain GDP changes in reaction to investment and spending shifts.

      Learning Objective #7: Aggregate Expenditure and Aggregate Demand Relationship

      • Connection Explained:

        • Aggregate Expenditure in relation to Aggregate Demand as defined by:

        • Example graphical representation:

        • As price levels increase to a specific threshold, aggregate demand subsequently contracts, leading to reduced equilibrium output.

        • Overall, equilibrium shifts reflecting changes observed across aggregate consumption, investment, government spending, and net exports