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AGGREGATE EXPENDITURES
Frederick University 2014
Aggregate Demand (AD)
AD – the quantity of GDP, which the economic agents are planning to buy at every price level, ceteris paribus (Y = const)
Aggregate Expenditures
АЕ – the expenditures that economic decision makers are planning to make at every level of income, ceteris paribus
Planned Spending Real GDP = Nominal GDP AE = C + I + G + X - M
Consumption Spending (С)
С – the expenditures that households are planning to make at every level of income, ceteris paribus
Consumption Spending (С)
Y C S
0
Consumption Spending (С) Y C S
0 500
500 – consumption spending which does not depend on income, autonomous consumption – С0 (Ca, a)
Consumption Spending (С)
Y C S
0 500 -500
Consumption Spending (С)
Y C S
0 500 -500
500
C = C0 + (Δ C /ΔY) x Y Δ C /ΔY – the increase in consumption
spending, caused by the increase in income – marginal propensity to consume – MPC (mpc, b)
C = C0 + MPC x Y
Consumption Spending (С) C = C0 + MPC x Y MPC = ¾ = 0,75 If income rises by $100,households increase their
consumption spending by $75 and increase their savings by $25
If income rises by $500, С rises by 5 х $75 = $375 C = 500 + 375 = 500 + 0.75 x 500
Y C S
0 500 -500
500 875
Savings (S) Marginal propensity to save – the increase in
savings, caused by the increase in income: MPS = Δ S /ΔY If income rises by $100, and households raise
their consumption spending by $75, savings increase by $25
MPC + MPS = 1 C + S = Y S = Y – C = Y – (C0 + MPC x Y) = Y - C0 - MPC x
Y = - C0 + Y - MPC x Y = - C0 + Y(1 - MPC) S = - C0 + MPS x Y
Consumption Spending (С) and Savings (S)
Y C S
0 500 -500
500 875 - 375
Consumption Spending (С) and Savings (S) Y = 1000 C = 500 + 0.75 x 1000
Y C S
0 500 -500
500 875 -375
1000 1250 -250
Consumption Spending (С) and Savings (S)
Y C S
0 500 -500
500 875 -375
1000 1250 -250
1500 1625 -125
2000 2000 0
2500 2375 125
3000 2750 250
Consumption Spending (С)
Y C S
0 500 -500
500 875 -375
1000 1250 -250
1500 1625 -125
2000 2000 0
2500 2375 125
3000 2750 250
450
C
Y
500
2000
2000500
875
500375
C = 500 + 0.75Y
0
A
B
D
Factors determining C Households’ income Indirect taxation Propensity to buy imported goods and services Direct taxation Consumers’ expectations Availability of consumer credit Income distribution Living standards Efficiency of market institutions
Investment spendingI = Gross Private Domestic Investment I – Depreciation = Net Investment Net investment = Purchases of New
Equipment + Change in Inventories Fixed Investment = Depreciation + Purchases
of New Equipment Net Fixed Investment = Purchases of New
Equipment Inventories = Raw Material + Unfinished Production + Finished Goods
Factors determining Investment Spending (I)
Interest rate (i) Expected future profits (π) Risk Excess capacity Capital-output ratio (α) Technological changes Cost of production Competitiveness of markets Depreciation policies Efficiency of market institutions
AE
450
C
Y
500
2000
2000500
875
500375
0
A
B
D
CAE = C
+ I +
G +
X -
M
AE
0
5001000
1500
2000
25003000
3500
0 1000 2000 3000 4000
Y
AE
HOUSEHOLDSFIRMS
Expenditures on final goods and services
Primary Income
importsМ
taxesТ
savingsS
exportsХ
Government purchasesG
InvestmentІ
LeakagesInjections
Production factors
Final goods and services
The Circular Flow
AE
Macroeconomic Equilibrium
I + G + X =S + T + M
(I - S) = (T - G) + (M - X)
Macroeconomic Equilibrium
Y < AE Reduction of inventories Y Y = AE Y > AE Increase in inventories Y Y = AE
The simple multiplier Y 2005 = C2005 + Inj2005 Y2004 = C2004 + Inj2004 Δ Y = ΔC + ΔInj ΔY = C0 2005 +MPCY2005 – C02004 – MPCY2004 + ΔInj ΔY = MPC ΔY + ΔInj ΔY - MPC ΔY = ΔInj ΔY (1-MPC) = ΔInj ΔY = Δ Inj x1/(1-MPC) 1/(1-MPC) = multiplier = К If МРС = 0.5, К = 2 If МРС = 0.75, К = 4
The complete multiplier
1K = MPS + t x MPC + MPI
Multiplier Constraints
Factors of production bottlenecks Limited productive capacity Institutions
Deriving the Complete Multiplier Y 2005 = C2005 + (I + G + X)2005 - M2005 Y2004 = C2004 + (I + G + X)2004 - M2004 Δ Y = ΔC + ΔInj - ΔM ΔY = C0 2005 +MPC x (Y2005 – t x Y2005) - C02004 – MPC x (Y2004 – t x
Y2004) + ΔInj - M0 2005 – MPI x (Y2005 – t x Y2005) - M02004 – MPI x (Y2004 – t x Y2004) + ΔInj
ΔY = MPC x Y2005 ( 1– t x) – MPC x Y2004 ( 1 - t) - MPI x Y2005 ( 1– t) – MPI x Y2004 (1– t)
ΔY = MPC ( 1 - t) x ΔY – MPI x ΔY + ΔInj ΔY - MPC ( 1 - t) ΔY + MPI x ΔY = ΔInj ΔY [(1-MPC + MPC x t) + MPI] = ΔInj ΔY = Δ Inj :1/(1-MPC + MPC x t + MPI) K = 1/(1-MPC + MPC x t + MPI) = 1/ (MPS + MPT + MPI)