Chapter 12 - Spending by Individuals,

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Chapter 12

Spending by Individuals,Firms, and Governments onReal Goods and Services


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Framework for Macroeconomic

Analysis

Focus on the Short Run

Analysis in Real Versus Nominal Terms Treatment of the Foreign Sector

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Outline for Macroeconomic

Analysis

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Market andExpenditure forReal Goods andServices(Chapter 12)

Money Market:

Supply andDemand forMoney(Chapter 13) Aggregate

Supply Curve(Chapter 14)

Model ofAggregateDemand andAggregateSupply(Chapter 14)

AggregateDemand Curve(Chapter 14)

Fixed Price Assumption Flexible Price Assumption


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Aggregate Expenditure

The sum of personal consumption expenditure,

investment expenditure, governmentexpenditure, and net export expenditure in agiven period of time.

E = C + I + G + (X M)

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Personal Consumption Expenditure

The amount of spending by households on

durable goods, nondurable goods, andservices in a given period of time.


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Consumption Function

The fundamental relationship in

macroeconomics that assumes that householdconsumption spending depends primarily onthe level of disposable income (net of taxes) inthe economy, all other variables held constant.

C = f(Yd), where

Yd = disposable, or after-tax income


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Marginal Propensity to Consume

(MPC)

The additional consumption spending

generated by an additional amount of realincome, assumed to take a value less than 1.

MPC =C/YdorC/(Y - TP)


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Saving Function

The amount of disposable income that

households do not spend onthe consumptionof goods and services.

S = Yd - C


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Marginal Propensity to Save (MPS)

The additional household saving generated by

an additional amount of real income, whichequals 1 MPC.

MPS = S/Ydor S/(Y TP) = 1 - MPC


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Other Factors Affecting the Level of

Consumption Spending

Personal taxes

Real interest rate Consumer confidence

Existing stock of wealth

Availability of consumer credit Stock of consumer debt outstanding


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Consumption Function - Graphical


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C

Y

C0

C2

C1

Y2

Y1

C

Y


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Gross Private Domestic Investment

Expenditure

The total amount of spending on nonresidential

structures, equipment, and software;residential structures; and business inventoriesin a given period of time.


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Determinants of Gross Private

Domestic Investment

Level of real income and output in the economy

Real interest rates Business taxes

Expected Profits and Business Confidence

Capacity utilization rates

Residential Investment Spending

Inventory Investment


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Government Expenditure

The total amount of spending by federal, state,

and local governments on consumption outlaysfor goods and services, depreciation chargesfor existing structures and equipment, andinvestment capital outlays for newly acquired

structures and equipment in a given period oftime.


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Determinants of the Level of

Government Expenditures

Government expenditure policy is determined

by the legislative and executive institutions atall levels of government.


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Net Export Expenditure

The difference between export spending on

domestically produced goods and services byindividuals in other countries and importspending on foreign produced goods andservices by domestic residents in a given

period of time.


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Determinants of the Level of Net

Export Expenditures

Relative economic growth rates around the

world. Currency exchange rates.

Relative interest rates.


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Aggregate Expenditure Function

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E = E0+ (c1 + i1 - m1)Y

where

E = aggregate expenditureE0= sum of all autonomous expenditurecomponentsc1 = marginal propensity to consume

i1 = marginal propensity to investm1 = marginal propensity to importY = real income


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Aggregate Expenditure Function

Graphical Treatment


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E

Y

E

E0

Slope = c1 + i1 m1


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Equilibrium Level of Income and

Output

The equilibrium level of income and output is

that level of income at which the desiredspending by all sectors of the economy justequals the value of the aggregate outputproduced and the income received from that

production.E = Y

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Equilibrium Level of Income and

Output - Graphical

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E

Y

E1

E0

EE

YE

A

Slope = c1,

assumingi1 = m1 = 0

45o

Equilibrium is that level of realincome,YE, where the aggregateexpenditure line, E1 , crossesthe 45 line.


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Disequilibrium Level Income and

Output Adjustment

Relationship of E to Y Inventories Output Adjustment

E > YUnexpected decrease ininventories

Output increases

E = YInventories are atexpected level Output equilibrium

E < YUnexpected increase ininventories

Output decreases


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The Multiplier

The multiple change in income and output that

results from a change in autonomousexpenditure.

m = Y E = 1 MPC


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Interest Rates and Aggregate

Expenditures

The interest-related expenditure (IRE) function

shows planned consumption and investmentspending as a function of the real interest rate,all else held constant.


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Interest Rates and Aggregate

Expenditures

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r2

r

IRE

IRE = f(r)

r1

IRE1 IRE2

A

B

E

Y

E(r1)

E(r2)

45o

A

B

Y1 Y2

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Chapter 12 - Spending by Individuals,