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7/27/2019 s 26 Aggregate Income Equilibrium
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3/2/2011 Econ 11 -- Lecture #26 1
MAJOR ANNOUNCEMENT
The unexpected class holiday on Feb. 25 created amajor problem to our planned Test No. 3. Thereforethe exam is rescheduled as stated below.
SCHEDULE OF EXAMS:
o TEST #1 and TEST #2 -- DONE!
oTEST #3 March 9, 2011(Wednesday)
o Time will be held from 7:30 am to 9:00 am in rooms to beannounced.
o FINAL EXAM To be announced [FINALEXAM WEEK]
3/2/2011 Econ 11 -- Lecture #26 2
Lecture 26:
AGGREGATE INCOME AND
OUTPUT EQUILIBRIUM
Second view: AGGREGATE
EXPENDITURE (C+I+G+[X-M]) AND
AGGREGATE OUTPUT (C+S+T)
INCOME AND OUTPUTMULTIPLIER LEAKAGES AND
THEIR EFFECTS
3/2/2011 Econ 11 -- Lecture #26 3
INTERACTION OF
AGGREGATE DEMAND
AND
AGGREGATE SUPPLY
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3/2/2011 Econ 11 -- Lecture #26 4
RELATIONS OF MAJOR
NATIONAL INCOME CONCEPTS
We know from accounting identities,
GNE=GDP.
We know from thefirst view that
total expenditure (aggregate
demand) is equal to total output
(aggregate supply).
3/2/2011 Econ 11 -- Lecture #26 5
We use some of the national income
definitions in the analysis.
GNE, or Aggregate demand, is broken
down as:
GNE = C + I + G + (X-M)
Where:
C = Consumption expenditure
I = Investment expenditure
G = Government expenditure
(X-M) = Net Value of Exports over Imports
3/2/2011 Econ 11 -- Lecture #26 6
Use some of the national income
definitions in the analysis.
GDP, or Aggregate Supply, is
broken down as:
GDP = C + S + T
Where:
C = Consumption expenditure
S = Saving
T = Tax revenue
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3/2/2011 Econ 11 -- Lecture #26 7
At Income/ Output Equilibrium
Aggregate Demand = Aggregate
Supply
Or:
E = Y
Or:
C + I + G + (X-M) = C + S +T.
3/2/2011 Econ 11 -- Lecture #26 8
At Income/ Output Equilibrium
Deduct T from both sides.
Or:
C + I + (G-T) + (X-M) = C + S.
This result can be simplified still:I + (G-T) + (X-M) = S.
oIf G-T and X-M were both zero, then
I = S.
9
Summary of our results:Aggregate demand and aggregate supply are in
equilibrium when
C+I+(G-T)+(X-M)=C+S.
The term, (G-T), is government expenditure minustaxes. It is the fiscal balance or the governmentsbudget.
The term, (X-M), is the net demand of foreigners forthe countrys goods. It is often called thetrade balance.
Note: If (G-T) and (X-M) are both zero, theequilibrium condition is simply:
C+I=C+S.
Or simply, I=S.
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3/2/2011 Econ 11 -- Lecture #26 10
Example: Table 16-1. Note: Y=C+S & E=C+I
AGGREGATE
DEMAND
AGGREGATE
SUPPLYAD
= E
I C AS
= Y
C S
80 700 700 0
80 750 750 50
80 820 820 80
80 880 880 120
3/2/2011 Econ 11 -- Lecture #26 11
Example: Table 16-1. Note: Y=C+S & E=C+I
AGGREGATE
DEMAND
AGGREGATE
SUPPLY
AD
= E
I C AS
= Y
C S
780 80 700 700 700 0
830 80 750 800 750 50
900 80 820 900 820 80
960 80 880 1,000 880 120
3/2/2011 Econ 11 -- Lecture #26 12
Example: Table 16-1. Note: Y=C+S & E=C+I
AGGREGATE
DEMAND
AGGREGATE
SUPPLY
AD
= E
I C >or
700 700 0 ?
830 80 750 > 800 750 50 ?
900 80 820 = 900 820 80 ?
960 80 880 < 1,000 880 120 ?
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3/2/2011 Econ 11 -- Lecture #26 13
Example: Table 16-1. Note: Y=C+S & E=C+I
AGGREGATE
DEMAND
AGGREGATE
SUPPLYAD
= E
I C >or
700 700 0 ?
830 80 750 > 800 750 50 ?
900 80 820 = 900 820 80 ?
960 80 880 < 1,000 880 120 ?
3/2/2011 Econ 11 -- Lecture #26 14
What happens when E>Y?
(Note: The same as: C+I>C+S).
With excess aggregate demand, sellersmake new orders from producers tomeet demand.
Sellers look at their inventory of goods.
They sell faster than their normalreplenishment of new supply. So, theymakeadditional orders for goods.
Output rises.
3/2/2011 Econ 11 -- Lecture #26 15
What happens when E
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3/2/2011 Econ 11 -- Lecture #26 16
Example: Table 16-1. Note: Y=C+S & E=C+I
AGGREGATE
DEMAND
AGGREGATE
SUPPLY
AD=
E
I C > or
700 700 0 increase
830 80 750 > 800 750 50 increase
900 80 820 = 900 820 80 equilibrium
960 80 880 < 1,000 880 120 decrease
3/2/2011 Econ 11 -- Lecture #26 17
Illustration of
Equilibrium
Output (Y0) with
E0=Y0 at 900
Saving
Output=Y
(billion pesos)
450 line
E=Y line
0900
E0 =900
1,000800
Y0Y
E
3/2/2011 Econ 11 -- Lecture #26 18
NOW THAT WE KNOW HOW
NATIONAL OUTPUT EQUILIBRIUM ISDETERMINED, WE ASK A NEW
QUESTION.
WHAT HAPPENS TO AGGREGATE
OUTPUT IF THE LEVEL OF
AGGREGATE EXPENDITURE
RISES?(FOR THE MOMENT, IGNORE WHETHER THE INCREASE IN
EXPENDITURE COMES FROM CONSUMPTION OR
INVESTMENT)
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3/2/2011 Econ 11 -- Lecture #26 19
Exactly by how much will
output increase if we knew themarginal propensity to
consume (mpc) to be and the
exact increase in expenditure
( = 10 billion pesos)?E
20
Quick answer to be fully
explained later:
For instance, change in expenditure, E, is
equal to 10 and mpc=0.75.
Multiply E by the multiplier.
1 1 1
Multiplier = 4.1- mpc 1 0.75 0.25
Therefore,
E=10 Multiplier = 10 4= 40.
= = =
3/2/2011 Econ 11 -- Lecture #26 21
Let us assume the Expenditure item is Consumption.
CThe marginal propensity to consume = c = .
Y
For every change in output equal to Y, the amount of new consumption
is:
C = c Y.
But every new cons
umption expenditure represents income to some other
economic agent, so it becomes a basis for new expenditure. Assuming that
the mpc is the same for all agents, we can say that at each evel of
consumption spending, the amount going to consumption is
C = c Y.
What is not consumed is a "leakage" from the output-spending chain.
The next table is an example where mpc or c = 0.75.
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3/2/2011 Econ 11 -- Lecture #26 22
First level
of spending
Second levelof spending
Third level
of spending
Fourth level
of spending
Leakage
Leakage
Leakage
23
Spending level Amount of
new spending
after leakage
Base spending
at level
Initial spending 10.00
1st level 7.50 10.00
2nd level 5.25 7.50
3rd level 4.21 5.25
4th level 3.16 4.21
5th level 2.37 3.16
6th level 1.78 2.37
7th level 1.33 1.78
8th level 1.00 1.33
9th level 0.75 1.00
10th level 0.56 0.75
mpc=c = 0.75
C=c Y
C=0.75 Y
Sum of spending up to 10th level = 38.3 billion
24
There is a simple way to calculate the total amount of
new spending ad infinitum. This is the formula from
elementary algebra for a chain of spending.
Given the value of the mpe or c, the total
sum of2 3
spending = 10 (1+c c c ... c )
1Change in output Change in spending .
1 - c
1We can call the factor as the MULTIPLIER.
1 - c
+ + + +
=
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3/2/2011 Econ 11 -- Lecture #26 25
The INCOME (OR
EXPENDITURE) MULTIPLIER :
For instance, change in expenditure, E, is
equal to 10 and mpc=0.75.
Multiply E by the multiplier.
1 1 1Multiplier = 4.
1- mpc 1 0.75 0.25
Therefore,
E=10 Multiplier = 10 4= 40.
= = =
26
Illustration of
Equilibrium
Output (Y0) with
E0=Y0 at 900
Saving
Output=Y
(billion pesos)
450 line
E=Y line
0900
E0 =900
1,000800
Y0Y
E
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An increase in E
and effect on
equilibrium
output
Output=Y
(billion pesos)
450 line
E=Y line
0
E0
Y0
E
E'=E+ E
Y
E
E
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3/2/2011 Econ 11 -- Lecture #26 28
THE INCOME
MULTIPLIER WORKS IN BOTH
DIRECTIONS:
AN EXPANSION OF EXPENDITURE
INCREASES OUTPUT BY THEAMOUNT OF THE MULTIPLIER.
A FALL OF EXPENDITURE
DECREASES OUTPUT BY THEAMOUNT OF THE MULTIPLIER.
3/2/2011 Econ 11 -- Lecture #26 29
THE INCOME
MULTIPLIER MODIFIED
BREAKING DOWN THE
COMPONENTS OF AGGREGATE
EXPENDITURE
o CONSUMPTION
o INVESTMENT
o GOVERNMENT BALANCE
o NET FOREIGN BALANCE
30
We label the
components of
expenditure:
E=C +I+..
Saving
Output=Y
(billion pesos)
450 line
E=Y line
0900
E0 =900
1,000800
Y0Y
E=C+I+
.
I (Investment)
C (Consumption)
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3/2/2011 Econ 11 -- Lecture #26 31
REVIEW: COMPONENTS OF
EXPENDITURE & OF OUTPUT
E = C + I + (G-T) + (X-M)
C Consumption spending
I Investment spending
G Government spending minus
Taxation (GOVERNMENT BUDGET )
X Foreign demand minus Import
Demand (NET FOREIGN DEMAND)
32
First level
of spending
Second level
of spending
Third level
of spending
Fourth level
of spending
Saving
Saving
Leakage=
Saving
THERE ARE
OTHER
FORMS OF
LEAKAGESTO THE
SPENDING
CHAIN!
33
First level
of spending
Second level
of spending
Third level
of spending
Fourth level
of spending
Leakage
Leakage
Leakage
Saving
Import
Tax
Saving
Import
Tax
Saving
Import
Tax
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3/2/2011 Econ 11 -- Lecture #26 34
THERE ARE THREE TYPES OF
LEAKAGES:
SAVING: What is not spent onconsumption goes to saving.
TAX: What the government collects as
tax is a leakage from aggregate
expenditure.
IMPORTS: What people buy from
abroad is a leakage on domestic
aggregate expenditure.
35
Saving
0Output
Saving
mps
Tax
0
Output
Tax
mpt
Imports
0 Output
Import
mpm
3/2/2011 Econ 11 -- Lecture #26 36
The modified multiplier formula
includes the
three leakages in the form of the
three marginal propensities:
to save,m;
to taxt;
and to importm.
mts
1Multiplier
++=
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Example: Given s=0.25, t=0.10, and m=0.15, what is
the effect of an increase in total expenditure of 10
billion pesos if initially, the GDP is 800 billion pesos.
First calculate the modified multiplier (we call it k).
k = 2
Because 1/[s+t+m] = 1/[0.25+0.10+0.15]=1/[0.5]=
2.
Y = E k = 10 2 = 20.
New output level = Old output + Change in output
= 800 + 20
= 820 billion pesos.
38
Example: Given s=0.25, t=0.10, and m=0.15, what is
the effect of an increase in total expenditure of 10
billion pesos if initially, the GDP is 800 billion pesos.
First calculate the modified multiplier (we call it k).
k = 2
Because 1/[s+t+m] = 1/[0.25+0.10+0.15]=1/[0.5]=
2.
Y = E k = 10 2 = 20.
New output level = Old output + Change in output
= 800 + 20
= 820 billion pesos.
3/2/2011 Econ 11 -- Lecture #26 39
End of todays lecture.
Good day!
Lecture 26