Unit 5—Aggregate Unit 5—Aggregate ModelsModels

Chapters 9, 10 and 11Chapters 9, 10 and 11

Time Period: 3 weeksTime Period: 3 weeks

Graphs: 7Graphs: 7

Chapter 9—Building the Chapter 9—Building the Aggregate Expenditures Aggregate Expenditures

ModelModelAggregate means TOTAL Aggregate means TOTAL

(aggregate expenditure means total (aggregate expenditure means total spending)spending)

Consumption and SavingConsumption and Saving

What can a person do with DI?What can a person do with DI? What is not spent is called savingsWhat is not spent is called savings

DI – C = SDI – C = S

LOOK AT THE GRAPH ON PAGE 160LOOK AT THE GRAPH ON PAGE 160

C & DI GraphC & DI Graph

The reference line is a 45° line The reference line is a 45° line Each point is equidistant from the axesEach point is equidistant from the axes C = DIC = DI

Green dots = CGreen dots = C When the green dot falls short of the reference When the green dot falls short of the reference

line, savings has occurredline, savings has occurred Again, DI – C = SAgain, DI – C = S

As DI increases both C and S increaseAs DI increases both C and S increase Direct relationship to the level of incomeDirect relationship to the level of income Household C most of their DIHousehold C most of their DI

C ScheduleC Schedule

Page 161 shows a hypothetical C schedulePage 161 shows a hypothetical C schedule Households spend a larger proportion of a small Households spend a larger proportion of a small

income than of a large incomeincome than of a large income See graph on Page 162See graph on Page 162 C Schedule GraphC Schedule Graph

45° reference line45° reference line Shows C and SShows C and S Shows Shows DISSAVINGS DISSAVINGS = occurs at low levels of = occurs at low levels of

income where C exceeds DI & people must borrowincome where C exceeds DI & people must borrow

Average Propensities to C & SAverage Propensities to C & S

Measures the average C (APC) or S (APS) at Measures the average C (APC) or S (APS) at any level of disposable incomeany level of disposable income

APC = C / DIAPC = C / DI APS = S / DIAPS = S / DI

C% C% and S% and S% as DI as DI

APC + APS = 1APC + APS = 1

Marginal Propensities to C & SMarginal Propensities to C & S

(marginal means extra)(marginal means extra) Proportion of any change in income C is called MPC Proportion of any change in income C is called MPC

or income S is called MPSor income S is called MPS MPC = change in C / change in DIMPC = change in C / change in DI MPS = change in S / change in DIMPS = change in S / change in DI

MPC + MPS = 1 MPC + MPS = 1 The only choice people have is to C or to S. An additional The only choice people have is to C or to S. An additional

dollar in income must result in a change in C and/or a dollar in income must result in a change in C and/or a change in S. change in S.

Practice WorksheetPractice Worksheet

Do together and correct in classDo together and correct in class

Investment (review)Investment (review)

Spending on new plants, capital equipment, Spending on new plants, capital equipment, machinery, construction, etc.machinery, construction, etc.

Investment decision weighs marginal benefits Investment decision weighs marginal benefits & marginal costs& marginal costs

The expected rate of return = marginal benefit The expected rate of return = marginal benefit The interest rate = marginal costThe interest rate = marginal cost

Expected Rate of ReturnExpected Rate of Return

Found by comparing the expected economic Found by comparing the expected economic profit (total revenue minus total cost) to cost of profit (total revenue minus total cost) to cost of investment to get expected rate of returninvestment to get expected rate of return Example in text (page 166)Example in text (page 166) Woodworker wants to buy equipment for $1,000. Woodworker wants to buy equipment for $1,000.

He expects a $100 profit. The expected rate of He expects a $100 profit. The expected rate of return is 10%. In order to make a profit, the return is 10%. In order to make a profit, the woodworker would not want to pay more than woodworker would not want to pay more than 10% interest on the investment.10% interest on the investment.

The Real Interest RateThe Real Interest Rate

The real interest rate, The real interest rate, ii, is the cost of the , is the cost of the investmentinvestment Real interest rate = nominal rate - inflationReal interest rate = nominal rate - inflation

Interest rate is either the cost of borrowed Interest rate is either the cost of borrowed funds or the cost of investing your own funds, funds or the cost of investing your own funds, which is income forgone.which is income forgone.

If If ii exceeds the expected rate of return, exceeds the expected rate of return, rr, the , the investment should not be madeinvestment should not be made

Investment Demand CurveInvestment Demand Curve

Shows an inverse relationship between the Shows an inverse relationship between the interest rate and amount of investmentinterest rate and amount of investment

As long as As long as rr exceeds exceeds i i, the investment is , the investment is expected to be profitableexpected to be profitable

See graph on page 168See graph on page 168 Investment demand curve is always downward Investment demand curve is always downward

slopingsloping Less will be invested if interest rates are highLess will be invested if interest rates are high

Self AssessmentSelf Assessment

Take the quick quiz on page 168 to assess your Take the quick quiz on page 168 to assess your own understanding. own understanding.

Shifts in the Investment Demand Shifts in the Investment Demand CurveCurve

Movement along the IDC or DIgC occur with Movement along the IDC or DIgC occur with a change in the interest ratea change in the interest rate

Shifts occur (Shifts occur ( to the right, to the right, to the left) to the left) 1. acquisition, maintenance and operating costs1. acquisition, maintenance and operating costs

When cost falls, theWhen cost falls, the r r from prospective investment from prospective investment project rises, shifts the IDC to the rightproject rises, shifts the IDC to the right

Higher electricity costs = shift to the leftHigher electricity costs = shift to the left 2. business taxes2. business taxes

in taxes = shift to the leftin taxes = shift to the left

Shifts ContinuedShifts Continued

3. technological change3. technological change Development stimulates investmentDevelopment stimulates investment Shift to the rightShift to the right

4. stock of capital goods on hand4. stock of capital goods on hand When firms are overstocked, the When firms are overstocked, the rr declines (shifts declines (shifts

to the left)to the left) There is little incentive to invest in new capital when There is little incentive to invest in new capital when

there is excess productionthere is excess production When firms are under stocked, the When firms are under stocked, the r r increases increases

(shifts to the right)(shifts to the right)

Shifts continued again . . .Shifts continued again . . .

5. Expectations5. Expectations Optimistic about future sales, the curve will Optimistic about future sales, the curve will

shift to the rightshift to the right Pessimistic outlook = shift to the leftPessimistic outlook = shift to the left

Instability of InvestmentInstability of Investment

1. capital goods are durable so spending can 1. capital goods are durable so spending can be postponedbe postponed

2. innovation occurs irregularly2. innovation occurs irregularly 3. profits vary considerably 3. profits vary considerably 4. expectations can be easily changed4. expectations can be easily changed

Classwork! Yeah! Classwork! Yeah! Page 179Page 179 Number 2Number 2 Number 3Number 3

A=c&s B=c&s C=c, s & i F=I G=c&s I=c&sA=c&s B=c&s C=c, s & i F=I G=c&s I=c&s Number 4Number 4 Number 5—complete the table and part B only (refer Number 5—complete the table and part B only (refer

to table 9.1)to table 9.1) Number 6Number 6 Due today Due today

Equilibrium GDPEquilibrium GDP

Equilibrium level of GDP is the level at which Equilibrium level of GDP is the level at which the total quantity of goods produced (GDP) = the total quantity of goods produced (GDP) = the total quantity of goods purchasedthe total quantity of goods purchased

GDP = C + IgGDP = C + Ig Savings and planned investment are equalSavings and planned investment are equal Savings represents a “leakage” from spending Savings represents a “leakage” from spending

and causes C to be < GDPand causes C to be < GDP

Table 9.4Table 9.4

See table on page 173See table on page 173 See line 8, GDP is $510 billionSee line 8, GDP is $510 billion C + Ig = 500 billion (disequilibrium)C + Ig = 500 billion (disequilibrium) Businesses have $10 billion of unplanned Businesses have $10 billion of unplanned

inventory investment on top of what was inventory investment on top of what was already plannedalready planned Unplanned portion is a business expenditureUnplanned portion is a business expenditure

Table 9.4Table 9.4

See line 5, GDP = $450 billionSee line 5, GDP = $450 billion Consumer spending is $435 billionConsumer spending is $435 billion $20 billion is planned investment$20 billion is planned investment Businesses have experienced a $5 billion Businesses have experienced a $5 billion

unplanned decline in inventory because of unplanned decline in inventory because of unexpected salesunexpected sales

Self AssessmentSelf Assessment

See graph on page 175See graph on page 175 Quick quiz on page 175—work with a partner Quick quiz on page 175—work with a partner

or on your own or on your own for your own assessment of for your own assessment of understandingunderstanding

Say Vs KeynesSay Vs Keynes

Read page 177Read page 177 Do question 16 on page 180—this will be Do question 16 on page 180—this will be

turned in. You need to actually draw a PPF turned in. You need to actually draw a PPF for and label efficiency for both men.for and label efficiency for both men.