Chapter
10 Aggregate Expenditure and Aggregate Demand
I.
Aggregate Expenditure and Income
In
the model we have developed, GDP = AGGREGATE INCOME.
The
aggregate demand curve (AD) tells us, at each price level, how much aggregate output
will be demanded.
A.
EXAMPLE:
Assume that the price level = 130. The following data tells us, at each level
of aggregate income (REAL GDP - Y), how much will be spent.
Real
GDP (Y) |
Net
Taxes (NT) |
Disposable
Income (Y-NT) |
Consumption
- C |
Savings (S) |
Planned
Investment (I) |
Government
Purchases (G) |
Net
Exports (X-M) |
Planned
Aggregate Expenditure (AE) |
Unintended
Change in Inventory (Y-AE) |
7.0 |
1.0 |
6.0 |
5.7 |
0.3 |
0.6 |
1.0 |
-0.1 |
7.2 |
-0.2 |
7.5 |
1.0 |
6.5 |
6.1 |
0.4 |
0.6 |
1.0 |
-0.1 |
7.6 |
-0.1 |
8.0 |
1.0 |
7.0 |
6.5 |
0.5 |
0.6 |
1.0 |
-0.1 |
8.0 |
0.0 |
8.5 |
1.0 |
7.5 |
6.9 |
0.6 |
0.6 |
1.0 |
-0.1 |
8.4 |
+0.1 |
9.0 |
1.0 |
8.0 |
7.3 |
0.7 |
0.6 |
1.0 |
-0.1 |
8.8 |
+0.2 |
What
is the Marginal Propensity to consume in this economy?
What
is the Marginal Propensity to save in this economy?
Which
variables are considered autonomous of aggregate income?
When
is planned investment equal to actual investment in this economy?
Planned Aggregate
Expenditure = C + I (Planned) + G + X - M
(Amount
that households, firms, government, and the rest of the world plans to spend on
U.S. output)
Aggregate
Expenditure Line -- a relationship showing, for a given price level, planned spending
at each level of income, i.e. total C + I (Planned) + G + X - M at each level
of aggregate income.
Graph:
Where
the 45 degree line crosses the Aggregate Expenditure Line, aggregate output
(real GDP) is equal to the amount people plan to spend on U.S. output. At the
current price level, this is the aggregate output demanded.
Up
to this point, we have assumed that the price level is constant at 130. What
happens to the quantity of aggregate output demanded if the price level
changes?
A.
What
if the price level increases? (140)
-
Consumption
changes.
-
Planned
investment changes.
Graph:
B.
What
if the price level decreases? (120)
-
Consumption
changes.
-
Investment
changes.
A.
How
do changes in autonomous spending affect real GDP demanded?
Example:
Suppose that firms become more optimistic. We learned in chapter 9 that they
will increase their planned investment spending. Suppose firms increase their
planned investment spending by $.1 trillion dollars. How does that change
affect real GDP demanded?
How
much does real GDP demanded change? Think about the circular flow of income,
and suppose that the MPC in this country is 4/5. What happens when I increases
by $.1 trillion.
1.
At
our original output level (Real GDP = $8.0 trillion), planned spending is
greater than output, so inventories fall (by $.1 trillion). In response, firms
increase output by $.1 trillion.
2.
This
increase in output translates directly to an increase in income to households.
If NT do not change, then DI increases by $.1 trillion. Households spend $.1
trillion * MPC = $.08 trillion more than they did before.
3.
At
$8.1 trillion in real GDP, planned spending is still greater than output by
$.08 trillion, so firms increase their output by $.08 trillion.
4.
This
increase in output translates directly to an increase in income to households.
Households spend $.08 * MPC = $.064 more than they did before.
5.
Now
spending is $.064 greater than output. This continues until the change in
consumer spending is too small to measure.
Mathematically,
the change in real GDP demanded from the increase in investment of $.1 trillion
is written as:
$.1 trillion (1 + 4/5 +
(4/5)2 + (4/5)3 +…)
The
infinite series can be solved so that
D Real GDP demanded = $.1 trillion (1/(1-4/5))
= $.5 trillion
We
can depict what occurred in our example graphically.
GRAPH:
B.
The
Simple Spending Multiplier
(1/(1-4/5))
is the simple spending multiplier in our example. In general, the multiplier is
1/(1-MPC).
Simple
Spending Multiplier - The ratio of a change in real GDP demanded to the initial change in
expenditure that brought it about.
D Real GDP
demanded = D autonomous
spending (planned AE) * simple spending multiplier
(in
equilibrium) (initial change)
Practice
Problems:
1.
Suppose
that currently real GDP is $7.0 trillion and the MPC for our economy is 2/3.
Depict graphically and explain what will happen in our economy if autonomous
spending (I, G, C, or (X-M)) increases by $.8 trillion.
2.
Suppose
that currently real GDP is $8.0 trillion and MPC for our economy is .8. If the
government wants to increase real GDP demanded to $10.0 trillion, how much do
they have to increase autonomous government spending? Depict what occurs
graphically.