Chapter Twenty- Four: Aggregate Demand and Economic Fluctuations.
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Chapter Twenty-
Four:
Aggregate Demand and
Economic Fluctuations
The Business Cycle
Figure 24.1: U.S. Real GDP and Recessions
Source: BEA quarterly data 1985–2012, and NBER
Figure 24.2: U.S. Unemployment Rate and Recessions
Figure 24.3: U.S. Inflation Rate and Recessions
Source: “Economic Report of the President” 1985–2005; rate is calculated as a three-month moving average of the CPI; NBER.
Year
Trough
Contraction ExpansionG
DP
Y*
Peak Peak
Figure 24.4: A Stylized Business Cycle
1929 1933(a) Real Standard and Poor’s Stock Index 100.0 45.7(b) Unemployment rate (official) 3.2% 24.9%(c) Price level (CPI) 100.0 75.4(d) Real gross domestic product 865.2 billion 635.5 billion(e) Real personal consumption
expenditures 661.4 billion 541.0 billion(f) Real gross private domestic
investment 91.3 billion 17 billion(g) Real private debt 88.9 billion 102.0 billion(h) Bankruptcy cases 56,867 67,031(i) Non-farm real estate foreclosures 134,900 252,400(j) Food energy per capita per day
(calories)3460 3280
Table 24.1: The Early Years of the Great Depression in the United States
Sources: (a) from Historical Statistics of the United States, p. 1004, series X495.; (b)-(c) from Dornbusch, Fischer, & Startz (2001);( d)-(f) from http://www.bea.doc.gov/bea/dn/nipaweb/TableView.asp#Mid; (g) from Historical Statistics of the United States, p. 989, series X399.; (h) from Bradley Hansen and Mary Eschenbach Hansen, The Transformation of Bankruptcy in the United States (http://academic2.american.edu/~mhansen/transform.pdf ); (i) from Historical Statistics of the United States, p. 651, series N301; (j) from Ibid., p. 328, series 851; (d) and (e) are inflation-corrected using (b)
Macroeconomic Modeling and Aggregate Demand
Output
(Y )
Income
(Y )
Spending
(Aggregate Demand or AD )
Spending stimulates firms to produce
Production generates incomes
Incomes give actors the ability to spend
Figure 24.5: The Output-Income-Spending Flow of an Economy in Equilibrium
Production generates income to households
Saving (S )
leakage
Intended Investment ( II )
injection
firms decide how much to invest
households decide how much to consume and save
Output (Y )
Spending (AD )
Income (Y )
Consumption (C )?Sufficient to sustain output at a steady level
Figure 24.6: The Output-Income-Spending Flow with Leakages and Injections
Quantity of funds borrowed and lent
Inte
rest
rat
e
140
5%
Supply of Loanable Funds
Demand for Loanable Funds
E1
Figure 24.7: The Classical Model of the Market for Loanable Funds
Quantity of funds borrowed and lent
Inte
rest
rat
e
140
5%
Supply of Loanable Funds
Original Demand
E1
New Demand
60
3%
E0
Figure 24.8: Adjustment to a Reduction in Intended Investment in the Classical Model
leakage
injection
Production generates income
Spending stimulates firms to produce
Saving (S )
Equilibrium in the market for loanable funds
Intended Investment (II ) is equal to S
Output (Y* )
Consumption (C )
Income (Y* )
Spending sufficient to sustain full
employment
AD = Y*
Figure 24.9: Macroeconomic Equilibrium at Full Employment in the Classical Model
The Keynesian Model
Table 24.2: The Consumption Schedule (and Saving)
45
Consumption (C )
(= + mpc Y)
Income (Y )
Co
nsu
mp
tio
n
(C )
Consumption = Income Line
400
Saving (S)
100
C
500
400
300
200
100
0
= 20
340
C
Slope = mpc
Figure 24.10: The Keynesian Consumption Function
Income (Y )
Inte
nded
Inv
estm
ent
(= I
I )
Intended Investment (II )
(= II )II = 60
Figure 24.11: The Keynesian Investment Function
Consumption (C )
Income (Y )
Con
sum
ptio
n, I
nves
tmen
t, a
nd
Agg
rega
te D
eman
d
400
400
Aggregate Demand(AD ) = C + II
Intended Investment (II )340
80C +II =
Figure 24.12: Aggregate Demand
Table 24.3: Deriving Aggregate Demand from the Consumption Function and Investment
(1)Income
(Y)
(2)Consumption
(C)
(3)Intended
Investment(II)
(4)Aggregate Demand
AD = C + II= column (2) + column (3)
0 20 60 80300 260 60 320400 340 60 400500 420 60 480600 500 60 560700 580 60 640800 660 60 720
Table 24.4: Aggregate Demand with Higher Intended Investment
(1)Income
(Y)
(2)Consumption
(C)
(3)Intended Investment
(II)
(4)Aggregate Demand
(AD)
0 20 140 160
300 260 140 400
400 340 140 480
500 420 140 560
600 500 140 640
700 580 140 720
800 660 140 800
Income (Y )
Agg
rega
te D
eman
d
400100
1000
800
700
600
500
400
300
200
100
0
AD (II = 140)
800
AD (II = 60)
480
160
80
Figure 24.13: Aggregate Demand with a Higher Level of Intended Investment
IIC IIC
==
(1)Income
(Y)
(2)Aggregate Demand
(AD)
(3)Excess Inventory
Accumulation (+) or Depletion (-)= column(1)-
column(2)
(4)Intended
Investment(II)
(5)Investment
(I)= column(3)+ column(4)
(6)Check that the
macroeconomic identity still holds:
Y = C+I
300 320 -20 60 40 300 400 400 0 60 60 400 500 480 20 60 80 500 600 560 40 60 100 600 700 640 60 60 120 700 800 720 80 60 140 800
Table 24.5: The Possibility of Excess Inventory Accumulation or Depletion
45
Income (Y )
Agg
rega
te D
eman
d an
d O
utpu
t
Output = Income Line
400100
1000
800
700
600
500
400
300
200
100
0
Aggregate Demand (AD )
800
E
unintended investment (build up of inventories)
80
720
Figure 24.14: Unintended Investment in the Keynesian Model
45
Income (Y )
Agg
rega
te D
eman
d an
d O
utpu
t
400100
1000
800
700
600
500
400
300
200
100
0
AD0 (II = 140)
800
E0
Full Employment
Y*
160
Figure 24.15: Full Employment Equilibrium with High Intended Investment
45
Income (Y )
Agg
rega
te D
eman
d an
d O
utpu
t
400100
1000
800
700
600
500
400
300
200
100
0
AD0 (II = 140)
800
E1
E0
Full Employment
AD1 (II = 60)
Persistent unemployment equilibrium
Y*
80
160
Figure 24.16: A Keynesian Unemployment Equilibrium
Income (Y* )
Insufficient Spending
AD < Y*
Production generates income
Income goes to households
If leakages are larger than injections…
Lower Income
Lower Spending
AD = lower YLower Output
Output (Y* )
Figure 24.17: Movement to an Unemployment Equilibrium
(1)Change in Intended Investment
(2)Change in Aggregate Demand
(as C or II change)and in Output and Income
(as firms respond to changes in AD)
(3)Change in Consumption
ΔC = mpc Δ Y= .8 Column (2)
1. Investors lose confidence.Δ II = 80
2. Reduced investment spending leads directly to Δ AD = 80.Producers respond to reduced demand for their goods by cutting back on production.Δ Y = 80
3. Less production means less income. With income reduced by 80, households cut consumptionby mpc Δ Y= .8 80ΔC = 64
4. Lowered consumption spending means lowered ADΔ AD = 64Producers respond.Δ Y = 64
5. Households cut consumptionby mpc Δ Y= .8 4ΔC = 51.2
6. Δ Y = 51.2 7. mpc Δ Y = .8 51.2ΔC = 40.96
8. Δ Y = 40.96 9. ΔC = 32.77
10. Δ Y = 32.77 11. ΔC = 26.21
etc. etc.
Sum of changes in Y= 80 + 64 + 51.2 + 40.96 + 32.77 +. . . .= 400
Table 24.6: The Multiplier at Work
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