Consumption, Savings, and Aggregate Expenditures.

Consumption, Savings, and Aggregate Expenditures

Do you agree or disagree with the following?

1. If income remains constant, when consumption increases savings must decrease.

2. If income increases, savings decreases and if income decreases, savings increases.

3. If consumption increases, ceteris paribus, GDP will increase.

4. If GDP rises, unemployment rises.

5. Consumption can be greater than income.

Consumption and Saving

• Largest component of AE is C

• DI = C + S

• If DI ↑, C ↑ and S ↑ ; if DI ↓, C ↓ and S ↓

• C can be > DI; S can be negative

• If AE ↑, GDP ↑ and unemployment ↓

• If AE ↓, GDP ↓ and unemployment ↑

APC, APS, MPC, and MPS

• APC = C / Income = % of income people are likely to consume

• APS = S / Income = % of income people are likely to save

• APC + APS = 1

• MPC = ∆C / ∆Income

• MPS = ∆Savings / ∆Income

• MPC + MPS = 1

Investment• If business expects to be able to

produce $1100 worth of goods from $1000 machine, r = 10% ($100/$1000)

• If MB>=MC, they’ll invest so…• r>=i• If r = 10%, nominal i = 12%, inflation =

5%, they’ll invest until nominal i = 15%

i

I ($)ID

20

I = $20 billion @ 8% Real interest rate

8%

The Simple Spending Multiplier

• Multiplier = (change in real GDP)/(change in spending) OR

• Change in GDP = Multiplier x (change in spending)

• Multiplier = 1/MPS OR 1/(1-MPC)

The Multiplier and GDP• MPS = .20; consumption increases by $10

billion; what is the increase to GDP?• $50 billion ($10 B x (1/.20)) = $10 B x 5• MPS = .25; income increases by $20 billion;

what is the increase to GDP?• Consumption increases by .75 x $20 B = $15 B;

GDP increases by $60 B ($15 B x 4)• If MPS falls to .20, how does that change the

increase to GDP?• C ↑ by .80 x $20 B = $16 B; GDP ↑ by $80 B

($16 B x 5)

Net Exports• Positive Xn increase AE and negative Xn

decrease AE

• Appreciation – value of currency rises against another

• Depreciation – value of currency falls against another

• Ex: $1.50 = 1 Euro;

• Appreciation -- $1 = 1 Euro ($1.50 = 1.5 Euros)

• Depreciation -- $2 = 1 Euro

Net Exports• If $ appreciates, U.S. goods more expensive

(costs more foreign currency) – X falls

• $ appreciates – foreign goods are cheaper; M rises so net exports fall

• If $ depreciates, U.S. goods cheaper (costs less foreign currency) – X rises

• $ depreciates – foreign goods more expensive (costs more $) so M falls; net exports rises

Government Purchases

• More purchases increase AE; fewer reduce AE

• ∆ in G have a greater effect on GDP than ∆ in taxes do

• Ex: MPS = .20; G ↑ by $20 B; GDP ↑ by $100 B ($20 B x 5)

• MPS = .20; taxes fall by $20 B; C ↑ by $16 B ($20 B x .80); GDP ↑ by $80 B ($16 B x 5)

• Some of the tax cut is saved and doesn’t affect GDP

Balanced Budget Multiplier

• Taxes and G change in the same direction by the same amount; i.e. -- $20 B

• GDP will change by the same amount in the same direction; i.e. -- $20 B

• Balanced budget multiplier is 1 (1 x ∆ in G and T)

• If G and T fall by $20 B, GDP will fall by $20 B

• Leakages – pull $ out of the economy: savings, taxes, imports

• Injections – inject $ into the economy: investment, government, exports

• Recessionary gap – the amount that AE must increase to pull GDP up to full-employment GDP

• Inflationary gap – the amount that AE must fall to bring GDP back down to full-employment GDP

The Simple Spending Multiplier

• Multiplier = (change in real GDP)/(change in spending) OR

• Change in GDP = Multiplier x (change in spending)

• Multiplier = 1/MPS OR 1/(1-MPC)

Practice – What happens to GDP?1. Income goes up by $5 M. MPC = 0.82. Investment falls by $40 B. MPS = 0.13. Government purchases falls by $100 B. MPC =

0.754. The dollar appreciates causing net exports to

change by $25 B. MPS = 0.25. The dollar depreciates causing net exports to

change by $10 B. MPS = 0.336. Taxes fall by $50 B. MPC = 0.87. Taxes and government purchases increase by

$25 B. MPC = 0.25

Answers

1. GDP increases by $20 B.

2. GDP falls by $400 B.






Consumption, Savings, and Aggregate Expenditures.

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