AGGREGATE EXPENDITURES Frederick University 2014 Aggregate Demand AD

AGGREGATE EXPENDITURES Frederick University 2014

Aggregate Demand (AD) AD – the quantity of GDP, which the economic agents are planning to buy at every price level, ceteris paribus (Y = const)

Aggregate Expenditures n АЕ – the expenditures that economic decision makers are planning to make at every level of income, ceteris paribus Planned Spending Real GDP = Nominal GDP n AE = C + I + G + X - M n n

Consumption Spending (С) n С – the expenditures that households are planning to make at every level of income, ceteris paribus

Consumption Spending (С) Y 0 C S

Consumption Spending (С) n Y C 0 500 S 500 – consumption spending which does not depend on income, autonomous consumption – С 0 (Ca, a)

Consumption Spending (С) Y C S 0 500 -500

Consumption Spending (С) Y 0 C 500 S -500 n n n C = C 0 + (Δ C /ΔY) x Y Δ C /ΔY – the increase in consumption spending, caused by the increase in income – marginal propensity to consume – MPC (mpc, b) C = C 0 + MPC x Y

Consumption Spending (С) n n n C = C 0 + MPC x Y MPC = ¾ = 0, 75 If income rises by $100, households increase their consumption spending by $75 and increase their savings by $25 If income rises by $500, С rises by 5 х $75 = $375 C = 500 + 375 = 500 + 0. 75 x 500 Y 0 500 C 500 875 S -500

Savings (S) n n n n Marginal propensity to save – the increase in savings, caused by the increase in income: MPS = Δ S /ΔY If income rises by $100, and households raise their consumption spending by $75, savings increase by $25 MPC + MPS = 1 C+S=Y S = Y – C = Y – (C 0 + MPC x Y) = Y - C 0 - MPC x Y = - C 0 + Y(1 - MPC) S = - C 0 + MPS x Y

Consumption Spending (С) and Savings (S) Y C S 0 500 -500 875 - 375

Consumption Spending (С) and Savings (S) n n Y = 1000 C = 500 + 0. 75 x 1000 Y C S 0 500 -500 875 -375 1000 1250 -250

Consumption Spending (С) and Savings (S) Y C S 0 500 -500 875 -375 1000 1250 -250 1500 1625 -125 2000 0 2500 2375 125 3000 2750 250

Consumption Spending (С) 2000 Y C 0 S 500 C + 0 0 -500 875 -375 1000 1250 -250 875 1500 1625 -125 2000 0 2500 2375 125 3000 2750 250 500 C D Y 5 0. 7 =5 B 375 A 500 450 0 500 2000 Y

Factors determining C n n n n n Households’ income Indirect taxation Propensity to buy imported goods and services Direct taxation Consumers’ expectations Availability of consumer credit Income distribution Living standards Efficiency of market institutions

Investment spending I = Gross Private Domestic Investment n I – Depreciation = Net Investment n Net investment = Purchases of New Equipment + Change in Inventories n Fixed Investment = Depreciation + Purchases of New Equipment n Net Fixed Investment = Purchases of New Equipment n Inventories = Ø Raw Material Ø + Unfinished Production Ø + Finished Goods

Factors determining Investment Spending (I) n n n n n Interest rate (i) Expected future profits (π) Risk Excess capacity Capital-output ratio (α) Technological changes Cost of production Competitiveness of markets Depreciation policies Efficiency of market institutions

AE 2000 C AE = C + I+ G + X -M D C B 875 500 375 A 500 450 0 500 2000 Y

AE

Injections imports М exports Х Leakages Government purchases G Expenditures on final goods and services Investment І Macroeconomic Equilibrium I+G+X= S+T+M (I - S) = (T - G) + (M - X) taxes Т AE Final goods and services savings S HOUSEHOLDS FIRMS Production factors Primary Income The Circular Flow

Macroeconomic Equilibrium n n n n Y < AE Reduction of inventories Y Y = AE Y > AE Increase in inventories Y Y = AE

The simple multiplier n n n Y 2005 = C 2005 + Inj 2005 Y 2004 = C 2004 + Inj 2004 Δ Y = ΔC + ΔInj ΔY = C 0 2005 +MPCY 2005 – C 02004 – MPCY 2004 + ΔInj ΔY = MPC ΔY + ΔInj ΔY - MPC ΔY = ΔInj ΔY (1 -MPC) = ΔInj ΔY = Δ Inj x 1/(1 -MPC) = multiplier = К If МРС = 0. 5, К = 2 If МРС = 0. 75, К = 4

The complete multiplier 1 K= MPS + t x MPC + MPI

Multiplier Constraints n n n Factors of production bottlenecks Limited productive capacity Institutions

Deriving the Complete Multiplier n n n n n Y 2005 = C 2005 + (I + G + X)2005 - M 2005 Y 2004 = C 2004 + (I + G + X)2004 - M 2004 Δ Y = ΔC + ΔInj - ΔM ΔY = C 0 2005 +MPC x (Y 2005 – t x Y 2005) - C 02004 – MPC x (Y 2004 – t x Y 2004) + ΔInj - M 0 2005 – MPI x (Y 2005 – t x Y 2005) - M 02004 – MPI x (Y 2004 – t x Y 2004) + ΔInj ΔY = MPC x Y 2005 ( 1– t x) – MPC x Y 2004 ( 1 - t) - MPI x Y 2005 ( 1 – t) – MPI x Y 2004 (1– t) ΔY = MPC ( 1 - t) x ΔY – MPI x ΔY + ΔInj ΔY - MPC ( 1 - t) ΔY + MPI x ΔY = ΔInj ΔY [(1 -MPC + MPC x t) + MPI] = ΔInj ΔY = Δ Inj : 1/(1 -MPC + MPC x t + MPI) K = 1/(1 -MPC + MPC x t + MPI) = 1/ (MPS + MPT + MPI)