Aggregate Expenditures The four expenditure components of national

Expenditures Function • AE = C + I + G + (X - IM)

$The Marginal Propensity to Consume • The mpc is the fraction spent from an$

Consumption and Income • Consumption depends on income. When income rises, consumption increases. •

Consumption and Saving • The MPC plus the MPS equals one. • To see

The Marginal Propensity to Consume and AE • Since only consumption expenditures depend on

Expenditures Function l The expenditures function is expressed as a mathematical function: AE =

The Multiplier Equation • The multiplier is a number that reveals how much income

Alternative Equation • By definition: mpc + mps = 1 • Alternatively expressed: mps

The two equations Multiplier = 1/(1 – mpc) multiplier = 1/mps Because 1 -mpc

An Upward Shift of AE, Fig. 10 -8 a, p 248 Real expenditur es

An Downward Shift of AE, Fig. 10 -8 b, p 248 Real expenditur es

An Example of the Multiplier • Suppose Investment rises by $ 100 million •

Realistic Multipliers • Our simple model pretends that no one pays taxes and no

Realistic Multipliers • Observe that the multiplier is calculated assuming prices are not changing.

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Aggregate Expenditures • The four expenditure components of national income accounting were developed around the multiplier model. AE = C + I + G + (X - IM)

Expenditures Function • AE = C + I + G + (X - IM) • AEo = autonomous expenditures that don’t change as income changes. • AE/ Y = those expenditures that change as income changes • We simplify the model for Econ 100: we pretend that only consumption changes when income changes.

$The Marginal Propensity to Consume • The mpc is the fraction spent from an$

The Marginal Propensity to Consume • The mpc is the fraction spent from an additional dollar of income.

Consumption and Income • Consumption depends on income. When income rises, consumption increases. • The marginal propensity to consume is the change in c divided by the change in y. – YD = C + S – MPC = C/ YD – MPS = S/ YD

Consumption and Saving • The MPC plus the MPS equals one. • To see why, note that, if you receive an additional $100 in disposable income, you will spend part of the income or not spend part of the income, that is save it. • In algebra: • C + S = YD.

Consumption Function

Aggregate Expenditure Diagram

The Marginal Propensity to Consume and AE • Since only consumption expenditures depend on income, in our simple model:

Expenditures Function l The expenditures function is expressed as a mathematical function: AE = AEo + mpc. Y AE = aggregate expenditures AEo = autonomous expenditures mpc = marginal propensity to consume Y = income

The Multiplier Equation • The multiplier is a number that reveals how much income will change in response to a change in autonomous expenditures. Multiplier = 1/(1 – mpc)

Alternative Equation • By definition: mpc + mps = 1 • Alternatively expressed: mps = 1 - mpc multiplier = 1/mps

The two equations Multiplier = 1/(1 – mpc) multiplier = 1/mps Because 1 -mpc = mps What you don’t consume is what you save.

An Upward Shift of AE, Fig. 10 -8 a, p 248 Real expenditur es $4, 210 AE 1 30 AE 0 4, 090 1, 052. 5 1, 022. 5 0 30 $120 $4, 090 $4, 210 Real income

An Downward Shift of AE, Fig. 10 -8 b, p 248 Real expenditur es $4, 152 Aggregate AE 0 production 30 AE 1 4, 062 1, 412 30 1, 382 0 $90 $4, 062 $4, 152 Real income

An Example of the Multiplier • Suppose Investment rises by $ 100 million • the mpc is. 8 so the mps is. 2 • Multiplier = 1/(1 – mpc) = 1/(1 -. 8) = 1/. 2 = 5 • multiplier = 1/mps = 1/. 2 = 10/2 = 5 • Rise in Equilibrium Income 5 * $100 = $500

Realistic Multipliers • Our simple model pretends that no one pays taxes and no one buys imports • We also assume that Investment and government spending don’t change when income changes. • The real multiplier is closer to 2 than to 5.

Realistic Multipliers • Observe that the multiplier is calculated assuming prices are not changing. • The multiplier tells us how much the AD curve shifts to the right. • When AD shifts, prices change so the change in equilibrium income is even less than an accurate multiplier predicts.