aggregate expenditure
DESCRIPTION
Aggregate expenditure . Autonomous versus induced expenditure The consumption function The theory of investment Government purchase function The net export function. Autonomous versus induced Expenditure. - PowerPoint PPT PresentationTRANSCRIPT
Aggregate expenditure 1. Autonomous versus induced
expenditure2. The consumption function3. The theory of investment4. Government purchase function5. The net export function
Autonomous versus induced Expenditure
•Autonomous expenditure: The components of aggregate expenditure that do not change when real GDP changes.•Induced expenditure: The components of aggregate expenditure that change when real GDP changes.
The consumption function
The consumption function reveals the relationship between
consumption and disposable income, other things constant.
4
Disposable income, consumption, and saving in US
5
US consumption depends on disposable income
Keynes’s fundamental lawof consumption
People show a tendency, as a rule and on average, to increase their consumption when their income increases—but not by as much as the increase in income.
Marginal propensities to consume (MPC) and save (MPS)
MPC: The fraction of the change in income that is spent on consumption.
DICMPC
MPS: The fraction of the change in income that is saved
DISMPS
Keynes’s fundamental law implies that:
10 MPC
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The consumption function
0 1 2 3 4 5 76 8 9 10 14131211
Real disposable income (trillions of dollars)
12345
76
89
1011
Real
con
sum
ption
(tril
lions
of d
olla
rs)
C
The consumption function, C, shows the relationship between consumption and disposable income, other things constant.
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Marginal propensities to consume and saveRe
al c
onsu
mpti
on (t
rillio
ns o
f dol
lars
)
Real
savi
ng (t
rillio
ns o
f dol
lars
)
0
Real disposable income (trillions of dollars)0
(a) Consumption function (b) Saving function
a
b
cd
∆C=0.4∆S=0.1
∆DI=0.5∆DI=0.5
MPC=∆C/∆DI=0.4/0.5=4/5
MPS=∆S/∆DI=0.1/0.5=1/5
The slope of the C function equals the marginal propensity to consume. For the straight-line C function in (a), the slope is the same at all levels of income and is given by the change in consumption divided by the change in disposable income that causes it: MPC=4/5.
The slope of the S function in (b) equals the marginal propensity to save, MPS=1/5.
Determinants of consumption
Consumption
Interest Rates
Net Wealth
Disposable Income
Expectations
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Shifts of the consumption function
C
C’
C’’
Real disposable income
Real
con
sum
ption An upward shift, such as from C
to C’’, can be caused by an increase in net wealth, a decrease in the price level, an favorable change in consumer expectations, or a decrease in the interest rate.
A downward shift of the consumption function, such as from C to C’, can be caused by a decrease in net wealth, an increase in the price level, an unfavorable change in consumer expectations, or an increase in the interest rate.
The crash of ‘08
Let’s take out a loan so we can “cash out” some home equity.
Rising home values have stimulated household borrowing and consumption in the past decade.
Consumer Confidence has fluctuated lately
Debtor nation
Theory of Investment
Why do firms purchase things like new offshore drilling platforms, food processing plants, or bulldozers? Because they expect they can
make a profit by doing so.
Investment Function
),( rfI Let
Where:•I is gross investment• is the expected profit of investment; and•r is the interest rate.
The Investment Decision
Acquisition cost of a tractor–trailer rig . . . . . . . . $150,000.00
Useful life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 years
Expected (extra) sales revenue per yearfrom the use of the asset . . . . . . . . . . . . . . . . . 200,000.00
Expected costs per year to operate the asset . . $180,000.00
Diesel fuel $38,000 Driver salary & benefits 68,000 Depreciation 50,000 Repairs (including tires) 19,000 Misc. (fees, fines, etc.) 5,000
Expected net sales revenue per year from the use of the asset . . . . . . . . . . . . . . . . . . $20,000.00
Computing expected profit ()
100Good Capital theofCost n AcquisitioYearPer Revenue SalesNet Expected
000,149$000,30$
To compute expected profit in percentage terms:
Thus we have:
%7.13100000,146$
000,20$
We would consider the tractor-trailer rig a
sound investment if the interest rate were less than 13.7 percent.
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Rates of return on golf carts and the opportunity cost of funds
0 $2,000 $4,000 $6,000 $8,000 $10,000
Investment
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10
15
20
25
Nom
inal
inte
rest
rate
(per
cent
)
Market rate of interest
Expected rate of return
An individual firm invests in any project with a rate of return that exceeds the market interest rate.At an interest rate of 8%, Hacker Haven purchases three golf carts, investing $6,000.
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Investment demand curve for the economy
0 0.9 1.0 1.1 Investment(trillions of dollars)
6
8
10
Nom
inal
inte
rest
rate
(per
cent
)
D
The investment demand curve for the economy sums the investment demanded by each firm at each interest rate.At lower interest rates, more investment projects become profitable for individual firms, so total investment in the economy increases.
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Investment function
0.9
1.0
1.1
Inve
stm
ent (
trill
ions
of d
olla
rs)
I
0 2.0 4.0 6.0 8.0 10.0Real disposable income(trillions of dollars)
12.0 14.0
I’
I’’
Investment is assumed to be independent of income, as shown by horizontal lines. Thus, investment is assumed to be autonomous.
An increase in the interest rate or less favorable business expectations would decrease investment at every level of income, as shown by the downward shift from I to I’.
A decrease in the interest rate or more upbeat business expectations would increase investment at every level of income, as shown by the upward shift from I to I’’.
Annual percentage change in US real GDP, consumption, and investment
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Government purchase function
Because government purchases are controlled by public
officials, we treat them as autonomous—that is,
determined independent of income
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Net export function
-420
-400
-380
Net
exp
orts
(bill
ions
of d
olla
rs)
X-M
0 2.0 4.0 6.0 8.0 10.0Real disposable income(trillions of dollars)
12.0 14.0
X’-M’
X’’-M’’
Net exports here are assumed to be independent of disposable income, as shown by the horizontal lines. X-M is the net export function when autonomous net exports equal -$400 billion.
An increase in the value of the dollar relative to other currencies would decrease net exports at each level of income, as shown by the shift down to X’-M’.
A decrease in the value of the dollar would increase net exports at each level of income, as shown by the shift up to X’’-M’’.
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US spending components as percentages of GDP since 1959