5000

6000

7000

8000

9000

10000

11000

1985

1986

1988

1990

1992

1993

1995

1997

1999

2000

2002

2004

GD

P

(Bill

ions

of

Cha

ined

200

0 D

olla

rs)

Year1990-1991

2001

Figure 9.1 U.S. Real GDP 1985-2005 and NBER Recessions

0

2

4

6

8

10

12

198519

8619

8719

8819

8919

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

051990-1991

2001 Year

Une

mp

loym

ent

Rat

e

Figure 9.2 U.S. Unemployment Rate 1985-2005 and NBER Recessions

-6

-4

-2

0

2

4

6

8

10

Year

Infla

tion

Ra

te

1990-1991 2001

Figure 9.3 Inflation Rate 1985-2005 and NBER Recessions

Year

Peak Peak

Trough

Contraction Expansion

GD

P

Y*

Figure 9.4 A Stylized Business Cycle

Table 9.1 The Early Years of the Great Depression in the United States

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

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 9.5 The Output-Income-Spending Flow of an Economy in Equilibrium

Production generates income tohouseholds

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 9.6 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

9.6 Figure 9.7 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

9.7Figure 9.8 Adjustment to a Reduction in Intended Investment in the Classical Model

leakage

injection

Production generates income

Spending stimulates firms to produce

saving (S)

equlibrium in the market for loanable funds

intended investment (II) is equal to S

9.8

output (Y*)

consumption (C)

income (Y*)

Spending sufficient to sustain full employment

AD = Y*

Figure 9.9 Macroeconomic Equilibrium at Full Employment in the Classical Model

Table 9.2 The Consumption Schedule (and Saving)

(1)Income

(Y)

(2)Autonomous Consumption

( )

(3)The part of consumption that depends on income, with mpc

= 0.8=0.8 column(1)

(4)Consumption

C = 20 + 0.8 Y= column(2)+ column(3)

(5)Saving

S = Y – C= column(1) – column(4)

0 20 0 20 -20

100 20 80 100 0

200 20 160 180 20

300 20 240 260 40

400 20 320 340 60

500 20 400 420 80

600 20 480 500 100

700 20 560 580 120

800 20 640 660 140

C

45

Consumption (C)

(= + mpc Y)

Income (Y)

Consu

mptio

n

(C)

Consumption = Income Line

400

Saving (S)

100

C

500

400

300

200

100

0= 20

340

C

Slope = mpc

Figure 9.10 The Keynesian Consumption Function

Income

Inte

nded

Inv

estm

ent

(II)

Intended Investment (II)

(= II )

__

II__

II__

II

II = 60

Figure 9.11 The Keynesian Investment Function

Table 9.3 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 80

300 260 60 320

400 340 60 400

500 420 60 480

600 500 60 560

700 580 60 640

800 660 60 720

Consumption (C)

Income (Y)

Con

sum

ptio

n, I

nves

tmen

t, a

nd

Agg

reg

ate

De

man

d

400

400

Aggregate Demand (AD) = C + II

Intended Investment (II)340

80C +II =

Figure 9.12 Aggregate Demand

Table 9.4 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)

Ag

gre

gate

Dem

and

400100

1000

800

700

600

500

400

300

200

100

0

AD (II = 140)

800

480

160C +II =

80C +II =

AD (II = 60)

Figure 9.13 Aggregate Demand with a Higher Level of Intended Investment

Table 9.5 The Possibility of Excess Inventory Accumulation or Depletion

(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

45

Income (Y)

Agg

reg

ate

De

man

d an

d O

utpu

tOutput = Income Line

400100

1000

800

700

600

500

400

300

200

100

0

Aggregate Demand (AD)

800

E

unintended investment (build up of inventories)

720

80

Figure 9.14 Unintended Investment in the Keynesian Model

45

Income (Y)

Agg

reg

ate

De

man

d an

d O

utpu

t

400100

1000

800

700

600

500

400

300

200

100

0

AD0 (II = 140)

800

160

E0

Full Employment

Y*

Figure 9.15 Full Employment Equilibrium with High Intended Investment

45

Income (Y)

Ag

gre

gate

Dem

and

an

d O

utp

ut

400100

1000

800

700

600

500

400

300

200

100

0

AD0 (II = 140)

800

E1

160

80

E0

Full Employment

AD1 (II = 60)

Persistent unemployment equilibrium

Y*

Figure 9.16 A Keynesian Unemployment Equilibrium

output (Y*)

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

Figure 9.17 Movement to an Unemployment Equilibrium

Sum of changes in Y= -80 + -64 + -51.2 +-40.96 + -32.77 + ….

= -400

etc.etc.

ΔC = - 26.21Δ Y = - 32.775

ΔC = - 32.77Δ Y = - 40.964

= .8 -51.2ΔC = - 40.96

Δ Y = - 51.23

Households cut consumption by mpc Δ Y= .8 - 64

ΔC = - 51.2

Lowered consumption spending means lowered ADΔ AD = -64

Producers respond.Δ Y = - 64

2

Less production means less income. With income

reduced by 80, households cut consumption

by mpc Δ Y= .8 -80ΔC = -64

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

Investors lose confidence.Δ II = -80

1

(3)Change in Consumption

ΔC = mpc Δ Y= .8 Column (2)

(2)Change in Aggregate Demand

(as C or II change)and in Output and Income

(as firms respond to changes in AD)

(1)Change in Intended

Investment

Table 9.6 The Multiplier at Work