ECON 1202 1st Edition Lecture 17 Outline of Last Lecture I. Review SessionII. Chapter 1III. Chapter 2IV. Chapter 3V. Chapter 4VI. Chapter 8VII. Chapter 9VIII. Chapter 10IX. Chapter 11 X. Federal Budget SheetOutline of Current Lecture I. Aggregate Expenditure ModelII. Determining the Level of Aggregate Expenditure in the EconomyCurrent LectureI. Aggregate Expenditure Modela. A macroeconomic model that focuses on the short-run relationship between total spending and real GDP, assuming that the price level is constant. b. Four Components of Aggregate Expenditurei. Consumptionii. Planned Investmentiii. Government Purchasesiv. Net Exportsc. Aggregate expenditure is the sum of these:These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.i. AE = C + I + G + NXd. Planned Investment vs. Actual Investmenti. Aggregate exp. Model uses planned investment, rather than actual investment, in this way, the definition of aggregate expenditures Is slightlydifferent from GDPii. Difference is that planned investment spending doesn’t include the build-up of inventories: goods that have been produced but not yet soldiii. Planned Investment = Actual Investment – Unplanned Investmente. Macroeconomic equilibriumi. Equilibrium in the macroeconomy occurs when spending on output is equal to the value of output produced; that is:1. Aggregate expenditure=GDPii. Just like markets for a particular product may not be in equilibrium, the macroeconomy may not be in equilibrium1. When aggregate expenditure is greater than GDP, inventories will decline and GDP and total employment will increase. 2. When aggregate expenditure is less than GDP, inventories will increase, and GDP and total employment will decrease. 3. If aggregate expenditure is EQUAL to GDP, inventories are unchanged and the economy is in macroeconomic equilibrium.II. Determining the Level of Aggregate Expenditure in the Economya. Components of Aggregate Expenditurei. Consumption 1. Tends to follow a relatively smooth upward trend; its growth declines during periods of recession.2. What affects the level of consumption: -Current Disposable Income (flow concept)i. Consumer expenditure is largely determined by how much money consumers receive in a given year. ii. Income expands most years, hence so does consumption-Household Wealth (stock concept: how much saved)-Expected Future Incomei. Most people prefer to keep their consumption fairly stable from year to year, a process known as consumption-smoothing.ii. If people expect to get high income in future, they will spend more.-The Price Leveli. As prices rise, household wealth falls. If you have $100,000 in the bank, that will buy fewer products at higher prices. Consequently, higher prices result in lower consumption spending.-The Interest Ratei. Higher real interest rates encourage saving rather than spending; so they result in lower spending, especially on durable goods. b. Consumption Functioni. There is a strong relationship between income and consumption. 1. A straight line (Consumption function) describes this relationship very well, suggesting that households spend a consistent fraction of each extra dollar of real disposable income on consumption. ii. The graph shows that consumers seem to have a relatively constant marginal propensity to consume: the amount by which consumption spending changes when disposable income changes. 1. This marginal propensity to consume (MPC) is the slope of the consumption function, the relationship between consumption spending and disposable income.2. We can estimate MPC- MPC = Change in consumption Change in disposable incomec. The distinction between national income and GDP is relatively minor; for this simple model, we will assume they are equal, and use the terms interchangeably.d. Disposable income not spent is saved. Therefore we can write:i. National Income= Consumption + Savings + Taxii. Y = C + S + Tiii. Marginal propensity to save (MPS)1. 1 = MPC + MPSe. Planned Investmenti. Investment has increase over time but unlike consumption, it has not increased smoothly, and recessions decrease investment more.ii. What affects the level of Investment (Determinants of Investment)1. Expectations of Future Profitability2. Interest Rate3. Taxes4. Cash