8 Aggregate Demand and the Powerful Consumer Men are disposed as a rule and on the average to increase their consumption as their income increases but not by as much as the increase in their income JOHN MAYNARD KEYNES Contents Contents Aggregate Aggregate Demand Demand Domestic Domestic Product Product and and National National Income Income The The Circular Circular Flow Flow of of Spending Spending Production Production and and Income Income Consumer Consumer Spending Spending and and Income Income The The Important Important Relationship Relationship The The Consumption Consumption Function Function and and the the Marginal Marginal Propensity Propensity to to Consume Consume Copyright 2006 South Western Thomson Learning All rights reserved Contents Contents continued continued Factors Factors that that Shift Shift the the Consumption Consumption Function Function The The Extreme Extreme Variability Variability of of Investment Investment The The Determinants Determinants of of Net Net Exports Exports How How Predictable Predictable isisAggregate Aggregate Demand Demand Appendix Appendix National National Income IncomeAccounting Accounting Copyright 2006 South Western Thomson Learning All rights reserved AD AD Domestic Domestic Product Product and and National National Income Income Aggregate Aggregate Demand Demand the the total total amount amount that that all all consumers consumers business business firms firms and and government government agencies agencies are are willing willing to to spend spend on on final final goods goods and and services services Consumer Consumer Expenditure Expenditure the the total total amount amount spent spent by by consumers consumers on on newly newly produced produced goods goods and and services services excluding excluding purchases purchases of of new new homes homes which which are are considered considered investment investment goods goods Copyright 2006 Southwestern Thomson Learning All rights reserved AD AD Domestic Domestic Product Product and and National National Income Income Investment Investment Spending Spending the the sum sum of of the the expenditures expenditures of of business business firms firms on on new new plant plant and and equipment equipment and and households households on on new new homes homes Financial Financial investments investments are are not not included included nor nor are are resales resales of of existing existing physical physical assets assets Government Government Purchases Purchases the the goods goods and and services services purchased purchased by by all all levels levels of of government government Copyright 2006 Southwestern Thomson Learning All rights reserved AD AD Domestic Domestic Product Product and and National National Income Income Net Net Exports Exports the the difference difference between between U S U S exports exports and and U S U S imports imports Indicates Indicates the the difference difference between between what what we we sell sell to to foreigners foreigners and and what what we we buy buy from from them them AD AD C C II G G X X IM IM Copyright 2006 Southwestern Thomson Learning All rights reserved AD AD Domestic Domestic Product Product and and National National Income Income National National Income Income the the sum sum of of the the incomes incomes that that all all individuals individuals in in the the economy economy earned earned in in the the forms forms of of wages wages interest interest rents rents and and profits profits Excludes Excludes government government transfer transfer payments payments Pre tax Pre tax Copyright 2006 Southwestern Thomson Learning All rights reserved AD AD Domestic Domestic Product Product and and National National Income Income Disposable Disposable Income Income the the sum sum of of the the incomes incomes of of all all the the individuals individuals in in the the economy economy after after all all taxes taxes have have been been deducted deducted and and all all transfer transfer payments payments have have been been added added DI DI GDP GDP Taxes Taxes Transfers Transfers Y Y TT Copyright 2006 Southwestern Thomson Learning All rights reserved Circular Circular Flow Flow of of Spending Spending Production Production and and Income Income Circular Circular flow flow diagram diagram shows shows the the relationship relationship of of the the different different components components of of expenditure expenditure and and income income National National income income domestic domestic product product Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 1 1 The The Circular Circular Flow Flow of of Expenditures Expenditures and and Income Income G 3 en tP ur c G S 4 C I 1 G Consumers Go ve rnm Investors IM X s t or rts p I m xp o E I ha se s 2 g vin Inv es tm en n C I C Sa io pt m u ns o C C t I Financial System Rest of the World X I Government M s Taxe s f er Trans le ab os sp Di In co m e D I 5 6 Firms produce the domestic product e ss Gro Incom al Nation Y Consumer Consumer Spending Spending and and Income Income A Ascatter scatter diagram diagram with with U S U S data data shows shows the the close close relationship relationship between between real real disposable disposable income income and and real real consumer consumer spending spending Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 2 2 Consumer Consumer Spending Spending and and Disposable Disposable Income Income 8 000 7 500 7 000 6 500 6 000 5 500 Billions of 2000 Dollars 5 000 4 500 4 000 Real disposable income 3 500 3 000 2 500 2 000 1 500 The Great Depression World War II Real consumer spending 1 000 500 0 2004 1930 1940 1950 1960 1970 1980 1990 2000 Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 3 3 Consumer Consumer Spending Spending and and Disposable Disposable Income Income 2004 2003 2002 2001 2000 Real Consumer Spending 1998 1997 5 619 1995 1994 1992 1990 1991 1989 1988 1987 1986 1984 1979 1980 1978 1976 1974 3 036 1999 1996 1985 1970 1964 1960 1955 1947 1945 1941 1942 1943 1939 1929 0 3 432 Real Disposable Income 6 081 Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 4 4 Consumer Consumer Spending Spending and and Disposable Disposable Income Income Real Consumer Spending 1900 1963 1700 1500 1360 1300 B 180 billion 1180 A 1100 200 900 0 1947 900 1100 billion 1300 1500 1700 1900 Real Disposable Income Copyright 2006 South Western