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UVA ECON 2020 - 10-12-2012Handout

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Components of the Multiplier ModelApplicationsComponents of the Multiplier ModelApplicationsMultiplier ModelElias YannopoulosOctober 12, 2012Elias Yannopoulos Multiplier ModelComponents of the Multiplier ModelApplicationsAggregate ExpenditureAggregate Production - the total amount of final goods andservices produced in an economyRemember! Production creates and equal amount of incomeAggregate production/income curve demonstrates thisrelationship, Ex: graphAggregate Expenditures - the total amount of spending onfinal goods and services in the economyThere are fours classifications of aggregate expenditures, andthey may look familiarConsumption, Investment, Government, and Net ExportsThere are two types of expendituresAutonomous expenditures - expenditures that do notsystematically vary with incomeInduced expenditures - expenditures that vary with incomeElias Yannopoulos Multiplier ModelComponents of the Multiplier ModelApplicationsExpenditure FunctionAggregate expenditure (AE) curve - graphicalrepresentation of the relationship between income andaggregate expenditureEx: graphThe slope of the AE curve is equal to the marginal propensityto expendMarginal propensity to expend (mpe) - the ratio of thechange in aggregate expenditures to a change in incomeBy assumption 0 < mpe < 1Compare with marginal propensity to consume (mpc)Aggregate expenditure function - the mathematicalrelationship between income and expenditureAE = AE0+ mpe × Y = autonomous expenditures + inducedexpendituresElias Yannopoulos Multiplier ModelComponents of the Multiplier ModelApplicationsShifts in the Expenditure FunctionShifts in autonomous expenditures - the primary shift for thismodelChanges to autonomous expenditures cause parallel shifts inthe AE curve↓ Autonomous expenditure ⇒↓ AE curve↑ Autonomous expenditure ⇒↑ AE curveThe second possible shift to the AE curve is changes in mpeA change in mpe changes the slope of the AE curve↑ mpe ⇒↑ slope of AE curve (becomes steeper)↓ mpe ⇒↓ slope of AE curve (becomes shallower)Elias Yannopoulos Multiplier ModelComponents of the Multiplier ModelApplicationsEquilibriumIn Equilibrium aggregate expenditure has to equal aggregateproduction, Ex: graphWhat if aggregate expenditure does not equal aggregateproduction?Aggregate production > Aggregate expenditureAggregate production < Aggregate expenditureExpenditures Multiplier - a number that tells how muchincome will change in response to a change in autonomousexpendituresY = Multiplier × Autonomous expendituresMultiplier =11−mpeProof (AE Func), proof (geometric series)Elias Yannopoulos Multiplier ModelComponents of the Multiplier ModelApplicationsMultiplier Model ApplicationsNow that we have determined the equilibrium level of income,what happens when there is a shock to autonomousexpenditure?Decrease in autonomous expenditure leads to aggregateproduction exceeding aggregate expenditure. which causesequilibrium income to fall, Ex: graphIncrease in autonomous expenditures leads to aggregateproduction falling short of aggregate expenditure, whichcauses equilibrium income to rise, Ex: graphTo find out how much income rises or falls we use themultiplier equation: Y = Multiplier × AutonomousexpendituresHow does the change in autonomous expenditures getmultiplied? Ex: graphElias Yannopoulos Multiplier


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UVA ECON 2020 - 10-12-2012Handout

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