Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Changes in Macroeconomic ActivityThe Business Cycle•The phases of the business cycle are:•Recovery or Expansion,•Peak or Boom (shaded green)•Recession or Contraction•trough or Depression (blue shaded areas).TimeReal GDPBusiness peakDepressionor troughRecessionRecoveryBusiness peakDepression or troughTrend line•Ups and downs characterize business activity.•There has been an upward trend in real GDP in the United States and other industrial nations.The Business Cycle•Cycles are irregular •Source: Economic Report of the President, various issues.•Annual growth rate of real GDP•6•8•4•2•0•- 2•1960•1965•1970•1975•1980•1985•1990•1995•2000•2005•Long-run growth rate(approx. 3%)•2009Changes in Total (Aggregate) Spending in the Economy, cause changes in total (aggregate) production and employment1. Households2. Businesses3. The Government4. ForeignersHouseholdsBusinessesGoods and Services MarketsResource MarketsResourcesPayments $$•Simple Case: all output is purchased by the household•Nothing left for businesses, government or foreigners1. Spend their earned income2. Biggest spenders (7.1 of 10.2 trillion)3. Expansiona. Increased spendingb. larger outputc. increased employmentd. more income4. Contractiona. Decreased spendingb. smaller outputc. decreased employmentd. less income•Next Case: households save some of their income, output is left over•Businesses purchase left over output, government or foreigners still get noneAnotherCircularFlow1. Investment spending2. Borrow to buy capital replace old and new machinery3. Reasons to buy or investa. expected profitsb. economic activityc. lower interest rates•Next Case: not all output is purchased by the household or businesses•something left for government or foreigners1. Second largest spender2. Purchases goods and services3. provides transfersNo goods or services receivedAnotherCircularFlow•Final Case: all output is not purchased domestically•Something left for foreigners1. ExportsForeign purchases of US goods and services2. ImportsUS purchases of Foreign goods and servicesAnotherCircularFlowFrom the Circular Flow:1. Savings – consumers not spending2. Taxes - money not able to spend3. Imports - money sent abroadFrom the Circular Flow:1. Investments –spending from Business2. Government transfers - money not earned by Households3. Exports - money from abroadThe Multiplier•The Multiplier: A change in an injection (e.g. investment) leads to an even larger change in output and employment. •An injection comes from outside of the circular flow. (non-household) •Once it enters, the dollars are spent over and over. •The multiplier is the number by which the change in spending is multiplied to obtain the total increase. •The size of the multiplier depends on how much is spent of each increase. •The greater this %, the greater the effectThe Multiplier•Remember:•injections will increase the size of the multiplier; •leakages will decrease the size of the multiplier,effectively, $4 million is spent in the economy.•Here, a $1,000,000 injection is spent, received as payment, saved and spent, received as payment, saved and spent … etc. … until …Expenditure stage Additional income(dollars) Marginal propensity to consumeAdditional consumption(dollars) For simplicity (here) it is assumed that all additions to income are either spent domestically or saved.1,000,000 750,000 562,500 421,875 316,406 949,219750,000 562,500 421,875 316,406 237,305 711,914 Round 1 Round 2 Round 3 Round 4 Round 5 Total4,000,000 3,000,000All others 3/4 3/4 3/4 3/4 3/4 3/4 3/4The Multiplier Principle•The multiplier concept is based upon the proportion of additional income that households choose to spend (here assumed to be 75% = 3/4).Assume the people will spend .8 (80%) of a change in their income and the change in business investment is $10 (billion). Complete the table below. How much will they save? ______change in incomechange in consumptionchange in savingsincrease in invest-ment of $10 billion+ $10 8 22nd round 8 6.4 1.63rd round 6.4 5.1 1.34th round 5.1 4.1 15th round 4.1 3.3 .8all other rounds 16.38 13.10 3.28Totals 50 40 10MPCSize of multiplier9/10 4/5 3/4 2/3 1/2 1/310.0 5.0 4.0 3.0 2.0 1.5M = 11 - %spentHigher SpendingMeans a Larger Multiplier•As the spending % increases more and more money of every injection is spent (and so received as payment and then spent again, received as payment and spent again, etc.).•The effect is that for higher spending, higher multipliers result, specifically the relationship follows this equation:Change in investment % saved multiplier effect $10 20% ________ $10 10% ________$10 25% ________$20 20% ________Calculating the effect of the multiplier:change in the injection % not spent (saved)•The phase of the business cycle where real GDP, or output, reaches its maximum is the:•a. limit •b. trough•c. peak•d. expansion•Money received by a household from the government for which there is no work directly performed in return is:•a. a surtax•b. a payment-in-kind.•c. a transfer payment.•d. an income tax refund.•Which of the following is a leakage from the spending stream by households?•a. saving•b. a decrease in earned income.•c. the receipt of transfer payments.•d. borrowing from financial institutions.•A decrease in interest rates would•a. have no effect on investment decisions•b. make investment projects less attractive.•c. make more investment projects attractive•d. make investment spending as stable as personal consumption expenditures.The 2 main categories of government expenditures are:a. defense expenditures and tax refundsb. purchases of goods and purchases of servicesc. purchases of goods and services and transfer paymentsd. income determined and non-income-determined spending.The multiplier effect is the change in:a. income-determined spending generated by a change in total output.b. total output generated by a change in income-determined spending.c. total output generated by a change in non-income-determined spending.d. non-income-determined spending generated by a change in total