Chapter 8 Aggregate Expenditure and Equilibrium Output Aggregate output the total quantity of goods and services produced or supplied in a economy in a given period Aggregate income the total income received by all factors of production in a given period There is an exact equality between aggregate output and aggregate income Aggregate output aka aggregate quantity supplied Aggregate output means real GDP Keynesian Theory of Consumption Key role in Keynes s model consumption rises with income Increase consumption as their incomes increase but not by as much as the increase in their income Consumption function the relationship between consumption and income o Upward sloping line slope less than 1 BUT can be curved o Straight line C a bY Y income C aggregate consumption b slope a y intercept o Marginal propensity to consume MPC that fraction of a change in income that is consumed or spent slope of consumption function MPC less than 1 tells us that individuals spend less than 100 of their income increase as Keynes suggested o Aggregate saving S the part of the aggregate income that is not consumed difference between aggregate income and aggregate consumption S triple equal sign Y C o Identity something that is always true o Marginal propensity to save MPS the fraction of a change in income that is saved o MPC MPS triple equal sign 1 o When the consumption curve is above the 45 degree line consumption exceeds income and saving is negative o When the consumption curve crosses the 45 degree line consumption is equal to income and saving is zero o When the consumption curve below the 45 degree line consumption is less than income and saving is positive Consumption is also dependent upon their wealth by the interest rate by their expectations of the future Planned Investment I The output of the economy consists not only of goods consumed by households but investments made by firms Inventory differs from other capital investments while purchases by firms of machinery and equipment are always deliberate sometimes inventories build up without any deliberate plans by firms therefore there s planned vs actual investment Planned investment those additions to capital stock and inventory that are planned by firms Actual investment the actual amount of investment that takes place it includes items such as unplanned changes in inventories The Determination of Equilibrium Output Income Equilibrium occurs when there is no tendency for change in microeconomics when planned aggregate expenditure is equal to aggregate output Planned aggregate expenditure AE the total amount the economy plans to spend in a given period consumption plus planned investment AE C I Equilibrium Y AE when aggregate output is equal to planned aggregate expenditure same thing as Y C I When output is greater than planned spending there is unplanned inventory investment firms planned to sell more of their goods than they sold increase in inventories When planned aggregate expenditure is greater than aggregate output firms have sold more than they planned to inventory investment is smaller than planned Where 45 degree line crosses planned aggregate expenditure function Keynesian cross Equilibrium condition Y C I not an identity triple equal sign bc it does not hold when we are out of equilibrium If planned spending is less than output there will be unplanned increases in inventories firms will reduce output output falls income falls consumption falls The Multiplier Change in equilibrium output will be greater than the initial change in planned investment if everyone decides to increase planned investment output will change by a multiple of the change in planned investment Multiplier the ratio of the change in the equilibrium level of output to a change in some exogenous variable Exogenous variable a variable that is assumed not to depend on the state of the economy does not change when the economy changes planned investment for our sake If planned investment goes up by say 25 an increase of output of 25 will not restore equilibrium bc it generates even more consumption spending Output and income can rise significantly more than the initial increase in planned investment but how much and how large is the multiplier Successive increases in income become smaller and smaller in each round of the multiplier process due to leakage as saving Size of the multiplier depends on the slope of the planned aggregate expenditure line steeper the slope the greater the change in output for a given change in investment Change in equilibrium income delta Y to the intial change in planned investment delta I times 1 MPS the multiplier is 1 MPS o Multiplier 1 1 MPC When tax payments depend on income the size of the multiplier is reduced
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