Chapter 11 The Short Run Macro Model Intro Spending depends on income and income depends on spending Short run macro model a macroeconomic model that explains how changes in spending can affect real GDP in the short run o Total spending determines the level of production and changes in spending play the central role in explaining economic fluctuations Consumption Spending Determinants of Consumption Spending Disposable Income The income households are free to spend or save as they wish Disposable Income Income Tax Payments Transfers Received o OR Disposable income Income Net Taxes A rise in disposable income with no other change causes a rise in consumption spending Wealth The Interest Rate Wealth is the total value of household assets home stocks bonds bank accounts minus outstanding liabilities student loans mortgage loans credit card debt A rise in wealth with no other change causes a rise in consumption spending Wealth Household assets outstanding liabilities The reward people get for saving or what they have to pay when they borrow The higher the interest rate the greater the incentive to pay back debt and the less they will spend on consumption goods A rise in the interest rate causes a decrease in consumption spending All else equal optimism about future income causes an increase in consumption spending Expectations Consumption and Disposable Income spending is disposable income The Consumption Function The most important and stable determinant of the factors that influence consumption The relationship between consumption and disposable income is roughly linear Consumption function a positively sloped relationship between real consumption spending and real disposable income Autonomous Consumption Autonomous Consumption spending the vertical intercept of the consumption function the part of consumption spending that is independent of income Represents the influence on consumption spending of everything other than disposable income Increase in autonomous consumption spending If household wealth were to increase consumption would be greater at any level of disposable income The entire consumption function would shift upward so its vertical intercept would increase Decrease in autonomous consumption caused by a decrease in wealth would shift the consumption function downward The Marginal Propensity to Consume Slope of the consumption function MPC the amount by which consumption spending rises when disposable income rises Chapter 11 The Short Run Macro Model by one dollar Slope Consumption Disposable income Representing Consumption with an Equation C a b Y T C consumption spending a vertical intercept autonomous consumption spending o Does not depend on disposable income b slope of consumption function MPC Consumption and Income Assume that the relationship between consumption spending and disposable income is Consumption income line a line showing aggregate consumption spending at each level At any level of income taxes reduce disposable income and therefore reduce the same of income or GDP consumption spending o Net taxes have lowered the consumption income line o Taxes cause disposable income to drop by T at any given income level which in turn causes consumption spending to drop by MPC x T o Because of taxes the vertical intercept of the consumption income line is no longer just autonomous consumption a but instead is a MPC x T The slope of the consumption income line is unaffected by net taxes o With net taxes held at a fixed amount disposable income rises dollar for dollar with income When the govt collects a fixed amount of taxes from households the line representing the relationship between consumption and income is shifted downward by the amount of the tax times the MPC The slope of this line is unaffected by taxes and is equal to the MPC Shifts in the Consumption Income Line Movement rightward along the consumption income line Shift upward of the consumption income line o Income Disposable Income Consumption Spending o Taxes Disposable Income at each income level Consumption at each income level Shift upward of the consumption income line o Autonomous consumption Consumption at each level of disposable income Consumption spending at each level of income When a change in income causes consumption spending to change we move along the consumption income line When a change in anything else besides income causes consumption spending to change the line will shift Total Spending Other Components of Total Spending Investment Spending Does not include changes in inventories Government Purchases Chapter 11 The Short Run Macro Model Include all of the goods and services that government agencies buy during the year A given value determined by forces outside of our analysis We must deduct imports or we would be over counting total spending on US goods and Net Exports services Summing Up Aggregate Expenditure Aggregate expenditure is the sum of spending by households businesses the government and the foreign sector on final goods and services produced in the US Aggregate Expenditure C IP G NX Income and Aggregate Expenditure Spending depends on income and income depends on spending Aggregate expenditure increases as income rises o The rise in aggregate expenditure is smaller than the rise in income When income increases aggregate expenditure AE will rise by the MPC times the change in income AE MPC x GDP Equilibrium GDP Finding the Equilibrium Spending determines the economy s equilibrium income or equilibrium GDP As ourselves what would happen hypothetically if the economy were operating at different levels of output When aggregate expenditure is less than GDP output will decline in the future Thus any level of output at which aggregate expenditure is less than GDP cannot be the equilibrium GDP When aggregate expenditure is greater than GDP output will rise in the future Thus any level of output at which aggregate expenditure exceeds GDP cannot be the equilibrium GDP In the short run equilibrium GDP is the level of output at which output and aggregate expenditure are equal Inventory and Equilibrium GDP When firms produce more goods than they sell the unsold output is added to their inventory stocks inventory stocks When firms sell more goods than they produce the additional goods come from firms The change in inventories during any period will always equal output minus AE Inventories GDP AE AE GDP Inventories 0 GDP in future periods AE GDP Inventories 0 GDP in future periods AE
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