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UGA ECON 2105 - Income and Expenditure continued
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ECON 2105 1nd Edition Lecture 11 Outline of Last Lecture I. Income and Expenditure II. MPC and MPS III. What determines consumer spendingIV. PracticeV. Aggregate Consumption VI. Multiplier Effect Outline of Current LectureI. Multiplier Effect II. Chain Reaction of Multiplier EffectIII. Practice IV. More practice V. What drives investment spending?VI. Inventories and unplanned investment spendingCurrent LectureModule 16 Income and Expenditure Continued I. Multiplier Effect - Assume that in the economy, MPC= 0.9 and MPS=0.1.- If construction spending rises by $100 billion, - What is the immediate impact of this constructing spending on GDP?These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o Change in investment spending is 100 billion (^I=100 billion) o ^GDP= ^C+^I o higher investment spending causes higher GDP - It increases by __100__ billion. (this is called the first round) o GDP= C+I o C= A+ MPC x YDo YD= Y + TR- T o Y is GDP o TR is transfer payment- (welfare check)o T is income tax o YD= Y o So… GDP= A+ I+ MPC x Y o A+ I is called aggregate autonomous spending- independent from the level of income (shock to the economy) when this increases gdp increases o Because of higher GDP and higher disposable income people will spend more o MPC x Y is induced consumption - Now, GDP has increased by $_100___ billion, hence income has increasedby $__100___ billion.o GDP= income - People will spend 90% of this additional income in the second round.- Consumption increased by $_90__ billiono ^c= MPC x y o .9 x 100 billion= 90 billion - Savings increased by $_10_ billion. o Reminder of the 100 billion, 100billion-90 billion = 10 billion - The impact on GDP is now $_90__ billion in the second round.- And total increase in GDP is _100_ + _90_=_190_ billion by the end of thesecond roundII. Chain Reaction of Multiplier Effect - The multiplier helps us understand the extent of the chain reactions in the economy.- In this module, we want to understand how much extra income and spending are created from an initial change in spending.- Increase in investment spending = $100 billion- + Second-round increase in consumer spending = MPC × $100 billion- + Third-round increase in consumer spending = MPC2 × $100 billion (MPC x ^y in the previous round) - + Fourth-round increase in consumer spending = MPC3 × $100 billion- Total increase in real GDP = (1 + MPC + MPC2 + MPC3 + . . .) × $100 billiono 100 billion is the initial one time increase in autonomous spending- multiplier = 1/MPS - if there is a higher MPC there will be a higher multiplier - if MPC= 0.9 - MPS= 0.1 - MPC+MPS=1 - MPS= 1-PMC - 1/0.1= 1/1-0.9= 10 - 10 means there will be a one time increase in autonomous spending, eventually GDP will rise by $10 III. Practice - Rounds of Increases of Real GDP When MPC = 0.6- Multiplier is 2.5 - GDP= C+I - ^I= 100 billion (one time) - Total impact on GDP  ^GDP=1/1-MPC x100= 250- Which means consumer spending increased by 150 - 0.6 x 250 = 150 IV. More Practice - Suppose that the marginal propensity to save in an economy is equal to 0.2. Suppose that the level of investment spending increases by $200 this year. - Trace out the total increase in real GDP, showing the increase in consumer spending for at least the second, third, and fourth round of spending and the overall increase in real GDP.o MPS= 0.2 o ^I= $200 o 1st round: ^C= 0, no impact on consumer spending, GDP goes up by $200o 2nd Round: 1-MPS= MPC so 1-.2= .8, consumer spending will rise by 80%, so ^C= $160, GDP will rise by $160 o 3rd round: ^C= 128, GDP rises by $128o total GDP increase: 1/1-MPC x 200 - Given that AAS stand for autonomous aggregate spending (demand not related to income) o AAS= A+I o ^y= 1/1-MPC x ^AAS o so the multiplier = ^y/ ^AAS = 1/1- MPC o or ^Y/^AAS = 1/MPS - Assume MPC= 0.75 - negative wealth shock  bursting of the negative housing bubble, hence A goes down by 1 trillion - C= A+ MPC x YD - What is the total impact on GDP- ^y = 1/1-MPC x ^AAS - AAS= A+I - ^AAS= lower ^A +lower ^I - 1/1-0.75 x (-1 trillion)= -4 trillion V. What drives investment spending?- Planned investment spending: the investment spending that businesses intend to undertake during a given period.- The interest rate (negatively)- Expected future real GDP (positively)- Current level of production capacity (negatively)- Interest rates are often the cost of investment projects. - When interest rates are low, more loans are undertaken and investment rises (other things equal).VI. Inventories and unplanned investment spending - Inventories: stocks of goods held to satisfy future sales.- Inventory investment: the value of the change in total inventories held in the economy during a given period.- Unplanned inventory investment: unplanned changes in inventories occurring when actual sales are more or less than businesses expected.- Actual investment spending: the sum of planned investment spending and unplanned inventory investment.- So in any period: I = IUnplanned +


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