econs lecture ch 10

7/23/2019 Econs Lecture Ch 10

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The Short-Run Macro Model Spending is very important in short-run

The more income households have, the more they will spend Spending depends on income

But the more households spend, the more output firms willproduce

More income they will pay to their workers Thus, income depends on spending

In short-run, spending depends on income, and income depends onspending

Many ideas behind the model were originally developed by Britisheconomist ohn Maynard !eynes in "#$%s

Short-run macro model focuses on spending in e&plainingeconomic fluctuations

'&plains how shocks that affect one sector influence other sectors (ausing changes in total output and employment


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Thinking )bout Spending

Spending on what* In short-run macro model, focus on spending in markets for currently

produced +S goods and services Things that are included in +S ./

0eed to organi1e our thinking about markets that contribute to ./

2hat3s the best way to categori1e all these buyers into larger groups sowe can analy1e their behavior* Macroeconomists have found that the most useful approach is to

divide those who purchase the ./ into four broad categories 4ouseholds, whose spending is called consumption spending 5(6 Business firms, whose spending is called planned investment spending

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overnment agencies, whose spending on goods and services is calledgovernment purchases 56 7oreigners, whose spending we measure as net e&ports 5086

Should we look at nominal or real spending* 2hen discuss 9consumption spending,: we mean 9real consumption

spending:


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(onsumption Spending

0atural place for us to begin our look atspending is with its largest component (onsumption spending

Total consumption spending is sum ofspending by over a hundred million +Shouseholds 2hat determines total amount of consumption

spending*

;ne way to answer is to start by thinkingabout yourself or your family 2hat determines your spending in any given

month,


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.isposable Income

7irst thing that comes to mind is your income The more you earn, the more you spend

It3s not e&actly your income per period that determines yourspending But rather what you get to keep from that income after

deducting any ta&es you have to pay If we start with income you earn, deduct all ta& payments,

and then add in any transfer received, would get yourdisposable income Income you are free to spend or save as you wish

.isposable Income = Income > Ta& /ayments ? Transfers Received

(an be rewritten as .isposable Income = Income > 5Ta&es > Transfers6 or .isposable Income = Income > 0et Ta&es

7or almost any household, a rise in disposable income@with noother change@causes a rise in consumption spending


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2ealth

iven your disposable income, howmuch of it will you spend and howmuch will you save* 2ill depend, in part, on your wealth

Total value of your assets minus youroutstanding liabilities

In general, a rise in wealth@with noother change@causes a rise inconsumption spending


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The Interest Rate Interest rate is reward people get for saving, or

what they have to pay when they borrow )ll else e


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'&pectations

'&pectations about future would affect your spending as well )ll else e


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7igure "A +S (onsumption and.isposable Income, "#C-D%%E

2000

1995

1990

1985

RealConsumptionS

pending

($Billions)

5,000

6,000

4,000

3,000

7,000

Real Disposable Income ($ Billions)

3,000 4,000 5,000 6,000 7,000


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(onsumption and .isposableIncome

;f all the factors that influence consumptionspending, most important and stabledeterminant is disposable income

Relationship between consumption and

disposable income is almost perfectly linear@points lie remarkably close to a straight line This almost-linear relationship between consumption

and disposable income has been observed in a widevariety of historical periods and a wide variety ofnations

Fertical intercept in 7igure D is called )utonomous consumption spending

/art of consumption spending that is independent ofincome


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7igure DA The (onsumption7unction

Consumption

Function

1,000

600

The consumption function shows the (linea!elationship "etween eal consumptionspen#in$ an# eal #isposa"le income

an# the slope of the line(0%6! is the ma$inal

popensit& to consume%RealConsumption

Spending

($Billions

)

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Real Disposable Income ($ Billions)

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

The 'etical intecept (2,000

"illion! is autonomousconsumption spen#in$ % % %


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(onsumption and .isposableIncome

Second important feature of 7igure D is the slope Shows change along vertical a&is divided by change along

hori1ontal a&is as we go from one point to another on the line Slope = G (onsumption H .isposable Income

'conomists have given this slope a special name Marginal propensity to consume, or M/(

(an think of M/( in three different ways, but each of themhas the same meaning Slope of consumption function (hange in consumption divided by change in disposable

income

)mount by which consumption spending rises whendisposable income rises by one dollar ogic suggests that the M/( should be larger than 1ero, but

less than " 2e will always assume that % J M/( J "


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Representing (onsumption with an'


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(onsumption and Income

(onsumption function is an important building block (onsumption is largest component of spending, and disposable

income is most important determinant of consumption If government collected no ta&es, total income and disposable

income would be e


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7igure $A The (onsumption-Income ine

1% To #aw the consumption)

income line, we measueeal income (instea# of eal#isposa"le income! on thehoi*ontal a+is%

Consumption)ncome -ine

600

A

B

Real ConsumptionSpending ($ Billions)

1,000

2,000

3,000

4,000

5,0005,600

Real Income ($ Billions)

2,000 4,000 6,000 8,000

1,000

2% The line has the sameslope as the consumptionfunction in Fi$ue 2 % % %

3% "ut a #iffeent'etical intecept%


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Shifts in the (onsumption-Incomeine

If income increases and net ta&es remainunchanged, disposable income will rise, andconsumption spending will rise along with it

.ut consumption spen#in$ can also chan$e fo easons othethan a chan$e in income, causin$ consumption)income lineitself to shift

/echanism wos lie this


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Shifts in the (onsumption-Incomeine

(an summari1e our discussion of changesin consumption spending as follows 2hen a change in income causes consumption

spending to change, we move alongconsumption-income line 2hen a change in anything else besides income

causes consumption spending to change, theline will shift

)ll changes that shift the line@other than achange in ta&es@work by increasing ordecreasing autonomous consumption 5a6


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7igure EA ) Shift in the(onsumption-Income ine

Consumption)ncome -inehen et Ta+es 500

Consumption)ncome -inehen et Ta+es 2,000

RealConsumption

Spending ($Billions)

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Real Income ($ Billions)

2,000 4,000 6,000 8,000


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Table $A (hanges in (onsumptionSpending and the (onsumption>Income ine


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Investment Spending

In definition of ./, word investment by itself5represented by the letter 9I: by itself6 consists of threecomponents Business spending on plant and e


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overnment /urchases

Include all goods and services thatgovernment agencies@federal, state,and local@buy during year In short-run macro model, government

purchases are treated as a given value .etermined by forces outside of model


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0et '&ports

If we want to measure total spending on+S output, we must also considerinternational sector +S e&ports

But international trade in goods and servicesalso re Total Imports


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0et '&ports

By including net e&ports, simultaneouslyensure that we have Included +S output that is sold to foreigners, and '&cluded consumption, investment, and

government spending on output produced abroad 7or now, we regard net e&ports as a given

value, determined by forces outside of ouranalysis

Important to remember that net e&ports can

be negative +nited States has had negative net e&ports since

"#D Imports are greater than e&ports


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Summing +pA )ggregate'&penditure

)ggregate e&penditure Sum of spending by households, businesses,

government, and foreign sector on final goods andservices produced in +nited States

)ggregate e&penditure = ( ? I/

? ? 08 ( stands for household consumption spending, I/forinvestment spending, for government purchase, and08 for net e&ports

/lays a key role in e&plaining economicfluctuations

2hy* Because over several


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Income and )ggregate '&penditure

Relationship between income and spending is circular Spending depends on income, and income depends on

spending 2e take up the first part of that circle

4ow total spending depends on income

0otice that aggregate e&penditure increases as income rises But notice also that rise in aggregate e&penditure is smaller

than rise in income 2hen income increases, aggregate e&penditure 5)'6 will

rise by M/( times change in income

G)' = M/( & G ./ 2e3ve used G./ to indicate change in total income

Because ./ and total income are always the samenumber


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7inding '


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Inventories and '


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7inding '


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7igure CA .eriving the )ggregate'&penditure ine

C + IP+ G

C + IP+ G + NX

C + IP

C

2% then a## planne# in'estment (IP! % % %

1% tat with theconsumption)income line,

5% to $et the a$$e$ate e+pen#itue line%

3% $o'enment puchases (G! % % %

4% an# net e+pots (! % % %

RealAggregate

Expenditure($ Billions)

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Real GDP ($ Billions)

2,000 4,000 6,000 8,000


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7inding '


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A

B

45

0

2.we can tanslatean& hoi*ontal#istance (suchas 0B! % % %

3.into an eual'etical #istance(BA!%

1.sin$ a 45)#e$ee line % % %

7ig +sing a ECN ine to Translate.istances


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7inding '


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7igure OA .etermining '


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'


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7igure A '


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7igure #A '


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) (hange in Investment Spending

Suppose e


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) (hange in Investment Spending

2hen households spend an additional P%% billion, firmsthat produce consumption goods and services will receive anadditional P%% billion in sales revenue 2hich will become income for households that supply

resources to these firms 2ith an M/( of %, consumption spending will rise by % &

P%% billion = P$% billion, creating still more sales revenuefor firms, and so on and so onQ

Increase in investment spending will set off a chain reaction eading to successive rounds of increased spending and

income )t end of process, when economy has reached its new

e


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7igure "%A The 'ffect of a (hangein Investment Spending

1,600

1,960

2,1762,306

2,500

1,000

nitial@ise in

IP

fte@oun#

2

fte@oun#

3

fte@oun#

4

fte@oun#

5

IncreaseinAnnual GDP

ftell

@oun#s


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The '&penditure Multiplier

2hatever the rise in investment spending, e


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The '&penditure Multiplier

) sustained increase in investmentspending will cause a sustained increase in./

Multiplier process works in both directions ust as increases in investment spending

cause e


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;ther Spending Shocks

Shocks to economy can come from other sourcesbesides investment spending

Suppose government agencies increased theirpurchases above previous levels

Besides planned investment and governmentpurchases, there are two other components ofspending that can set off the same process )n increase in net e&ports 5086 ) change in autonomous consumption

(hanges in planned investment, government

purchases, net e&ports, or autonomous consumptionlead to a multiplier effect on ./ '&penditure multiplier is what we multiply initial change

in spending by in order to get change in e


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;ther Spending Shocks 7ollowing four e+/=C!)(1

1

=GDP

+/=C!)(1

1

=GDP

a+

/=C!)(1

1

=GDP


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) raphical Fiew of the Multiplier

7igure "" illustrates multiplier using aggregatee&penditure diagram

4pen#in$+/=C!)(1

1

=GDP

A n incease in autonomous consumption spen#in$,in'estment spen#in$, $o'enment puchases, o net e+potswill shift a$$e$ate e+pen#itue line upwa# "& incease inspen#in$B Causin$ euili"ium >


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7igure ""A ) raphical Fiew of theMultiplier

F

E

2,500.illion

Real GDP ($ Billions)2,000 4,000 6,000 8,000

Real AggregateExpenditure($ Billions)

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

45

AE2

AE1

ncease in:uili"ium >


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The 'ffect of 7iscal /olicy

In classical model fiscal policy@changes ingovernment spending or ta&es designed to changee

econs lecture ch 10

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