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Lect 10

1) The document discusses expenditure multipliers and how an increase in autonomous expenditure like investment or government spending can increase aggregate expenditure and real GDP through a multiplier effect. 2) It explains that the multiplier effect occurs because the initial increase in expenditure induces further rounds of spending as income increases, up until equilibrium is reached. 3) The size of the multiplier depends on factors like the marginal propensity to consume, marginal propensity to save, and marginal propensity to import, with a higher MPC and lower MPS and MPM resulting in a larger multiplier effect.

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101 views

Lect 10

1) The document discusses expenditure multipliers and how an increase in autonomous expenditure like investment or government spending can increase aggregate expenditure and real GDP through a multiplier effect. 2) It explains that the multiplier effect occurs because the initial increase in expenditure induces further rounds of spending as income increases, up until equilibrium is reached. 3) The size of the multiplier depends on factors like the marginal propensity to consume, marginal propensity to save, and marginal propensity to import, with a higher MPC and lower MPS and MPM resulting in a larger multiplier effect.

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EXPENDITURE

MULTIPLIERS
Fixed Prices and Expenditure Plans

Expenditure Plans
The four components of aggregate expenditure—
consumption expenditure, investment, government
purchases of goods and services, and net exports—sum
to real GDP.
Aggregate planned expenditure equals planned
consumption expenditure plus planned investment plus
planned government purchases plus planned exports
minus planned imports.
Fixed Prices and Expenditure Plans

A two-way link exists between aggregate expenditure and


real GDP:
 An increase in real GDP increases aggregate
expenditure
 An increase in aggregate expenditure increases real
GDP
Fixed Prices and Expenditure Plans

Consumption Function and Saving Function


Consumption and saving are influenced by:
 The real interest rate
 Disposable income
 Wealth
 Expected future income
Disposable income is aggregate income (GDP) minus
taxes plus transfer payments.
Fixed Prices and Expenditure Plans

To explore the two-way link between real GDP and


planned consumption expenditure, we focus on the
relationship between consumption expenditure and
disposable income when the other factors are constant.
The relationship between consumption expenditure and
disposable income, other things remaining the same, is
the consumption function.
And the relationship between saving and disposable
income, other things remaining the same, is the saving
function.
Fixed Prices and
Expenditure Plans

Figure 10.1 illustrates the


consumption function and
the saving function.
Fixed Prices and Expenditure Plans

Marginal Propensities to Consume and Save


The marginal propensity to consume (MPC) is the fraction
of a change in disposable income spent on consumption.
It is calculated as the change in consumption expenditure,
C, divided by the change in disposable income, YD, that
brought it about.
That is:

MPC = C/ YD
Fixed Prices and Expenditure Plans

The marginal propensity to save (MPS) is the fraction of a


change in disposable income that is saved.
It is calculated as the change in saving, S, divided by the
change in disposable income, YD, that brought it about.
That is:

MPS = S/ YD
Fixed Prices and Expenditure Plans

The MPC plus the MPS equals one.


To see why, note that,
C + S = YD.
Divide this equation by YD to obtain,
C/ YD + S/ YD = YD/ YD,
or
MPC + MPS = 1.
Fixed Prices and
Expenditure Plans

Slopes and Marginal


Propensities
Figure 10.2 shows that the
MPC is the slope of the
consumption function and
the MPS is the slope of
the saving function.
Fixed Prices and
Expenditure Plans

Other Influences on
Consumption
Expenditure and Saving
When an influence other
than disposable income
changes—the real
interest rate, wealth, or
expected future income—
the consumption function
and saving function shift.
Figure 10.3 illustrates
these effects.
Fixed Prices and Expenditure Plans

Import Function
In the short run, imports are influenced primarily by U.S.
real GDP.
The marginal propensity to import is the fraction of an
increase in real GDP spent on imports.
In recent years, NAFTA and increased integration in the
global economy have increased U.S. imports.
Removing the effects of these influences, the U.S.
marginal propensity to import is probably about 0.2.
Real GDP with a Fixed Price Level

Equilibrium Expenditure
Equilibrium expenditure is the level of aggregate
expenditure that occurs when aggregate planned
expenditure equals real GDP.
The Multiplier

The multiplier is the amount by which a change in


autonomous expenditure is magnified or multiplied to
determine the change in equilibrium expenditure and real
GDP.
The Multiplier

The Basic Idea of the Multiplier


An increase in investment (or any other component of
autonomous expenditure) increases aggregate
expenditure and real GDP and the increase in real GDP
leads to an increase in induced expenditure.
The increase in induced expenditure leads to a further
increase in aggregate expenditure and real GDP.
So real GDP increases by more than the initial increase in
autonomous expenditure.
The Multiplier

Figure 10.7 illustrates the


multiplier.
The Multiplier Effect
The amplified change in
real GDP that follows an
increase in autonomous
expenditure is the
multiplier effect.
The Multiplier

When autonomous
expenditure increases,
inventories make an
unplanned decrease, so
firms increase production
and real GDP increases to
a new equilibrium.
The Multiplier

Why Is the Multiplier Greater than 1?


The multiplier is greater than 1 because an increase in
autonomous expenditure induces further increases in
expenditure.
The Size of the Multiplier
The size of the multiplier is the change in equilibrium
expenditure divided by the change in autonomous
expenditure.
The Multiplier

The Multiplier and the Marginal Propensities to


Consume and Save
Ignoring imports and income taxes, the marginal
propensity to consume determines the magnitude of the
multiplier.
The multiplier equals 1/(1 – MPC) or, alternatively,
1/MPS.
The Multiplier

Imports and Income Taxes


Income taxes and imports both reduce the size of the
multiplier.
Including income taxes and imports, the multiplier equals
1/(1 – slope of the AE curve).
The Multiplier

Figure 10.9 shows the


relation between the
multiplier and the slope of
the AE curve.
In part (a) the slope of the
AE curve is 0.75 and the
multiplier is 4.
The Multiplier

In part (b) the slope of the


AE curve is 0.5 and the
multiplier is 2.
The Multiplier

Business Cycle Turning Points


Turning points in the business cycle—peaks and troughs
—occur when autonomous expenditure changes.
An increase in autonomous expenditure brings an
unplanned decrease in inventories, which triggers an
expansion.
A decrease in autonomous expenditure brings an
unplanned increase in inventories, which triggers a
recession.
EXPENDITURE
MULTIPLIERS

THE
END

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