Income and Expenditures EquilibriumIncome and Expenditures Equilibrium

2

Equilibrium Real GDP: mpc = .7, mpi = .1(1)

RealGDP(Y)

(2)

Consumption(C)

(3)

Investment(I)

(4)Gov’t

Spending(G)

(5)Net

Exports(X)

(6)Aggregate

Expenditures(AE)

(7)Unplanned Change in Inventories

(8)Change in Real

GDP

0 30 50 70 50 200 -200 Up

100 100 50 70 40 260 -160 Up

200 170 50 70 30 320 -120 Up

300 240 50 70 20 380 -80 Up

400 310 50 70 10 440 -40 Up

500 380 50 70 0 500 0 No chg

600 450 50 70 -10 560 40 Down

700 520 50 70 -20 620 80 Down

3Real GDP (Output)

Agg

rega

te p

lan

ned

expe

ndit

ure

400

500

600

700

0 300 400 500 600 700

45o line: AE = Y

Total Expenditure

Reduce Output,Reduce Employment

Increase Output,increase Employment

Movement to EquilibriumMovement to Equilibrium

4

Leakages and InjectionsLeakages and Injections

5

Spending Multiplier

The spending multiplier measures the change in equilibrium income (real GDP) produced by change in autonomous expenditures:

ΔY/ΔI = ΔY/ΔG = ΔY/ΔX – By how many dollars does real GDP change for

every dollar change in autonomous expenditures?

MPIMPS 1

leakages1

Multiplier

6

Computing the Spending Multiplier:Marginal propensity to save = mps = .3Marginal propensity to import = mpi = .1

MPIMPS 1

leakages1

Multiplier

If MPS = 0.30 and MPI is 0.10, then MPS + MPI = 0.40 = 4/10.

1/0.40 = 1/(4/10) = 10/4 = 2.5

The multiplier is 2.5.

NOTE: The spending multiplier would be larger in a closed economy because MPI would be zero.

7

Multiplier at WorkMultiplier at Work

8

Gaps: Recessionary Gap, GDP Gap

9

GDP Gap, Recessionary GapGDP gap = potential real GDP

– actual real GDP– How much does real GDP have to

increase to generate full employment?

Recessionary gap

– How much additional spending is needed to achieve potential GDP (to create full employment)?

multiplier spendinggap GDP

gapry Recessiona

10

Sequence of ExpendituresSequence of Expenditures

11

Sequence of ExpendituresSequence of Expenditures

12

From Aggregate ExpendituretoAggregate Demand

13

The Fixed-Price, Keynesian AS-AD Model

14

The Paradox of ThriftThe Paradox of Thrift