Chapter 30
AE = C + I + G + NX
C = Consumption expendituresDurable goods: T.V.s, and cars. Does
not include housesNon-durable goods: clothing, food, and
fuelServices: health care, education
I = Investment expendituresBusiness fixed investment on
structures (factories, warehouses) and equipment (vehicles,
furniture, computers)Residential investment on the construction of
new homes
G = Government expenditures on goods and servicesNew aircraft
carriers, Air Force I, Presidential limo, FBI vehicles, etc.Does
the government buy US products only?
NX = net exports = eXports iMportsX is the amount spent by
foreigners on goods built in the USAM is the amount spent by
Americans on goods from outside of the USAAggregate
Expenditure1Consumption expenditureThe Consumption function is the
relationship between consumption and disposable income
Disposable income (DI) is aggregate income (GDP) minus net taxes
(T).
DI = Y T
where T = taxes paid to the government minus transfer payments
received from the government.
The diagram to the right shows how C and DI evolve over
time.
Download the data, use Excel to derive the C
functionhttp://research.stlouisfed.org/fred2/graph/?g=o4I Simulated
consumption
2Consumption expenditureSimulated consumption
A = W + Ye PL r
C = A + mpc DI
C = [ W + Ye PL r ] + mpc DI
Example: Suppose consumer wealth is $8 trillion, expected future
income is $12 trillion, the price level is $14.5 thousand, the real
rate of interest is 3.5 percent, net tax revenue is $3 trillion,
government expenditure is $3 trillion, and the marginal propensity
to consume is 0.75. Derive the consumption function.
C = [ W + Ye PL r ] + mpc DI3Consumption expenditureSimulated
consumption
A = W + Ye PL r
C = A + mpc DI
C = [ W + Ye PL r ] + mpc DI
Example: Suppose consumer wealth is $8 trillion, expected future
income is $12 trillion, the price level is $14.5 thousand, the real
rate of interest is 3.5 percent, net tax revenue is $3 trillion,
government expenditure is $3 trillion, and the marginal propensity
to consume is 0.75. Derive the consumption function.
C = [ 8 + Ye PL r ] + mpc DI4Consumption expenditureSimulated
consumption
A = W + Ye PL r
C = A + mpc DI
C = [ W + Ye PL r ] + mpc DI
Example: Suppose consumer wealth is $8 trillion, expected future
income is $12 trillion, the price level is $14.5 thousand, the real
rate of interest is 3.5 percent, net tax revenue is $3 trillion,
government expenditure is $3 trillion, and the marginal propensity
to consume is 0.75. Derive the consumption function.
C = [ 8 + 12 PL r ] + mpc DI5Consumption expenditureSimulated
consumption
A = W + Ye PL r
C = A + mpc DI
C = [ W + Ye PL r ] + mpc DI
Example: Suppose consumer wealth is $8 trillion, expected future
income is $12 trillion, the price level is $14.5 thousand, the real
rate of interest is 3.5 percent, net tax revenue is $3 trillion,
government expenditure is $3 trillion, and the marginal propensity
to consume is 0.75. Derive the consumption function.
C = [ 8 + 12 14.5 r ] + mpc DI6Consumption expenditureSimulated
consumption
A = W + Ye PL r
C = A + mpc DI
C = [ W + Ye PL r ] + mpc DI
Example: Suppose consumer wealth is $8 trillion, expected future
income is $12 trillion, the price level is $14.5 thousand, the real
rate of interest is 3.5 percent, net tax revenue is $3 trillion,
government expenditure is $3 trillion, and the marginal propensity
to consume is 0.75. Derive the consumption function.
C = [ 8 + 12 14.5 3.5 ] + mpc DI7Consumption
expenditureSimulated consumption
A = W + Ye PL r
C = A + mpc DI
C = [ W + Ye PL r ] + mpc DI
Example: Suppose consumer wealth is $8 trillion, expected future
income is $12 trillion, the price level is $14.5 thousand, the real
rate of interest is 3.5 percent, net tax revenue is $3 trillion,
government expenditure is $3 trillion, and the marginal propensity
to consume is 0.75. Derive the consumption function.
C = [ 8 + 12 14.5 3.5 ] + 0.75 DI8Consumption
expenditureSimulated consumption
A = W + Ye PL r
C = A + mpc DI
C = [ W + Ye PL r ] + mpc DI
Example: Suppose consumer wealth is $8 trillion, expected future
income is $12 trillion, the price level is $14.5 thousand, the real
rate of interest is 3.5 percent, net tax revenue is $3 trillion,
government expenditure is $3 trillion, and the marginal propensity
to consume is 0.75. Derive the consumption function.
C = 2 + 0.75 DI9Consumption expenditureExample (continued):
C = 2 + 0.75 DI
When DI = 0
C = 2 + 0.75(0)
C = 2
When DI = 8
C = 2 + 0.75(8)
C = 2 + 6
C = 8
02DIC88Simulated consumption10Consumption
expenditure02DIC88Example (continued):
C = 2 + 0.75 DI
When consumption lies on the 45 line, all disposable income is
consumed and saving is zero.
Saving = DI C = 8 8 = 0
45 oSimulated consumption11Consumption expenditureExample
(continued):
C = 2 + 0.75 DI
When consumption lies below the 45 line, saving occurs.
When DI = 9.5
C = 2 + 0.75(9.5) = 2 + 7.125 = 9.125
S = DI C = 9.5 9.125 = 0.3750
9.502DIC45 o9.125Simulated consumption12Consumption
expenditureExample (continued):
C = 2 + 0.75 DI
When consumption lies above the 45 line, dissaving occurs.
When DI = 6
C = 2 + 0.75(6) = 2 + 4.5 = 6.5
S = DI C = 6 6.5 = 0.5
602DIC45 o6.5Simulated consumption13Consumption
expenditureExample (continued): With real GDP held constant at 15
trillion dollars, show what happens to the consumption model
whenconsumer wealth rises to 8.5 trillion dollarsexpected future
income decreases to 11.5 trillion dollars price level increases to
14.5 thousand dollarsmpc increases to 0.8 real rate of interest
increases by 0.5 pct. pointstax revenue is cut by 0.5 trillion
dollarsgovernment expenditure is raised by 0.5 trillion dollarsWhat
is monetary policy, and who conducts it?What is fiscal policy, and
who conducts it?Compute the budget balance. Is there a budget
deficit or surplus?
Simulated consumption
14wealth is $8 trillionexpected future income is $12 trillionthe
price level is $14.5 thousandthe real rate of interest is 3.5
percentnet tax revenue is $3 trilliongovernment expenditure is $3
trillionConsumption expenditureBecause AE, AD, SRAS, and LRAS are
graphed with Y on the horizontal axis, C should be too:C = [ W + Ye
PL r ] + mpc DI
DI = Y T
C = [ W + Ye PL r ] + mpc (DI)
C = [ W + Ye PL r ] + mpc (Y T )
C = [ W + Ye PL r ] + mpc Y mpc T
C = [ W + Ye PL r mpc T ] + mpc Y
Simulated consumer expenditure 15Consumption
expenditureSimulated consumer expenditure
Example (continued): With real GDP held constant at 15 trillion
dollars, show what happens to the consumption model whenconsumer
wealth rises to 8.5 trillion dollarsexpected future income
decreases to 11.5 trillion dollars price level increases to 14.5
thousand dollarsmpc increases to 0.8 real rate of interest
increases by 0.5 pct. pointstax revenue is cut by 0.5 trillion
dollarsgovernment expenditure is raised by 0.5 trillion dollarsWhat
is monetary policy, and who conducts it?What is fiscal policy, and
who conducts it?Compute the budget balance. Is there a budget
deficit or surplus?
16wealth is $8 trillionexpected future income is $12 trillionthe
price level is $14.5 thousandthe real rate of interest is 3.5
percentnet tax revenue is $3 trilliongovernment expenditure is $3
trillionImport function Money is spent on domestic products (C )
& imported products (M ). M is the amount spent by Americans on
goods from outside of the USA. In the short run, the factor
influencing imports is U.S. real GDP
If Y = 0, products cannot be imported (M = 0)As Y rises,
expenditures on imports increase. Download the following data to
generate an empirical iMport function
http://research.stlouisfed.org/fred2/graph/?g=o4M
Marginal Propensity to iMport is the fraction of a rise in Y
spent on imports.
M = mpm Y
Simulated net foreigner expenditure eXports are exogenousNX = X
MNX = X mpmY
Example: In addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc
= 0.75, and T = 3, assume, investment expenditures total $2.75
trillion, government expenditures total $3 trillion, exports total
$2 trillion, and mpm = 0.25. Derive the AE equation.
NX = 0.5 0.25Y Net foreigner expenditure17Aggregate
ExpenditureAE = [C ]+ I + G + NX }Simulated AE18AE = [C ]+ I + G +
{NX}
NX = X mpm Y
C = W + Ye PL r mpc T + mpc Y
AE = [W + Ye PL r mpc T + mpc Y ] + I + G + {X mpm Y }
AE = [W + Ye PL r mpc T + I + G + X ] + mpc Y mpm Y
AE = [W + Ye PL r mpc T + I + G + X ] + { mpc mpm } Y Aggregate
ExpenditureSimulated AE19AE = [C ]+ I + G + {NX}
M = mpm Y
C = W + Ye PL r mpc T + mpc Y
AE = [W + Ye PL r mpc T + mpc Y ]+ I + G + X {mpm Y }
AE = [W + Ye PL r mpc T + I + G + X ] + mpc Y mpm Y
AE = [W + Ye PL r mpc T + I + G + X ] + { mpc mpm } Y Aggregate
ExpenditureSimulated AE20Aggregate ExpenditureSimulated AEExample:
In addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and
T = 3, assume, investment expenditures total $2.75 trillion,
government expenditures total $3 trillion, exports total $2
trillion, and mpm = 0.25. Derive the AE equation.AE = [W + Ye PL r
mpc T + I + G + X ] + { mpc mpm } Y21Aggregate ExpenditureSimulated
AEExample: In addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc =
0.75, and T = 3, assume, investment expenditures total $2.75
trillion, government expenditures total $3 trillion, exports total
$2 trillion, and mpm = 0.25. Derive the AE equation.AE = [8 + Ye PL
r mpc T + I + G + X ] + { mpc mpm } Y22Aggregate ExpenditureAE = [8
+ 12 PL r mpc T + I + G + X ] + { mpc mpm } YSimulated AEExample:
In addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and
T = 3, assume, investment expenditures total $2.75 trillion,
government expenditures total $3 trillion, exports total $2
trillion, and mpm = 0.25. Derive the AE equation.23Aggregate
ExpenditureSimulated AEExample: In addition to W = 8, Ye = 12, PL =
14.5, r = 3.5, mpc = 0.75, and T = 3, assume, investment
expenditures total $2.75 trillion, government expenditures total $3
trillion, exports total $2 trillion, and mpm = 0.25. Derive the AE
equation.AE = [8 + 12 14.5 r mpc T + I + G + X ] + { mpc mpm }
Y24Aggregate ExpenditureSimulated AEExample: In addition to W = 8,
Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and T = 3, assume,
investment expenditures total $2.75 trillion, government
expenditures total $3 trillion, exports total $2 trillion, and mpm
= 0.25. Derive the AE equation.AE = [8 + 12 14.5 3.5 mpc T + I + G
+ X ] + { mpc mpm } Y25Aggregate ExpenditureSimulated AEExample: In
addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and T =
3, assume, investment expenditures total $2.75 trillion, government
expenditures total $3 trillion, exports total $2 trillion, and mpm
= 0.25. Derive the AE equation.AE = [8 + 12 14.5 3.5 0.75 T + I + G
+ X ] + { 0.75 mpm } Y26Aggregate ExpenditureSimulated AEExample:
In addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and
T = 3, assume, investment expenditures total $2.75 trillion,
government expenditures total $3 trillion, exports total $2
trillion, and mpm = 0.25. Derive the AE equation.AE = [8 + 12 14.5
3.5 0.75 3 + I + G + X ] + { 0.75 mpm } Y27Aggregate
ExpenditureSimulated AEExample: In addition to W = 8, Ye = 12, PL =
14.5, r = 3.5, mpc = 0.75, and T = 3, assume, investment
expenditures total $2.75 trillion, government expenditures total $3
trillion, exports total $2 trillion, and mpm = 0.25. Derive the AE
equation.AE = [8 + 12 14.5 3.5 0.75 3 + 2.75 + G + X ] + { 0.75 mpm
} Y28Aggregate ExpenditureSimulated AEExample: In addition to W =
8, Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and T = 3, assume,
investment expenditures total $2.75 trillion, government
expenditures total $3 trillion, exports total $2 trillion, and mpm
= 0.25. Derive the AE equation.AE = [8 + 12 14.5 3.5 0.75 3 + 2.75
+ 3 + X ] + { 0.75 mpm } Y29Aggregate ExpenditureSimulated
AEExample: In addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc =
0.75, and T = 3, assume, investment expenditures total $2.75
trillion, government expenditures total $3 trillion, exports total
$2 trillion, and mpm = 0.25. Derive the AE equation.AE = [8 + 12
14.5 3.5 0.75 3 + 2.75 + 3 + 2 ] + { 0.75 mpm } Y30Aggregate
ExpenditureSimulated AEExample: In addition to W = 8, Ye = 12, PL =
14.5, r = 3.5, mpc = 0.75, and T = 3, assume, investment
expenditures total $2.75 trillion, government expenditures total $3
trillion, exports total $2 trillion, and mpm = 0.25. Derive the AE
equation.AE = [8 + 12 14.5 3.5 0.75 3 + 2.75 + 3 + 2 ] + { 0.75
0.25 } Y31Aggregate ExpenditureSimulated AEExample: In addition to
W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and T = 3, assume,
investment expenditures total $2.75 trillion, government
expenditures total $3 trillion, exports total $2 trillion, and mpm
= 0.25. Derive the AE equation.AE = [ 7.5 ] + { 0.5 } Y32Aggregate
Expenditure
When Y = 0 AE = 7.5 + 0.5 (0) = 7.5
When Y = 15 AE = 7.5 + 0.5 (15) = 15Simulated AEExample: In
addition to W = 8, Ye = 12, PL = 14.5, r = 3.5, mpc = 0.75, and T =
3, assume, investment expenditures total $2.75 trillion, government
expenditures total $3 trillion, exports total $2 trillion, and mpm
= 0.25. Derive the AE equation.AE = 7.5 + 0.5 Y33Example:
Point 1Y = 0 AE = 7.5
Point 2Y = 15AE = 15
Since aggregate planned expenditure equals GDP, the change in
firms inventories equals the planned change. The AE model has
reached an equilibrium
07.5YAE151545 oAggregate ExpenditureSimulated AE34Example:
Suppose real GDP is $19 trillion.
AE = 7.5 + 0.5(19) = 7.5 + 9.5 = 17
AE < YWhen aggregate planned expenditure is less than real
GDP, an unplanned increase in inventories occurs.0YAE45 oAggregate
Expenditure19 17Simulated AE350YAE45 oAggregate Expenditure19AE =
YSimulated AE 171515firms cut production. Real GDP decreases until
it reaches equilibrium.Example: Suppose real GDP is $19
trillion.
AE = 7.5 + 0.5(19) = 7.5 + 9.5 = 17
AE < YWhen aggregate planned expenditure is less than real
GDP, an unplanned increase in inventories occurs.3613Example:
Suppose real GDP is $11 trillion.
AE = 7.5 + 0.5(11) = 7.5 + 5.5 = 13
AE > YWhen aggregate planned expenditure exceeds real GDP ,
an unplanned decrease in inventories occurs.0YAE45 oAggregate
Expenditure11Simulated AE3713firms raise production. Real GDP
increases until it reaches equilibrium.0YAE45 oAggregate
Expenditure111515Example: Suppose real GDP is $11 trillion.
AE = 7.5 + 0.5(11) = 7.5 + 5.5 = 13
AE > YWhen aggregate planned expenditure exceeds real GDP ,
an unplanned decrease in inventories occurs.AE = YSimulated
AE38Aggregate ExpenditureSimulated AE
Example (continued): With real GDP held constant at 15 trillion
dollars, show what happens to the consumption model whenconsumer
wealth rises to 8.5 trillion dollarsexpected future income
decreases to 11.5 trillion dollars price level increases to 14.5
thousand dollarsmpc increases to 0.8 real rate of interest
increases by 0.5 pct. pointstax revenue is cut by 0.5 trillion
dollars. Compute the tax cut multiplier. Compute the budget
balance. government expenditure is raised by 0.5 trillion dollars.
Compute the government expenditure multiplier. Compute the budget
balance.What is monetary policy, and who conducts it?What is fiscal
policy, and who conducts it?
39wealth is $8 trillionexpected future income is $12 trillionthe
price level is $14.5 thousandthe real rate of interest is 3.5
percentnet tax revenue is $3 trilliongovernment expenditure is $3
trillioninvestment expenditures total $2.75 trillionexports total
$2 trillionAE = [8 + 12 14.5 3.5 0.75 3 + 2.75 + 3 + 2 ] + { 0.75
0.25 } YYAE What happens if the price level rises by 1 thousand
dollars?
15.5AE > Y13AE = 5.25 + 0.5 YY = 5.25 + 0.5 Y0.5 Y= 5.25Y=
10.51545 oYPL15AD13Aggregate ExpenditureSimulated ADExample
(continued):6.57.5(PL = 15.5)(PL = 14.5)14.515.5Unplanned increase
in inventoriesReal GDP will fall40
