Equilibrium Output

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Equilibrium Output

• Class 10

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We know the components of output. What
determines the level of output?

• Equilibrium Output
• GDPCIG(Ex-Im)
• Lets ignore net exports for the moment (recall,
  they dont account for much -wise)
• Lets ignore government, too (for simplicity)
• GDPCI
• The consumption/income schedule determines output
• Shows the amount of desired consumption at
  different levels of national output

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In a given period, households use part of their
income for consumptions and part on saving

• Income, Consumption, Saving Patterns
• Families with higher incomes tend to have higher
  consumption expenditures
• Higher-income families tend to save a larger
  portion of their disposable income than do
  lower-income families
• Higher-income families spend a smaller portion of
  disposable income on food than do lower-income
  families
• Income Consumption Savings
• Y C S

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The marginal propensity to consume is the
fraction of additional income that is spent on
consumption

• MPC
• Extra consumption induced by another dollar of
  disposable income

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Marginal Propensity to Save is the fraction of
the increased in income that is saved

• MPS
• Change in desired saving that is brought about by
  a change in income of 1
• Can be completely derived from MPC
• MPC MPS 1

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Dissaving
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Income is not the only determinant of consumption

• Nonincome Factors that Affect Consumption
• When income changes, we have a movement along the
  consumption/income curve
• There is a shift in the consumption curve when
  something other than income changes
• Expectations
• Stock of Assets
• Purchasing Power
• Taxation
• Attitudes

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Now, lets add investment (I)

• Assumption The amount of desired investment is
  fixed
• No Gov, No International Trade

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Desired Decisions are not necessarily realized

• Title
• Bullets

45 degree line
CI
C
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Equilibrium occurs when the economy produces an
output that equals desired aggregate expenditures

• Equilibrium
• Aggregate Output Y
• Aggregate Expenditure C I
• Y C I
• S I

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Now, we can start to build the downward sloping
AD curve
AE (at p)
AE (at p)

• AD Curve
• Recall, as prices fall, purchasing power for
  every given level of income goes up
• Consumption for every level of income goes up

Expenditures
y
y
p
Price Level
p
AD
y
y
Income
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What happens to the income/expenditure
equilibrium when desired aggregate expenditures
change?

• Autonomous Expenditures
• We are talking only about what happens when
  autonomous expenditures change
• Expenditures that shift the level of desired
  aggregate expenditures
• Independent of income changes
• Changes in government spending
• Changes in investment
• Changing attitudes towards thrift
• Changing expectations

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Lets say there is a change in planned investment
spending
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Example 50 billion increase in investment
450
400
400
600
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A 50 billion increase in investment spending
causes a 200 billion increase in output (from
400 billion to 600 billion)

• Expenditure Multiplier Effect
• Ration of the change in output to the change in
  autonomous expenditures
• Investment Multiplier
• In this case 200/50 4

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Why would the investment multiplier be greater
than one?

• Multiplier Effects
• If investment increases by 50 billion
• Income increases by 50 billion
• Some of the new income will be saved, some will
  be consumed
• MPC 50 billion will be consumed
• 0.75 50 billion 37.5 billion
• Income increases by 37.5 billion
• Some of the new income will be saved, some will
  be consumed
• MPC 37.5 billion will be consumed
• 0.75 37.5 billion 28 billion

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Algebraically
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The multiplier has implications for output
instability

• The Theory of Investment
• If investment spending is highly unstable, the
  multiplier would magnify this instability
• Is there a role for government to stabilize
  spending?

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Another example

• Calculate the saving/income schedule
• Determine the MPC and MPS
• Determine at what level of income the break-even
  point of zerp saving is reached
• Determine the aggregate expenditure schedule if
  investment is constant at 50
• Find equilibrium output. What is investment and
  saving at this point?
• What happens to equilibrium output if investment
  falls to zero?
• What is the investment multiplier?

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Next Class

• Optional stock market class tomorrow
• Fiscal and Monetary Policy