Chapter 13 Private Sector Components of

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• Chapter 13 Private Sector Components of
• Aggregate Demand
• Read pages 267-286
• I Determining the Level of Consumption
• Consumption and Disposable Personal Income.
• 1) Disposable Personal Income is the income
  that people have available to spend on goods and
  services.
• 2) The relationship between consumption and
  disposable personal income is called the
  consumption function.

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• 3) The marginal propensity to consume (MPC) is
  the change in consumption one expects for a one
  unit change in disposable income.
• a) Example MPC 400/500 .8
• b) It is the slope of the consumption function.
• 4) Personal savings is disposable personal income
  not spent on consumption during a particular
  period.

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• a) Personal savings disposable income
  consumption.
• 5) The savings function relates personal saving
  in any period to disposable personal income in
  that period.
• 6) The ratio of the change in personal savings
  to the change in disposable personal income is
  the marginal propensity to save.
• a) Example MPS 100/500 .2
• b) The marginal propensity to save is the
  slope of the savings function.

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• C) Current versus Permanent Income
• 1) The current income hypothesis holds that
  consumption in any one period depends on income
  during that period (alone).
• 2) Permanent income is the average annual income
  people expect to receive for the rest of their
  lives.
• 3) The permanent income hypothesis assumes that
  consumption in any period depends on permanent
  income.

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• D) Other Determinants of Consumption
• Changes in real Wealth an increase or decrease
  in stock and bond prices makes holders of these
  assets wealthier or poorer and they would be
  likely change their consumption in response.
• 2) Changes in expectations consumers are more
  willing to consume when they are optimistic about
  the future.

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• II The Aggregate Expenditure Model
• The aggregate expenditure model relates aggregate
  expenditures, which equal the sum of planned
  levels of consumption, investment and government
  purchases and net exports at a given price level
  to the level of real GDP.

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• B) The Aggregate Expenditure Model A simplified
  View
• 1) We will only included investment and
  consumption.
• 2) The level of investment firms intend to
  make in a period is called planned investment.
• 3) Unplanned investment is investment during a
  period that firms did not intend to make.
  Typically consists of changes in inventories.

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• C) Autonomous and Induced Aggregate Expenditures.
• 1) Expenditures that do not vary with the level
  of real GDP are called autonomous aggregate
  expenditures.
• 2) Expenditures that vary with real GDP are
  called induced aggregate expenditures.

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• D) Autonomous and Induced Consumption
• Consider the consumption function
• C 300 Billion .8Y
• 1) Autonomous consumption is 300 Billion.
• 2) Induced consumption is .8Y

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• E) Plotting the Aggregate Expenditure Curve.
• Assume planned investment is entirely
  autonomous Ip 1,100Billion.
• AE C Ip
• 300 B .8Y 1,100 B
• 1,400B .8Y
• 1) If Y6000 B, then AE 6,200 B
• F) The Slope of the Aggregate Expenditure Curve
  equals the marginal propensity to consume.

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• F) Equilibrium in the Aggregate Expenditure Model
• 1) Equilibrium occurs when aggregate
  expenditures equals aggregate supply,
• AEAS.
• 2) The possible equilibrium can be graphed as a
  45 degree line.
• 3) The observed equilibrium occurs where the
  observed AE curve crosses the 45 degree line.

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• G) Changes in Aggregate Expenditures The
  Multiplier.
• 1) Consider the previous model, but assume
  that planned investment expenditures increases to
  1,400 B. The new
• AE 300 B .8 Y 1,400 B
• 1,700 B .8Y
• The new equilibrium occurs when AEY, or at
  8,500 for an increase of 8,500-7,000 1,500.
  Thus a 300 increase in spending resulted in a
  1,500 increase in GDP for a multiplier of
  1,500/3005.

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• 2) The domino effect of a spending change can be
  illustrated by Exhibit 13-11.
• 3) The multiplier is related to the marginal
  propensity to consume by
• Multiplier 1/(1-MPC)
• Example In the example MPC.8, so
• Multiplier 1/.2 5

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• H) Application of the Aggregate Expenditure Model
  to a More Realistic View of the Economy.
• 1) In a model in which taxes take some of the
  additional income, disposable income does not
  increase by as much in each successive round and
  thus the multiplier is smaller.
• 2) Government spending and net exports become
  part of autonomous spending.

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• 3) This differences make the AE curve somewhat
  flatter and have a higher intercept.
• 4) The flatter curve implies a smaller
  multiplier and can be illustrated in the
  following diagram.

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• III Aggregate Expenditures and Aggregate Demand.
• A) Aggregate expenditure curves and price
  levels.
• 1) Consider an initial price level of p1.0 as
  our reference point. This induces a demand for
  goods in our diagram of 6,000.
• 2) Next consider a higher price level of p1.5.
  Due to a negative wealth effect, expenditures
  will be lower inducing a demand of 2,000.
• 3) Next consider a price level of p.5. Due to
  a positive wealth effect, expenditures will be
  higher inducing a demand of 10,000.
• 4) These produce a downward sloping demand
  curve.

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• B) The multiplier and changes in Aggregate
  Demand.
• Any change in autonomous aggregate
  expenditures shifts the aggregate demand curve.
  The amount that it shifts equals the change in
  autonomous aggregate expenditures times the
  multiplier.