MGEB06H3 Lecture Notes - Lecture 5: Permanent Income Hypothesis, Autonomous Consumption, Government Spending

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Macroeconomics Notes: Lecture Five (Chapter Eleven) PART1:
The Multiplier: An Informal Introduction:
ā€¢ Macroeconomics is NOT just adding things up; we also need to consider the interactions
of different sectors.
ā€¢ The income-expenditure simple model that examines the chain reaction of an initial
change in autonomous expenditure (spending that is considered automatic and necessary)
on output so that we can explain the business cycles.
ā€¢ The income-expenditure model shows that the ultimate change in output (Y) due to a
change in autonomous expenditure (AE0) is:
ā€¢ ļ„Y = M Ɨ ļ„AE0, where M = the multiplier (how much will output change).
ā€¢ The multiplier (M) is the ratio of the total change in real GDP caused by an
autonomous change in aggregate expenditure to the size of that autonomous change,
i.e., M = īŽæīƒ
īŽæī®ŗī®¾ī°¬
ā€¢ Autonomous is an initial change in the desired level of spending by firmā€™s
households or government at a given level of real GDP
Assumptions of the Income-Expenditure Model (In the Meantime):
ā€¢ Producers are willing supply additional output at a fixed price
ā€¢ change in aggregate expenditure leads to change in aggregate output (real GDP).
ā€¢ Ex. If the consumer buying investments goods decide to spend an addition $1 billion that
will translate the production of $1 billion worth of addition goods without driving up
overall level of prices
ā€¢ Interest rate is held fixed ļƒž i = ī¬“ī’§.
ā€¢ Government spending, taxes and transfers are given ļƒž G = īœ©ī’§, T = T0 (lump-sum taxes), &
TR = TR0 (lump-sum transfers). We expect them to be zero
ā€¢ Exports and imports are given ļƒž X = X0 (autonomous exports) & IM = IM0 (autonomous
imports). We expect them to be zero
Consumer Spending:
Assumptions:
ā€¢ Households split their disposable income (YD) between consumption and savings. YD = Y
ā€“ T + TR = C + SPrivate.
ā€¢ Households spend a constant fraction of their current disposable income on final goods and
services.
ā€¢
Implications:
ā€¢ When disposable income increases, households divide the increase in disposable income
between consumption and savings.
ā€¢ ļ„YD = ļ„Consumption + ļ„Sprivate
ā€¢ The marginal propensity to consume (MPC) refers to the change in consumption for a
given change in disposable income. MPC = īŽæī€ƒī®¼īÆ¢īÆ”īƦīÆØīÆ īÆ£īƧīƜīÆ¢īÆ”
īŽæī®½īƜīƦīÆ£īÆ¢īƦīƔīƕīƟīƘī€ƒīƜīÆ”īƖīÆ¢īÆ īƘ; where 1 > MPC > 0
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Document Summary

Assumptions of the income-expenditure model (in the meantime): producers are willing supply additional output at a fixed price, change in aggregate expenditure leads to change in aggregate output (real gdp), ex. If the consumer buying investments goods decide to spend an addition billion that will translate the production of billion worth of addition goods without driving up overall level of prices. Assumptions: households split their disposable income (yd) between consumption and savings. T + tr = c + sprivate: households spend a constant fraction of their current disposable income on final goods and services. (cid:3005)(cid:3046)(cid:3043)(cid:3042)(cid:3046)(cid:3028)(cid:3029)(cid:3039) (cid:3041)(cid:3030)(cid:3042)(cid:3040); where 1 > mpc > 0: any change in disposable income is split between consumption and savings. Changes in expected future disposable income: holding all else constant, autonomous consumption increases when expected future disposable income increases. If there is a temporary increase in income, households would save most of their income and just spend a small portion from the income now.

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