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Lecture

# ECO101H1 Lecture Notes - International Monetary Fund, Autonomous Consumption, Inventory Investment

Department
Economics
Course Code
ECO101H1
Professor
James Pesando

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GDP measures:
1)national output
and
2)national income
Question: How is national income determined?
Answer: -Where desired spending- called Aggregate expenditure (AE)
equals national income (output)
Simple Model: AE= C + I
AE= Aggregate expenditure = desired spending
C= planned (desired) consumption by households
I= planned (desired) investment by firms
(Price level is fixed)
Price level is fixed Nominal GDP = Real GDP
Simplifying assumption to start analysis.
Eg; International Monetary Fund (IMF)
January 2011 projections of real GDP (measure of output)
CountryReal GDP Growth
2008 2009 2010 2011
U.S.0.4-2.5 2.7 2.4
China9.6 8.7 10.0 9.7
Russia5.6-9.0 3.6 3.4
World3.0-0.8 3.9 4.3
Consumption:
1.households consumption (C) depends upon income (Y)
Savings (S) = income not consumed
2.Key concepts
Marginal- propensity-to-consume (mpc)= C/Y
Marginal-propensity-to-save (MPS) = S/Y
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mpc+mps = 1
INVESTMENT
1. firms undertake investment ( I ) in anticipation of earning a profit.
2.Will treat I as fixed ( I = 25 in example #1)
Example: Consumption Function
YCS(=Y-C) C/ Y S/ Y
0 10 -10- -
100 100 0 .9.1
200 190 10 .9.1
300 280 20 .9.1
C= 10 + 0.9Ympc=0.9
S = Y C = Y (10 +0.9Y)
= -10 + 0.1 Ymps = 0.1
Diagram #1) Consumption Function
Autonomous Consumption
If there is no change in Y, but C changes, result is change in autonomous
consumption.
C = 10 + 0.9Y
Vs.
C1 = 20 + 0.9Y
1)autonomous consumption has increased by 10.
2)Consumption function shifts up by 10.
Change in Autonomous consumption is change not due to change in income
Sources: -change in wealth ( if wealth increases, so does spending)
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-change in interest rates
U.S. 2009
Deep recession
Why?
Consumption (68% of GDP in U.S.) fell sharply
Why?
Large decline in household wealth (housing) downward shift in
consumption function
Firms’ Investment
1.new plant and equipment
2.residential construction
3.inventories
Insight
Undesired (unplanned) fluctuations in inventory investment cause firms to
change production.
Undesired inventory investment (actual sales < planned sales)
reduce production
Undesired inventory disinvestment (Actual sales > planned sales)
expand production
example; Firm Produces/Sells shirts
Desired inventory: 5,000 shirts
Current Production: 10,000 shirts (per month)
Sales (month) in inventory
production
10,000 0 no change
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