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Lecture 29

Lecture 29-Aggregate Demand and Aggregate Supply

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Department
Economics
Course Code
ECO102H1
Professor
Jack Carr

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Tuesday, February 2nd, 2010.
Aggregate demand and Aggregate Supply
GDP Measures:
(1) National output
(2) National income
Question:
How is national income determined?
Answer:
Where desired spending -!FDOOHG³$JJUHJDWH([SHQGLWXUH´$(HTXDOVQDWLRQDOLQFRPH
(output)
Simple Model:
AE = C + I
C: planned (desired) consumption by households
I: planned (desired) investment by firms
Consumption
1. +RXVHKROGV¶FRQVXPSWLRQ&) depends upon income (Y)
Savings (S) = Income Not Consumed
2. Key Concepts
Marginal ± propensity ± to ± consume (mpc) = ¨&¨Y
Marginal ± propensity ± to ± VDYHPSV ¨6¨<
MPC + MPS = 1
Investment
1. Firms undertake investment (I) in anticipation of earning a profit
2. Will treat I as fixed (I = 25 in first example)
Example: Consumption Function
Y C S(=Y-C) ¨&¨< ¨6¨<
0 10 -10 - -
100 100 0 0.9 0.1
200 190 10 0.9 0.1
300 280 20 0.9 0.1
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Description
Tuesday, February 2nd, 2010. Aggregate demand and Aggregate Supply GDP Measures: (1) National output (2) National income Question: How is national income determined? Answer: Where desired spending -!FDOOHG³$JJUHJDWH([SHQGLWXUH´$(HTXDOVQDWLRQDOLQFRPH(output) Simple Model: AE = C + I C: planned (desired) consumption by households I: planned (desired) investment by firms Consumption 1. +RXVHKROGV¶FRQVXPSWLRQ&) depends upon income (Y) Savings (S) = Income Not Consumed 2. Key Concepts Marginal ± propensity ± to ± consume (mpc) = ¨&¨Y Marginal ± propensity ± to ± VDYHPSV ¨6¨< MPC + MPS = 1 Investment 1. Firms undertake investment (I) in anticipation of earning a profit 2. Will treat I as fixed (I = 25 in first example) Example: Consumption Function Y C S(=Y-C) ¨&¨< ¨6¨< 0 10 -10 - - 100 100 0 0.9 0.1 200 190 10 0.9 0.1 300 280 20 0.9 0.1 www.notesolution.com C = 10 + 0.9Y mpc = 0.9 S = Y ± C = Y ± (10 + 0.9Y) = -10 + 0.1Y mpc = 0.1 Consumption Function C = 10 + 0.9Y Induced consumption (changes due to change in disposable income) Autonomous consumption (change not due to change in disposable income) Example (text): changes in - wealth - interest rates - expectations about future Insight x Induced consumption = movement along consumption function x Autonomous consumption = shift in 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. &¶ < (1) Autonomous consumption has increased by 10 (2) Consumption function shift up by 10 10 C 100 100 200 Y 190 C 45° www.notesolution.com )LUP¶V,QYHVWPHQW 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) Ö Reduce production Undesired inventory disinvestment (actual sales > planned sales) Ö Expand production National Income (Output) Determination AE National Y C I (C+I) Income . 250 235 25 260 Expands 300 280 25 305 Expands 350 325 25 350 Equilibrium 400 370 25 395 Contracts 450 415 25 440 Contracts Involuntary inventory investment $(!2XWSXW:inventories involuntarily declines :Iirms increase production AE < Output : inventories involuntarily rise :Iirms reduce production 10 C + I = AE 35 350 C Y National Output Aggregate Planned Expenditure 45° 25 www.notesolution.com AE = Output :inventories are at desired levels (so firms have no incentive to change production) Question: If firms increase investment [I] from 25 to 35: Will Y increase by more than 10? exactly 10? less than 10? www.notesolution.comnd Tuesday, February 2 , 2010. Aggregate demand and Aggregate Supply GDP Measures: (1) National output (2) National income Question: How is national income determined? Answer: Where desired spending -.,OO0JJ70J,90[503L9:70 06:,O83,9L43,OL3.420 (output) Simple Model: AE = C + I C: planned (desired) consumption by households I: planned (desired) investment by firms Consumption 1. +4:80K4O8.438:259L43 ) depends upon income (Y) Savings (S) = Income Notonsumed 2. Key Concepts Marginal propensity to consume (mpc) = Y Marginal propensity to 8,;0 258 $ < MPC + MPS = 1 Investment 1. Firms undertake investment (I) in anticipation of earning a profit 2. Will treat I as fixed (I = 25 in first example) Example: Consumption Function Y C S(=Y-C) < $ < 0 10 -10 - - 100 100 0 0.9 0.1 200 190 10 0.9 0.1 300 280 20 0.9 0.1 www.notesolution.com
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