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Economics 1022A/B
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Jeannie Gillmore
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Economics

Economics 1022A/B

Jeannie Gillmore

Summer

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Chapter 27 Notes
Fixed Prices and Expenditure Plans
on any given day, firms prices are fixed and the quantity they sell as depend on
demand, not supply
o because each firm’s price are fixed, for economy as a whole:
the price level is fixed
aggregate demand determines real GDP
the Keynesian model explains fluctuations in aggregate demand at a fixed price level
by identifying the forces that determine expenditure plans
Expenditure Plans
aggregate planned expenditure is equal to the sum of the planned levels of
consumption expenditure, investment, government expenditure on goods and
services, and net exports
o consumption expenditure and imports change when income changes so they
depend on Real GDP
other things remaining the same:
o an increase in real GDP increases aggregate expenditure
o an increase in aggregate expenditure increases real GDP
it is thus a two-way link
Consumption and Saving Plans
saving is influenced by the following factors:
o disposable income
o real interest rate
o wealth
o expected future income
disposable income is aggregate income minus taxes plus transfer payments
o since aggregate income equals real GDP, disposable income depends on real
GDP
o we focus on the relationship between disposable income and consumption
expenditure when the other three factors are constant
Consumption Expenditure and Saving
households can only spend their disposable income on
consumption or save it, so planned consumption plus
planned saving always equals income
consumption function
o the consumption function is the relationship
between consumption expenditure and
disposable income
autonomous consumption is the
amount of consumption that would
take place if people had no current
income induced consumption is the amount of consumption expenditure
induced by an increase in
disposable income
the 45˚ line measures disposable income
saving function
o the saving function is the relationship
between saving and disposable income
o when consumption expenditure exceeds
disposable income, saving is negative
(dissaving)
Marginal Propensities to Consume and Save
the marginal propensity to consume (MPC) is the fraction
of a change in disposable income that is spent on
consumption
o calculated as the change in consumption expenditure
divided by the change in disposable income
o in 2010, the Canadian MPC was 0.85
the marginal propensity to save (MPS) is the fraction of a change in disposable
income that is saved
o calculated as the change in saving divided by the
change in disposable income
the sum of MPC + MPS always equals 1
o disposable income is always spent or saved
the MPS and MPC can also be found by calculation the slope
of the saving and consumption function respectively
Consumption as a Function of Real GDP
consumption expenditure changes when disposable income changes and disposable
income changes when real GDP changes
o therefore, consumption expenditure depends also on real GDP
o we use this to help determine equilibrium expenditure
Import Function
an increase in Canadian real GDP increases the quantity of Canadian imports
the relationship between imports and real GDP is determined by the marginal
propensity to import
o calculated as the fraction of an increase in real GDP that is spent on
imports Real GDP with a Fixed Price Level
aggregate planned expenditure
o to calculate aggregate planned expenditure at a given real GDP, we add
the expenditure components
together (C + I + G + X – M)
o consumption expenditure minus
imports (which varies with real
GDP) is called induced
expenditure
o the sum of investment,
government expenditure, and
exports (which does not vary
with real GDP) is called
autonomous expenditure
equals the level of
aggregate planned
expenditure if real GDP were zero
o the aggregate expenditure curve summarizes the relationship between
aggregate planned expenditure and real GDP
actual aggregate expenditure is always equal to real GDP (planned expenditure is not
always equal to actual, thus not always equal to real GDP)
o actual and planned expenditure can differ when firms end up with
inventories that are greater or smaller than planned
o people carry out their consumption expenditure plans, the government
expenditure plans, and net exports are as planned
firms carry out their plans to purchase new capital (investment)
however, a firms’ inventory varies
o if aggregate planned expenditure is less than real GDP, firms sell less
than they planned to sell and end up with unplanned inventories
o if aggregate planned expenditure exceeds
real GDP, firms sell more than they
planned to sell and end up with
inventories that are too low
Equilibrium Expenditure
equilibrium expenditure is the level of aggregate
expenditure that occurs when aggregate planned
expenditure equals real GDP
o is a level of aggregate expenditure and real
GDP at which spending plans are fulfilled
o at a given price level, equilibrium
expenditure determines real GDP
convergence to equilibrium (from below)
o suppose real GDP is 1000, meaning that actual
expenditure is also 1000
o planned expenditure is 1100 o when people spend 1100 and firms produce 1000, inventories fall by 100
because the change in inventories is part of investment, actual
investment is 100 less than planned investment
when inventories fall below a firms target, firms increase production to
restore them to target level to do this they hire additional labour and
increase production
production than increases by 100, so real GDP increases by 100 to 1100
the process continues until real GDP and planned expenditure are equal,
and unplanned inventory changes are zero (firms don’t change
production)
convergence to equilibrium (from above)
o suppose real GDP is 1400, actual aggregate expenditure is 1400, but planned
expenditure is 1300
o firms inventories than rise by 100 firms cut production until real GDP
reaches 1200
The Multiplier
the multiplier is the amount by which a change in autonomous expenditure is
multiplied by to determine the change in equilibrium expenditure and real GDP
suppose that investment increases
o the additional expenditure by business means that aggregate expenditure and
real GDP increase increase in real GDP leads to increases in disposable
income, and with no income taxes, real GDP and disposable income increase
by the same amount
o the increase in disposable income brings an increase in consumption
expenditure adds even more to aggregate expenditure
o the initial increase in investment brings an
even bigger increase in aggregate
expenditure because it induces an increase in
consumption expenditure
the magnitude of the increase in

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