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Economics 1022A/B
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Jeannie Gillmore
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Economics

Economics 1022A/B

Jeannie Gillmore

Fall

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Chapter 27
Expenditure Multipliers
Fixed Prices and Expenditure Plans
• Several factors influence consumption expenditure and saving.
• The most direct influence is disposable income, which is real GDP or aggregate income minus
net taxes (taxes minus transfer payments).
• Planned consumption expenditure plus planned saving equals disposable income.
• The greater the disposable income, the greater is consumption expenditure and the greater is
saving.
• The relationship between consumption expenditure and disposable income, other things
remaining the same, is called the consumption function.
• The relationship between saving and disposable income, other things remaining the same, is
called the saving function.
• The extent to which a change in disposable income changes consumption expenditure depends
on the marginal propensity to consume.
• The marginal propensity to consume(MPC) is the fraction of a change in disposable income
that is consumed.
• The marginal propensity to consume is calculated as the changein consumption expenditure ΔC,
divided by the change in disposable income, ΔYD.
• That is:
MPC = ΔC ÷ ΔYD
• The extent to which a change in disposable income changes saving depends on the marginal
propensity to save.
• The marginal propensity to save (MPS) is the fraction of a change in disposable income that is
saved.
• The marginal propensity to save is calculated as the changein saving ΔS, divided by the change
in disposable income, ΔYD.
• That is:
MPS = ΔS ÷ ΔYD
• The marginal propensity to consume plus the marginal propensity to save sum to 1.
• You can see this from the following:
C + S = YD
ΔC + ΔS = ΔYD
(ΔC ÷ ΔYD) + (ΔS ÷ ΔYD) = (ΔYD ÷ ΔYD)
MPC + MPS = 1 • The figure below shows the MPC as the slope of the consumption function.
• MPC is $150 billion ÷ $200 billion = 0.75.
• The figure below shows the MPS as the slope of the saving function.
• MPS is $50 billion ÷ $200 billion = 0.25.
The relationship between imports and real GDP is determined by themarginal propensity to import.
• The marginal propensity to importis the fraction of an increase in real GDP that is spent on
imports.
• It is calculated as the change in imports divided by the change in real GDP that brought it about,
other things remaining the same. Real GDP with a Fixed Price Level
• Aggregate planned expenditure equals planned consumption expenditure plus planned
investment plus planned government expenditures plus planned exports minus planned imports.
• The table sets out an aggregate expenditure schedule, together with the components of
aggregate planned expenditure.
• The figure shows the AE curve.
• It is made up from the consumption function minus the import function plus I, G, and X.
• The AE curve can be thought of as
two parts:
o Autonomous expenditure
o Induced expenditure
• Autonomous expenditure is the
sum of investment, government
expenditures, and exports, which
does not vary with real GDP.
• Induced expenditure is
consumption expenditure minus
imports, which varies with real GDP.
• Actual aggregate expenditure is always equal to real GDP.
• Aggregate planned expenditure is not necessarily equal to real GDP.
• Planned expenditure can depart from real GDP because of unplanned changes in inventories.
• Equilibrium expenditure is in the level of aggregate expenditure that occurs when aggregate
planned expenditure equals real GDP. • The figure shows equilibrium expenditure.
• The AE curve shows aggregate planned
expenditure at each level of real GDP.
• The 45-degree line shows actual aggregate
expenditure at each level of real GDP.
• Only at point D is actual aggregate expenditure
equal to aggregate planned expenditure.
• So, $1,200 billion is equilibrium real GDP.
• Below $1,200 billion, aggregate planned
expenditure exceeds real GDP.
• Above $1,200 billion, aggregate planned
expenditure is less than real GDP.
• The bottom figure shows the unplanned
inventory changes that bring a convergence to
equilibrium expenditure.
• Below $1,200 billion, aggregate planned
expenditure exceeds real GDP, so inventories
fall below their target levels.
• Firms increase production.
• Real GDP increases.
• Above $1,200 billion, aggregate planned
expenditure is less than real GDP, so
inventories rise above their target levels.
• Firms decrease production.
• Real GDP decreases.
• At $1,200 billion, aggregate planned expenditure equals real GDP, so inventories remain at their
target levels.
• Firms do not change production.
• Real GDP remains constant.
The Multiplier
• A change in expenditure generates a change in income.
• The change in income induces a change in consumption expenditure.
• The change in consumption expenditure increases income further.
• Where does the process end?
• The multiplier is the amount by which a change in autonomous expenditure is magnified or
multiplied to determine the change in equilibrium expenditure and real GDP. • Let’s look at the table of an AE schedule.
• By studying the schedule, you can work out the equilibrium of real GDP (Y) and aggregate
expenditure, AE.
• The equilibrium is $1,200 billion, the level at which aggregate planned expenditure equals real
GDP.
• Now suppose that aggregate planned expenditure increases $50 billion.
• We must make a new AE schedule.
• Now what is the equilibrium?
• Again, you can work it out from the schedule.
• Equilibrium expenditure has now increased to $1,400 billion, an increase of $200 billion.
• But aggregate planned expenditure increased by only $50 billion.
• The additional $150 billion is induced expenditure and results from the multiplier.
• Let’s look at this same phenomenon in the figureabove.
• Initially, equilibrium is at $1,200 billion.
• When aggregate planned expenditure increases, the AE curve shifts upward.
• Here, the AE curve shifts upward by $50 billion.
• The new AE curve is AE 1
• Equilibrium is now at $1,400 billion.
• In the example we’ve just studied, the multiplier is 4. • It is calculated as:
Multiplier = Change in equilibrium expenditure
Change in autonomous expenditure

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