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**preview**shows pages 1-2. to view the full**6 pages of the document.**ECON 102: Chapter 27

Expenditure Multipliers: Keynesian Model

Fixed Prices and Expenditure Plans

-in the Keynesian Model all firms set their prices and sell the quantities their customers are willing to buy

-if the firms continuously sell more than they plan to and are running out of inventory, they will raise

their prices

-if the firms continuously sell more than they plan to and have excess inventory, they will lower their

prices

-on any given day the prices are fixed and the quantities the firms sell depend on demand not supply

-because of this, for the economy as a whole:

1. the price level is fixed

2. 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 expenditure has four components: consumption expenditure, investment, government expenditure

on goods and services and net exports

-these four components sum to real GDP

-aggregate planned expenditure: equal to the sum of the planned levels of consumption expenditure,

investment, government expenditure on goods and services and exports minus imports

-two of these components (consumption expenditure and imports) change when income changes and

so they depend on real GDP

A Two-Way Link Between Aggregate Expenditure and Real GDP

-all else remaining the same:

-an increase in real GDP increased aggregate expenditure

-an increase in aggregate expenditure increases real GDP

Consumption and Saving Plans

-the most important factors that influence consumption expenditure are:

1. disposable income

2. real interest rate

3. wealth

4. expected future income

-disposable income: aggregate income minus taxes plus transfer payments

-aggregate income equals real GDP so disposable income depends on real GDP

Consumption Expenditure and Saving

-households can only spend their disposable income on consumptions or save it, so planned

consumption expenditure plus planned saving always equals disposable income

-consumption function: the relationship between consumption expenditure and disposable income

-saving function: the relationship between saving and disposable income

Consumption Function

-disposable income is on the x-axis and consumption expenditure is on the y-axis

-as disposable income increases, so does consumption expenditure

-autonomous consumption: the amount of consumption that would take place in the short run even if

people had no current income (when disposable income is zero; y-intercept)

-induced consumption: consumption expenditure in excess of the autonomous amount; consumptions

expenditure that is induced by an increase in disposable income

45o Line

-the line showing disposable income

-when this line is above consumption expenditure, disposable income is greater than consumption

expenditure

-the reverse is true when this line is below consumption expenditure

Saving Function

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-as disposable income increases, savings increases

-when consumption expenditure exceeds disposable income saving is negative

Marginal Propensities to Consume and Save

-marginal propensity to consume (MPC): the fraction of a change in disposable

income that is spend on consumption

-calculated as the change in consumption expenditure divided by the change in disposable income

- marginal propensity to save (MPS): the fraction of a change in disposable income that is

saved

-calculated as the change in saving divided by the change in disposable income

-because an increase in disposable income is either spent or saved, the marginal propensity to consume plus

the marginal propensity to save equals 1

-MPS + MPC = 1

Slopes and Marginal Propensities

-the slope of the consumption function is the marginal propensity to consume

-the slope of the saving function is the marginal propensity to save

Consumption as a Function of Real GDP

-consumption expenditure changes when disposable income changes and disposable income changes when

real GDP changes

-consumption expenditure depends not only on disposable income but also on real GDP

Import Function

-Canadian real GDP is the main influence on Canadian imports

-an increase in Canadian real GDP increases the quantity of Canadian imports

-marginal propensity to import: the relationship between imports and real GDP

-the fraction of an increase in real GDP that is spend on income

-calculated as the change in imports divided by the change in real GDP

Real GDP with a Fixed Price Level

-aggregate expenditure schedule: lists aggregate planned expenditure generated at each level of real GDP

-aggregate expenditure curve: graph of the aggregate expenditure schedule

Aggregate Planned Expenditure

-see page 653 for table and graph example

-to calculate aggregate planned expenditure at a given real GDP we add the expenditure components together

-investment and government expenditure on goods and services are independent of the level of real GDP

-investment depends on the real interest rate and the expected profit

-exports are influenced by events in the rest of the world, prices of foreign-produced goods and services

relative to the prices of similar Canadian produced goods and services, and exchange rates

-exports are not directly affected by Canadian real GDP

-aggregate expenditure curve has real GDP on the x-axis and aggregate planned expenditure on the y-axis

-to construct this curve (also known as the AE curve) subtract imports from I + G + X + C

-induced expenditure: consumption expenditure minus imports, which varies with real GDP

-autonomous expenditure: the sum of investment, government expenditure, and exports which doesn’t vary

with real GDP

-another way of think about this expenditure is that it is the level of aggregate planned expenditure if

real GDP were zero

-aggregate expenditure curve summarizes the relationship between aggregate planned expenditure and real

GDP

Actual Expenditure, Planned Expenditure and Real GDP

-actual aggregate expenditure is always equal to real GDP

-aggregate planned expenditure isn’t always equal to actual aggregate expenditure and therefore isn’t always

equal to real GDP

-the reason for this is due to the fact that firms can end up with inventories that are greater or smaller

than planned

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