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Western University

Management and Organizational Studies

Management and Organizational Studies 2275A/B

Henry Meredith

Winter

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Chapter 27
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 theving 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 thenge in consumption
expenditure ∆C, divided by the change in disposable income, ∆YD.
• That is:
MPC = ∆C ÷ ∆YD
• 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 change in saving ∆S, divided
by the change in disposable income,YD.
• That is:
MPS = ∆S ÷ ∆YD
• The marginal propensity to consume plus the marginal propensity to save sum to
1.
• You can see this from the following:
C + S = YD
∆C + ∆S = ∆YD
(∆C ÷∆YD)+ (∆S ÷∆YD) = (∆YD ÷ ∆YD)
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 the marginal
propensity to import.
• The marginal propensity to import is 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
plusplanned investment plus planned government expenditures plus planned
exports minuslanned imports.
• The table sets out an aggregate expenditure schedule, together with the
components of aggregate planned expenditure.
Planned expenditure
Y C I G X M AE
(billions of 1997 dollars)
0 0 150 180 170 0 500
A 700 490 150 180 170 140 850
B 800 560 150 180 170 160 900
C 900 630 150 180 170 180 950
D 1,000 700 150 180 170 200 1,000
E 1,100 770 150 180 170 220 1,050
F 1,200 840 150 180 170 240 1,100 • 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 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
a ctual aggregate
expenditure equal to
aggregate planned
expenditure.
• So, $1,000 billion is
equilibrium real GDP.
• Below $1,000 billion,
aggregate planned
expenditure exceeds
real GDP.
• Above $1,000 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 $1,000 billion,
aggregate planned
expenditure exceeds
real GDP, so
inventories fall below
their target levels.
Figure 23.6: Equilibrium Expenditure
• Firms increase
production.
• Real GDP increases.
• Above $1,000 billion, aggregate planned expenditure is less than real GDP, so
inventories rise above their target levels.
• Firms decrease production.
• Real GDP decreases. • At $1,000 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 anschedule.
• By studying this schedule, you can work out the equilibrium level of real GDP (
and aggregate expenditure, AE.
Y AE
0
A 900 925
B 1,000 1,000
C 1,100 1,075
D 1,200 1,150
E 1,300 1,225
• The equilibrium is $1,000 billion, the level at which aggregate planned
expenditure equals real GDP.
• Now suppose that aggregate planned expenditure increases by $50 billion.
• We must make a new AE schedule. • Now what is the equilibrium?
• Again, you can work it out from the schedule.
Y AE 0 AE1
A 900 925 975
B 1,000 1,000 1,050
C 1,100 1,075 1,125
D 1,200

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