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# Chapter%20270.pdf

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School
Western University
Department
Management and Organizational Studies
Course
Management and Organizational Studies 2275A/B
Professor
Henry Meredith
Semester
Winter

Description
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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