ECON1102 Chapter Notes - Chapter 9: Nominal Interest Rate, Macroeconomic Model, Disposable And Discretionary Income
Chapter 9: Aggregate Expenditure and Output in the Short Run
The Aggregate Expenditure Model:
Aggregate Expenditure Model: A macroeconomic model that focuses on the short-
run relationship between total spending and real GDP, assuming that the price level
is constant
• Key idea: in any year, the level of GDP is determined mainly by the level of
aggregate expenditure
Four components of aggregate expenditure that together equal GDP:
1. Consumption
2. Planned investment
3. Government purchases
4. Net Exports
AE = C + I + G + NX
The Difference between Planned Investment and Actual Investment:
• Planned investment that is a component of aggregate expenditure
Inventories: Goods that have been produced but not yet sold
• Are included as part of investment spending
• The amount businesses plant to spend on inventories may be different from
the actual amount they spend
• Actual investment spending (for economy as a whole) will be greater than
planned investment spending when there is an unplanned increase in
inventories (visa versa)
Actual investment will equal planned investment only when there is no unplanned
change in inventories
Macroeconomic Equilibrium: AE = GDP
• If it is assumed that the economy is not growing that equilibrium GDP will not
change unless aggregate expenditure changes
Adjustments to Macroeconomic Equilibrium:
• Increases/decreases in AE cause the fluctuations in GDP
AE > GDP
• Inventories decline
• GDP and employment increase
AE < GDP
• Inventories increase
• GDP and employment decrease
AE = GDP
• Inventories unchanged
• Macroeconomic equilibrium
Determining the Level of Aggregate Expenditure in the Economy:
find more resources at oneclass.com
find more resources at oneclass.com
Consumption:
Variables that determine level of consumption:
1. Current disposable income
• Income households have after they paid personal income tax and
received government transfer payments (e.g. social security)
• C to increase when disposable income increases (visa versa)
2. Household wealth
• Value of assets – value of its liabilities
• Asset – anything owned by person or firm
• Liability – anything owed by a person or firm
• C to increase when household wealth increases
3. Expected future income
• Current income explains current consumption well only when current
income is not unusually high or unusually low compared with expected
future income
• C high when expected future prices high
4. The price level
• Increase of one produced on the quantity demanded of that produced is
different from the effect of an increase in the price level on total spending
by households on goods and services
• Increase in price → decrease in real household wealth
5. The interest rate
• Nominal interest rate is the stated interest rate on a loan or a financial
security (e.g. bond)
• Real interest rate correct the nominal interest rate for the impact of
inflation
• Consumption spending depends on the real interest rate
• Real interest rate high → reward for saving is increased → C decreases
• When interest rate is high spending on durable goods is affected → high
real interest rate increase the cost of spending financed by borrowing
The Consumption Function: The relationship between consumption and disposable
income
• Consumption is a function of disposable income
Marginal Propensity to Consume (MPC): The slope of the consumption function: the
change in consumption divided by the change in disposable income
MPC = change in consumption/change in disposable income
The Relationship between Consumption and National Income:
• Linear curve → as real national income/real GDP increases, real consumption
spending increases (constant)
Disposable income = national income (GDP) – net taxes
GDP = Disposable income + Net Taxes
Income, consumption and saving
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Chapter 9: aggregate expenditure and output in the short run. Four components of aggregate expenditure that together equal gdp: consumption, planned investment, government purchases, net exports. Ae = c + i + g + nx. The difference between planned investment and actual investment: planned investment that is a component of aggregate expenditure. Actual investment will equal planned investment only when there is no unplanned change in inventories. If it is assumed that the economy is not growing that equilibrium gdp will not change unless aggregate expenditure changes. Increases/decreases in ae cause the fluctuations in gdp. Determining the level of aggregate expenditure in the economy: Variables that determine level of consumption: current disposable income. Increase of one produced on the quantity demanded of that produced is different from the effect of an increase in the price level on total spending by households on goods and services.
