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ECN 204 (295)
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Chapter 8

Chapter 8 and 9

12 Pages
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Department
Economics
Course Code
ECN 204
Professor
Amy Peng

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Chapter 8 and 9.1; 9.2
Aggregate Expenditures Model
Aggregate expenditures (AE): Total planned spending on final goods and
services
oFour components
oConsumer expenditure (C)
oInvestment (I)
oGovernment purchases (G)
oNet exports (NX)
Income-Consumption and Income-Saving Relationships
45 line: A reference line indicating where consumption equals disposable
income. (C=DI)
Consumption Schedule: A schedule showing the amounts households plan to
spend for consumer goods at different levels of disposable income.
Saving schedule: A schedule that shows the amounts households plan to save
at different levels of disposable income. (S = DI C)
oGap in between the 45 line and the Consumption schedule
Break even income: the level of disposable income at which households plan
to consume all their income and to save none of it
oWhere Consumption schedule intersects with 45 line
Consumption function
 
www.notesolution.com
Saving function
 
Marginal propensity to consume: The fraction of any change in disposable
income spent for consumer goods.
        
Marginal propensity to save : The fraction of any change in disposable income
that households save
      
Non income determinants of Consumption and Savings
oWealth
oExpectations
oReal Interest Rates
oHousehold Debt
oTaxation
oBorrowing
www.notesolution.com
o
o
oThe interest Rate-Investment Relationship
Expected rate of return(r) : The increase in profit a firm anticipates it will
obtain by purchasing capital.
Real interest rate
oRate of return > interest rate = profit
oRate of return < interest rate = loss
oTo find interest:
o
o    
o
Investment demand curve: A curve that shows the amount of investment
demanded by an economy at a series of real interest rates
o
oShifts in the investment demand Curve
Determinants:
oAcquisition, Maintenance and Operating Costs
oBusiness Taxes
oTechnological Change
oStock of Capital Goods on Hand
oPlanned inventory
oExpectations
Fluctuations
www.notesolution.com

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Description
Chapter 8 and 9.1; 9.2 Aggregate Expenditures Model • Aggregate expenditures (AE): Total planned spending on final goods and services o Four components o Consumer expenditure (C) o Investment (I) o Government purchases (G) o Net exports (NX) Income-Consumption and Income-Saving Relationships • 45 line: A reference line indicating where consumption equals disposable income. (C=DI) • Consumption Schedule: A schedule showing the amounts households plan to spend for consumer goods at different levels of disposable income. • Saving schedule: A schedule that shows the amounts households plan to save at different levels of disposable income. (S = DI – C) o Gap in between the 45 line and the Consumption schedule • Break even income: the level of disposable income at which households plan to consume all their income and to save none of it o Where Consumption schedule intersects with 45 line • Consumption function www.notesolution.com • Saving function • Marginal propensity to consume: The fraction of any change in disposable income spent for consumer goods. • Marginal propensity to save : The fraction of any change in disposable income that households save • Non income determinants of Consumption and Savings o Wealth o Household Debt o Expectations o Taxation o Real Interest Rates o Borrowing www.notesolution.com o o o The interest Rate-Investment Relationship • Expected rate of return(r) : The increase in profit a firm anticipates it will obtain by purchasing capital. • Real interest rate o Rate of return > interest rate = profit o Rate of return < interest rate = loss o To find interest: o o o • Investment demand curve: A curve that shows the amount of investment demanded by an economy at a series of real interest rates o o Shifts in the investment demand Curve • Determinants: o Acquisition, Maintenance and Operating Costs o Business Taxes o Technological Change o Stock of Capital Goods on Hand o Planned inventory o Expectations • Fluctuations www.notesolution.com o Durability o Irregularity of innovation o Variability of profits o Variability of expectations o o Determination of the Equilibrium levels of Employment, Output and Income • Investment schedule (gross investment Ig) = A curve or schedule that shows the amounts firms plan to invest at various possible values of real GDP • Aggregate expenditure o o • Unplanned changes in inventory: changes in inventories that firms did not anticipate o o • Equilibrium arises when savings = Gross investment o empl o o o o o o o te oym un n ent de (mill nc ions) y of ou tp ut o 2.5 o o o o o o o in - cr www.notesolution.com ea se o 5.0 o o o o o o o in - cr ea se o 7.5 o o o o o o o in - cr ea se o 10.0 o o o o o o o in - cr ea se o 12.5 o o o o o o o in -5 cr ea se o 15.0 o o o o o o o eq 0 uil ibr iu m o 17.5 o o o o o o o de +5 cr ea se o 20.0 o o o o o o o de +1 cr ea se o 22.5 o o o o o o o de +1 cr ea se o 25.0 o o o o o o o de +2 cr ea se o www.notesolution.com • Assumption o AE = C + I o I=S o C = C + cY 0 o I = g o Y = C +
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