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Intro to macroeconomics.docx

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University of Toronto St. George
Iris Au

Chapter 21 Desired aggregate expenditure – the sum of desired spending on domestically produced output. AE = C + I + G + (X-IM) - It is no equal to actual spending. “National income accounts measure actual expenditures in each of the four expenditure categories. National income theory deals with desired expenditure in each of the four categories” ** categories ( consumption, investment, government spending and net exports) Autonomous vs induced Autonomous expenditure – components of aggregated expenditure that do not depend on the national income. Spending that regardless of how much money there is supplied a given amount has to be spent. Ex food and water – essentials Induced expenditure – components of aggregated expenditure that do change systematically in response to changes in national income. Important simplifications - consumptions is 55-60% of GDP, investment is about 20% closed economy – an economy that have no foreign trade in goods service or assets. Desired consumption expenditure. “ there are only two possible uses of disposable income- consumption and saving. When the - households decides how much to put to one use, it has automatically decided how much to put to the other use. “ consumption function: - the total desired consumption expenditure of all households to several factors that determine it. factors : wealth, disposable income, interest rates & expectations on the future. Ex if a households disposable income increases form $3000-$3500 its monthly consumption will increase but less than the amount of increase ($500) the remainder will be saved. “ an increase in disposable income is assumed to lead to an increase in desired consumption” C=30 + 0.8Y D c – consumption - If the desired income is zero yD -disposable income consumption will be 30 billion 30 = autonomous expenditure - For every $1 increase in income consumption will 0.8YD = induced expenditure increase by 80 cents Average and marginal propensities to consume Average propensity to consume (APC) – desired consumption expenditure divided by disposable income. APC falls as income rises. APC = C/Y D Marginal propensity to consume (MC) – the change in desired consumption to the change in disposable income that brought about. MPC = C/Y D Slope – positive slope – the MPC is positive; increase in income leads to increase in consumption expenditure. 45 degrees line – a line where desired consumption is equal to disposable income, the consumption cuts the 45 line it is called “break even” – when desired consumption exceeds disposable income. Shifts in consumption function: Change in household wealth- when a household suddenly has an increase in income their buget will have more room and be more flexible in terms of spending. If there’s a sudden decrease in income the house hold will have to revaluate their spending to spend less in order to compensate for the decrease. “An increase in household wealth shifts the consumption function up; a decrease will shift the function down” Change in interest rates – durable goods is more expensive many of them are purchased on credit. Ex car, house. If the interest rates are low people will be more willing to spend on durable goods therefore borrows money. If the interest rates are high people will be less willing to borrow money. “ a fall in interest rates usually leads to an increase in desired consumption at any level of disposable income; the consumption function shifts up. A rise in interest rates shifts the consumption function down.” Change in expectations – households expectations of the future if they are aware that there will be a big change in money flow in the next few years then they will be saving up. Ex child going to university, New born child. If a household one of the supporting members in the future will get a raise = increase in income that will lead to an increase in consumption. “Optimism leads to an upward shift in consumption function; pessimism leads to a downward shift in consumption” The saving function - Households decide how much to consume and how they when to save Average propensity to save (APS) – the proportion of disposable income that households want to save. APS = S/Y D Marginal propensity to save ( MPS) – the change in desired saving to the change in disposable income that brought it about. APS = S/Y D Relationship: APC + APS = 1 MPC + MPS = 1 Desired investment expenditure Three categories of investment: -residential investment -new plant & equipment investment -inventory investment -most volatile components of GDP, changes in investment are strongly associated with aggregated economic fluctuations. Important determinates of aggregated investment expenditure: - the real interest rate - changes in the level of sales - business confidence Real interest rate: Inventories- as an alternative to holding inventories firms lend out money at the going rate of interest. The higher the real rate of interest, the higher the opportunity cost of holding an inventory of a given size; the higher the opportunity cost the smaller inventories will be desired. - firms, as interest rates increase, the amount to hold their inventories will cost more therefore to prevent from paying a lot of interest firms are willing to hold smaller inventories. Residential construction - money borrowed use to pay for houses ex mortgages New plant & equipment – high interest rates firms are less willing to invest in new plants and equipment due to the credit that it involves therefore leads to a reduction in desired investment whereas low real interest rates increase desired investment. “The real interest rates reflect the opportunity cost associated with investment, whether it is investment in inventories, residential construction or plant and equipment. The higher the real interest rate, the higher the opportunity cost of investment and thus the lower the amount of desired investment.” Changes in sales- firms have target sales in which they meet in order to meet those sales so that they have enough products to sell firms have inventories that they hold. If there is an increase in sales then they will need to take products from their inventory to continue with the sudden demand therefore creating the notion a change in sales is a change in inventory. ex a firm has a month sales of $100,000 and an inventories of $10,000 if the month sales were to increase to $110,000 then inventories will also have to increase to $11,000 to compensate for the demand. “The higher the level of sales, the larger the desired stock of inventories. Changes in the rate of sales therefore cause temporary bouts of investment (or disinvestment) in inventories” Business confidence- if firms are optimistic in the future they will want to invest, have a larger production capacity to ready for a great demand in the near future. If there are bad times they wll invest due to the payoff don’t be present from doing so. “Investment depends on firms expectations about the future state of the economy. Optimism about the future leas to more desired investment; pessimism leads to less desired investment.” The aggregated expenditure function aggregated expenditure (AE) – the level of desired aggregate expenditure to the level of actual income. - In a simple closed economy with no government the function would be: AE = C + I - Recall: C= 30 + 0.8Y and I = 75 AE = (105) + 0.8Y Marginal propensity to spend: fraction of any increment to national income that people spend on purchasing domestic output. MPS = AE/Y AE = change in aggregated “ the amount of extra total expenditure induced when national expenditure income rises by $1, whereas the MPC is the amount of extra Y = change in national income consumption expenditure induced when households disposable income rises by $1” 21.2 “For any level of national income at which desired aggregate expenditure exceeds actual income, there will be pressure for actual national income to rise” - Demand for products is more then they except therefore firms must decrease their inventories and increase production of output to restore equilibrium. “ for any level of income at which desired aggregate expenditure is less than actual income, there will be pressure for national income to fall” - When firms make more than the demand the unsold items will be stashed away as inventory and soon reduce sales. Make more then earn. “ the equilibrium level of national income occurs where desired aggragte expenditure equals actual national income” - What firms sell is how much they earn, inventory changes or incetives for firms to alter their output. AE=Y - The AE curve lies above the 45 degree line = desired spending (of customers) exceeds output. Vertical distance = the size of this excess demand – reduction in inventories &
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