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Chapter 27

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York University
ECON 1010
Jean Adams

CHAPTER 27: EXPENDITURE MULTIPLIERS ECON 1010 WEEK 5 • Consumption and imports are influenced by real gdp o There is a feedback loop between aggregate expenditure and real gdp • Consumption expenditure is influenced by many factors, but the most direct one is disposable income • Disposable income (YD) is real GDP (Y) minus Net taxes (NT) • Disposable income is either spent on consumption goods © or saved (S) • The relationship between the consumption expenditure and the disposable income is the consumption function o Drawing a 45degree line through the consumption function illustrates saving and dissaving • The relationship between saving and disposable income is the saving function o The point at which the saving function is above the x axis represents saving and vice versa • Marginal propensity to consume is the fraction of a change in disposable income that is spent on consumption o MPC= delta C/deltaYD o That is: the change in consumption expenditure for each unit of change in disposable income • Marginal propensity to save is the fraction of a change in disposable income that is salved o MPS = delta S/delta YD • deltaC/deltaYD + deltaS/deltaYD = deltaYD/deltaYD (because deltaC + deltaS = deltaYD) therefore; MPC+MPS = 1 • When an influence other than disposable income changes (e.g. wealth, interest rate) the consumption and saving functions shift • AE = I + G + X + C – M • Induced expenditure: Consumption expenditure – imports (those that variate with real GDP) • Autonomous expenditure: Investment + Government + Exports +Autonomous parts of Consumption + Imports expenditures • Actual aggregate expenditure = Real GDP • Aggregate planned expenditure may differ from actual because of unplanned changes in inventories • Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate planned expenditure = real GDP • Equilibrium occurs when the aggregate expenditure curve crosses the 45degree line (at this point, there are no unplanned changes) • If aggregate planned expenditure = Real GDP, no unplanned changes in inventories occur so firms maintain their current production • 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 • Why a multiplier exists: o An increase in investment (or other component of autonomous expenditure) increases aggregate expenditure and real GDP and the increase in real GDP
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