Macro Ch. 11

Two-Way Link Between Aggregate Expenditure and Real GDP

< An increase in real GDP increases aggregate expenditure. < An increase in aggregate expenditure increases real GDP.

Actual aggregate expenditure

always equal to real GDP

The Basic Idea of the Multiplier

An increase in investment (or any other component of autonomous expenditure) increases aggregate expenditure and real GDP. The increase in real GDP leads to an increase in induced expenditure. The increase in induced expenditure leads to a further increase in aggregate expenditure and real GDP. So real GDP increases by more than the initial increase in autonomous expenditure.

Why Is the Multiplier Greater than 1?

The multiplier is greater than 1 because an increase in autonomous expenditure induces further increases in aggregate expenditure.

consumption function

The relationship between consumption expenditure and disposable income, other things remaining the same, is the

saving function

The relationship between saving and disposable income, other things remaining the same

The size of the multiplier is..

The size of the multiplier is the change in equilibrium expenditure divided by the change in autonomous expenditure.

autonomous expenditure

The sum of investment, government expenditure, and exports, which does not vary with GDP

An increase in autonomous expenditure brings

an unplanned decrease in inventories, which triggers an expansion.

Disposable income changes when

either real GDP changes or net taxes change. If tax rates don't change, real GDP is the only influence on disposable income, so consumption expenditure is a function of real GDP.

Disposable Income

is aggregate income or real GDP, Y, minus net taxes, T. Call disposable income YD. The equation for disposable income is YD = Y - T

Aggregate planned expenditure

is planned consumption expenditure plus planned investment plus planned government expenditure plus planned exports minus planned imports.

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.

marginal propensity to consume

is the fraction of a change in disposable income spent on consumption. It is calculated as the change in consumption expenditure, C, divided by the change in disposable income, YD, that brought it about. That is, MPC = C ÷ YD

marginal propensity to import

is the fraction of an increase in real GDP spent on imports.

Equilibrium expenditure

is the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP.

aggregate expenditure curve

is the relationship between aggregate planned expenditure and real GDP, with all other influences on aggregate planned expenditure remaining the same.

aggregate demand curve

is the relationship between the quantity of real GDP demanded and the price level, with all other influences on aggregate demand remaining the same.

When real GDP increases

planned consumption expenditure and planned imports increase.

The MPC determines

the magnitude of the amount of induced expenditure at each round as aggregate expenditure moves toward equilibrium expenditure.

The Keynesian model

1. The price level is fixed. 2. Aggregate demand determines real GDP.

induced expenditure

Consumption expenditure minus imports, which varies with real GDP

From Above Equilibrium

If real GDP exceeds aggregate planned expenditure, ... there is an unplanned increase in inventories. To reduce inventories, firms fire workers and decrease production. Real GDP decreases.

...

Disposable income, YD, is either spent on consumption goods and services, C, or saved, S. That is, YD = C + S.

From below equilibrium

If aggregate planned expenditure exceeds real GDP, there is an unplanned decrease in inventories. To restore inventories, firms hire workers and increase production. Real GDP increases.

Marginal Propensity to Save

MPS) is the fraction of a change in disposable income that is saved. It is calculated as the change in saving, S, divided by the change in disposable income, YD, that brought it about. That is, © 2014 Pearson Addison-Wesley MPS = S ÷ YD.

A decrease in autonomous expenditure brings an

unplanned increase in inventories, which triggers a recession.