Ch 14 - Aggregate Expenditure Multiplier

Other influences on consumption expenditure are

- Real interest rare - Wealth - Expected future income

How do we divide expenditure plans into autonomous expenditure and induced expenditure?

-Autonomous expenditure does not respond to changes in real GDP -Induced expenditure does respond to changed in real GDP

Why does an increase in U.S real GDP increase U.S imports?

-Because an increase in U.S real GDP is also an increase in income, as income increases, people increase their expenditure on most goods and services. -Many goods and services are imported, so as income increase imports increase

When an expansion is triggered by an increase in autonomous expenditure, as the economy turns the corner to expansion, what happens to aggregate planned expenditure and real GDP? Explain how this is demonstrating the buying-cycle turning points

Aggregate planned expenditure exceeds real GDP Firms see their inventories taking an unplanned dive. Firms increase production and real GDP increases. This initial increase in real GDP brings higher incomes, which stimulate consumption expenditure. The multiplier process kicks in and the expansion picks up speed.

What is the basic idea of the multiplier?

An increase in investment increases real GDP, which increases disposable income and consumption expenditure. The increase in consumption expenditure adds to the increase in investment and a multiplier determined the magnitude of the resulting increase in aggregate expenditure.

What happens when aggregate planned expenditure exceeds real GDP?

An unplanned decrease in inventories occurs. Firms increase production, and real GDP increases

What happens when real GDP exceeds aggregate planned expenditure?

An unplanned increase in inventories occurs. Firms decrease production, and real GDP decreases

Why would the multiplier be greater than 1?

Because an increase in autonomous expenditure induces further increase in aggregate expenditure- induced expenditure increases

Why do we use the aggregate demand expenditure model?

Because it explains what determines the quantity of real GDP demanded and changes in that quantity at a given price level

Induced expenditure equals

Consumption expenditure - imports

What happens to consumption expenditure when either wealth or expected future income decreases?

Consumption expenditure also decreases and when wealth or expected future income increases, consumption expenditure also increases.

What happens to consumption expenditure when the real interest falls?

Consumption expenditure increases (and savings decrease) and when the real interest rate rises, consumption expenditure decreases (and savings increase).

Firms have inventory targets based on their sales, and when inventories fall below target

Firms increase productions

What does government expenditure on goods and services depend on?

Government policy priorities

What happens when an increase in investment increases real GDP?

Income tax payments increase, so disposable income increases by less than the increase in real GDP and consumption expenditure increases by less than it would if income tax payments had not changed

What is the sum of aggregate planned expenditure?

Induced expenditure and autonomous expenditure

What does autonomous expenditure consist of?

Investment, government expenditure on goods and services, exports, and the autonomous consumption expenditure

The change in equilibrium expenditure also equals the change in real GDP. The change in autonomous expenditure is a change in investment. So..

Multiplier = Change in real GDP (Y) / Change in investment (I)

What happens when there is an increase in investment that increases real GDP and consumption expenditure?

Part of the increase in expenditure is on imports, not U.S produced goods and services

What is aggregate planned expenditure?

Planned consumption expenditure + planned investment + planned government expenditure + planned exports - planned imports

At equilibrium expenditure

Production plans and spending plans agree, and there is no reason for production or spending to change

What does investment responds to?

Real interest rate and expected profits

What is the multiplier?

The amount by which a change in any component of autonomous expenditure is magnified or multiplied to determine the change that it generates in equilibrium expenditure and real GDP

What does the marginal tax rate determines?

The extent to which income tax payments change when real GDP change

What is the definition of marginal tax?

The fraction of a change in real GDP that is paid in income taxes- the change in tax payments divided by the change in real GDP

What is the marginal propensity to import?

The fraction of an increase in real GDP that is spent on imports- the change in imports divided by the change in real GDP

What is the marginal propensity to consume?

The fraction of change in disposable income that is spent on consumption- the change in consumption expenditure divided by the change in disposable income that brought it about -Also is the slope of the line

What do exports depend on?

The global demand for U.S produced goods and services

What is the relationship between the multiplier and the MPC?

The greater the marginal propensity to consume, the larger the multiplier. (But with no income taxes, the change in consumption expenditure is determined by the change in real GDP and the marginal propensity to consume)

What is equilibrium expenditure?

The level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP

What does an aggregate expenditure schedule and an aggregate expenditure curve describe?

The relationship between aggregate planned expenditure and real GDP

What is the consumption function?

The relationship between consumption expenditure and disposable income, other things remaining the same -Households must either spend their disposable income on consumption or save it

What was the aggregate expenditure model originally designed for?

To explain what happens in an economy in deep recession when firms can't cut their prices any further but can increase production without raising their prices, so the price level is actually fixed- it is also known as the Keynesian model

What happens when there is an increase in U.S. real GDP to U.S imports?

U.S imports also increase- other things remaining the same

Many factors influence U.S imports, but in the short-run, one factor dominates, which is

U.S real GDP

Only expenditure on U.S produced goods and services increase

U.S real GDP

The multiplier is the amount by which a change in​ ______ expenditure is magnified or multiplied to determine​ ______.

autonomous expenditure the change in equilibrium expenditure that it generates Multiplier: Change in equilibrium expenditure / Change in autonomous expenditure

Along the consumption function, as disposable income increases,

consumption expenditure increases

An increase in real GDP brings a larger increase in consumption expenditure than imports, so induced expenditure

increases as real GDP increases

The size of the multiplier depends on imports and income taxes, both of which

make the multiplier smaller

For households and the economy as a whole, as disposable income increases

planned consumption expenditure increases but the increase in planned consumption is less than the increase in expenditure income.

The larger the marginal tax rate,

the smaller are the changes in disposable income and real GDP that result from a given change in autonomous expenditure

The larget the marginal propensity to import,

the smaller is the multiplier

Starting from below equilibrium: Starting from above equilibrium:

unplanned decreases in inventories induce firms to increase production unplanned increases in inventories induce firms to decrease production.