Chapter 11 Expenditure Multipliers
The AE curve is the relationship between _____ other things remaining the same
Aggregate Planned Expenditure and Real GDP
The multiplier is determined by ____
The slope of the AE curve
Main influence on U.S. imports
U.S. real GDP
*Test* Which two components of Aggregate Planned Expenditure depend on real GDP (they change when income changes)
consumption expenditure imports
*TEST* if Aggregate Planned Expenditure is less than Real GDP, firms ____ production in a response to an unplanned ____ in inventories
decrease; increase
If an income tax is introduced into the economy, the multiplier ____ because _____
decreases; disposable income increases by less than real GDP
*TEST* The multiplier *increases* when the marginal propensity to import ___ or the income tax rate _____
decreases; decreases
Consumption expenditure is determined by
disposable income
Autonomous Expenditure ____ vary with real GDP; Induced Expenditure __ vary with real GDP
does not does
The autonomous tax multiplier is the change in
equilibrium expenditure and real GDP resulting from a change in autonomous taxes / the change in autonomous taxes
*TEST* if Aggregate Planned Expenditure *exceeds* Real GDP, firms ____ production in a response to an unplanned ____ in inventories
increase; decrease
*TEST* The multiplier increases when the marginal propensity to consume ____
increases
As the consumption function shifts upward, Autonomous consumption ________
increases
*TEST* When Real GDP > Aggregate Planned Expenditure, inventories are
increasing (above equilibrium point)
*TEST* When Aggregate Planned Expenditure is greater than real GDP, *actual investment* is ____ than planned investment
less (firms have less than planned inventory)
In Keynesian model of aggregate expenditure, real GDP is determined by
level of aggregate demand
*TEST* Equilibrium Expenditure
level of aggregate expenditure that occurs when *Aggregate Planned Expenditure = Real GDP* **where Aggregate Planned Expenditure intersects 45 degree line on graph**
*Test* Fluctuations in autonomous expenditure bring ___ fluctuations in real GDP opposing equal magnified diminishing
magnified
*TEST* When Aggregate Planned Expenditure is less than real GDP, *actual investment* is ____ than planned investment
more (firms have excess *unplanned* inventory)
*Test* *Sample* An economy has a fixed price level, no imports, and no income taxes. MPC is 0.8, and real GDP is $250 billion. Businesses increase investment by $2 billion. Calculate the multiplier and the change in real GD
multiplier = 5 real GDP increases by $10 billion
*TEST* To calculate the effect of real GDP on imports, we need to know _____
only the Marginal propensity to import (calculation uses GDP, not YD, as denominator)
The slope of the AE curve = MPC when
there are *no* income taxes or imports;
The magnitude of the multiplier depends on the
slope of the AE curve
How to construct the Aggregate Planned Expenditure AE curve
subtract M from C + I + G + X; Expenditure on U.S. - produced goods and services
*Test* *Test* When aggregate planned expenditure is *less than* real GDP, inventories are _____ target, so firms ____ production and inventories return to target level until equilibrium is reached
above; decrease
*TEST* Equilibrium expenditure occurs on the graph where
aggregate planned expenditure equals real GDP equals actual expenditure
When autonomous expenditure increases, aggregate expenditure ___ real GDP _____ and equilibrium expenditure ______
all increase; AE curve shifts up
Aggregate Planned Expenditure is *less than* real GDP on the graph ____ the equilibrium point
ABOVE
An economy has a fixed price level, no imports, and no income taxes. MPC is 0.8, and real GDP is $100 billion. Businesses increase investment by $2 billion. Calculate the new level of real GDP and explain why real GDP increases by more than $2 billion. The new level of real GDP is ____
$110 billion
*TEST* When Actual Expenditure *exceeds* Aggregate Planned Expenditure is the graph above or below equilibrium point
*Above* equilibrium point; (firms have *unplanned inventory* so cut production* ; real GDP decreases)
*TEST* To calculate the effect of real GDP on consumption expenditure, we need to know _____
*BOTH* The Marginal Propensity to Consume MPC *AND* the effect of real GDP on disposable income
*TEST* When Aggregate Planned Expenditure *exceeds* real GDP, is the graph above or below equilibrium point
*Below* equilibrium point; (firms will increase production; real GDP increases)
*TEST* *TEST* *TEST* multiplier vs. MPC in relation to AE curve
*MPC = slope of AE curve* size of multiplier *depends on* slope of AE cuve
What effect does a change in the price level have on the AE curve
*SHIFT* (movement along AD curve)
A change in *autonomous expenditure* that is *not* caused by a change in the price level has what effect on the AD and AE curve
*SHIFTS* both (*The magnitude of the shift of the AD curve depends on the multiplier and on the change in autonomous expenditure*)
According to Keynesian theory, how does the typical firm change its prices in response to aggregate demand fluctuations
*does not change immediately*
*Test* Possible reasons that the U.S. MPS today is LOWER than it was before 1984 and the MPC is GREATER than it was before 1984
*lower return to saving*
The AD curve is the relationship between ______ other things remaining the same
*quantity* of real GDP demanded and price level
How to calculate the MPC using AE graph
*slope* of AE graph; Change in expenditure / Change in real GDP
If an economy has a fixed price level and no income taxes/imports; The multiplier is 4 The MPC is ____
0.75 ; 1 / (1- *0.75*) = 4
If the slope of the consumption function is 0.9, a $1 trillion increase in disposable income would increase consumption by
0.9 trillion
Calculation for Multiplier when *no* income taxes or imports
1 / (1-MPC) = 1 / MPS
With a fixed price level, the multiplier equals
1 / (1-MPC) or 1 / MPS
Keynesian mode: Because each firm's prices are fixed on any given day, for the economy as a whole
1. *price level* is fixed 2. *Aggregate Demand* determines real GDP
Four most important factors that influence spending and saving plans
1. Disposable income 2. Real interest rate 3. Wealth 4. Expected future income
If investment increases by 100 and the multiplier is 3, the *aggregate demand* curve *shifts right* by ____
300
*****STUDY***** *TEST* *TEST* If autonomous spending is 40 and the slope of the AE curve (aka MPC) is 0.6, the equation for the AE curve is How do we calculate equilibrium expenditure from this?
AE = 40 + 0.6Y set AE = Y , so equilibrium = 100 because 100 = 40 + 0.6 (100)
*TEST* *TEST* *TEST* When the price level rises, how do the Aggregate Expenditure and Aggregate Demand curves change
Aggregate Expenditure *SHIFTS down* *MOVEMENT up* along Aggregate Demand
Relationship between Aggregate Planned Expenditure, Aggregate (*Actual*) Expenditure, and real GDP
Aggregate Expenditure *always* = real GDP Aggregate Planned Expenditure *not always* = real GDP
Induced Expenditure =
Aggregate Expenditure - Autonomous Expenditure
Vocab: Disposable income
Aggregate Income - Taxes + Transfer payments *Aggregate income depends on real GDP, therefore Disposable income depends on real GDP*
Vocab: Aggregate Expenditure Graph
Aggregate Planned Expenditure (y axis) at each given level of real GDP (x axis); Government spending G, Investment I, and Exports X are *constants*: *horizontal lines*; Consumption C and Imports M are *sloped*: dependent on real GDP
When *Actual Expenditure* *exceeds* Aggregate Planned Expenditure, how do real GDP and Aggregate Planned Expenditure compare?
Aggregate Planned Expenditure < real GDP (b/c real GDP always = Actual Expenditure)
Vocab: Balanced budget multiplier
Amount of change in expenditure and real GDP that results from *equal changes* in government expenditure and lump-sum taxes;
*test* Business Investment is a component of ____ Aggregate Expenditure; When is increases, the AE curve _____ and equilibrium expenditure _____
Autonomous; shift up; icnreases
Aggregate Planned Expenditure *exceeds* real GDP ____ the equilibrium point
BELOW
How to calculate Autonomous Consumption Expenditure given YD and C table
C value when YD = 0
*TEST******* Calculation for Multiplier
Change in *equilibrium expenditure* / Change in *autonomous expenditure*
Calculation for Government Expenditure multiplier
Change in equilibrium expenditure and real GDP / change in gov't expenditure
Vocab: Government Expenditure Multiplier
Change in equilibrium expenditure and real GDP resulting from change in government expenditure
How to calculate increase in induced expenditure using autonomous expenditure and equilibrium expenditure
Change in induced = Change in equilibrium - Change in autonomous
*Test* **test* *est* Which components of aggregate expenditure are influenced by real GDP?
Consumption expenditure and imports C and I
*Test* How to calculate *Autonomous Expenditure* given table
Consumption when Real GDP = 0 + Investment + Gov't + Exports + Imports when Real GDP = 0
*Test* *Missed* The ______ curve shifts upward by an amount equal to the increases in autonomous expenditure. The ______ curve shifts rightward by an amount equal to the increases in autonomous expenditure times the multiplier because the ______ at each price level. A. AE; AD; AD curve plots aggregate planned expenditure Your answer is not correct.B. AD; AE; AE curve plots equilibrium expenditure C. AD; AE; AE curve plots aggregate planned expenditure D. AE; AD; AD curve plots equilibrium expenditure
D
Choose the correct statement. A.Equilibrium expenditure occurs at the point at which the AE curve intersects the x-axis. B.Equilibrium expenditure occurs at all points along the AE curve. C.Equilibrium expenditure occurs at all points along the 45degrees line. D.The level of aggregate expenditure that occurs where the AE curve intersects the 45degrees line is equilibrium expenditure
D
Planned saving + Planned consumption =
Disposable income
The height of the 45 degree line on the consumption function graph measures
Disposable income; Where consumption function intersects line, *consumption expenditure = disposable income*
Exports do not depend directly on Real GDP: What do they depend on?
Events in the World Economy Prices of foreign-produced goods/service Exchange rates
*TEST* *VERY IMPORTANT* How can actual expenditure and planned expenditure differ?
Firms end up with inventories that are greater or smaller than planned; *if Aggregate Planned Expenditure < Real GDP, firms *SELL LESS* than they planned to sell* = *UNPLANNED INVENTORIES* *if Aggregate Planned Expenditure > Real GDP, = firms have *SMALLER INVENTORIES* than planned
*Test* If real GDP increases by 2 million and potential GDP increases by $3 million and the Marginal Propensity to Import is 0.2, by how much do imports change?
Increase by $400,000; 2 million (0.2) ; use only real GDP
Two way link between Aggregate Expenditure and real GDP
Increase in real GDP = increase in agg. expenditure Increase in aggregate expenditure = increase in real GDP
*TEST* *TEST* *TEST* Induced Expenditure vs. Autonomous Expenditure
Induced: sum of components that *vary* with real GDP: Consumption Expenditure - Imports Autonomous Expenditure: the sum of components that *do not vary* with Real GDP: Investment + Govt Exp + Exports + (Consumption when GDP = 0) - (Imports when GDP = 0)
MPC and MPS equations
MPC + MPS = 1 (ΔC/ΔYD)+ (ΔS/ΔYD) = 1 ΔC+ ΔS = ΔYD
Calculation for MPC
MPC = (Change in consumption C $) / (Change in Disposable income YD$)
*Test* *Easy Review* In an economy, when disposable income increases from $400 to $500, consumption expenditure increases from $450 billion to $525. Calculate the marginal propensity to consume, the change in saving, and the marginal propensity to save.
MPC = 0.75 (525-450) / (500-400) MPS = 0.25 (-25 - (-50)) / (500-400)
the *slope* of the AE curve changes when _____ A *shift* of the AE curve happens when _____
MPC changes; *tax rates* or government spending* changes
Calculation for Marginal Propensity to Import
MPI = Change in imports / Change in real GDP
Calculation for MPS
MPS = (Change in saving S $) / (Change in disposable income YD $)
_____ determines the change in consumption expenditure brought about by a change in disposable income
Marginal Propensity to Consume MPC
The slope of the AE curve is influenced by ______
Marginal Propensity to consume Marginal Propensity to Import Income tax rate
*Test* *Sample* An economy has a fixed price level, no imports, and no income taxes. MPC is 0.9, and real GDP is $150 billion. Businesses increase investment by $5 billion. Calculate the new level of real GDP and explain why real GDP increases by more than $5 billion.
New GDP = 200 billion: 100 billion + 10 (5 billion)
Aggregate Planned Expenditure depends on _____
Real GDP
Imports are determined by _____
Real GDP
What factors bring *shifts* up or down of the consumption and savings function
Real interest Rate Wealth
What do the slope of the consumption and saving function tell
Slope of consumption function *IS THE MPC* Slope of savings function *IS THE MPS* (y axis = consumption $, saving $, x axis = disposable income $)
*TEST* Difference between Aggregate Expenditure and Aggregate Demand curves
The aggregate expenditure curve is the relationship between the aggregate planned expenditure and real GDP, all other influences on aggregate planned expenditure remaining the same. The aggregate demand curve is the relationship between the aggregate quantity of goods and services demanded and the price level, all other influences on aggregate demand remaining the same
Vocab: Induced consumption
The amount of consumption expenditure in excess of autonomous consumption; consumption expenditure that is induced by an increase in disposable income
For a given increase in aggregate demand, the steeper the slope of the short-run aggregate supply curve, the ______ is the increase in the price level and the ______ is the multiplier effect on real GDP in the short run.
The steeper the slope of the short-run aggregate supply curve, the *larger* is the increase in the price level and the *smaller* is the multiplier effect on real GDP.
Vocab: Aggregate Planned Expenditure
The sum of the *planned* levels of consumption expenditure investment government expenditure on goods/services exports - imports
*Test* A reason for the difference in MPS values for the US and China may be _____
U.S. consumers are more confident about the future (U.S. MPS < China MPS)
The level of disposable income at which all disposable income is consumed is ____ on the consumption function graph
Where the consumption function *intersects the 45 degree line*
You observe that unplanned inventories are increasing. You predict that there will be _______.
a recession
*Test* *Test* *Test* When aggregate planned expenditure is *greater than* real GDP, inventories are _____ target, so firms ____ production and inventories return to target level until equilibrium is reached
below target; increase
When expenditure increase, the AE curve shifts by the ____ and the AD curve shifts by the ____ Why?
change in autonomous expenditure; change in autonomous expenditure *times the multiplier* b/c *the AD curve plots EQUILIBRIUM EXPENDITURE*
What two variables of expenditure vary with real GDP? What are these called?
consumption expenditure and imports; Induced expenditure
**TEST* If Real GDP *and* Aggregate Expenditure are *less* than *equilibrium expenditure*, firm's inventories
decrease (so they increase production and real GDP increases)
Initially, when autonomous expenditure increases, aggregate planned expenditure ______ real GDP. As a result, inventories _______. How do firms respond?
exceeds; decrease Firms respond by increasing production so as to restore their inventories to the target level. As production increases, so does real GDP. With a higher level of real GDP, *induced* expenditure increases
When the price level is fixed, ______ determine real GDP
expenditure plans
*Test* *Review* Equilibrium Expenditure comes about because firms adjust their _____ in response to unplanned changes in ______
firms adjust *production* in response to unplanned changes in *inventory*
*TEST* When Aggregate Planned Expenditure *exceeds* real GDP and firms have *less inventory* than planned, what happens
firms hire more labor and *increase* production to increase inventory real GDP *increases* until equilibrium
*Test* the Multiplier mater because we can use it to determine by how much we should change autonomous expenditure to _____
increase real GDP by a given amount
Real GDP increases by more than $5 billion because an increase in investment
induced an increase in consumption expenditure
*Test* Real GDP increases by more than autonomous expenditure because the _____ increases
induced consumption expenditure
Examples of increases in autonomous expenditure
innovation = rise in *expected future profits* economic boom in other countries
*TEST* As long as *Actual Expenditure* exceeds *Planned Expenditure*, inventories _____ and firms ____ production
inventories *rise* (unplanned inventories) firms *cut* production until real GDP = agg planned expenditure at equilibrium point
What three variables of expenditure *do not* vary with real GDP? What are these called?
investment, govt expenditure, exports *autonomous* expenditure
Investment does not depend directly on Real GDP: What does it depend on?
real interest rate expected profit
Vocab: Consumption Function
relationship between consumption expenditure (y axis) and *Disposable Income* (x axis) all other factors *remaining the same*
*****TEST*** Relationship between slope of the AE curve and expenditure multiplier
slope of AE curve = MPC multiplier = 1/MPS MPC + MPS = 1
Imports and income taxes make the size of the multiplier ____
smaller
*TEST* Vocab: Multiplier
the amount by which a change in *AUTONOMOUS* expenditure is multiplied to determine the resulting change in *equilibrium expenditure* and *real GDP*
Vocab: Autonomous Consumption
the amount of consumption expenditure that would take place in the short run even if people had no current disposable income
*Test* Vocab: Marginal Propensity to Save
the fraction of a *change* in disposable income that is saved
*Test* Vocab: Marginal Propensity to Consume
the fraction of a *change* in disposable income that is spent on consumption
*Test* Marginal Propensity to Import
the fraction of an increase in real GDP that is spent on imports; change in imports brought about by a change in real GDP
When autonomous expenditure increases, *equilibrium expenditure* increases by
the sum of the increase in autonomous expenditure + increase in induced expenditure
True/False: Planned consumption expenditure + Planned saving *always* = Disposable income
true
*TEST* *IMPORTANT* *REVIEW* If real GDP *and* aggregate expenditure are *less than* equilibrium expenditure, there is an unplanned ____ in inventories; so firms ___ production and real GDP ____
unplanned *decrease*; (counter-intuitive) firms *increase* production, real GDP *increases*
*TEST* *IMPORTANT* When Real GDP and Aggregate Expenditure are *greater* than equilibrium expenditure, there is an unplanned _____ in inventories; firms ____ production and real GDP ___
unplanned *increase* (counter-intuitive); firms *decrease* production real GDP *decreases*
The long-run multiplier =
zero
Calculation for *change in induced expenditure*
ΔN = Slope of AE curve × ΔY
Calculation for slope of the AE curve
ΔN÷ΔY Change in induced exp / change in real GDP
Calculation for Multiplier
ΔY / ΔA : change in real GDP/change in autonomous expenditure = 1 / (1−Slope of AE curve) aka 1/MPS
Calculation for change in Real GDP
ΔY=ΔN+ΔA Change in real GDP = change in induced expenditure + change in autonomous expenditure
