mba lecture 4

8/6/2019 MBA Lecture 4

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Spending and

Output in theShort Run: Part 1

Spending and

Output in theShort Run: Part 1

Lecture 4


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Macro Lecture 4 Slide 2

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Contents

1. Planned Aggregate Expenditure

2. The Components of Planned Aggregate Expenditure

3. Planned Spending Versus Actual Spending

4. Consumption Function

5. Planned Aggregate Expenditure and Output


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Planned Aggregate Expenditure

Planned Aggregate ExpenditureTotalplannedspending on final goods and

services

Output at each point in time is determinedby the amount that the people throughoutthe economy want (plan) to spend.


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The Components of Planned AggregateExpenditure

1. Consumer expenditure orConsumption (C)Household spending on durables,

nondurables, and services


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2. Investment expenditure (I),New capital goods spendingNew residential spending

Increases in inventories


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3. Government purchases (G)Federal, state, and local governments

spending on goods and services


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4. Net exports (NX)Exports - imports

Therefore,

PAE = C + I + G + NX


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Planned Spending Versus ActualSpendingIn the Keynesian model, output is

determined by PAE.Actual expenditures may not equal PAE.

If inventories are larger than expected:

o I > planned Investment (IP)If inventories are smaller than expected:

o I < IP


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Planned Aggregate Expenditure PAE = C + Ip + G + NX

Because firms meet demand at preset prices

and cannot control how much they sell, theiractual investment (including inventory) may differform planned investment. Thats why we write Ip

for planned investment to distinguish from I

(actual investment).


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PAE = C + Ip + G + NX

For consumption, govt. spending andnet export we assume planned andactual spending are the same. So we

need not write Cp Gp,etc.


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Consumer Spending and the Economy

Consumption (C) accounts for two thirds oftotal spending

The primary determinant ofC isdisposable income or Y - T ( or Yd)


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Consumption Function

It shows the relationship betweenconsumption spending and itsdeterminants, in particular,

disposable (after-tax) income


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Relating Consumption to Income and OtherDeterminantsThe consumption function:

C = + c(Y - T)

= a constant; represents the non income determinantof C (also called autonomous consumption).

Consumer optimism

Wealth

Real interest rates


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Consumption FunctionC = + c(Y - T)

C = + cYd

c= marginal propensity to consume

c = the amount by which consumption

rises when disposable income rises by$1; 0 < c< 1


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A Consumption Function

Disposable income Y-T

Consum

ptions

pending

C

Consumption

function

Slope = c = MPCC

T)-c(YCC +=


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1960-2001


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Planned Aggregate Expenditure andOutputThe relationship between changes in

production and income and PAECis a large part ofPAE

Cdepends on Y

PAEdepends on Y


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ExamplePAE = C + IP + G + NX

C = + c(Y T)

PAE = + c(Y T) + IP + G + NX

Suppose

= 620; c = 0.8; T = 250; IP= 220; G =300; NX = 20


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Example:Then: Substituting

PAE = 620 + 0.8(Y - 250) + 220 + 300 + 20

PAE = 620 + 0.8Y - 0.8(250) + 220 + 330 +

20

PAE = 620 + 0.8Y - 200 + 220 + 300 + 20

PAE = (620 - 200 + 220 + 300 + 20) + 0.8Y

PAE = 960 + 0.8Y


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ExamplePAE = 960 + 0.8Y

0.8 = Marginal propensity to consume

(MPC)If Y increases by $1, Cwill increase by 80

cents (c= 0.80)

Cis part ofPAEPAEincreases by 80 cents ($1 X 0.80)

mba lecture 4

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