Chapter 12 - Spending by Individuals,.ppt

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1. Chapter 12
Spending by Individuals,
Firms, and Governments on
Real Goods and Services

2. Framework for Macroeconomic
Analysis
Focus on the Short Run
Analysis in Real Versus Nominal Terms
Treatment of the Foreign Sector
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3. Outline for Macroeconomic
Analysis
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Market and
Expenditure for
Real Goods and
Services
(Chapter 12)
Money Market:
Supply and
Demand for
Money
(Chapter 13)
Aggregate
Supply Curve
(Chapter 14)
Model of
Aggregate
Demand and
Aggregate
Supply
(Chapter 14)
Aggregate
Demand Curve
(Chapter 14)
Fixed Price Assumption Flexible Price Assumption

4. Aggregate Expenditure
The sum of personal consumption expenditure,
investment expenditure, government
expenditure, and net export expenditure in a
given period of time.
E = C + I + G + (X – M)
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5. Personal Consumption Expenditure
The amount of spending by households on
durable goods, nondurable goods, and
services in a given period of time.
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6. Consumption Function
The fundamental relationship in macroeconomics
that assumes that household consumption
spending depends primarily on the level of
disposable income (net of taxes) in the economy,
all other variables held constant.
C = f(Y
d), where
Y
d = disposable, or after-tax income
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7. Marginal Propensity to Consume
(MPC)
The additional consumption spending
generated by an additional amount of real
income, assumed to take a value less than 1.
MPC = ΔC/ΔY
d or ΔC/Δ(Y - T
P)
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8. Saving Function
The amount of disposable income that
households do not spend on the consumption
of goods and services.
S = Y
d - C
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9. Marginal Propensity to Save (MPS)
The additional household saving generated by
an additional amount of real income, which
equals 1 MPC.
MPS = ΔS/ΔY
d or ΔS/Δ(Y – T
P) = 1 - MPC
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10. Other Factors Affecting the Level of
Consumption Spending
Personal taxes
Real interest rate
Consumer confidence
Existing stock of wealth
Availability of consumer credit
Stock of consumer debt outstanding
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11. Consumption Function - Graphical
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C
Y
C
0
C
2
C
1
Y
2
Y
1
∆C
∆Y

12. Gross Private Domestic Investment
Expenditure
The total amount of spending on nonresidential
structures, equipment, and software;
residential structures; and business inventories
in a given period of time.
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13. Determinants of Gross Private
Domestic Investment
Level of real income and output in the economy
Real interest rates
Business taxes
Expected Profits and Business Confidence
Capacity utilization rates
Residential Investment Spending
Inventory Investment
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14. Government Expenditure
The total amount of spending by federal, state,
and local governments on consumption outlays
for goods and services, depreciation charges
for existing structures and equipment, and
investment capital outlays for newly acquired
structures and equipment in a given period of
time.
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15. Determinants of the Level of
Government Expenditures
Government expenditure policy is determined
by the legislative and executive institutions at
all levels of government.
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16. Net Export Expenditure
The difference between export spending on
domestically produced goods and services by
individuals in other countries and import
spending on foreign produced goods and
services by domestic residents in a given
period of time.
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17. Determinants of the Level of Net
Export Expenditures
Relative economic growth rates around the
world.
Currency exchange rates.
Relative interest rates.
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18. Aggregate Expenditure Function
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E = E
0
+ (c
1
+ i
1
- m
1
)Y
where
E = aggregate expenditure
E
0
= sum of all autonomous expenditure
components
c
1 = marginal propensity to consume
i
1 = marginal propensity to invest
m
1
= marginal propensity to import
Y = real income

19. Aggregate Expenditure Function –
Graphical Treatment
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E
Y
E
E
0
Slope = c
1
+ i
1
– m
1

20. Equilibrium Level of Income and
Output
The equilibrium level of income and output is
that level of income at which the desired
spending by all sectors of the economy just
equals the value of the aggregate output
produced and the income received from that
production.
E = Y
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21. Equilibrium Level of Income and
Output - Graphical
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E
Y
E
1
E
0
E
E
Y
E
A
Slope = c
1
,
assuming
i
1
= m
1
= 0
45
o
Equilibrium is that level of real
income,Y
E
, where the aggregate
expenditure line, E
1 , crosses
the 45° line.

22. Disequilibrium Level Income and
Output Adjustment
Relationship of E to Y Inventories Output Adjustment
E > Y
Unexpected decrease in
inventories
Output increases
E = Y
Inventories are at
expected level
Output equilibrium
E < Y
Unexpected increase in
inventories
Output decreases
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23. The Multiplier
The multiple change in income and output that
results from a change in autonomous
expenditure.
m = ∆Y ÷ ∆E = 1 ÷ MPC
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24. Interest Rates and Aggregate
Expenditures
The interest-related expenditure (IRE) function
shows planned consumption and investment
spending as a function of the real interest rate,
all else held constant.
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25. Interest Rates and Aggregate
Expenditures
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r
2
r
IRE
IRE = f(r)
r
1
IRE
1
IRE
2
A
B
E
Y
E
(r1)
E
(r2)
45
o
A
B
Y
1 Y
2