Aggregate Aggregate Expenditures:Expenditures:

The Multiplier, The Multiplier, Net Exports, Net Exports,

and and GovernmentGovernment

CHAPTER TEN

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

Pri

va

te s

pe

nd

ing

(b

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on

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ars

)S

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ing

an

d i

nv

es

tme

nt

(bil

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ns

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rs)

o

o45

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

2020Ig0

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

Equilibrium GDPEquilibrium GDPat at IIg0g0 level of investment level of investment

S

(C + Ig ) 0

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

Pri

va

te s

pe

nd

ing

(b

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an

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(bil

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

2020Ig0

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

Equilibrium GDPEquilibrium GDPat at IIg0g0 level of investment level of investment

S

(C + Ig ) 0

If I If I gg

increases...increases...

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

Pri

va

te s

pe

nd

ing

(b

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(C + Ig ) 1

Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

2020Ig0

Ig1

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

Equilibrium GDPEquilibrium GDPat at IIg1g1 level of investment level of investment

S

(C + Ig ) 0

Pri

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(b

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avin

g a

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(bill

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o45

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

2020 Ig0

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

Equilibrium GDPEquilibrium GDPat at IIg0g0 level of investment level of investment

(C + Ig ) 0

S

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

If I If I gg

decreases...decreases...

Pri

vate

sp

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ing

(b

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ns

of

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)S

avin

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(C + Ig ) 2

Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

2020 Ig0

Ig2

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

Equilibrium GDPEquilibrium GDPat at IIg2g2 level of investment level of investment

(C + Ig ) 0

S

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

CHANGES IN EQUILIBRIUM GDPAND THE MULTIPLIER

THE MULTIPLIER EFFECTTHE MULTIPLIER EFFECTTHE MULTIPLIER EFFECTTHE MULTIPLIER EFFECT

Multiplier Multiplier ==change in real GDPchange in real GDP

initial change in spendinginitial change in spending

OROR

Change in GDPChange in GDP == Multiplier Multiplier xx initial changeinitial changein spendingin spending

Rationale - $ spent in the economy is earned by others as income.Others go and spend part of their income and so on, and so on…

Change in GDPChange in GDP == Multiplier Multiplier xx initial changeinitial changein spendingin spending

and the marginal propensities....and the marginal propensities....

Inverse relationship betweenInverse relationship betweenMultiplier & MPSMultiplier & MPS

SimplifiedSimplifiedMultiplier Multiplier

== OROR11

MPSMPS11

1 - MPC1 - MPC

THE MULTIPLIER EFFECTTHE MULTIPLIER EFFECTTHE MULTIPLIER EFFECTTHE MULTIPLIER EFFECT

How much will a dollar spent, not saved have an impact on the economy?

The Multiplier EffectThe Multiplier Effect• The multiplier helps us

understand that spending changes are magnified when applied to the economy.

• This is especially important for fiscal policy considerations!

• The complex multiplier current being applied by the President is 2.

• Remember the simple multiplier only takes into effect the leakage of savings.

• Complex takes into effect taxes and imports.

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

NET EXPORTSNET EXPORTSNET EXPORTSNET EXPORTS

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

NET EXPORTSNET EXPORTSNET EXPORTSNET EXPORTS

PositivePositive if exports > imports if exports > imports

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

NET EXPORTSNET EXPORTSNET EXPORTSNET EXPORTS

PositivePositive if exports > imports if exports > imports

NegativeNegative if imports > exports if imports > exports

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

INTERNATIONAL TRADE INTERNATIONAL TRADE EQUILIBRIUM OUTPUTEQUILIBRIUM OUTPUT

NET EXPORTSNET EXPORTSNET EXPORTSNET EXPORTSPositivePositive if exports > imports if exports > imports

NegativeNegative if imports > exports if imports > exports

Now C + I + (x-m) orNow C + I + (x-m) orC + I + XC + I + X n

g

g

INTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUT

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

+5+5

-5-5

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

C + Ig

Equilibrium GDP atEquilibrium GDP atnet export = 0 net export = 0 levellevel

INTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUT

Pri

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

+5+5

-5-5

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

C + Ig

Equilibrium GDP atEquilibrium GDP atnet export = 0 net export = 0 levellevel

ToToillustrateillustrate

positivepositive net netexportsexports

INTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUT

Pri

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

+5+5

-5-5

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

C + Ig

Equilibrium GDP atEquilibrium GDP atpositive net export positive net export

level Xlevel Xn1n1

Xn1

C + Ig + Xn1

INTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUT

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

+5+5

-5-5

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

C + Ig

Equilibrium GDP atEquilibrium GDP atnet export = 0 net export = 0 levellevel

ToToillustrateillustrate

negativenegative net netexportsexports

INTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUTINTERNATIONAL TRADE EQUILIBRIUM OUTPUT

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Real domestic product, GDP (billions of dollars)

510510

490490

470470

450450

430430

Real domestic product, GDP (billions of dollars)

+5+5

-5-5

430 450 470 490 510430 450 470 490 510

430 450 470 490 510430 450 470 490 510

C + Ig

Xn2

Equilibrium GDP atEquilibrium GDP atnegative net exportnegative net export

level Xlevel Xn2n2

C + Ig + Xn2

International Economic International Economic Linkages…These shift Linkages…These shift the net export curve.the net export curve.

International Economic International Economic Linkages…These shift Linkages…These shift the net export curve.the net export curve.

• Prosperity AbroadProsperity Abroad• Prosperity AbroadProsperity AbroadThe more prosperous our trading partners are we will likely seean increase in exports.

International Economic International Economic Linkages...Linkages...International Economic International Economic Linkages...Linkages...

• Prosperity AbroadProsperity Abroad

• TariffsTariffs

• Prosperity AbroadProsperity Abroad

• TariffsTariffsTariffs imposed by other countries on our products will reduce ourExports.

International Economic International Economic Linkages...Linkages...International Economic International Economic Linkages...Linkages...

• Prosperity AbroadProsperity Abroad•TariffsTariffs• Exchange RatesExchange Rates

• Prosperity AbroadProsperity Abroad•TariffsTariffs• Exchange RatesExchange Rates

Depreciation of the $ will cause exports to increase. We alsoWon’t buy as many imports as they will be more expensive.

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

o45

o

Real domestic product, GDP (billions of dollars)

5050

3030

00

470 510 550470 510 550

C + Ig + Xn

Real domestic product, GDP (billions of dollars)470 510 550470 510 550

C

Ig + X

S+M

C +

I g +

Xn +

G(b

illi

on

s o

f d

oll

ars)

Sa+

M+

T, I

g +

X +

G(b

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ns

of

do

llars

)

Show the effect ofShow the effect ofgovernment spendinggovernment spending

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

o45

o

Real domestic product, GDP (billions of dollars)

5050

3030

00

470 510 550470 510 550

C + Ig + Xn + G

Equilibrium GDPEquilibrium GDPafterafter $20 billion $20 billion

government spendinggovernment spending

C + Ig + Xn

Real domestic product, GDP (billions of dollars)470 510 550470 510 550

C

Ig + XIg + X + G

S+M

Governmentspending

$20 billion

Government spending $20 billion

C +

I g +

Xn +

G(b

illi

on

s o

f d

oll

ars)

Sa+

M+

T, I

g +

X +

G(b

illio

ns

of

do

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)

C +

I g +

Xn +

G(b

illi

on

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ars)

Sa+

M+

T, I

g +

X +

G(b

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ns

of

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)

o45

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Real domestic product, GDP (billions of dollars)

5050

3030

00

490 550490 550

C + Ig + Xn + G

Impact of taxes onImpact of taxes onequilibrium GDPequilibrium GDP

Real domestic product, GDP (billions of dollars)

Ig + XIg + X + G

S+M

$15 billiondecrease in

consumption

490 550490 550

$20 billion increasein taxes

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

C +

I g +

Xn +

G(b

illi

on

s o

f d

oll

ars)

Sa+

M+

T, I

g +

X +

G(b

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ns

of

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)

o45

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Real domestic product, GDP (billions of dollars)

5050

3030

00

490 550490 550

C + Ig + Xn + G

Impact of taxes onImpact of taxes onequilibrium GDPequilibrium GDP

Real domestic product, GDP (billions of dollars)

Ig + XIg + X + G

S+M

$15 billiondecrease in

consumption

490 550490 550

$20 billion increasein taxes

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

Toillustrate a

$20 billion taxincrease

Toillustrate a

$20 billion taxincrease

Lump-Sum TaxesLump-Sum Taxes

C +

I g +

Xn +

G(b

illi

on

s o

f d

oll

ars)

Sa+

M+

T, I

g +

X +

G(b

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ns

of

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)

o45

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Real domestic product, GDP (billions of dollars)

5050

3030

00

490 550490 550

C + Ig + Xn + G

Impact of taxes onImpact of taxes onequilibrium GDPequilibrium GDP

Real domestic product, GDP (billions of dollars)

Ig + XIg + X + G

S+M

$15 billiondecrease in

consumption

$5 billion decreasein saving

490 550490 550

Sa+MSa+M+T

Ca + Ig + Xn + G

$20 billion increasein taxes

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

C +

I g +

Xn +

G(b

illi

on

s o

f d

oll

ars)

Sa+

M+

T, I

g +

X +

G(b

illio

ns

of

do

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)

o45

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Real domestic product, GDP (billions of dollars)

5050

3030

00

490 550490 550

C + Ig + Xn + G

Impact of taxes onImpact of taxes onequilibrium GDPequilibrium GDP

Real domestic product, GDP (billions of dollars)

Ig + XIg + X + G

S+M

$15 billiondecrease in

consumption

$5 billion decreasein saving

490 550490 550

Sa+MSa+M+T

Ca + Ig + Xn + G

$20 billion increasein taxes

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

BalancedBalancedBudgetBudget

MultiplierMultiplier

Real GDP (billions of dollars)

o45

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490 510 530490 510 530

(C + Ig + Xn + G)0

Full EmploymentPri

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an

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ove

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spen

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Recessionary gap - Whenaggregate expendituresare inadequate to bringabout full employment

Recessionary gap - Whenaggregate expendituresare inadequate to bringabout full employment

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

Real GDP (billions of dollars)

(C + Ig + Xn + G)1

o45

o

490 510 530490 510 530

(C + Ig + Xn + G)0

Full Employment

} RecessionaryRecessionaryGap = $5 billion Gap = $5 billion

Pri

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Recessionary gap - Whenaggregate expendituresare inadequate to bringabout full employment

Recessionary gap - Whenaggregate expendituresare inadequate to bringabout full employment

ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

Real GDP (billions of dollars)

o45

o

490 510 530490 510 530

Full EmploymentPri

vate

an

d g

ove

rnm

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spen

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bil

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ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORInflationary gap - Whenaggregate expendituresare greater than the full

employment level causingdemand-pull inflation

Inflationary gap - Whenaggregate expendituresare greater than the full

employment level causingdemand-pull inflation

(C + Ig + Xn + G)0

Real GDP (billions of dollars)

o45

o

490 510 530490 510 530

(C + Ig + Xn + G)0

Full EmploymentPri

vate

an

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bil

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ADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTORADDING THE PUBLIC SECTOR

(C + Ig + Xn + G)1

{ InflationaryGap = $5 billion

InflationaryGap = $5 billion

Inflationary gap - Whenaggregate expendituresare greater than the full

employment level causingdemand-pull inflation

Inflationary gap - Whenaggregate expendituresare greater than the full

employment level causingdemand-pull inflation

Historical Applications...Historical Applications...• Great DepressionGreat Depression

Historical Applications...Historical Applications...• Great DepressionGreat Depression• Overcapacity & Business Overcapacity & Business

IndebtednessIndebtedness

Historical Applications...Historical Applications...• Great DepressionGreat Depression• Overcapacity & Business Overcapacity & Business

IndebtednessIndebtedness• Decline in Residential Decline in Residential

ConstructionConstruction

Historical Applications...Historical Applications...• Great DepressionGreat Depression• Overcapacity & Business Overcapacity & Business

IndebtednessIndebtedness• Decline in Residential Decline in Residential

ConstructionConstruction• Stock Market CrashStock Market Crash

Historical Applications...Historical Applications...• Great DepressionGreat Depression• Overcapacity & Business Overcapacity & Business

IndebtednessIndebtedness• Decline in Residential Decline in Residential

ConstructionConstruction• Stock Market CrashStock Market Crash• Shrinking Money SupplyShrinking Money Supply

Historical Applications...Historical Applications...• Great DepressionGreat Depression• Overcapacity & Business Overcapacity & Business

IndebtednessIndebtedness• Decline in Residential Decline in Residential

ConstructionConstruction• Stock Market CrashStock Market Crash• Shrinking Money SupplyShrinking Money Supply

• Vietnam War InflationVietnam War Inflation

•Recessionary gapRecessionary gap•Inflationary gapInflationary gap•Multipliers: Simple, Multipliers: Simple, Tax, and balanced-Tax, and balanced-budget multiplierbudget multiplier

•Lump-sum taxLump-sum tax

•Recessionary gapRecessionary gap•Inflationary gapInflationary gap•Multipliers: Simple, Multipliers: Simple, Tax, and balanced-Tax, and balanced-budget multiplierbudget multiplier

•Lump-sum taxLump-sum tax

Coming Next:Coming Next:Coming Next:Coming Next:

AGGREGATE DEMANDAGGREGATE DEMANDANDAND

AGGREGATE SUPPLYAGGREGATE SUPPLY

AGGREGATE DEMANDAGGREGATE DEMANDANDAND

AGGREGATE SUPPLYAGGREGATE SUPPLYCHAPTER 11CHAPTER 11CHAPTER 11CHAPTER 11