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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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Planned Aggregate Expenditure
The Components of Planned AggregateExpenditure
1. Consumer expenditure orConsumption (C)Household spending on durables,
nondurables, and services
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Planned Aggregate Expenditure
The Components of Planned AggregateExpenditure
2. Investment expenditure (I),New capital goods spendingNew residential spending
Increases in inventories
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Planned Aggregate Expenditure
The Components of Planned AggregateExpenditure
3. Government purchases (G)Federal, state, and local governments
spending on goods and services
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Planned Aggregate Expenditure
The Components of Planned AggregateExpenditure
4. Net exports (NX)Exports - imports
Therefore,
PAE = C + I + G + NX
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Planned Aggregate Expenditure
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
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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Planned Aggregate Expenditure
Planned Aggregate Expenditure
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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Planned Aggregate Expenditure
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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Planned Aggregate Expenditure
Consumption Function
It shows the relationship betweenconsumption spending and itsdeterminants, in particular,
disposable (after-tax) income
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Planned Aggregate Expenditure
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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Planned Aggregate Expenditure
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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MB MC The U.S. Consumption Function,
1960-2001
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Planned Aggregate Expenditure
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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Planned Aggregate Expenditure
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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Planned Aggregate Expenditure
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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Planned Aggregate Expenditure
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)