Equilibrium National Income

10/2/2013
1999 South-Western College Publishing

What is Aggregate Expenditure?

The total spending by consumers, investors, government, and foreigners
1999 South-Western College Publishing

What assumption do we make?

There is no government spending or foreign trade disposable income is the same as total income
1999 South-Western College Publishing

2 Ways of Looking at Equilibrium

Income/expenditure approach Savings/Investment approach
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What is the Aggregate Expenditure Curve?

A curve that shows the quantity of aggregate expenditures at different levels of national income or GDP
1999 South-Western College Publishing

Income - Expenditure Model

Aggregate Expenditure

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National Income
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Income - Expenditure Model

Aggregate Expenditure Aggregate expenditure function

Equilibrium
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Ye

National Income
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In equilibrium, C+I = Ye, planned spending equals output produced

Income - Expenditure Model

Aggregate Expenditure Aggregate expenditure function

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Ye

Y1

National Income
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What happens at output above equilibrium, like Y1?

Aggregate expenditure is less than output, leading to an unplanned inventory accumulation Firms will likely cut production, leading to lower GDP and national income
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Income - Expenditure Model

Aggregate Expenditure Aggregate expenditure function

Y2

National Income

Ye
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What happens at output below equilibrium, like Y2?

Aggregate expenditure is greater than output, leading to an unplanned inventory depletion

Firms will likely increase production, leading to higher GDP and national income
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Income - Expenditure Model

Aggregate Expenditure Aggregate expenditure function

Equilibrium
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National Income
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The Bureau of Economic Analysis has data on current income

http://www.bea.doc.gov/bea/dn1.htm

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What happens when Consumption or Investment change?

The equilibrium level of national income changes
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Shift in Aggregate Expenditure

Aggregate Expenditure

C2+I2
C1+I1
original equilibrium new equilibrium
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National Income

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What is the Income Multiplier?

The multiple by which income changes as a result of a change in aggregate expenditure
1999 South-Western College Publishing

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Change in Y
Multiplier = change in AE

1999 South-Western College Publishing

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If investors increase spending by $100 billion, will GDP increase by $100 billion?
NO, it will increase by more than $100 billion because of the multiplier
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$100 $90 MPC = 9/10 $81 MPS = 1/10 $74

...

$1,000
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How do we measure the multiplier?

1/MPS or 1/ (1-MPC)
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If MPC equals 9/10, what is MPS?

1/10
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1 . 1
X

One divided by one tenth equals 10 Simple Multiplier . 1 =

10 10 =

10
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MPC = .9
Aggregate Expenditure

MPS = .1

C+I
90 100

National Income

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If the multiplier is 10, how much does GDP increase when investment increases by $1billion?

10 x $1bil = $10 billion

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If the multiplier is 10, how much does GDP decrease when investment decreases by $1billion?

10 x -$1bil = -$10 billion

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More multiplier problems

Assume MPC=.75, initial change in Investment = 5 billion, then change in GDP equals?
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MPS = 1/3, initial change in consumption = -8 billion, then change in GDP =

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MPC = .8
Say investment increases by 6 billion, what is the maximum change in GDP???
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Note that the actual value of the multiplier is smaller than our formula suggestsWhy?
The effect of taxes has been ignored The effect of imports has been ignored The effect of inflation has been ignored

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What is the Paradox of Thrift?

The more people try to save (in the aggregate) , the more income falls, leaving them with no more and perhaps with even less saving
1999 South-Western College Publishing

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 What is Aggregate Expenditure? At what point is the Equilibrium? Why is intended I = intended S an equilibrium? What is Actual Investment? What happens when actual Investment > intended Investment? What happens when actual Investment < intended Investment?
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What happens when Consumption or Investment change? What is the Income Multiplier? If the price level increases what happens to AE? If the price level decreases what happens to AE? What is the Paradox of Thrift?
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END
1999 South-Western College Publishing

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