Consumption, Savings, and
Aggregate Expenditures
Do you agree or disagree with the
following?
1. If income remains constant, when
consumption increases savings must
decrease.
2. If income increases, savings decreases and if
income decreases, savings increases.
3. If consumption increases, ceteris paribus,
GDP will increase.
4. If GDP rises, unemployment rises.
5. Consumption can be greater than income.
Consumption and Saving
•
•
•
•
•
•
Largest component of AE is C
DI = C + S
If DI ↑, C ↑ and S ↑ ; if DI ↓, C ↓ and S ↓
C can be > DI; S can be negative
If AE ↑, GDP ↑ and unemployment ↓
If AE ↓, GDP ↓ and unemployment ↑
APC, APS, MPC, and MPS
• APC = C / Income = % of income people
are likely to consume
• APS = S / Income = % of income people
are likely to save
• APC + APS = 1
• MPC = ∆C / ∆Income
• MPS = ∆Savings / ∆Income
• MPC + MPS = 1
Investment
• If business expects to be able to
produce $1100 worth of goods from
$1000 machine, r = 10%
($100/$1000)
• If MB>=MC, they’ll invest so…
• r>=i
• If r = 10%, nominal i = 12%, inflation =
5%, they’ll invest until nominal i =
15%
i
I = $20 billion @ 8%
Real interest rate
8%
20
ID
I ($)
The Simple Spending
Multiplier
• Multiplier = (change in real
GDP)/(change in spending) OR
• Change in GDP = Multiplier x
(change in spending)
• Multiplier = 1/MPS OR 1/(1-MPC)
The Multiplier and GDP
• MPS = .20; consumption increases by $10
billion; what is the increase to GDP?
• $50 billion ($10 B x (1/.20)) = $10 B x 5
• MPS = .25; income increases by $20 billion;
what is the increase to GDP?
• Consumption increases by .75 x $20 B = $15 B;
GDP increases by $60 B ($15 B x 4)
• If MPS falls to .20, how does that change the
increase to GDP?
• C ↑ by .80 x $20 B = $16 B; GDP ↑ by $80 B
($16 B x 5)
Net Exports
• Positive Xn increase AE and negative Xn
decrease AE
• Appreciation – value of currency rises against
another
• Depreciation – value of currency falls against
another
• Ex: $1.50 = 1 Euro;
• Appreciation -- $1 = 1 Euro ($1.50 = 1.5 Euros)
• Depreciation -- $2 = 1 Euro
Net Exports
• If $ appreciates, U.S. goods more expensive
(costs more foreign currency) – X falls
• $ appreciates – foreign goods are cheaper;
M rises so net exports fall
• If $ depreciates, U.S. goods cheaper (costs
less foreign currency) – X rises
• $ depreciates – foreign goods more
expensive (costs more $) so M falls; net
exports rises
Government Purchases
• More purchases increase AE; fewer reduce
AE
• ∆ in G have a greater effect on GDP than ∆ in
taxes do
• Ex: MPS = .20; G ↑ by $20 B; GDP ↑ by
$100 B ($20 B x 5)
• MPS = .20; taxes fall by $20 B; C ↑ by $16 B
($20 B x .80); GDP ↑ by $80 B ($16 B x 5)
• Some of the tax cut is saved and doesn’t
affect GDP
Balanced Budget Multiplier
• Taxes and G change in the same direction
by the same amount; i.e. -- $20 B
• GDP will change by the same amount in
the same direction; i.e. -- $20 B
• Balanced budget multiplier is 1 (1 x ∆ in G
and T)
• If G and T fall by $20 B, GDP will fall by
$20 B
• Leakages – pull $ out of the economy:
savings, taxes, imports
• Injections – inject $ into the economy:
investment, government, exports
• Recessionary gap – the amount that AE
must increase to pull GDP up to fullemployment GDP
• Inflationary gap – the amount that AE must
fall to bring GDP back down to fullemployment GDP
The Simple Spending
Multiplier
• Multiplier = (change in real
GDP)/(change in spending) OR
• Change in GDP = Multiplier x
(change in spending)
• Multiplier = 1/MPS OR 1/(1-MPC)
Practice – What happens to GDP?
1. Income goes up by $5 M. MPC = 0.8
2. Investment falls by $40 B. MPS = 0.1
3. Government purchases falls by $100 B. MPC =
0.75
4. The dollar appreciates causing net exports to
change by $25 B. MPS = 0.2
5. The dollar depreciates causing net exports to
change by $10 B. MPS = 0.33
6. Taxes fall by $50 B. MPC = 0.8
7. Taxes and government purchases increase by
$25 B. MPC = 0.25
Answers
1.
2.
3.
4.
5.
6.
7.
GDP increases by $20 B.
GDP falls by $400 B.
GDP falls by $400 B.
GDP falls by $125 B.
GDP increases by $30 B.
GDP increases by $200 B.
GDP increases by $25 B.