Principles of Economics
by Fred M Gottheil
PowerPoint Slides prepared by Ken Long
©1999 South-Western College Publishing
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Chapter 22
Equilibrium National
Income
3/19/2016
©1999 South-Western College Publishing
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What is the purpose of
this chapter?
To build an economic
model to represent an
economy tending toward
or being in equilibrium
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What is
Aggregate Expenditure?
The total spending by
consumers, investors,
government, and foreigners
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What assumption do we
make in this chapter?
There is no government
spending or foreign trade disposable income is the
same as total income
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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
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Aggregate Expenditure
Income - Expenditure Model
45o
National Income
88
Aggregate Expenditure
Income - Expenditure Model
Aggregate expenditure function
Equilibrium
45o
Ye
National Income
99
In equilibrium, C+I = Ye,
planned spending equals
output produced
10
Aggregate Expenditure
Income - Expenditure Model
Aggregate expenditure function
45o
Ye
Y1
National Income
111
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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Aggregate Expenditure
Income - Expenditure Model
Aggregate expenditure function
Y2
National Income
Ye
1313
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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Aggregate Expenditure
Income - Expenditure Model
Aggregate expenditure function
Equilibrium
45o
National Income
1515
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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Aggregate Expenditure
Shift in Aggregate Expenditure
C2+I2
C1+I1
original equilibrium
new equilibrium
45o
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
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Change in Y
Multiplier =
change in AE
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20 0
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
2
2
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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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One divided by one
tenth equals 10
Simple Multiplier
. 1 =
1 .
1
X
10
10 =
1
10
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Aggregate Expenditure
MPC = .9
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?
29
MPS = 1/3, initial change in
consumption = -8 billion,
then change in GDP =
30
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
suggests—Why?
• 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
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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
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