Chapter 25 aggregate demand and the powerful consumer
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Transcript of Chapter 25 aggregate demand and the powerful consumer
PowerPoint Slides prepared by: Andreea CHIRITESCU
Eastern Illinois University1© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Aggregate Demand and the
Powerful ConsumerMen are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.
JOHN MAYNARD KEYNES
Aggregate Demand
• Aggregate demand– Total amount that all
• Consumers• Business firms• Government agencies• Foreigners
– Spend on final goods and services
– Is a schedule, not a fixed number• The numerical value depends on the price
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Aggregate Demand
• Components of aggregate demand– Consumer expenditure (C, consumption)
– Investment spending (I)
– Government purchases (G)
– Net exports (X-IM)
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Aggregate Demand
• C - Consumer expenditure / consumption– Total amount spent by consumers
– On newly produced goods and services• Excluding purchases of new homes
– 2/3 of total spending
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Aggregate Demand
• I - Investment spending – Sum of expenditures of business firms
• On new plant, equipment, and software
– And households on new homes
– Not included• Financial “investments”• Re-sales of existing physical assets
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Aggregate Demand
• G - Government purchases– All the goods and services purchased by
all levels of government
• X-IM - Net exports– Difference between exports (X) and
imports (IM)
• Aggregate demand
C + I + G + (X-IM)
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National Income
• National income– Sum of the incomes
– That all individuals in the economy earn • In the forms of wages, interest, rents, and
profits
– Excludes government transfer payments
– Is calculated before any deductions are taken for income taxes
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National Income
• Disposable income (DI)– Sum of the incomes of all individuals in
the economy
– After all taxes have been deducted and all transfer payments have been added
– How much consumers have available to spend and save
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National Income
• Transfer payments– Sums of money
– That the government gives certain individuals as outright grants• Rather than as payments for services
rendered to employers
– Examples• Social Security and unemployment benefits
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Circular Flow
• Disposable income, DI = C+S– Consumption (C)
– Savings (S)
• “Leakages”– S, IM, Taxes
• “Injections”– I, G, X, Transfers
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Figure 1The Circular Flow of Expenditures and Income
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Circular Flow
• Aggregate demand = C+I+G+(X-IM)
= Gross national income
• National income = Domestic product
• DI=GDP - Taxes + Transfer Payments
=GDP - (Taxes – Transfers)
=Y - T12© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Consumer Spending and Income
• Consumer spending - responds– Change in income taxes
• If DI increases– C – increases
• If DI decreases– C – falls
13
change Horizontalchange Vertical
Slope
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Figure 2Consumer Spending and Disposable Income
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Consumer Spending and Income
• Scatter diagram – graph– Graph showing the relationship between
two variables
– Each year: a point in the diagram • Coordinates of each year’s point: values of
the two variables in that year
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Figure 3Scatter Diagram of Consumer Spending and Disposable Income
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Figure 4Scatter Diagram of Consumer Spending and Disposable Income, 1947–1963
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The C Function and the MPC
• Consumption function, C– Relationship between
• Total consumer expenditures• Total disposable income in the economy
– Holding all other determinants of consumer spending constant
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The C Function and the MPC
• Marginal propensity to consume (MPC)– Ratio of changes in consumption to
changes in disposable income
– Slope of consumption function
– How much more consumers will spend if DI rises by $1
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C in change the produces that DI in ChangeC in ChangeMPC
The C Function and the MPC
• To estimate the initial effect of a tax cut on consumer spending– Estimate the MPC
– Multiply the amount of the tax cut by the estimated MPC
– Prediction – subject to some margin of error
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Table 1Consumption and Income in a Hypothetical Economy
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Figure 5A Consumption Function
22
C
2,700
3,000
3,300
3,600
3,900
Rea
l Con
sum
er S
pend
ing,
C
$4,200
3,200 3,600 4,0000 4,400 4,800
Real Disposable Income, DI
5,200
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Factors that Shift the C Function
• Movement along a given C function– Change in disposable income
• Shift of the C function– Change in other determinants of C
• Wealth • Price level• Real interest rate• Future income expectations
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Figure 6Shifts of the Consumption Function
24
C0
Rea
l Con
sum
er S
pend
ing
Real Disposable Income
A
C2
C1Movements along
consumption function
Shifts of consumption
function
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Factors that Shift the C Function
• Wealth – Stock market wealth
• Higher stock prices – increase in C function
– Houses • Lower price of houses – fall in C function
• Price level– Higher price level – lower purchasing
power of money-fixed assets
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Factors that Shift the C Function
• Real interest rate– Interest rates have negligible effects on
consumption decisions
• Future income expectations – Permanent cuts in income taxes cause
greater increases in consumer spending
• Than do temporary cuts of equal magnitude
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Table 2Incomes of Three Consumers
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The Extreme Variability of I
• Investment spending (I)– The most volatile component of aggregate
demand
• Business investment – influenced by– Interest rates
– Tax provisions
– Technical change
– Strength of economy
– State of business confidence
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The Extreme Variability of I
• Investment in housing – influenced by– Consumer incomes
– Interest rates
– Interest rates on home mortgages
– Expected rate of price appreciation (or depreciation)
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Determinants of Net Exports
• Exports, X– Foreign purchases of U.S. goods
• Imports, IM– Portion of domestic demand that is
satisfied by foreign producers
• Net exports– Exports minus Imports
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Determinants of Net Exports
• Changes in national income– Our GDP rises
• Our imports rise
– Our GDP falls• Our imports fall
– Our exports• Relatively insensitive to our GDP• Sensitive to the GDPs of other countries
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Determinants of Net Exports
• Relative prices and exchange rates– Prices increase
• Net exports decrease
– Prices decline• Net exports increase
– Foreign prices increase• Net exports increase
– Foreign prices decrease• Net exports decrease
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How Predictable is AD?
• Aggregate demand – difficult to predict– Consumption
• Wealth, stock market• Future prices, income tax law
– Investment• Business confidence, expectations
– Government purchases• Politics, military and national security events
– Net exports• Development abroad
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Appendix National income accounting
• National income accounting – System of measurement devised for
collecting and expressing macroeconomic data
• Gross domestic product (GDP)– Sum of money values
– All final goods and services
– Produced over a specified period of time• Usually one year
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Appendix GDP – exceptions to the rule
• Government output– Valued at cost of inputs
• Inventories– Counted in GDP
• Investment goods– Intermediate goods
– Included in GDP
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Appendix GDP: sum of final goods and services
• Y = C + I + G + (X – IM)• I = Gross private domestic investment
– Business investment
– Residential construction
– Inventory investment
– Includes only newly produced capital goods
– Doesn’t include exchanges of existing assets
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Appendix GDP: sum of final goods and services
• Y = C + I + G + (X – IM)• G = Government purchases
– Current goods and services
– Purchased by all levels of government
– Don’t include transfer payments
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Appendix GDP: sum of final goods and services
• Nation’s total output
Y=C+I+G+(X-IM)– Shares of GDP used up by
• Consumers (C)• Investors (I)• Government (G)• Foreigners (X-IM)
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Table 3Gross Domestic Product in 2009 as the Sum of Final Demands
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Appendix GDP: sum of all factor payments
• GDP = National income– Add up all income in the economy
– GDP = Wages + Interest + Rents + Profits
– Includes indirect business taxes
– Excludes transfer payments
– No deduction for income taxes
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Table 4Gross Domestic Product in 2009 as the Sum of Incomes
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Appendix GDP: sum of all factor payments
• Net national product (NNP) – A measure of production
– Is conceptually identical to national income
• Gross national product (GNP)– NNP plus depreciation
• Depreciation– Portion of capital equipment used up
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Appendix GDP: sum of value added
• Value added by a firm– Revenue from selling a product
– Minus amount paid for goods and services purchased from other firms
• GDP = sum of values added by all firms• Value added
= Wages + Interest + Rents + Profits
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Table 5An Illustration of Final and Intermediate Goods
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Table 6An Illustration of Value Added
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