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Chapter 10: Aggregate Expenditure

Chapter 10: Aggregate Expenditure. The Multiplier, Net Exports, and Government. GDP = Total Expenditure = C + I Equilibrium GDP: C + I = GDP e At equilibrium: S = I Recall that s is a leak while I is an injection. Changes in GDP r*.

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Chapter 10: Aggregate Expenditure

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  1. Chapter 10: Aggregate Expenditure The Multiplier, Net Exports, and Government Alomar_111_14

  2. GDP = Total Expenditure = C + I • Equilibrium GDP: C + I = GDPe • At equilibrium: S = I • Recall that s is a leak while I is an injection Alomar_111_14

  3. Changes in GDPr* • The level of equilibrium GDPr may change as consumption schedule (C) and investment schedule (I) change. • Since changes in (I) are the main source of instability, we focus on them now. • The following graph shows changes in GDPr* as investment schedule changes: Alomar_111_14

  4. C GDP = DI C a C = GDP=DI GDP Alomar_111_14

  5. C Adding the level of I: ∆I GDP = DI C + I ∆I C a + Io C = GDP=DI GDP Alomar_111_14

  6. C GDP = DI C + I ∆I C GDP C = GDP=DI C +I = GDP=DI Alomar_111_14

  7. AE= C+I GDP = DI C + I ∆I C Adding I increased the level of GDPe GDP C = GDP=DI C +I = GDP=DI Alomar_111_14

  8. AE GDP = DI C + I ∆I C Adding I increased the level of GDPe GDP C = GDP=DI C +I = GDP=DI Alomar_111_14

  9. But what if the level of investment decreases? • HW # 3 Alomar_111_14

  10. AE Question: Which is bigger: ∆I or ∆GDP? GDP = DI C + I ∆I C Adding I increased the level of GDPe ∆I ∆ GDP GDP Alomar_111_14

  11. The effect on Y? • We notice that (∆I < ∆Y) as level of (I) increases. • Therefore, changes in (I) lead to multiple effect on the level of (Y). • This is called the “multiplier effect” • Multiplier = (∆ GDPr / ∆ Spending) Alomar_111_14

  12. The multiplier shows by how much the level of income and output (GDP or Y) will change as the level of planned investment (I) changes. Or: ΔY = (ΔI) x (Multiplier) m = 1/MPS Alomar_111_14

  13. Example: • Assume that ΔGDPr* (or Y*) =400 as a result of ΔI by 100. Find the multiplier. Answer: from equation (2), ΔY = (ΔI) x (Multiplier) 400 = 100 x multiplier Multiplier = 400/100 Multiplier = 4 Alomar_111_14

  14. This means that as Investment expenditure increases by (100), equilibrium GDPr will increase 4 times (by 400). Or: • As Investment expenditure falls by (100), equilibrium GDPr will decline 4 times (by 400). Alomar_111_14

  15. 2. Assume that initial Y = 1000, and the corresponding I=100. if MPC=75%, and I increased to 250, what is the new Y level? Answer:ΔY = Δ I / (MPS) ΔY = 150 / 0.25 ΔY = 600 Alomar_111_14

  16. This means that the new Y=1000 + 600 =1600 • The multiplier = 1/0.25 = 4 • (I) changed by (150) therefore: • Changes in (Y) = 4 x 150 = 600 Alomar_111_14

  17. Note that an increase in (I) by (100) will increase total spending by 100 which means that total spending schedule (C + I) “shifts-up” by 100. • However, the effect on Y* is greater than 100 as a result of the multiplier = 4. Alomar_111_14

  18. AE ∆I ∆I ∆GDP Alomar_111_14

  19. Multiplier = 1 / MPS, • Changes in MPS and effect of the multiplier? Alomar_111_14

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