INCOME AND EXPENDITURES

2. INCOMEAND EXPENDITURES INCOME AND EXPENDITURES Wages (salaries) earned by labor Rents earned by land owners Interest earned by capitalists Profits earned by entrepreneurs

3. INCOME ANDEXPENDITURES INCOME AND EXPENDITURES Consumption Investment Government

4. INCOME AND EXPENDITURES Wages Rents Interest Profits Consumption Investment Government Y = C + I + G

5. Income-Expenditure analysis, as introduced by John Maynard Keynes in 1936, hinges not on how people earn their incomes but rather on how they spend them. If all the income gets spent, then the economy is in “equilibrium,” but it is not necessarily performing at its full-employment potential. Y = C + I + G

6. Does Y always equal C + I + G? No. The equality holds only when the economy is in macro-equilibrium. Is the economy always in macro-equilibrium? No. Only when all income is spent (Y = C + I + G) is the economy in macro-equilibrium. Does macro-equilibrium imply full employment? No, it’s only by “accident or design” that Yeq = Yfe. Does full employment imply an unemployment rate of zero? No, it implies no unemployment beyond the 5-6% that characterizes a healthy economy.

7. WHY DIVIDE EXPENDITURES INTO THREE COMPONENTS? Consumption Stable Not constant but predictable on the basis of income. Investment Unstable Based on guesses about market conditions in the future. Government Stabilizing Deliberately altered to offset changes in investment activity. Stabilizable C + I + G Potentially stable—with wise and well-time stimulus packages.

8. FOR STARTERS, WE WORK WITH ONLY TWO COMPONENTS. Consumption Stable Investment Unstable Unstable C + I

9. I. EARNING MONEY AND SPENDING IT A. The Expenditure Sequence

10. Read Chapter 8, pp. 141-151 in Case, Fair, and Oster’s Principles of Macroeconomics

11. E = Y

12. The E strands for total expenditures for a wholly private economy, i.e., E = C + I For starters, let’s just deal with the first component.

13. Suppose you earn an income of $1200/mo. And you spend $1000/mo on consumption.

14. Now your income increases to $2700/mo. So, you now spend $2000/mo. An increase in consumption of $1000/mo. A raise of $1500/mo.!

15. Your Marginal Propensity to Consume, abbreviated MPC, is 1000/1500 = 2/3. Marginal Propensity to Consume $1000/mo. Average Propensity to Consume $1500/mo.

16. A straight line connecting these two combinations of C and Y shows how consumption spending varies with income.

17. A straight line connecting these two combinations of C and Y shows how consumption spending varies with income.

18. The MPC is the slope of the line and is symbolized here by “b.” The vertical intercept is symbolized by “a.” So, a = 200, and b = 2/3. C = a + bY C = 200 + 2/3 Y

20. The 45-degree line allows us to measure saving as the difference between income and consumption. That is, S = Y – C.

21. The 45-degree line allows us to measure saving as the difference between income and consumption. That is, S = Y – C.

22. For a wholly private economy: S = Y – C, where C = a + bY S = Y – (a + bY) S = Y – a – bY S = – a + Y – bY S = – a + (1 – b)Y

23. Proof: C = a + bY S = – a + (1 – b)Y C + S = 0 + bY + (1 – b)Y C + S = (b + 1 – b) Y C + S = Y

24. Note: C = a + bY S = – a + (1 – b)Y If you know the consumption equation, you can write the saving equation by inspection.

25. Note: C = a + bY S = – a + (1 – b)Y Just change the sign on the intercept term and choose an MPS so that the two marginal propensities add up to one.

26. For example: C = 392.7 + 0.92Y What is the saving equation? S = -392.7 + 0.08Y S = – a + (1 – b)Y

30. For a wholly private economy: The equilibrium condition is: Y = C + I It’s necessarily true that: Y = C + S --since S = Y - C What can you say, then, about the relationship between I and S in macroeconomic equilibrium?

31. For a wholly private economy in macroeconomic equilibrium, Y = E C + S = Y = E = C + I C + I = C + S I = S The equality of saving and investment implies an income-expenditure equilibrium.

32. According to Keynes: It isn’t movements in the interest rate that bring saving and invest-ment in line with one another. Rather, it is movements in the level of income that bring saving in line with investment. Rather, it is movements in the level of income that bring saving in line with investment.

33. According to Keynes, this is the great inherent fault of a totally decentralized capitalist system. The variable that is in charge of macroeconomic equilibration (Y) is at the same time the magnitude upon which the prosperity of the economy depends.

34. So, what part of the totally decentralized capitalist system do you think Keynes wanted to centralize? As Keynes saw things, “a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment.”

35. When Y = 2700, C = 2000. How much investment would there have to be for Y = 2700 to be an equilibrium? I = 700 (S = 700) C = 2000 And just how might that investment be financed? Y = 2700

36. You can actually calculate the equilibrium value of Y if you know the parameters of the consumption equation ( a and b) and you know the current level of investment (I).

37. A wholly private economy is in macroeconomic equilibrium when: Y = C + I Consumers spending is given by: C = a + bY With I = 200 and C = 200 + 2/3 Y, we can write Y = (200 + 2/3 Y) + 200 Y = 200 + 2/3 Y + 200

38. Y = 200 + 2/3 Y + 200 Y - 2/3 Y = 400 1/3 Y = 400 Y = 1200 Proof: C = 200 + 2/3 Y = 200 + 2/3 (1200) C = 200 + 800 = 1000 C + I = 1000 + 200 = 1200 = Y

39. I = 200 C = 1000 Y = 1200 Yfe

40. Suppose that investment increases by some amount, say, I = 600. By how much will the equilibrium level of Y increase? That is, what value of Y corresponds to a I of 600 Yfe

41. Yfe

42. Watch the economy spiral upwards. Yfe

43. Watch the economy spiral upwards. W Going wage 1200 3000 N Yfe

44. Watch the economy spiral upwards. Yfe

45. Yfe