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Chapter 25

Chapter 25. Aggregate Demand and the Powerful Consumer. Men 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

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Chapter 25

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  1. Chapter 25 Aggregate Demand and the Powerful Consumer Men 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

  2. Aggregate Demand • Aggregate demand • Total amount • All consumers, business firms, & government agencies • Spend: final goods and services • Components of aggregate demand • Consumer expenditure (C, consumption) • Investment spending (I) • Government purchases (G) • Net exports (X-IM)

  3. Aggregate Demand • C - Consumer expenditure / consumption • Total amount • Spent by consumers • Newly produced goods & services • Exclude: purchases of new homes • Investment goods • 2/3 of total spending

  4. Aggregate Demand • I - Investment spending • Sum of expenditures • Business firms - new plant & equipment • Households - new homes • Not included • Financial “investments” • Re-sales of existing physical assets

  5. Aggregate Demand • G - Government purchases • Goods & services • Purchased by – all levels of government • X-IM - Net exports • X – exports • Sell to foreigners • IM – imports • Buy from foreigners • Aggregate demand = C + I + G + (X-IM)

  6. National Income • National income • Total income - all individuals in economy • Wages, interest, rents, profits • Excludes • Government transfer payments • Before taxes / deductions

  7. National Income • Disposable income (DI) • Total income - all individuals in economy • After taxes – deducted • After transfer payments - added • Spend and save • Transfer payments • Sums of money • Form government – to certain individuals • Outright grants

  8. Circular Flow: Spending, Production, Income • Disposable income, DI = C+S • Consumption (C) • Savings (S) • “Leakages” • S, IM, Taxes • “Injections” • I, G, X, Transfers

  9. Figure 1 The circular flow of expenditures and income

  10. Circular Flow: Spending, Production, Income • Aggregate demand = C+I+G+(X-IM) = Gross national income • National income = Domestic product • DI=GDP - Taxes + Transfer Payments =GDP - (Taxes - Transfers) =Y - T

  11. Consumer Spending and Income • Consumer spending - responds • Change in income taxes • If DI increases • C – increases • If DI decreases • C – falls

  12. Figure 2 Consumer spending and disposable income

  13. Consumer Spending and Income • Scatter diagram – graph • Relationship between two variables • Each year – a point in diagram • Coordinates of each year’s point • Values of two variables - year

  14. Figure 3 Scatter diagram: consumer spending &disposable income

  15. Figure 4 Scatter diagram of consumer spending and disposable income, 1947–1963

  16. Consumption Function & MPC • Consumption function • Relationship • Total consumer expenditures • Total disposable income • All other determinants constant • Marginal propensity to consume (MPC) • Ratio of changes in consumption • To changes in disposable income • Slope of consumption function

  17. Consumption Function & MPC • Estimate initial effect of tax cut - on C • Estimate MPC = Amount of tax cut ˣ MPC

  18. Table 1 Consumption and income in a hypothetical economy

  19. Figure 5 A consumption function C $4,200 3,900 3,600 Real Consumer Spending, C 3,300 3,000 2,700 0 3,200 3,600 4,000 4,400 4,800 5,200 Real Disposable Income, DI

  20. Factors that Shift the Consumption Function • Change: disposable income • Movement along - consumption function • Change: other determinants of C • Shift - consumption function

  21. Figure 6 Shifts of the consumption function Movements along consumption function C0 C2 C1 Real Consumer Spending A Shifts of consumption function Real Disposable Income

  22. Factors that Shift the Consumption Function • Other determinants of C • Wealth • Stock market boom: upward shift • Price level • Money-fixed assets • Real interest rate • Future income expectations • Permanent cuts in income taxes • Greater increase in C • Than temporary cuts

  23. Table 2 Incomes of three consumers

  24. Extreme Variability Of Investment • Investment spending (I) • Volatility • Interest rates • Tax provisions • Technical change • Strength of economy • State of business confidence • Expectations about future

  25. Determinants of Net Exports • Income levels • GDP rises • Imports – rise • GDP falls • Imports – fall • Exports - relatively insensitive to GDP

  26. Determinants of Net Exports • Relative prices & Exchange rates • Prices increase • Net exports – decrease • Prices decline • Net exports – increase • Foreign prices – increase • Net exports – increase • Foreign prices – decrease • Net exports – decrease

  27. How Predictable is Aggregate Demand? • 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

  28. National income accounting • National income accounting • System of measurement • Collect & express macroeconomic data • Gross domestic product (GDP) • Sum of money values • All final goods & services • Produced - specified period of time • Usually one year

  29. GDP – exceptions to the rule • Government output • Valued at cost of inputs • Inventories • Counted in GDP • Investment goods • Intermediate goods • Included in GDP

  30. GDP: sum of final goods and services • Y = C + I + G + (X – IM) • I = Gross private domestic investment • Business investment • Plant, Equipment, Software • Residential construction • Inventory investment • Includes only • Newly produced capital goods • Doesn’t include • Exchanges of existing assets

  31. GDP: sum of final goods and services • Y = C + I + G + (X – IM) • G = Government purchases • Current goods & services • Purchased: all levels of government • Don’t include transfer payments

  32. 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)

  33. Table 3 Gross Domestic Product, 2007: sum of final demands

  34. GDP: sum of all factor payments • GDP = National income • Add up - All income in economy • GDP = Wages + Interest + Rents + Profits • Includes: indirect business taxes • Excludes: transfer payments • No deduction for income taxes

  35. Table 4 Gross Domestic Product in 2007: sum of incomes

  36. GDP: sum of all factor payments • Net national product (NNP) • Gross national product (GNP) • Depreciation • Portion of capital equipment - Used up

  37. GDP: sum of value added • Value added firm • Revenue from selling a product • Minus amount paid • Goods & services purchased from other firms • GDP = sum of values added by all firms • Value added = Wages + Interest + Rents + Profits

  38. Table 5 An illustration of final and intermediate goods

  39. Table 6 An illustration of value added

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