Chapter 9

Chapter 9 - Chapter 9: Aggregate Demand Aggregate Demand...

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Chapter 9: Aggregate Demand Aggregate Demand – the total quantity of output demanded at alternative price levels in a given time period, ceteris paribus. Four Components o Consumption (C) – expenditures by consumers on final goods and services Account for two thirds of total spending. Most consumers simply spend most of whatever income they have Disposable Income – after tax income of consumers; personal income less personal taxes Disposable income can be either: o Consumed (spent) o Saved (not spent) – that part of disposable income not spend on current consumption; disposable income less consumption Too much saving could leave aggregate demand short of its full-employment potential Disposable Income = Consumption + Saving Y D C S o Keynes discovered two ways of describing the consumption-income relationship. Focuses on the ratio of total consumption to total disposable income. Average Propensity to Consume – total consumption in a given period divided by total disposable income. APC = total consumption _ = C total disposable income Y D Focuses on the relationship of changes in consumption to changes in disposable income. Marginal Propensity to Consume (MPC) – the fraction of each additional (marginal) dollar of disposable income spend on consumption; the change in consumption divided by the change in disposable income. MPC = change in consumption _ = Δ     C    change in disposable income ΔY D o Annual changes in disposable income entail hundreds of billions of dollars. o Once we know how much of their disposable income consumers will spend, we also know how much they will save. All disposable income is either consumed or spent!
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Saving is just whatever income is left over after consumption expenditures. Marginal Propensity to Save – the fraction of each additional dollar saved MPS = 1 – MPC o The Consumption Function MPC, MPS, APC and APS are simply statistical measures of observed consumer behavior. Keynes had many ideas about the determinants of consumption: Although he observed that consumer spending and income were highly correlated, he knew consumption wasn’t completely determined by current income. o People who have no income in a given period continue to consume goods and services. o They finance their purchases by dipping into their savings accounts (past income) or using credit (future income). o Peoples spending sometimes changes even when income doesn’t, suggesting that income isn’t the only determinant of consumption. Other non-income determinants of demand include: o Expectations o Wealth Changes in wealth will also change consumer behavior. When the stock market rises, stockholders respond by saving less and spending more of current income. Wealth Effect –
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Chapter 9 - Chapter 9: Aggregate Demand Aggregate Demand...

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