macsg08 - 8 [23] Aggregate Expenditure and Equilibrium...

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193 8 [23] Aggregate Expenditure and Equilibrium Output C hapter objectives: 1. Describe the relationship between consumption and income. Define the marginal propensity to consume ( MPC ) and the marginal propensity to save ( MPS ). 2. Explain how actual investment and intended investment differ. Describe the role of inventory change in establishing equilibrium in the economy. 3. Derive and graph the planned aggregate expenditure ( AE ) function. State why its slope has a value of less than one. Describe the adjustment process when planned aggregate expenditure differs from aggregate output. Use the expenditure and output approach and the saving/investment (leakages/injections) approach to specify the meaning of equilibrium in the model. 4. Analyze the effects on the macroeconomy of a change in planned investment or consumption. Describe the role of the multiplier in the inventory-adjustment process and, given MPC , derive the numerical value of the multiplier. 5. Describe the reasoning behind the paradox of thrift and explain what is paradoxical. Give yourself plenty of time to understand the model developed in this chapter—it’s the basis for what comes later. Can you prove that aggregate output does equal aggregate income? Can you confirm that income must equal consumption plus saving? Given the consumption function diagram, can you draw the related saving function diagram? Can you derive the consumption and saving equations? Can you see how unplanned inventory changes “balance” expenditures and output? Can you see why a $100 change in investment is “multiplied”? If not, work through this chapter again. ±±± LEARNING TIP: Don’t skip over the introductory material on pp. 139-140 [451-452]. This easily- missed little section sets the scene and establishes the structure of the macroeconomy (goods-and- services and money markets leading to aggregate demand and the labor market leading to aggregate supply) analyzed in Chapters 8-14 (23-29). The figure on page 139 [451] will be referenced throughout. ² BRAIN TEASER: Do a thought experiment. Suppose your after-tax monthly income rose by $100. What would you do with the extra money? How much would you spend; how much would you
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194 Study Guide to Principles of Macroeconomics save? Calculate your marginal propensity to consume and your marginal propensity to save. Calculate the expenditure multiplier. Case, Fair and Oster observe that the actual expenditure multiplier for the American economy is about 1.4. Can you explain the apparent discrepancy? OBJECTIVE 1: Describe the relationship between consumption and income. Define the marginal propensity to consume ( MPC ) and the marginal propensity to save ( MPS ). In the complete model of the economy, aggregate expenditure ( AE ) is found by adding: C + I + G + ( EX IM ). That formula now simplifies to AE = C + I because the model in this chapter has only two sectors (household and business) and only one market (goods-and-services). (page 142 [454]) For households, income ( Y ) is split between consumption ( C ) and saving ( S ). Determinants of aggregate consumption include i.
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macsg08 - 8 [23] Aggregate Expenditure and Equilibrium...

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