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# sg29 - Chapter 13 EXPENDITURE MULTIPLIERS THE KEYNESIAN...

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191 13 EXPENDITURE MULTIPLIERS: THE KEYNESIAN MODEL* K e y C o n c e p t s Fixed Prices and Expenditure Plans 1 In the very short run, firms do not change their prices and they sell the amount that is demanded. As a result: The price level is fixed. GDP is determined by aggregate demand. Aggregate planned expenditure is the sum of planned consumption expenditure, planned investment, planned government purchases, and planned exports minus planned imports. GDP and aggregate planned expenditures have a two- way link: An increase in real GDP increases aggregate planned expenditures, and an increase in aggregate expenditures increases real GDP. Consumption expenditure, C , and saving, S , depend on disposable income ( disposable income , YD , is in- come minus taxes plus transfer payments), the real in- terest rate, wealth, and expected future income. The consumption function is the relationship be- tween consumption expenditure and disposable in- come. Figure 13.1 illustrates a consumption function. The amount of consumption when disposable in- come is zero (\$1 trillion in Figure 13.1) is called autonomous consumption. Consumption above this amount is called induced consumption . The marginal propensity to consume , MPC , is the fraction of a change in disposable income that is consumed, or MPC = YD C where means “change in.” 1 * This is Chapter 29 in Economics . The slope of the consumption function equals the MPC . The slope of the U.S. consumption function is about 0.9. Changes in the real interest rate, wealth, or ex- pected future income shift the consumption func- tion. Consumption varies when real GDP changes because changes in real GDP change disposable income. The saving function is the relationship between saving and disposable income. The marginal propensity to save, MPS , is the fraction of a change in disposable income that is saved, or MPS = YD S . The sum of the MPC plus MPS equals 1. Domestic imports are determined in the short run mainly by U.S. GDP. The marginal propensity to import is the fraction of an increase in real GDP spent on imports. C h a p t e r

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1 9 2 C H A P T E R 1 3 ( 2 9 ) Real GDP with a Fixed Price Level The aggregate planned expenditure schedule shows how aggregate expenditure depends on real GDP. The aggregate expenditure curve plots the aggregate planned expenditure schedule. Figure 13.2 illustrates an aggre- gate expenditure curve, AE = C + I + G + NX , where NX is exports minus imports. Induced expenditure is the sum of the compo- nents of aggregate expenditure that change with GDP. Autonomous expenditure is the sum of the com- ponents of aggregate expenditure that do not change when real GDP changes. In Figure 13.2 autonomous expenditure is \$8 trillion. Equilibrium expenditure is the level of aggregate ex- penditure that occurs when aggregate planned expendi- ture equals real GDP. In Figure 13.2 the equilibrium expenditure is the point at which the 45 ° line crosses the AE line, or \$10 trillion.
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sg29 - Chapter 13 EXPENDITURE MULTIPLIERS THE KEYNESIAN...

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