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Unformatted text preview: Modern Approach to the Aggregate Modern Approach to the Aggregate Expenditure Model Expenditure Model We now incorporate interest rates into the savings and investment functions, and add income taxes to the model. Showing effect of interest rate on saving and consumption spending: As we said earlier in the course, savings depends on the interest rate to some degree. To show this, we rewrite consumption spending: C = a(r) + MPC*DI where a(r) is consumption spending that is sensitive to interest rates, not to changes in the yearly value of DI. Examples: Durable consumer goods; washing machines, cars, stereos, etc., are types of interestsensitive consumer spending. Therefore, a(r) will be inversely related to the real rate of interest: ∆ a(r)/ ∆ r < 0, so that a rise in r will lead to a drop in a(r). Example: a(r) = 100  2r where r  percentage real return So, if r = 5, then the value of the real interest rate is 5% INVESTMENT As we said earlier, as market interest rates fall, investment projects that were not profitable at higher...
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 Spring '11
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 Macroeconomics, Interest Rates, Fisher equation

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