CH9 - 9 INCOMEANDSPENDING FOCUSOFTHECHAPTER Thischapter...

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9 I NCOME   AND  S PENDING FOCUS OF THE CHAPTER • This chapter  takes a closer look at the way  that changes in the goods  market  affect aggregate   demand  by examining  the link between  income and  spending i.e., we use the fundamental   national income identity  ( Y = C + I + G + NX ) to analyze the way  that changes in consumption   affect output.   We treat both income and  consumption  as endogenous  variables.   • A basic result is that an increase in autonomous  spending  will increase output  by an amount   greater than  that of the spending  increase.  SECTION SUMMARIES 1. Aggregate Demand and Equilibrium Output The fundamental  national income accounting  identity, Y = C + I + G, states that the  actual  level  of output  must  always  equal the sum  of all the different  sources of aggregate demand.   (Notice   that we’re ignoring  net exports for the moment; we’ll talk about  how  to incorporate  these into   our analysis in Chapter  12.)  It is easy, however, to imagine a situation  in which   planned  levels of  output  differ from  planned  levels of consumption,  investment, and  government  spending.   When  this happens,  the goods  market  is not in equilibrium the quantity  of output  produced   does not equal the quantity  demanded.   Unintended  changes in inventories occur. These unplanned  inventory  changes  cause firms to increase or decrease their production.  The   level of output  rises or falls accordingly, and  brings the goods  market  back into equilibrium. 2. The Consumption Function and Aggregate Demand Increased  income causes increased  consumption.   This relationship  is captured  by the   consumption function : 89
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90 C HAPTER  9    C = + cY , where  c    is a number  between  zero and  one, and       is positive. The fraction of each additional dollar of income that is consumed  is represented  by the variable   c  in the equation  above and  called  the  marginal propensity  to consume  ( mpc ).  The fraction that   is saved  is equal to (1 –  c ), and  is called the  marginal propensity  to save  ( mps ).   Neither the mpc  nor the mps  can be greater than  1; that would  mean  that people were consuming  or saving  an   amount  greater than  their income.  The amount  that people choose to consume  when  their   income is zero the variable     is positive because people consume  out of wealth  as well as  income. Since saving  (
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CH9 - 9 INCOMEANDSPENDING FOCUSOFTHECHAPTER Thischapter...

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