• Shifts caused by taxes o Two modern approaches: Life-Cycle Hypothesis, permanent income hypothesis ▪ Current consumption levels are based on Expected Lifetime income levels • Effects of tax cuts depend on their term o Permanent – will increase spending (shift consumption intercept up) o Temporary – will either not increase spending, or increase it imperceptivit y Explanation: - Because you expect to earn a surplus of income over your current spending, you are okay borrowing against that (i.e. student loans, mortgage, etc.) -
Later in life, when you retire, you earn less than your spending amount, so you use up your savings from earlier in life • Average Propensity to Consume (APC) = Household Spending/Household Consumption o Decreases with higher income levels, although the difference is probably not as large as in reported figures b/c: ▪ When people report their income, they often don’t include transfer payments (unemployment, disability, etc.) • Transfer payments would lower income (denominator) for lower income families ▪ High-income people tend to understate their consumption levels • Lowers the spending (numerator) for higher income families o APC v. MPC ▪ MPC determines how much spending results from a redistribution of income • High APC doesn’t necessarily imply a high MPC ▪ Can’t assume that MPCs are necessarily larger for poorer households • Low-income households might use additional income to pay off debt, work less hours, etc. • Economy has achieved a spending balance when the amount of GDP produced (Y) equals C + I + G + X • Graph of the Spending Balance model starts with the expenditure line o This line’s graph plots desired spending as a function of Y • Finding the point of spending balance o Graphical method: draw a 45-degree line, Spending = Y ▪ The point of the spending balance is the point where the expenditure line intersects the 45-degree line o Algebraic method – solve the spending equation for Y • Multipliers o Shifts in autonomous spending will have a multiplied effect on Y o Only important in the context of the EFM o Multiple = 1/(1-mpc)
• Deriving the Aggregate Demand Curve (refer below for diagrams) o Aggregate demand story starts with a change in the inflation rate ▪ Once you get this inflation rate, go over to the monetary rule curve and see what that inflation rate implies in terms of R • Spending (C, I, and X) depends on R o After you figure out the R, draw this curve on the spending balance model and you will be able to see the value of Y ▪ Y = change in spending x multiplier ▪ Connecting the dots yields the aggregate demand curve o Shifts in the AD Curve ▪ Anything that shifts the Monetary Rule curve will shift the AD curve. • If the monetary rule curve shifts down, then the spending line will shift up, and the AD curve will shift right. ▪ Anything that shifts the expenditure curve besides a change in R • If the expenditure curve shifts up, then the AD curve will shift right • No action occurring on the monetary rule curve The Inflation-Adjustment Line (IA) • IA curve = graphed on same set of axes used for the aggregate demand curve o Horizontal axis (x) = GDP (Y)
o Vertical axis (y) = inflation (@) o
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