An upward shift of the consumption schedule entails a downward shift of the saving schedule ■ If households consume more at each level of real GDP, they are saving less ○ A downward shift of the consumption schedule is reflected in an upward shift of the saving schedule ■ If households consume less at each level of real GDP, they are saving more The Interest Rate-Investment Relationship ● Expected rate of return, r ● The real interest rate ○ i = nominal rate - rate of inflation ○ Crucial in making investment decisions Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
26 ● The investment demand curve ○ Constructed by arraying all potential investment projects in descending order of their expected rates of return ○ Curve slopes downward, reflecting an inverse relationship between the real interest rate and the quantity of investment demanded Shifts in the Investment Demand Curve ● Acquisition, maintenance, and operating costs ● Business taxes ● Technological change ● Stock of capital goods on hand ● Planned inventory ● Expectations ● Fluctuations of investment ○ Variability of expectations ○ Durability ○ Irregularity of innovation ○ Variability of profits Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
27 ● Increases in the investment demand are shown as rightward shifts of the investment demand curve ● Decreases in investment demand are shown as leftward shifts of the investment demand curve The Multiplier Effect ● A change in spending changes real GDP more than the initial change in spending ● Changes in spending ripple through the economy to generate even larger changes in real GDP - this is called the multiplier effect Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
28 ● The multiplier and marginal propensities ○ Multiplier and MPC directly related ■ Large MPC results in larger increases in spending ○ Multiplier and MPS inversely related ■ Large MPS results in smaller increases in spending Building the Aggregate Expenditures Model Consumption and Saving ● Assumptions and simplifications ○ Use the Keynesian aggregate expenditures model ○ Prices are fixed ○ GDP = DI ○ Begin with private, closed economy - one without international trade or government ■ Consumption spending ■ Investment spending ● The investment demand curve and the investment schedule ○ The level of investment spending is determined by the real interest rate together with the investment demand curve ID ○ The investment schedule Ig relates the amount of investment to the various levels of GDP Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
29 Equilibrium GDP ● Equilibrium GDP in a private closed economy ○ Aggregate expenditures schedule, C + Ig, is determined by adding the investment schedule, Ig, to the upsloping consumption schedule, C ○ Equilibrium GDP is determined where the aggregate expenditures schedule intersects the 45 degree line (in this case at $470 billion) ● Other features of equilibrium GDP ○ Saving equals planned investment ■ Saving represents a leakage of spending ■
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- Winter '08
- Inflation, Ryan L.