expenditure multipliers. . 248 fixed prices and expenditure plans in the very short term, firms’...
TRANSCRIPT
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ExpenditureMultipliers
ExpenditureMultipliers
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2 Fixed Prices and Expenditure Plans
In the very short term, firms’ prices are fixed.
The quantities they sell depend on demand, not supply.
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3 Fixed Prices and Expenditure Plans
The Aggregate Implications of Fixed Prices
1) Because each firm’s price is fixed, the price level is fixed.
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4 Fixed Prices and Expenditure Plans
The Aggregate Implications of Fixed Prices
2) Because demand determines the quantities that each firm sells,
aggregate demand determines the aggregate quantity of goods and services sold, which equals GDP.
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5 Fixed Prices and Expenditure Plans
The aggregate expenditure model explains fluctuations in aggregate demand by identifying the forces that determine expenditure plans.
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6 Fixed Prices and Expenditure Plans
Expenditure Plans
The components of aggregate expenditure are:
1) Consumption expenditure
2) Investment
3) Government purchases of goods and services
4) Net exports (exports minus imports)
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7 Fixed Prices and Expenditure Plans
Expenditure Plans (cont.)
Aggregate planned expenditure is equal to planned consumption expenditure plus planned investment plus planned government purchases plus planned exports minus planned imports.
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8 Fixed Prices and Expenditure Plans
Expenditure Plans (cont.)
In the very short term all are fixed except planned consumption expenditure and planned imports.
They depend on the level of GDP.
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9 Fixed Prices and Expenditure Plans
A Two-Way Link Between Aggregate Expenditure and GDP (cont.)
1) An increase in real GDP increases aggregate planned expenditure
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10 Fixed Prices and Expenditure Plans
A Two-Way Link Between Aggregate Expenditure and GDP (cont.)
2) An increase in aggregate expenditure increases real GDP
How does real GDP influence planned consumption expenditure and saving?
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11 Fixed Prices and Expenditure Plans
Consumption Function and Saving Function
We are going to focus on the relationship between consumption expenditures and disposable income when other factors are constant.
The reason: disposable income and consumption expenditures are interrelated.
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12 Fixed Prices and Expenditure Plans
The main factors that influence consumption and saving are:
1) Real interest rate
2) Disposable income
3) Purchasing power of net assets
4) Expected future income
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13 Fixed Prices and Expenditure Plans
Consumption Function and Saving Function
• The consumption function shows the relationship between consumption expenditure and disposable income.
• The saving function shows the relationship between saving and disposable income.
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14Consumption Function and Saving Function
a 0 0.75 -0.75
b 11.50 -0.50
c 22.25 -0.25
d 33.00 0
e 43.75 0.25
f 54.5 0.50
PlannedDisposable consumption Plannedincome expenditure saving
(trillions of 1992 dollars per year)
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15Consumption Function and Saving Function
Disposable income (trillions of 1992 dollars per year)
Con
sum
ptio
n ex
pend
iture
(t
rilli
ons
of 1
992
dolla
rs/y
ear)
1
2
3
4
5
0
a
b
c d
e
fSaving
DissavingConsumptionfunction
1 2 3 4 5
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16 Consumption Functionand Saving Function
• Consumption expenditure that occurs when disposable income is zero is autonomous consumption.
• Consumption in excess of this is called induced consumption.
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17 Consumption Functionand Saving Function
0
-1
1
1 3 4 5
Dissaving
SavingSavingfunction
a bc
de
f
Disposable income(trillions of 1992 dollars per year)
Sav
ing
(tri
llion
s of
199
2 do
llars
per
yea
r)
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18 Fixed Prices and Expenditure Plans
Marginal Propensities to Consume and Save
The marginal propensity to consume (MPC) is the fraction of a change in disposable income that is consumed.
YD
CMPC
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19 Fixed Prices and Expenditure Plans
Marginal Propensities to Consume and Save
The marginal propensity to save (MPS) is the fraction of a change in disposable income that is saved.
YD
SMPS
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20 Fixed Prices and Expenditure Plans
Marginal Propensities to Consume and Save
Example:
• An increase in disposable income from $3 trillion to $4 trillion increases saving from zero to $0.25 trillion.
• The $1 trillion increase in disposable income increases saving by $0.25 trillion.
• The MPS is $0.25 trillion divided by $1 trillion, or 0.25.
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21 Fixed Prices and Expenditure Plans
Marginal Propensities to Consume and Save
Example:
• The MPS plus the MPC always equals 1.
• Therefore, the MPC is 0.75.
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22 Fixed Prices and Expenditure Plans
Marginal Propensities to Consume and Save
1
YD
S
YD
C
Divide both sides of the equation by the changein disposable income to obtain:
YDSC
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23 Fixed Prices and Expenditure Plans
These two values are the marginal propensity to consume and the marginal propensity to save, so:
1 MPSMPC
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24 Fixed Prices and Expenditure Plans
Slopes and Marginal Propensities
The slopes of the consumption function and the saving function are the marginal propensities to consume and save.
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25
Consumptionfunction
Marginal Propensities to Consume and Save
Disposable income (trillions of 1992 dollars per year)
Con
sum
ptio
n ex
pend
itur
e (t
rill
ions
of
1992
dol
lars
/yea
r)
1
2
3
4
5
0 1 2 3 4 5
a
b
c d
e
f
45o line
1$YD trillion
75.0$C trillion
MPC= 0.75
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26
0
-1
1
1
Savingfunction
3 4 5
a bc
de
f
Sav
ing
(tri
llion
s of
199
2 do
llars
per
yea
r)
Disposable income(trillions of 1992 dollars per year)
MPS= 0.25
1$YD trillion
25.0$S
Marginal Propensities to Consume and Save
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27 Fixed Prices and Expenditure Plans
Other Influences on Consumption Expenditure and Saving
Changes in disposable income leads to movements along the consumption function and saving function.
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28 Fixed Prices and Expenditure Plans
Other Influences on Consumption Expenditure and Saving
A change in any other factor that influences consumption expenditure and saving shifts both the consumption function and the saving function.
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29 Fixed Prices and Expenditure Plans
The other factors that change consumption expenditure and saving are:
1) Real interest rates
2) The purchasing power of net assets
3) Expected future income
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30 Shifts in the Consumptionand Saving Function
Disposable income (trillions of 1992 dollars per year)
Con
sum
ptio
n ex
pend
itur
e (t
rill
ions
of
1992
dol
lars
/yea
r)
1
2
3
4
5
0 1 2 3 4 5
45o line
CF0
CF1
CF2
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31
0
-1
1
1 4 5
Sav
ing
(tri
llion
s of
199
2 do
llars
per
yea
r)
Disposable income(trillions of 1992 dollars per year)
2
SF0
SF1
SF2
3
Shifts in the Consumptionand Saving Function
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32
The U.S. Consumption Function
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33 Fixed Prices and Expenditure Plans
Consumption as a Function of Real GDP
• Consumption changes when disposable income changes.
• Disposable income changes when either real GDP changes or net taxes change.
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34 Fixed Prices and Expenditure Plans
Consumption as a Function of Real GDP
• Holding taxes constant, consumption depends not only on disposable income, but also on real GDP.
• Imports are also influenced by real GDP.
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35 Fixed Prices and Expenditure Plans
Import Function
• The greater the U.S. real GDP, the larger is the quantity of U.S. imports, other things remaining the same.
• The marginal propensity to import is the fraction of an increase in real GDP that is spent on imports.
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36
Learning Objectives
• Explain how expenditure plans are determined when the price level is fixed
• Explain how real GDP is determined when the price level is fixed
• Explain the expenditure multiplier
• Explain how imports and taxes influence the multiplier
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37 Real GDP with a Fixed Price Level
How does aggregate expenditure plans interact to determine real GDP when the price level is fixed?
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38 Real GDP with a Fixed Price Level
• First, we will study the relationship between aggregate planned expenditure and real GDP.
• Second, we’ll learn about the key distinction between planned expenditure and actual expenditure.
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39 Real GDP with a Fixed Price Level
• An aggregate expenditure schedule lists aggregate planned expenditure generated at each level of real GDP.
• An aggregate expenditure curve is a graph of the aggregate expenditure schedule.
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40Aggregate Planned Expenditure
a 0 0.75 0.5 0.55 1.2 0.0 3
b 2 2.25 0.5 0.55 1.2 0.5 4
c 4 3.75 0.5 0.55 1.2 1.0 5
d 6 5.25 0.5 0.55 1.2 1.5 6
e 8 6.75 0.5 0.55 1.2 2.0 7
f 10 8.25 0.5 0.55 1.2 2.5 8
AggregateConsumption Government planned
Real GDP expenditure Investment purchases Exports Imports expenditure(Y) (C) (I) (G) (X) (M) (AE=C+I+G+X–M)
(trillions of 1992 dollars)
Planned expenditure
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41
I + G + X + C
Aggregate Planned Expenditure
Real GDP (trillions of 1992 dollars per year)
Agg
rega
te p
lann
ed e
xpen
ditu
re(t
rill
ions
of
1992
dol
lars
/yea
r)
2
4
6
8
10
0 2 4 6 8 10
II + G
I + G + X
AE
a b
cd
ef
Imports
Consumptionexpenditure
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42 Aggregate Planned Expenditure and Real GDP
• Induced expenditure is the sum of the components of aggregate expenditure that vary with real GDP.
• Autonomous expenditure is the sum of the components of aggregate expenditure that are not influenced by real GDP.
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43 Aggregate Planned Expenditure and Real GDP
Actual Expenditure, Planned Expenditure, and Real GDP
• Actual aggregate expenditure is always equal to real GDP
• However, aggregate planned expenditure is not necessarily equal to actual aggregate expenditure and therefore is not necessarily equal to real GDP.
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44 Aggregate Planned Expenditure and Real GDP
Actual Expenditure, Planned Expenditure, and Real GDP
Actual and planned expenditure sometimes differ because firms might end up with more inventories than planned or with less inventories than planned.
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45 Aggregate Planned Expenditure and Real GDP
Equilibrium Expenditure
• Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP.
• When aggregate planned expenditure and actual aggregate expenditure are unequal, a process of convergence toward equilibrium expenditure occurs.
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46 Aggregate Planned Expenditure and Real GDP
Convergence to Equilibrium
• When actual and planned expenditure are unequal, unplanned changes in business inventories (investment) occur.
• GDP either increases or decreases until actual expenditures equal planned expenditures.
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47Equilibrium Expenditure
a 0 3–3
b 2 4 –2
c 4 5 –1
d 6 60
e 8 71
f 10 82
Aggregate planned UnplannedReal GDP expenditure inventory change
(Y) (AE) (Y-AE)
(trillions of 1992 dollars)
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48
d
Plannedexpenditureexceeds real GDP
Equilibrium Expenditure
Real GDP (trillions of 1992 dollars per year)
Agg
rega
te p
lann
ed e
xpen
ditu
re(t
rill
ions
of
1992
dol
lars
/yea
r)
2.0
4.0
6.0
8.0
10.0
0 2 4 6 8 10
a
b c
e
f
Real GDP exceedsplanned expenditure
45o line
Equilibriumexpenditure
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49Equilibrium Expenditure
0
–2.0
2.0
2 8 10
Unp
lann
ed in
vent
ory
chan
ge (
tril
lion
s of
199
2 do
llar
s pe
r ye
ar)
Real GDP(trillions of 1992 dollars per year)
4 6
4.0
–4.0
d
ab
c
e
f
Unplannedinventory investment
Unplannedincrease ininventories
Unplanneddecrease ininventories
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50
The Multiplier
A fall in real interest rates, a wave of innovation, or an increase in the demand for U.S. exports will lead to an increase in autonomous expenditure.
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51
The Multiplier
The multiplier is the amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real GDP.
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52
The Multiplier
The Basic Idea of the Multiplier
• Suppose that investment increases.
• This means that aggregate expenditure and real GDP increases.
• Disposable income increases.
• Consumption expenditures increase.
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53
The Multiplier
The Basic Idea of the Multiplier
• Aggregate expenditure increases again.
• Real GDP, disposable income, and consumption expenditure increase more.
• The initial increase in investment brings an even bigger increase in aggregate expenditure because it induces an increase in consumption expenditure.
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54The Multiplier
5 a 5.25 a' 5.75
6 b 6.00 b' 6.50
7 c 6.75 c' 7.25
8 d 7.50 d' 8.00
9 e 8.25 e' 8.75
Real GDP Original New(Y) (AE0) (AE1)
(trillions of 1992 dollars)
Aggregate planned expenditure
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55The Multiplier
Real GDP (trillions of 1992 dollars)
Agg
rega
te e
xpen
ditu
re
(tri
llion
s of
199
2 do
llars
)
5
6
7
8
9
5 6 7 8 9
45o line
ab
c
d
e
e' AE0
…increasesreal GDP by$2 trillion
A $0.5 trillionincrease ininvestment...
AE1
a'
b'
c'
d'
0
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56
The Multiplier
The Size of the Multiplier
The multiplier is the amount by which a change in autonomous expenditure is multiplied to determine the change in equilibrium expenditure that it generates.
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57
The Multiplier
The multiplier is (from the table shown earlier):
Multiplier =Change in equilibrium expenditureChange in autonomous expenditure
= = 4$2 trillion
$0.5 trillion
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58
The Multiplier
The Multiplier and the Marginal Propensity to Consume and Save
The larger the marginal propensity to consume, the larger the multiplier.
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59
The Multiplier
A change in real GDP equals the change in consumption expenditure plus the change in investment:
ICY
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60
The Multiplier
But the change in consumption expenditure is determined by the change in real GDP and the marginal propensity to consume:
YMPCxC
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61
The Multiplier
Substituting in the previous equation we get:
IYMPCY )(
YMPC
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62
The Multiplier
Solving for we get:
MPC
IY
1
Y
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63
The Multiplier
Dividing both sides of this equation by we get:
MPCI
YMultiplier
1
1
I
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64
The Multiplier
Using this formula, with MPC = 0.75, the multiplier is:
425.0
1
)75.01(
1
Multiplier
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65The Multiplier Process
Expenditure roundIncrease in current round
Cumulative increase from previous rounds
0
0.5
1.0
1.5
2.0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
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66The Multiplier Process
Imports and Income Taxes
• The marginal propensity to import and the marginal tax rate also affects the multiplier.
• Imports and income taxes reduce the multiplier.
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67
AE1
The Multiplier and theSlope of the AE Curve
Real GDP (trillions of 1992 dollars)
Agg
rega
te e
xpen
ditu
re(t
rilli
ons
of 1
992
dolla
rs)
5
6
7
8
9
5 6 7 8 9
45o line
bAE0
When the slope of the AEcurve is 0.75, the multiplier is
475.01
1
0
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68 The Multiplier and theSlope of the AE Curve
Real GDP (trillions of 1992 dollars)
Agg
rega
te e
xpen
ditu
re(t
rilli
ons
of 1
992
dolla
rs)
5
6
7
8
9
5 6 7 8 9
AE1
45o line
AE0
When the slope of the AEcurve is 0.50, the multiplier is
250.01
1
0
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69
The Multiplier
Business Cycle Turning Points
An Expansion Begins
• An expansion is triggered by an increase in autonomous expenditure that increases aggregate planned expenditure.
• At the trough of the business cycle, aggregate planned expenditure exceeds real GDP.
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70
The Multiplier
Business Cycle Turning Points
An Expansion Begins
• Business inventories take an unplanned dive.
• Production increases and incomes increase.
• The multiplier effect causes the expansion to gain speed.
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71
The Multiplier
Business Cycle Turning Points
A Recession Begins
• A recession is triggered by an decrease in autonomous expenditure that decreases aggregate planned expenditure.
• At the peak of the business cycle, real GDP exceeds aggregate planned expenditure.
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72
The Multiplier
Business Cycle Turning Points
A Recession Begins
• Unplanned inventories begin to increase.
• Production decreases and incomes decrease.
• The multiplier effect causes the recession to take hold.
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73
The Multiplier
Business Cycle Turning Points
The Next U.S. Recession?
• The U.S. economy has been in a business cycle expansion since 1991.
• Inventories began to increase in 1994, but they were planned increases.
• Recessions will occur — predicting them far in advance with any accuracy is virtually impossible.
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74 The Multiplier andthe Price Level
When firms inventories fall below the desired level, they increase production.
• At some point, they also increase their prices.
When firms inventories are above the desired level, they decrease production.
• Eventually, they cut their prices.
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75 The Multiplier andthe Price Level
We will use the aggregate supply-aggregate demand model to study the determination of real GDP and the price level.
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76 The Multiplier andthe Price Level
• We must understand the distinction between the aggregate expenditure and aggregate demand.
• Furthermore, we must understand the distinction between their corresponding curves.
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77 The Multiplier andthe Price Level
• The aggregate expenditure curve illustrates the relationship between the aggregate planned expenditure and real GDP.
• The aggregate demand curve illustrates the relationship between aggregate demand and the price level.
Let's look at how these are related
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78 The Multiplier andthe Price Level
Aggregate Expenditure and the Price Level
The aggregate demand curve is downward sloping for two main reasons
1) Wealth effect
2) Substitution effects
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79
AE2
AE0
Aggregate Demand
Real GDP (trillions of 1992 dollars)
Agg
rega
te p
lann
ed e
xpen
ditu
re(t
rilli
ons
of 1
992
dolla
rs)
5
6
7
8
9
5 6 7 8 9
AE1
45o lineEffect ofdecrease in price level
Effect ofincrease in price level
a
b
c
0
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80Aggregate Demand
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
90
100
110
120
130
5 6 7 8 9
140
AD
a
b
c
Effect ofincreasein price level
Effect ofdecreasein price level
0
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81
AE1
A Change in Aggregate Demand
Real GDP (trillions of 1992 dollars)
Agg
rega
te p
lann
ed e
xpen
ditu
re
(tri
llion
s of
199
2 do
llars
)
7
8
9
10
7 8 9 10
AE0
45o line
a
b
A $1 trillion increasein investment increasesaggregate planned expenditure...
0
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82
AD1
Real GDP (trillions of 1992 dollars)
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
90
100
110
120
130
140
a
b
AD0
…and increasesaggregate demand.The multiplier in thisexample is 2.
A Change in Aggregate Demand
7 8 9 100
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83
A Change in Aggregate Demand
Summary
1) If some factor other that a change in the price level increases autonomous expenditure,
the AE curve shifts upward and the AD curve shifts rightward.
2) The size of the AD curve shift depends on the change in autonomous expenditure and the multiplier.
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84 The Multiplier andthe Price Level
An Increase in Aggregate Demand in the Short Run
When price level effects are taken into account, an increase in investment still has a multiplier effect on real GDP, but the effect is smaller than it would be if the price level were fixed.
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85 The Multiplier andthe Price Level
An Increase in Aggregate Demand in the Short Run
The steeper the slope of the short-run aggregate supply curve, the larger is the increase in the price level and the smaller is the multiplier effect on real GDP.
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86
AE2
AE1
The Multiplier in the Short Run
Real GDP (trillions of 1992 dollars)
Agg
rega
te p
lann
ed e
xpen
ditu
re
(tri
llion
s of
199
2 do
llars
)
7
8
9
10
7 8 9 10
AE0
45o line
a
b
An increase in investmentincreases aggregate planned expenditure...
8.6
8.6
…but the pricelevel rises, whichdecreases aggregateplanned expenditure
c
0
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87
AD1
The Multiplier in the Short Run
Real GDP (trillions of 1992 dollars)7 8 9 10
a
AD0
8.6
Pri
ce le
vel
(GD
P d
efla
tor,
199
2 =
100
)
90
100
110
130
140
116
SAS
b
c
…but the pricelevel rises, whichdecreases aggregateplanned expenditure
An increase in investmentincreases aggregate planned expenditure...
0
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88 The Multiplier andthe Price Level
An Increase in Aggregate Demand in the Long Run
• In the long run, an increase in aggregate demand leaves real GDP unchanged but increases the price level.
• In the long run, the multiplier is zero.
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89
AE2
AE1
The Multiplier in the Long Run
Real GDP (trillions of 1992 dollars)
Agg
rega
te p
lann
ed e
xpen
ditu
re
(tri
llion
s of
199
2 do
llars
)
6
7
8
9
7 8 9
AE0
45o line
a
6
b
c
a'
0
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90The Multiplier in the Long Run
Real GDP (trillions of 1992 dollars)
Agg
rega
te p
lann
ed e
xpen
ditu
re
(tri
llion
s of
199
2 do
llars
)
6
7
8
9
7 8 9
AE0
45o line
a
6
a'
0
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91
SAS1
AD1
The Multiplier in the Long Run
Real GDP (trillions of 1992 dollars)
a
AD0
90
100
110
130
140
SAS0
150
7 8 96
LAS
b116
c
8.6
a'
Pri
ce le
vel (
GD
P d
efla
tor)
0
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92
Review
• A change in the price level shifts the AE curve and brings a movement along the AD curve.
• A change in autonomous expenditure that is not caused by a change in the price level shifts both the AE curve and the AD curve, and the multiplier determines the magnitude of the shift in the AD curve.
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93
Review
• In the short run, the increase in real GDP that results from an increase in autonomous expenditure is smaller than the increase in aggregate demand.
• In the long run, an increase in aggregate demand leaves real GDP unchanged but increases the price level. In the long run, the multiplier is zero.
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94
The Algebra of the Multiplier
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95
The Algebra of the Multiplier
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96
The Algebra of the Multiplier
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97
Next:
The Federal Budget and
Fiscal Policy