Module Income and Expenditure KRUGMAN'S MACROECONOMICS for AP* 16 Margaret Ray and David Anderson Use a Picture of a retiree here

What you will learn in this Module : The nature of the multiplier, which shows how initial changes in spending lead to further changes The meaning of the aggregate consumption function, which shows how current disposable income affects consumer spending How expected future income and aggregate wealth affect consumer spending The determinants of investment spending Why investment spending is considered a leading indicator of the future state of the economy

Multiplier Effect Spending in one area of the economy leads to income, and therefore spending in the next area of the economy A ripple effect $1 spending leads to more than $1 of spending in the economy

Spending Multiplier in action Jerry the real estate developer decides to buy and renovate house, spending $100,000 at Pete’s Everything is a Buck store. Pete now has $100,000 and spends 80% or $80,000 on a new car that Teresa built at the factory. The auto company uses that money or 80% of that or $ 64,000 for new machinery from Lawrence’s British company. Lawrence’s company now spends 80% of that or $51,200 on a home for Lawrence (since he is an ex-pat and needs a place to live) from Bernie’s bank. Bernie’s bank spends 80% or $40,960 hiring Elmer as a security guard. Now he can buy some more plaid shirts.

Yd= C + S (after txs, consume or save, w/ more Y, both will increase-by how much? Marginal Propensity to Consume (MPC) Marginal Propensity to Save (MPS) MPC = ∆ Consumer Spending ∆ Disposable Income MPS = ∆ Saving ∆ Disposable Income MPC + MPS = 1 MPC = 1 - MPS MPS = 1 - MPC To understand the Multiplier, you first need to understand spend/save behavior

Consumption/Savings Behavior YdCS MPC= Δ C/ Change/D MPS= Δ S/ Change DI $05-5 $ $ $ $ How can you have $0 income and still consume $5? At Yd = $0, $5 is called “autonomous consumption” How much of each new $1 does this HH consume? Save?

Consumption Function c=a + (MPC x Yd) 5 = a = autonomous consumption Slope = MPC ΔC/ Δ/Yd 13-5=8 10-0=10 c=5+.80(Yd) Or HH spending

Same pattern for Aggregate Consumption Aggregate Consumption Function C = A + MPC X Yd As Yd increases or decreases, we have a movement along the C function What Non-Income determinants would cause a shift in the Aggregate Consumption (AC) function?

Non-Income Shifters of the Aggregate Consumption Function Wealth Effect-value of real financial assets like stock portfolio, home Expected Future Disposable Income Interest Rates Real Interest rates Debt-levels held in the aggregate

Autonomous Change in Aggregate Spending (AAS) Multiplier also 1/MPS ∆Y = 1_________ (1 - MPC) X ∆AAS Multiplier = ∆Y_____ ∆AAS = 1_________ (1 - MPC) The size of MPC/MPS impacts overall change to GDP Or Δ GDP = multiplier x autonomous spending If AAS was $787B and MPC is.53, what should Y be?

Planned Investment Depends on: ---interest rate ---expected future real GDP ---current capacity Investment Spending Drives Business Cycle

The Interest Rate Inversely Related to Investment Spending A decrease in the real interest rate will result in more gross private investment r r’ I I’ ROI = Profit /Cost If ROI >= r/i projects will proceed

eveition Non-Interest rate shifters of Investment Demand Business Taxes Expectations about future Business environment Acquisition/ Operating costs affecting ROI Stock Capital Goods or Capacity Technology r I I’