Principles of Economics 2nd edition by Fred M Gottheil PowerPoint Slides prepared by Ken Long ©1999 South-Western College Publishing

Equilibrium National Income Chapter 22 Equilibrium National Income 7/30/2018 ©1999 South-Western College Publishing

This chapter discusses principles associated with The relationship between Saving and Investing The relationship between Aggregate Expenditure & Aggregate Demand The Equilibrium Level of National Income Aggregate Expenditure The Income Multiplier The Paradox of Thrift ©1999 South-Western College Publishing

What is the purpose of this chapter? To build an economic model to represent an economy tending toward or being in equilibrium ©1999 South-Western College Publishing

What is Aggregate Expenditure? The total spending by consumers, investors, government, and foreigners ©1999 South-Western College Publishing

What assumption do we make in this chapter? There is no government spending or foreign trade - disposable income is the same as total income ©1999 South-Western College Publishing

At what point is the Equilibrium? Where intended Investment equals intended Savings I = S ©1999 South-Western College Publishing

Why is intended I = intended S an equilibrium? I > S (the economy grows) I < S (the economy shrinks) ©1999 South-Western College Publishing

What happens when intended I > intended S? The optimism of investors concerning the future leads to more investments and economic growth ©1999 South-Western College Publishing

What happens when intended I < intended S? There is a shrinkage in the circulation of money, spending declines, leading to an economic slump ©1999 South-Western College Publishing

Can actual Investment be greater than Saving? No! Every dollar invested has to come from savings ©1999 South-Western College Publishing

What is the Aggregate Expenditure Curve? A curve that shows the quantity of aggregate expenditures at different levels of national income or GDP ©1999 South-Western College Publishing

Income - Expenditure Model (C+I) C Aggregate Expenditure 45o National Income 1313

Income - Expenditure Model Aggregate expenditure function C+I Saving Aggregate Expenditure Equilibrium (Ii =Si) 45o National Income 1414

What are Unwanted Inventories? Goods produced for consumption that remain unsold ©1999 South-Western College Publishing

What is Actual Investment? Intended investment plus or minus unintended changes in inventory ©1999 South-Western College Publishing

What causes Unemployment? Unwanted inventories ©1999 South-Western College Publishing

When Ia > Ii unemployment increases What happens when actual Investment is greater than intended Investment? When Ia > Ii unemployment increases ©1999 South-Western College Publishing

What happens when actual Investment is less than intended Investment? When Ia < Ii unemployment decreases ©1999 South-Western College Publishing

What happens when actual Investment equals intended Investment? When Ia = Ii the economy is in equilibrium ©1999 South-Western College Publishing

The Bureau of Economic Analysis has data on current income http://www.bea.doc.gov/bea/dn1.htm ©1999 South-Western College Publishing

What happens when Consumption or Investment change? The equilibrium level of national income changes ©1999 South-Western College Publishing

Shift in Aggregate Expenditure C2+I2 C1+I1 Aggregate Expenditure original equilibrium new employment 45o National Income 23

What is the Income Multiplier? The multiple by which income changes as a result of a change in aggregate expenditure ©1999 South-Western College Publishing

Change in Y change in AE Multiplier = 2525 ©1999 South-Western College Publishing

If investors increase spending by $100 billion, will GDP increase by $100 billion? NO, it will increase by more than $100 billion because of the multiplier

$100 $90 $81 $74 MPC = 9/10 MPS = 1/10 ... $1,000 2727

How do we measure the multiplier? 1/MPS

If MPC equals 9/10, what is MPS? 1/10

. 1 . 1 10 One divided by one tenth equals 10 1 1 = 10 10 = X Simple Multiplier 1 1 . = 10 10 1 = 10 X 1 30

MPC = .9 MPS = .1 C+I 90 Aggregate Expenditure 100 National Income 31

If the multiplier is 10, how much does GDP increase when investment increases by $1billion? 10 x $1bil = $10 billion

If the multiplier is 10, how much does GDP decrease when investment decreases by $1billion? 10 x -$1bil = -$10 billion

If the price level increases what happens to AE? Aggregate expenditure will decrease lowering equilibrium GDP

If the price level decreases what happens to AE? Aggregate expenditure will increase raising equilibrium GDP

What is the Paradox of Thrift? The more people try to save, the more income falls, leaving them with no more and perhaps with even less saving ©1999 South-Western College Publishing

What is Aggregate Expenditure? At what point is the Equilibrium? Why is intended I = intended S an equilibrium? What is Actual Investment? What happens when actual Investment > intended Investment? What happens when actual Investment < intended Investment?

What happens when Consumption or Investment change? What is the Income Multiplier? If the price level increases what happens to AE? If the price level decreases what happens to AE? What is the Paradox of Thrift?

END ©1999 South-Western College Publishing