Basic Macroeconomic Relationships Chapter 9

Chapter 9 Figure 9.1

Average and Marginal Propensities to Consume and Save Average Propensities APC = C/DI APS = S/DI since DI = S + C APC + APS = 1 Marginal Propensities MPC = ∆C/∆DI MPS = ∆S/∆DI Since DI = S + C ∆DI = ∆S + ∆C MPC + MPS = 1

Chapter 9 Table 9.1

The Consumption and Saving Functions Chapter 9 Figure 9.2 The Consumption and Saving Functions

Consumption and Saving Functions I Consumption function: C = CA + MPC(Y) Where CA (intercept) = “Autonomous Consumption” MPC (slope) = “Marginal Propensity to Consume” (also = 1 – MPS) Y = GDP or “Disposable Income”

Consumption and Saving Functions II S = S0 + MPS(Y) Where S0 (intercept) = “Maximum Dissaving” = - CA MPS (slope) = “Marginal Propensity to Save” (also = 1 – MPC) Y = GDP or “Disposable Income”

Consumption and Saving Functions III Since CA = - S0 and MPS +MPC = 1 If the consumption function is C = 100 + .85Y The saving function must be S = -100 + .15Y If the saving function is S = -125 + .3Y The consumption function must be C = 125 + .7Y

Chapter 9 Figure 9.3

Shifting the Consumption Schedule Chapter 9 Figure 9.4(a) Shifting the Consumption Schedule

Shifting the Saving Schedule Chapter 9 Figure 9.4(b) Shifting the Saving Schedule

The Investment Demand Schedule Chapter 9 Table 9.2 The Investment Demand Schedule

The Investment Demand Function Chapter 9 Figure 9.5 The Investment Demand Function

Chapter 9 Figure 9.6

What Shifts the Investment Demand Function? Changes in the cost of acquiring capital equipment, maintaining capital equipment, or operating capital equipment e.g., changes in the price of gasoline Changes in taxes on business e.g., accelerated depreciation Technological Improvements How much capital equipment is already installed Producer Expectations Overoptimistic during the expansionary phase of the business cycle Frustrating efforts to slow down the economy Overpessimistic during the contractionary phase of the business cycle Delaying recovery

Investment is highly volatile! Chapter 9 Figure 9.7 Investment is highly volatile!

The AE multiplier M = 1/(1- MPC) = 1/MPS Chapter 9 Table 9.3 The AE multiplier M = 1/(1- MPC) = 1/MPS

The Multiplier Formula First round, increase in Aggregate Expenditure = ∆AE0 This induces an increase in C, ∆C1 = (MPC)∆AE0 Which becomes the second round increase in income Inducing a further increase in C, ∆C2 = (MPC)∆C1 = (MPC)2∆AE0 ∆C3 = (MPC)∆C2 = (MPC)3∆AE0, etc.

Derivation of the Multiplier ∆Y = ∆AE0 + ∆AE1 + ∆AE2 + ∆AE3 + … + ∆AEn + … ∆Y = ∆AE0 + (MPC)∆AE0 + (MPC)∆AE1 + (MPC)∆AE2 + … + ∆AEn + … ∆Y = ∆AE0 + (MPC)∆AE0 + (MPC)2∆AE0 + (MPC)3∆AE0 + … + (MPC)n∆AE0 + … ∆Y = (MPC)0∆AE0 + (MPC)1∆AE0 + (MPC)2∆AE0 + (MPC)3∆AE0 + … + (MPC)n∆AE0 + …

Derivation of the Multiplier ∆Y = (MPC)0∆AE0 + (MPC)1∆AE0 + (MPC)2∆AE0 + (MPC)3∆AE0 + … + (MPC)n∆AE0 + … ∆Y = ∑i=0,∞(MPC)n∆AE0 = ∆AE0∑i=0,∞(MPC)n for infinite convergent sums, m = ∆Y/∆AE = 1/(1 – MPC) = 1/MPS MPC < 1 necessary for infinite sum to converge

Chapter 9 Figure 9.8

How M varies with the MPC Chapter 9 Figure 9.9 How M varies with the MPC

The AE multiplier M = 1/(1- MPC) = 1/MPS M = change in real GDP/change in spending M = ∆GDP/∆AE = ∆Y/∆AE Change in AE can come from any component of aggregate expenditure AE = C + Ig + G + Xn