Unit 5—Aggregate Models Chapters 9, 10 and focus on 11 Time Period: 3 weeks Graphs: 6

Chapter 9—Building the Aggregate Expenditures Model Aggregate means TOTAL (aggregate expenditure means total spending)

Consumption and Saving What can a person do with DI? What can a person do with DI? What is not spent is called savings What is not spent is called savings DI – C = S DI – C = S LOOK AT THE GRAPH ON PAGE 160

C & DI Graph The reference line is a 45° line The reference line is a 45° line Each point is equidistant from the axes Each point is equidistant from the axes C = DI C = DI Green dots = C Green dots = C When the green dot falls short of the reference line, savings has occurred When the green dot falls short of the reference line, savings has occurred Again, DI – C = S Again, DI – C = S As DI increases both C and S increase As DI increases both C and S increase Direct relationship to the level of income Direct relationship to the level of income Household C most of their DI Household C most of their DI

C Schedule Page 161 shows a hypothetical C schedule Page 161 shows a hypothetical C schedule Households spend a larger proportion of a small income than of a large income Households spend a larger proportion of a small income than of a large income See graph on Page 162 See graph on Page 162 C Schedule Graph C Schedule Graph 45° reference line 45° reference line Shows C and S Shows C and S Shows DISSAVINGS = occurs at low levels of income where C exceeds DI & people must borrow Shows DISSAVINGS = occurs at low levels of income where C exceeds DI & people must borrow

Average Propensities to C & S Measures the average C (APC) or S (APS) at any level of disposable income Measures the average C (APC) or S (APS) at any level of disposable income APC = C / DI APC = C / DI APS = S / DI APS = S / DI C%  and S%  as DI  C%  and S%  as DI  APC + APS = 1 APC + APS = 1

Marginal Propensities to C & S (marginal means extra) (marginal means extra) Proportion of any change in income C is called MPC or income S is called MPS Proportion of any change in income C is called MPC or income S is called MPS MPC = ∆ C / ∆ DI MPC = ∆ C / ∆ DI MPS = ∆ S / ∆ DI MPS = ∆ S / ∆ DI MPC + MPS = 1 MPC + MPS = 1 The only choice people have is to C or to S. An additional dollar in income must result in a change in C and/or a change in S. The only choice people have is to C or to S. An additional dollar in income must result in a change in C and/or a change in S.

Practice worksheet

Investment Spending on new plants, capital equipment, machinery, construction, etc. Spending on new plants, capital equipment, machinery, construction, etc. Investment decision weighs mb & mc Investment decision weighs mb & mc The expected rate of return = mb The expected rate of return = mb The interest rate = mc The interest rate = mc

Expected Rate of Return Found by comparing the expected economic profit (total revenue minus total cost) to cost of investment to get expected rate of return Found by comparing the expected economic profit (total revenue minus total cost) to cost of investment to get expected rate of return Example in text (page 166) Example in text (page 166) Woodworker wants to buy equipment for $1,000. He expects a $100 profit. The expected rate of return in 10%. In order to make a profit, the woodworker would not want to pay more than 10% interest on the investment. Woodworker wants to buy equipment for $1,000. He expects a $100 profit. The expected rate of return in 10%. In order to make a profit, the woodworker would not want to pay more than 10% interest on the investment.

The Real Interest Rate The real interest rate, i, is the cost of the investment The real interest rate, i, is the cost of the investment Real interest rate = nominal rate - inflation Real interest rate = nominal rate - inflation Interest rate is either the cost of borrowed funds or the cost of investing your own funds, which is income forgone. Interest rate is either the cost of borrowed funds or the cost of investing your own funds, which is income forgone. If i exceeds the expected rate of return, r, the investment should not be made If i exceeds the expected rate of return, r, the investment should not be made

Investment Demand Curve Shows an inverse relationship between the interest rate and amount of investment Shows an inverse relationship between the interest rate and amount of investment As long as r exceeds i, the investment is expected to be profitable As long as r exceeds i, the investment is expected to be profitable See graph on page 168 See graph on page 168 demand curve is always downward sloping demand curve is always downward sloping

Self Assessment Take the quick quiz on page 168 to assess your own understanding. Take the quick quiz on page 168 to assess your own understanding.

Shifts in the Investment Demand Curve—IDC or DIgC Movement occurs with a change in the interest rate Movement occurs with a change in the interest rate Shifts occur due to these determinates: Shifts occur due to these determinates: 1. acquisition, maintenance and operating costs 1. acquisition, maintenance and operating costs When cost falls, the r from prospective investment project rises, shifts the IDC to the right When cost falls, the r from prospective investment project rises, shifts the IDC to the right Higher electricity costs = shift to the left Higher electricity costs = shift to the left 2. business taxes 2. business taxes  in taxes = shift to the left  in taxes = shift to the left

Shifts Continued 3. technological change 3. technological change Development stimulates investment Development stimulates investment (shifts to the right) (shifts to the right) 4. stock of capital goods on hand 4. stock of capital goods on hand When firms are overstocked, the r declines (shifts to the left) When firms are overstocked, the r declines (shifts to the left) There is little incentive to invest in new capital when there is excess production There is little incentive to invest in new capital when there is excess production When firms are under stocked, the r increases (shifts to the right) When firms are under stocked, the r increases (shifts to the right)

Shifts continued again Expectations 5. Expectations Optimistic about future sales, the curve will shift to the right Optimistic about future sales, the curve will shift to the right Pessimistic outlook = shift to the left Pessimistic outlook = shift to the left

Instability of Investment 1. capital goods are durable so spending can be postponed 1. capital goods are durable so spending can be postponed 2. innovation occurs irregularly 2. innovation occurs irregularly 3. profits vary considerably 3. profits vary considerably 4. expectations can be easily changed 4. expectations can be easily changed

Classwork! Yeah! Page 179 Page 179 Number 2 Number 2 Number 3 Number 3 Number 4 Number 4 Number 5—complete the table only—and part b (refer to table 9.1) Number 5—complete the table only—and part b (refer to table 9.1) Number 6 Number 6 Due today -- or homework if not finished Due today -- or homework if not finished

Equilibrium GDP Equilibrium level of GDP is the level at which the total quantity of goods produced (GDP) = the total quantity of goods purchased Equilibrium level of GDP is the level at which the total quantity of goods produced (GDP) = the total quantity of goods purchased GDP = C + Ig (in a closed economy) GDP = C + Ig (in a closed economy) Savings and investment are equal Savings and investment are equal Savings represents a “leakage” from spending and causes C to be less than GDP Savings represents a “leakage” from spending and causes C to be less than GDP

Table 9.4 See table on page 173 See table on page 173 See line 8, GDP is $510 billion See line 8, GDP is $510 billion C + Ig = 500 billion (disequilibrium) C + Ig = 500 billion (disequilibrium) Businesses have $10 billion of unplanned inventory investment on top of what was already planned Businesses have $10 billion of unplanned inventory investment on top of what was already planned Unplanned portion is a business expenditure Unplanned portion is a business expenditure

Table 9.4 See line 5, GDP = $450 billion See line 5, GDP = $450 billion Consumer spending is $435 billion Consumer spending is $435 billion $20 billion is planned investment $20 billion is planned investment Businesses have experienced a $5 billion unplanned decline in inventory because of unexpected sales Businesses have experienced a $5 billion unplanned decline in inventory because of unexpected sales

Self Assessment See graph on page 175 See graph on page 175 Quick quiz on page 175—work with a partner or on your own for your own assessment of understanding Quick quiz on page 175—work with a partner or on your own for your own assessment of understanding

Says Vs Keynes Read page 177 Read page 177 Do question 16 on page 180—this will be turned in. You need to actually draw a PPF and label efficiency for both men. Do question 16 on page 180—this will be turned in. You need to actually draw a PPF and label efficiency for both men.