1. National Income and Price Determination

2. Disposable Income – DI
A. Personal income after taxes
B. Consumption + Savings = Disposable Income

3. pro·pen·si·ty
prəˈpensətē/
noun
noun: propensity; plural noun: propensities
an inclination or natural tendency to behave in a particular way

4. Average Propensity to Consume
Percentage of total income that is consumed
APC =
III. Average Propensity to Save
Percentage of total income that is saved
APS =
APC + APS = 1
Consumption
income
savings
income

5. Let’s work a sample problem
C + S = DI DI C S
APC
APS
$1500
$1540
1600
1620
1700
1800
1780
1900
1840
2000
1940
2100
2020

6. Let’s work a sample problem
C + S = DI DI C S
APC
APS
$1500
$1540
-40
1600
1620
1700
1800
1780
1900
1860
2000
1940
2100
2020

7. Let’s work a sample problem
C + S = DI DI C S
APC
APS
$1500
$1540
-40
1600
1620
-20
1700
1800
1780 20
1900
1840 60
2000
1940
2100
2020 80

8. Let’s work a sample problem
Consumption
income
APC = DI C S
APC
APS
$1500
$1540
-40
1.027
1600
1620
-20
1700
1800
1780 20
1900
1840 60
2000
1940
2100
2020 80

9. Let’s work a sample problem
Consumption
income
APC = DI C S
APC
APS
$1500
$1540
-40
1.027
1600
1620
-20
1.013
1700 1
1800
1780 20
.989
1900
1840 60
.968
2000
1940
.97
2100
2020 80
.962

10. Let’s work a sample problem
savings
income
APS = OR APC + APS = 1 DI C S
APC
APS
$1500
$1540
-40
1.027
-.027
1600
1620
-20
1.013
1700 1
1800
1780 20
.989
1900
1840 60
.968
2000
1940
.97
2100
2020 80
.962

11. Let’s work a sample problem
APS = OR APC + APS = 1
savings
income DI C S
APC
APS
$1500
$1540
-40
1.027
-.027
1600
1620
-20
1.013
-.013
1700 1
1800
1780 20
.989
.011
1900
1840 60
.968
.03
2000
1940
.97
2100
2020 80
.962
.038

12. Marginal Propensity to consume
A. Marginal = extra
B. proportion of any change in income that is consumed
C. MPC = change in consumption
change in income
V. Marginal Propensity to Save
A. proportion of any change in income that is saved
B. MPS = change in saving
C. MPC + MPS = 1

13. Savings = DI - C Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375
390
410
405
430
420
450
435
Savings = DI - C

14. Savings = DI - C Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
390
410
405
430
420
450
435
Savings = DI - C

15. Savings = DI - C Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
390
410
405 5
430
420 10
450
435 15
Savings = DI - C

16. APC = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
390
410
405 5
430
420 10
450
435 15
Consumption
Disposable income
APC =

17. APC = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
390
410
405 5
430
420 10
450
435 15
Consumption
Disposable income
APC =

18. APC = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
390
1.0
410
405 5
.99
430
420 10
.98
450
435 15
.97
Consumption
Disposable income
APC =

19. APS = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
390
1.0
410
405 5
.99
430
420 10
.98
450
435 15
.97
savings
Disposable income
APS =

20. APS = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01
390
1.0
410
405 5
.99
430
420 10
.98
450
435 15
.97
savings
Disposable income
APS =

21. APS = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01
390
1.0
410
405 5
.99
.01
430
420 10
.98
.02
450
435 15
.97
.03
savings
Disposable income
APS =

22. MPC = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01 -
390
1.0
410
405 5
.99
.01
430
420 10
.98
.02
450
435 15
.97
.03
___consumption
Disposable income
MPC =

23. MPC = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01 -
390
1.0
.75
410
405 5
.99
.01
430
420 10
.98
.02
450
435 15
.97
.03
___consumption
Disposable income
MPC =

24. MPC = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01 -
390
1.0
.75
410
405 5
.99
.01
430
420 10
.98
.02
450
435 15
.97
.03
___consumption
Disposable income
MPC =

25. MPS = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01 -
390
1.0
.75
410
405 5
.99
.01
430
420 10
.98
.02
450
435 15
.97
.03
______savings___
Disposable income
MPS =

26. MPS = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01 -
390
1.0
.75
.25
410
405 5
.99
.01
430
420 10
.98
.02
450
435 15
.97
.03
______savings___
Disposable income
MPS =

27. MPS = Disposable income
Sample Problem – From page 161 in your textbook
= change in
(1)
GDP = DI
(2)
Consumption C
(3)
Savings
(S)
– (2)
DI - C
(4)
APC
(2)/(1)
C/DI
(5)
APS
(3)/(1)
S/DI
(6)
MPC
(2)/ (1)
C/ DI
(7)
MPS
(3)/ (1)
S/ DI
$370
$375 -5
1.01
-.01 -
390
1.0
.75
.25
410
405 5
.99
.01
430
420 10
.98
.02
450
435 15
.97
.03
______savings___
Disposable income
MPS =

28. Investment spending (Ig) Government purchases (G) Net exports (Xn)
VI. Multiplier
A small change in:
Consumption (C)
Investment spending (Ig)
Government purchases (G)
Net exports (Xn)
leads to an even bigger change in GDP

29. leads to an even bigger change in GDP
VI. Multiplier
A small change in
Investment spending
Consumption
Net exports
Government purchases
leads to an even bigger change in GDP
Multiplier determines how large the change will be
Multiplier =
___1___
1 - MPC
_1__
MPS

30. Let’s review and go through an example - Fill in your handout as we go
Disposable Income
APC (as a % or fraction) -- The average of what people will
APS (as a % or fraction) -- The average of what people will
APC + APS will always =
consume.
save.
one

31. Marginal Analysis: What happens when a NEW unit is added?
consume.
MPC = What % of new DI people will
MPS = What % of new DI people will
MPC + MPS will always =
save.
one

32. Assume new marginal income is created – a $1000 tax cut
Assume new marginal income is created – a $1000 tax cut SO – everyone has an extra $1000 of DI MPC = 90% MPS = 10%
Person
MPC
MPS
First person to get the $1000

33. WOW! $1,000 How much will I spend?
MPC = 90% MPS = 10%
Person
MPC
MPS
First person to get the $1000

34. I’m going to buy that new $900 guitar I wanted and save the rest
MPC = 90% MPS = 10%
I’m going to buy that new $900 guitar I wanted and save the rest
Person
MPC
MPS
First person to get the $1000
$900
$100

35. I just sold a $900 guitar! What should I do with the money?
MPC = 90% MPS = 10%
I just sold a $900 guitar! What should I do with the money?
Person
MPC
MPS
First person to get the $1000
$900
$100
Second person gets $900

36. I’m going to buy my wife the diamond earrings she wanted.
MPC = 90% MPS = 10%
I’m going to buy my wife the diamond earrings she wanted.
Person
MPC
MPS
First person to get the $1000
$900
$100
Second person gets $900
$810
$90

37. How should I spend my extra cash?
MPC = 90% MPS = 10%
How should I spend my extra cash?
Person
MPC
MPS
First person to get the $1000
$900
$100
Second person gets $900
$810
$90
Third person gets $810

38. First person to get the $1000 $900 $100
MPC = 90% MPS = 10%
Person
MPC
MPS
First person to get the $1000
$900
$100
Second person gets $900
$810
$90
Third person gets $810
$729
$81

39. First person to get the $1000 $900 $100
MPC = 90% MPS = 10%
Person
MPC
MPS
First person to get the $1000
$900
$100
Second person gets $900
$810
$90
Third person gets $810
$729
$81
Fourth person gets $729
$656.10
$72.90

40. First person to get the $1000 $900 $100
MPC = 90% MPS = 10%
Person
MPC
MPS
First person to get the $1000
$900
$100
Second person gets $900
$810
$90
Third person gets $810
$729
$81
Fourth person gets $729
$656.10
$72.90
Fifth person to gets $656.10
$590.49
$65.61
Total so far of the original $1000

41. First person to get the $1000 $900 $100
MPC = 90% MPS = 10%
Person
MPC
MPS
First person to get the $1000
$900
$100
Second person gets $900
$810
$90
Third person gets $810
$729
$81
Fourth person gets $729
$656.10
$72.90
Fifth person to gets $656.10
$590.49
$65.61
Total so far of the original $1000 $
$409.51

42. NOTICE
For each person getting $1,000, several consumption events will occur.
How long will the consumption pattern continue?
The spending multiplier Formula is used to estimate the number of times the pattern will repeat
__1___ _1_
1 – MPC MPS

43. THEREFORE . . .
If the MPC is .9, what is the multiplier?

44. THEREFORE . . . If the MPC is .9, what is the multiplier?
__1___ __1__ _1_
1 – MPC
Multiplier = = =
= 10

45. THEREFORE . . .
SO - How many new dollars of consumption will be created if society receives $1 million?
__1__ _1__ _1_
1 – MPC =
Multiplier = =
= 10
Multiplier x initial change in GDP = TOTAL change in GDP
10 x 1 = $10

46. What if the MPC is .5?
If the MPC is only .5 what is the multiplier?

47. What if the MPC is .5? If the MPC is only .5 what is the multiplier?
__1___ __1__ _1_
1 – MPC
Multiplier = = =
= 2

48. What if the MPC is .5?
SO – how many new dollars of consumption will be created if society receives $1million?
Multiplier x initial change in GDP = TOTAL change in GDP
2 x $1 = $2 million

49. Finish the rest of the work on the handout and we will go over the answers.

50. VII. Aggregate demand
adjective
adjective: aggregate 1.
formed or calculated by the combination of many separate units or items; total.

51. VII. Aggregate demand
A. The amounts of real output that buyers collectively desire to purchase at every possible price.

52. VII. Aggregate demand
A. The amounts of real output that buyers collectively desire to purchase at every possible price.
B. Curve is downward sloping showing an inverse relationship between price and GDP
1. slope is NOT a consequence of the law of demand
2. demand curve represents ONE good
3. when the price of that ONE good goes up people switch to a substitute.
4. Switch to a substitute does not change AD since TOTAL spending remains the same

53. C. Downward slope is caused by 3 things
1. Real balances effect (wealth effect)
a. a higher price level reduces purchasing power
b. the public is poorer in real terms
c. spending is reduced

54. Downward slope is caused by 3 things
1. Real balances effect (wealth effect)
2. Interest Rate Effect
a. people need more money
b. public increases cash holdings
c. reduces funds available for others to borrow
d. interest rates go up
1. Reduces investment spending
2. Increases savings which reduces spending

55. C. Downward slope is caused by 3 things
1. Real balances effect (wealth effect)
2. Interest Rate Effect
3. Foreign purchases effect
a. U.S. prices rise compared to foreign prices
b. foreigners buy fewer U.S. goods
c. Americans buy more foreign goods

56. D. Movement along the AD curve
1. caused by a change in price level
2. movements along a fixed aggregate demand curve represent changes in real GDP

57. E. Shift in the curve or demand shock
Rightward shift shows increase in AD
Price
level
Real GDP

58. E. Shift in the curve or demand shock
Rightward shift shows increase in AD
Leftward shift shows decrease in AD
Real GDP

59. The same formula works for AD AD = C + I + G + Xn
Remember this formula?
Instead of X – M we used Xn
The same formula works for AD
AD = C + I + G + Xn
When part of the formula changes the curve will shift

60. E. Shift in the curve or demand shock
Rightward shift shows increase in AD
Leftward shift shows decrease in AD
Shifts caused by a change in the determinants of AD
a. Consumer spending - C
1. Consumer wealth - increase in wealth causes increase in spending
2. Consumer expectations – expectations of a raise will increase spending
3. Household indebtedness – if debt rises consumers will temporarily cut spending
4. Taxes – cut in taxes means more DI and more spending

61. b. Investment spending - Ig
1. Interest rates – increase in interest rates lowers spending
2. Expected returns – expected high returns on investment leads to increased spending
c. Government spending - G
d. Net export spending - Xn
1. National income abroad – foreigners making more money will buy American goods
2. Exchange rates – if the dollar depreciates – a lower value of dollars and higher value of Euro encourages foreigners to buy

62. You Decide
In each situation decide if the action will cause an increase, decrease or no change in AD.
Always start at curve B and determine which curve (if any) will be the new demand curve

63. Congress cuts taxes AD
New curve - C

64. Investment spending decreasedAD
New curve - A

65. Government spending increasesAD
New curve - C

66. Stock market collapses; investors lose billionsAD
New curve - A

67. AD Practice

68. Your textbook draws AS as one curve
FYI
Your textbook draws AS as one curve
INSTEAD
We will draw two curves

69. THEN – put both curves on the same graph

70. VIII. Aggregate Supply
Shows the level of real domestic output firms will produce at each price level
SRAS curve is upward sloping showing a positive relationship between price and output
SRAS
SRAS

71. Short Run Curve
1. costs of production are fixed in the short run
a. Wages are biggest production cost
b. Wages are inflexible or “sticky”
As price rises producers produce more
a. BECAUSE Price – cost = profit
b. Increased price means increased profit

72. 3. Movement along the curve caused by change in price

73. 4. Shift in the curve or Supply Shock
Leftward shift – decrease in SRAS
Rightward Shift – increase in SRAS
Changes in factors other than price shift curve
Change in input
a. price of resources
b. wages
Changes in productivity

74. You Decide! Based on the situation decide:
Which component of AS is affected
Input prices OR
productivity
Will AS increase or decrease
Which curve will the economy be at after the shift

75. Unions are effective so wages increase
What determinant is affected?
Input prices
AS will
Resulting curve
AS1

76. OPEC successfully increases oil prices
What determinant is affected?
Input prices
AS will
Resulting curve
AS1

77. Computer technology brings new efficiency to industry
What determinant is affected?
productivity
AS will
Resulting curve
AS2

78. Improved schools have increased the skills of American workers
What determinant is affected?
productivity
AS will
Resulting curve
AS2

79. SRAS Practice What people think Economists dream about
What Economists really dream about

80. A. Real GDP demanded equals real GDP supplied
IX. Equilibrium
A. Real GDP demanded equals real GDP supplied
Price Level
SRAS
PL1
AD1 Y1
Real GDP

81. A. Real GDP demanded equals real GDP supplied
IX. Equilibrium
A. Real GDP demanded equals real GDP supplied
B. Shift AD curve OR demand shock
1. negative demand shock shifts curve left
a. Lower output
b. Lower equilibrium price
Price Level AS P1 P2
AD1
AD2 Y2 Y1
Real GDP

82. A. Real GDP demanded equals real GDP supplied
IX. Equilibrium
A. Real GDP demanded equals real GDP supplied
B. Shift AD curve OR demand shock
1. negative demand shock shifts curve left
a. Lower output
b. Lower equilibrium price
2. positive demand shock shifts curve right
a. Higher output
b. Higher equilibrium price
Price Level AS P2 P1
AD2
AD1
Real GDP Y1 Y2

83. C. Shift SRAS curve OR supply shock
1. price level and output move in opposite directions
2. negative supply shock shifts left - stagflation
a. Lower output
b. Higher price

84. C. Shift SRAS curve or supply shock
1. price level and output move in opposite directions
2. negative supply shock shifts left - stagflation
a. Lower output
b. Higher price
3. positive supply shock shifts right
a. Higher output
b. Lower price

85. Equilibrium Practice!

86. X. Long Run Aggregate Supply A. Vertical
B. LRAS crosses horizontal axis at the economy’s potential – or at full employment GDP
C. In the long run price level has no effect on AS
1. all inputs are flexible
2. inflation or deflation has the same effect on ALL prices by the same proportion
Real GDP

87. Long Run Equilibrium
Where short run equilibrium and LRAS curve intersect
The economy self corrects

88. E. From short run to long run 1. If economy is on SRAS only
a. not producing at the potential or full employment GDP a AD
Full employment GDP

89. E. From short run to long run 1. If economy is on SRAS only
a. not producing at the potential
b. Inflationary or recessionary gaps are created e AD
Inflationary Gap

90. E. From short run to long run 1. If economy is on SRAS only
a. not producing at the potential
b. Inflationary or recessionary gaps are created e AD
recessionary Gap

91. E. From short run to long run 1. If economy is on SRAS only
a. not producing at the potential
b. Inflationary or recessionary gaps are created
c. Inflation or recession causes wages to adjust
d. SRAS shifts accordingly to close the gap
SRAS 1 b a AD

92. F. LRAS shifts to right over VERY LONG run
1. Increase in quantity of resources
2. Increase in quality of resources
3. Technology progress
Real GDP