1. ECO 121 Macroeconomics Lecture Seven Aisha Khan Section L & M
Spring 2010
Aisha Khan
Section L & M
Lecture Seven

2. Recap Aggregate Model Consumption schedule Saving schedule
Upward sloping with a slope = MPC
Saving schedule
Upward sloping with a slope = MPS

3. Investment
Spending on new plants, capital equipment, machinery , inventories, construction
Unstable spending
Marginal benefits vs marginal costs
Expected rate of return  marginal benefit
Interest rate  marginal cost

4. Real interest rate (adjusted for inflation)
Cost of investment
Interest rate cost of borrowed funds
Or the cost of investing your own funds
If real interest rate > expected rate of return  investment should not be made

5. Investment demand schedule
Inverse relationship between interest rate and investment
Shifts :
Greater expected returns  shift Investment schedule outwards

6. Investment demand curve
Movements along the I demand curve depend on changes in the interest rate
Shifts of the curve depend on
Non-interest rate determinants of investment
Changes in expected returns of a project due to non- interest rate determinants will shift the crve

7. Shifts of the Investment curve
Acquisition, maintenance, and operating costs
As costs fall  expected rate of return of a project rises  shifts I upwards
Business taxes
If government is considered  increase in taxes reduces expected profitability of investments  shifts I down

8. Stock of capital goods on hand
Technological change
More efficient technology  lowers production costs  increases expected returns  shifts I outwards/upwards
Stock of capital goods on hand
Extra stock  expected return falls  downwards
Expectations
Future expectations  higher expected returns  ?

9. Instability of Investment
Durability
Irregularity of innovation
Variability of profits
Variability of expectations

10. Multiplier Effect Multiplier
= change in real GDP / initial change in spending

11. Aggregate Expenditures Model
Chapter 9

12. Next? We have consumption and investment schedules
Can now put them together to find GDP– true?
GDP = C + I
Therefore by the identity we can find the total output/income

13. Unplanned  in inventories Tendency of income/output
Just for this example  investment is independent of income (fixed)
Employ-ment levels
GDP = DI C S I
C+I
Unplanned  in inventories
Tendency of income/output 40
370
375 -5 20
395
-25  85
550
510
530 

14. Unplanned  in inventories Tendency of income/output
Equilibrium GDP
Employ-ment levels
GDP = DI C S I
C+I
Unplanned  in inventories
Tendency of income/output 40
370
375 -5 20
395
-25  45
390
410
-20 50
405 5
425
-15 55
430
420 10
440
-10 60
450
435 15
455 65
470 ~ 70
490
465 25
485  75
510
480 30
500 80
530
495 35
515 85
550

15. Graphical Analysis C+I C+I = GDP Aggregate expenditure C C+ I
I = $20 billion
C = $450 billion
45
GDP

16. Other features of GDP Savings = planned Investment
Savings is a “leakage” from spending stream (therefore C not equal to GDP)
Some output is planned for investment and not for consumption
This investment spending replaces the leakage
No unplanned changes in inventory
Look at table again

17. Say’s Law
“Supply creates its own demand”