1. Instructor: MELTEM INCE
Expenditures Multipliers: The Keynesian Model
Lecture notes 9
Instructor: MELTEM INCE

2. Expenditure Plans
The aggregate expenditure model explains fluctuations in aggregate demand by identifying the forces that determine expenditure plans.
The components of aggregate expenditure are:
1) Consumption expenditure
2) Investment
3) Government purchases of goods and services
4) Net exports (exports minus imports)

3. Expenditure Plans
The main factors that influence consumption and saving
are:
1) Real interest rate
2) Disposable income
3) Purchasing power of net assets
4) Expected future income

4. Expenditure Plans
The consumption function shows the relationship between consumption expenditure and disposable income.
The saving function shows the relationship between saving and disposable income.

5. Planned Disposable consumption Planned income expenditure saving
(trillions of 1992 dollars per year) a b c d e f

6. Consumption and Saving Plans
Disposable income is either spent on consumption (C)
or saved (S), so
YD = C + S
The relationship between consumption expenditure and
disposable income, with other things remaining the same, is
called the consumption function.
The amount of consumption expenditure that takes place when
people have zero income is called autonomous consumption
expenditure.

7. Consumption and Saving Plans
500
Consumption
function f
Saving
400 e
(billions of 1995 pounds per year)
Consumption expenditure
Dissaving
300 d c
200 b a
100
100
200
300
400
500
Disposable income
(billions of 1995 pounds per year)

8. Consumption and Saving Plans
The relationship between saving and disposable income,
with other things remaining the same, is called the
saving function.
Negative saving is called dissaving

9. Consumption and Saving Plans
function
100 f
Saving e
Dissaving
Saving
(billions of 1995 pounds per year) d
100
200
300
400
500 c
Disposable income
(billions of 1995 pounds per year) b
-100 a

10. Marginal Propensity to Consume
The marginal propensity to consume (MPC) is the
fraction of a change in disposable income that is
consumed.
MPC= ΔC
ΔYd

11. f e d c billion b billion a 500 Consumption function MPC= 0.75 400
45o line
500
Consumption
function
MPC= 0.75 f
400 e
billion
(billions of 1992 pounds per year)
Consumption expenditure
300 d
billion c
200 b a
100
100
200
300
400
500
Disposable income
(billions of 1992 pounds per year)

12. Marginal Propensity to Save
The marginal propensity to save (MPS) is the fraction of
a change in disposable income that is saved.
MPS= ΔS
ΔYd

13. MPC AND MPS ΔC + ΔS = ΔYd MPC + MPS = 1
Because consumption expenditure and saving exhaust disposable
income, the marginal propensity to consume plus the marginal
propensity to save always equals 1.
ΔC + ΔS = ΔYd
Dividing both sides by DYD
ΔYd ΔYd ΔYd
MPC + MPS = 1

14. The Aggregate Expenditure Model
Aggregate planned expenditure is planned consumption
expenditure plus planned investment plus planned
government expenditures plus planned exports minus
planned imports.
Planned consumption expenditure and planned imports
are influenced — and influence — real GDP

15. The Aggregate Expenditure Model
The aggregate expenditure schedule lists aggregate planned expenditure
generated at each level of real GDP.
Aggregate planned expenditure increases as real GDP increases.
However, only consumption expenditure and imports increase with real
GDP.
Induced expenditure is the sum of the components of aggregate
expenditure that vary with real GDP.
Autonomous expenditure is the sum of the components of aggregate
expenditure that are not influenced by real GDP.

17. (trillions of 1992 dollars)
Planned expenditure
Aggregate
Consumption Government planned
Real GDP expenditure Investment purchases Exports Imports expenditure
(Y) (C) (I) (G) (X) (M) (AE=C+I+G+X–M)
(trillions of 1992 dollars)

18. The Size of the Multiplier
The multiplier is the amount by which a change in
autonomous expenditure is multiplied to determine the
change in equilibrium expenditure that it generates.
Multiplier =
Change in equilibrium expenditure
Change in autonomous expenditure
= = 4
£200 billion
£50 billion

19. The Multiplier and the Slope of the AE Curve
The slope of the AE curve determines the magnitude of the multiplier.
The steeper the AE curve, the greater is the increase in induced expenditure
that results from a given increase in real GDP.
Multiplier = ΔY =
ΔA Slope of AE curve
If the slope of the AE curve is 0.75:
Multiplier = = = 4

20. The Algebra of the Multiplier
Symbols:
Aggregate planned expenditure, AE
Real GDP, Y
Consumption expenditure, C
Investment, I
Government expenditures, G
Exports, X
Imports, M
Net taxes, NT
Disposable income, YD
Autonomous consumption expenditure, a
Marginal propensity to consume, b
Marginal propensity to import, m
Marginal tax rate, t
Autonomous expenditure expenditures, A

21. Aggregate Expenditure
Aggregate expenditure is the sum of planned amounts
of consumption expenditure, investment, government
expenditures, and exports minus the planned amount of
imports:
AE = C + I + G + X – M
We write the consumption function as:
C = a + bYd

22. Equilibrium Expenditure
Grouping together terms that involve Y we obtain:
AE = [a + I + G + X] + [b(1 – t) – m]Y
Autonomous expenditure (A)
Slope of the AE curve

24. Equilibrium Expenditure
Equilibrium expenditure occurs when aggregate planned
expenditure equals real GDP:
AE = Y
To calculate equilibrium expenditure and real GDP, we
solve the equation for the AE curve and the 45º line for
AE and Y:
AE = A + [b(1 – t) – m]Y

25. Equilibrium Expenditure
Replace AE with Y in the AE equation to obtain:
Y = A + [b(1 – t) – m]Y or