1. Income and Expenditures Equilibrium

2. 2 Equilibrium Real GDP: mpc =.7, mpi =.1 (1) Real GDP (Y) (2) Consumption (C) (3) Investment (I) (4) Gov’t Spending (G) (5) Net Exports (X) (6) Aggregate Expenditures (AE) (7) Unplanned Change in Inventories (8) Change in Real GDP 030507050200-200Up 100 507040260-160Up 200170507030320-120Up 300240507020380-80Up 400310507010440-40Up 500380507005000No chg 6004505070-1056040Down 7005205070-2062080Down

3. 3 Real GDP (Output) Aggregate planned expenditure 400 500 600 700 0300400500600700 45 o line: AE = Y Total Expenditure Reduce Output, Reduce Employment Increase Output, increase Employment Movement to Equilibrium

4. 4 Leakages and Injections

5. 5 Spending Multiplier The spending multiplier measures the change in equilibrium income (real GDP) produced by change in autonomous expenditures: ΔY/ΔI = ΔY/ΔG = ΔY/ΔX – By how many dollars does real GDP change for every dollar change in autonomous expenditures?

6. 6 Computing the Spending Multiplier: Marginal propensity to save = mps =.3 Marginal propensity to import = mpi =.1 If MPS = 0.30 and MPI is 0.10, then MPS + MPI = 0.40 = 4/10. 1/0.40 = 1/(4/10) = 10/4 = 2.5 The multiplier is 2.5. NOTE: The spending multiplier would be larger in a closed economy because MPI would be zero.

7. 7 Multiplier at Work

8. 8 Gaps: Recessionary Gap, GDP Gap

9. 9 GDP Gap, Recessionary Gap GDP gap = potential real GDP – actual real GDP – How much does real GDP have to increase to generate full employment? Recessionary gap – How much additional spending is needed to achieve potential GDP (to create full employment)?

10. 10 Sequence of Expenditures

11. 11 Sequence of Expenditures

12. 12 From Aggregate Expenditure to Aggregate Demand

13. 13 The Fixed-Price, Keynesian AS-AD Model

14. 14 The Paradox of Thrift