2. 1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics by Fred M Gottheil

3. 2 Chapter 22 Equilibrium National Income 5/18/2015 © ©1999 South-Western College Publishing

4. 3 What is the purpose of this chapter? To build an economic model to represent an economy tending toward or being in equilibrium © ©1999 South-Western College Publishing

5. 4 What is Aggregate Expenditure? The total spending by consumers, investors, government, and foreigners © ©1999 South-Western College Publishing

6. 5 What assumption do we make in this chapter? There is no government spending or foreign trade - disposable income is the same as total income © ©1999 South-Western College Publishing

7. 6 2 Ways of Looking at Equilibrium Income/expenditure approach Savings/Investment approach

8. 7 What is the Aggregate Expenditure Curve? A curve that shows the quantity of aggregate expenditures at different levels of national income or GDP © ©1999 South-Western College Publishing

9. 8 Income - Expenditure Model National Income C 45 o Aggregate Expenditure 8 (C+I)

10. 9 Income - Expenditure Model National Income C+I 45 o Aggregate expenditure function Equilibrium Aggregate Expenditure 9 Ye

11. 10 In equilibrium, C+I = Ye, planned spending equals output produced

12. 11 Income - Expenditure Model National Income C+I 45 o Aggregate expenditure function Aggregate Expenditure 11 Ye Y1

13. 12 What happens at output above equilibrium, like Y1? Aggregate expenditure is less than output, leading to an unplanned inventory accumulation Firms will likely cut production, leading to lower GDP and national income

14. 13 Income - Expenditure Model National Income C+I Aggregate expenditure function Aggregate Expenditure 13 Ye Y2

15. 14 What happens at output below equilibrium, like Y2? Aggregate expenditure is greater than output, leading to an unplanned inventory depletion Firms will likely increase production, leading to higher GDP and national income

16. 15 Income - Expenditure Model National Income C+I 45 o Aggregate expenditure function Equilibrium Aggregate Expenditure 15

17. 16 The Bureau of Economic Analysis has data on current income http://www.bea.doc.gov/bea/dn1.htm © ©1999 South-Western College Publishing

18. 17 What happens when Consumption or Investment change? The equilibrium level of national income changes © ©1999 South-Western College Publishing

19. 18 Shift in Aggregate Expenditure C 1 +I 1 45 o original equilibrium C 2 +I 2 new equilibrium 18 Aggregate Expenditure National Income

20. 19 What is the Income Multiplier? The multiple by which income changes as a result of a change in aggregate expenditure © ©1999 South-Western College Publishing

21. 20 20 © ©1999 South-Western College Publishing Multiplier = Change in Y change in AE

22. 21 If investors increase spending by $100 billion, will GDP increase by $100 billion? NO, it will increase by more than $100 billion because of the multiplier

23. 22 $100 $90 $81 $74 $1,000... 22 MPC = 9/10 MPS = 1/10

24. 23 How do we measure the multiplier? 1/MPS or 1/ (1-MPC)

25. 24 If MPC equals 9/10, what is MPS? 1/10

26. 25 One divided by one tenth equals 10 1 1.. 10 = 1 X 1 = Simple Multiplier 10 25

27. 26 MPC =.9 MPS =.1 C+I 26 90 100 Aggregate Expenditure National Income

28. 27 If the multiplier is 10, how much does GDP increase when investment increases by $1billion? 10 x $1bil = $10 billion

29. 28 If the multiplier is 10, how much does GDP decrease when investment decreases by $1billion? 10 x -$1bil = -$10 billion

30. 29 More multiplier problems Assume MPC=.75, initial change in Investment = 5 billion, then change in GDP equals?

31. 30 MPS = 1/3, initial change in consumption = -8 billion, then change in GDP =

32. 31 MPC =.8 Say investment increases by 6 billion, what is the maximum change in GDP???

33. 32 Note that the actual value of the multiplier is smaller than our formula suggests—Why? The effect of taxes has been ignored The effect of imports has been ignored The effect of inflation has been ignored

34. 33 What is the Paradox of Thrift? The more people try to save (in the aggregate), the more income falls, leaving them with no more and perhaps with even less saving © ©1999 South-Western College Publishing

35. 34 What is Aggregate Expenditure? At what point is the Equilibrium? Why is intended I = intended S an equilibrium?Why is intended I = intended S an equilibrium? What is Actual Investment? What happens when actual Investment > intended Investment?What happens when actual Investment > intended Investment? What happens when actual Investment < intended Investment?What happens when actual Investment < intended Investment?

36. 35 What happens when Consumption or Investment change?What happens when Consumption or Investment change? What is the Income Multiplier? If the price level increases what happens to AE?If the price level increases what happens to AE? If the price level decreases what happens to AE?If the price level decreases what happens to AE? What is the Paradox of Thrift?

37. 36 ENDEND © ©1999 South-Western College Publishing