1. GDP (Trillions of Chained 2000 Dollars) Year 1990- 1991 2001

2. Unemployment Rate 1990- 1991 Year 2001

3. Year Inflation Rate 1990- 1991 2001

4. Year Trough ContractionExpansion GDP Y* Peak

6. Output (Y ) Income (Y ) Spending (Aggregate Demand or AD ) Spending stimulates firms to produce Production generates incomes Incomes give actors the ability to spend

7. Production generates income to households Saving (S ) leakage Intended Investment ( II ) injection firms decide how much to invest households decide how much to consume and save Output (Y ) Spending (AD ) Income (Y ) Consumption (C ) ? Sufficient to sustain output at a steady level

8. Quantity of funds borrowed and lent Interest rate 140 5% Supply of Loanable Funds Demand for Loanable Funds E1E1

9. Quantity of funds borrowed and lent Interest rate 140 5% Supply of Loanable Funds Original Demand E1E1 New Demand 60 3% E0E0

10. leakage injection Production generates income Spending stimulates firms to produce Saving (S ) Equilibrium in the market for loanable funds Intended Investment (II ) is equal to S Output (Y* ) Consumption (C ) Income (Y* ) Spending sufficient to sustain full employment AD = Y*

12. 45 Consumption (C ) (= + mpc Y) Income (Y ) Consumption (C ) Consumption = Income Line 400 Saving (S) 100 500 400 300 200 100 0 = 20 340 Slope = mpc

13. Income (Y ) Intended Investment (II ) (= II ) II = 60

15. Consumption (C ) Income (Y ) Consumption, Investment, and Aggregate Demand 400 Aggregate Demand (AD ) = C + II Intended Investment (II ) 340 80C +II =

17. Income (Y ) Aggregate Demand 400100 1000 800 700 600 500 400 300 200 100 0 AD (II = 140) 800 C +II = AD (II = 60) 480 160 80 C +II =

19. 45 Income (Y ) Aggregate Demand and Output Output = Income Line 400100 1000 800 700 600 500 400 300 200 100 0 Aggregate Demand (AD ) 800 E unintended investment (build up of inventories) 80 720

20. 45 Income (Y ) Aggregate Demand and Output 400100 1000 800 700 600 500 400 300 200 100 0 AD 0 (II = 140) 800 E0E0 Full Employment Y* 160

21. 45 Income (Y ) Aggregate Demand and Output 400100 1000 800 700 600 500 400 300 200 100 0 AD 0 (II = 140) 800 E1E1 E0E0 Full Employment AD 1 (II = 60) Persistent unemployment equilibrium Y* 80 160

22. Output (Y* ) Income (Y* ) Insufficient Spending AD < Y* Production generates income Income goes to households If leakages are larger than injections… Lower Income Lower Spending AD = lower Y Lower Output

23. The Multiplier at Work (1) Change in Intended Investment (2) Change in Aggregate Demand (as C or II change) and in Output and Income (as firms respond to changes in AD) (3) Change in Consumption ΔC = mpc Δ Y =.8  Column (2) 1. Investors lose confidence. Δ II =  80 2. Reduced investment spending leads directly to Δ AD =  80. Producers respond to reduced demand for their goods by cutting back on production. Δ Y =  80 3. Less production means less income. With income reduced by 80, households cut consumption by mpc Δ Y =.8   80 ΔC =  64 4. Lowered consumption spending means lowered AD Δ AD =  64 Producers respond. Δ Y =  64 5. Households cut consumption by mpc Δ Y =.8   64 ΔC =  51.2 6. Δ Y =  51.2 7. mpc Δ Y =.8   51.2 ΔC =  40.96 8. Δ Y =  40.969. ΔC =  32.77 10. Δ Y =  32.7711. ΔC =  26.21 etc. Sum of changes in Y =  80 +  64 +  51.2 +  40.96 +  32.77 +.... =  400