1. Chapter Nine: Aggregate Demand and Economic Fluctuations

2. The Business Cycle

3. Figure 9.1: U.S. Real GDP and Recessions Source: BEA quarterly data 1985–2012, and NBER

4. Figure 9.2: U.S. Unemployment Rate and Recessions

5. Figure 9.3: U.S. Inflation Rate and Recessions Source: “Economic Report of the President” 1985–2005; rate is calculated as a three-month moving average of the CPI; NBER.

6. Year Trough ContractionExpansion GDP Y* Peak Figure 9.4: A Stylized Business Cycle

7. 19291933 (a)Real Standard and Poor’s Stock Index 100.045.7 (b)Unemployment rate (official) 3.2%24.9% (c)Price level (CPI) 100.075.4 (d) Real gross domestic product865.2 billion635.5 billion (e) Real personal consumption expenditures661.4 billion541.0 billion (f) Real gross private domestic investment91.3 billion17 billion (g)Real private debt 88.9 billion102.0 billion (h)Bankruptcy cases 56,86767,031 (i)Non-farm real estate foreclosures 134,900252,400 (j)Food energy per capita per day (calories) 34603280 Table 9.1: The Early Years of the Great Depression in the United States Sources: (a) from Historical Statistics of the United States, p. 1004, series X495.; (b)-(c) from Dornbusch, Fischer, & Startz (2001);( d)-(f) from http://www.bea.doc.gov/bea/dn/nipaweb/TableView.asp#Mid; (g) from Historical Statistics of the United States, p. 989, series X399.; (h) from Bradley Hansen and Mary Eschenbach Hansen, The Transformation of Bankruptcy in the United States (http://academic2.american.edu/~mhansen/transform.pdf ); (i) from Historical Statistics of the United States, p. 651, series N301; (j) from Ibid., p. 328, series 851; (d) and (e) are inflation-corrected using (b) http://www.bea.doc.gov/bea/dn/nipaweb/TableView.asp#Midhttp://academic2.american.edu/~mhansen/transform.pdf

8. Macroeconomic Modeling and Aggregate Demand

9. Output (Y ) Income (Y ) Spending (Aggregate Demand or AD ) Spending stimulates firms to produce Production generates incomes Incomes give actors the ability to spend Figure 9.5: The Output-Income-Spending Flow of an Economy in Equilibrium

10. Production generates income to households Saving (S ) leakage Intended Investment ( I I ) 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 Figure 9.6: The Output-Income-Spending Flow with Leakages and Injections

11. Quantity of funds borrowed and lent Interest rate 140 5% Supply of Loanable Funds Demand for Loanable Funds E1E1 Figure 9.7: The Classical Model of the Market for Loanable Funds

12. Quantity of funds borrowed and lent Interest rate 140 5% Supply of Loanable Funds Original Demand E1E1 New Demand 60 3% E0E0 Figure 9.8: Adjustment to a Reduction in Intended Investment in the Classical Model

13. leakage injection Production generates income Spending stimulates firms to produce Saving (S ) Equilibrium in the market for loanable funds Intended Investment (I I ) is equal to S Output (Y* ) Consumption (C ) Income (Y* ) Spending sufficient to sustain full employment AD = Y* Figure 9.9: Macroeconomic Equilibrium at Full Employment in the Classical Model

14. The Keynesian Model

15. (1) Income (Y) (3) The part of consumption that depends on income, with mpc = 0.8 =0.8  column(1) (4) Consumption C = 20 + 0.8 Y = column(2) + column(3) (5) Saving S = Y–C = column(1) –column(4) 0200 -20 10020801000 2002016018020 3002024026040 4002032034060 5002040042080 60020480500100 70020560580120 80020640660140 Table 9.2: The Consumption Schedule (and Saving)

16. 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 Figure 9.10: The Keynesian Consumption Function

17. Income (Y ) Intended Investment (= I I ) Intended Investment (I I ) (= I I ) I I = 60 Figure 9.11: The Keynesian Investment Function

18. Consumption (C ) Income (Y ) Consumption, Investment, and Aggregate Demand 400 Aggregate Demand (AD ) = C + I I Intended Investment (I I ) 340 80C +I I = Figure 9.12: Aggregate Demand

19. Table 9.3: Deriving Aggregate Demand from the Consumption Function and Investment (1) Income (Y) (2) Consumption (C) (3) Intended Investment (II) (4) Aggregate Demand AD = C + II = column (2) + column (3) 0206080 30026060320 40034060400 50042060480 60050060560 70058060640 80066060720

20. Table 9.4: Aggregate Demand with Higher Intended Investment (1) Income (Y) (2) Consumption (C) (3) Intended Investment (II) (4) Aggregate Demand (AD) 020140160 300260140400 340140480 500420140560 600500140640 700580140720 800660140800

21. Income (Y ) Aggregate Demand 400100 1000 800 700 600 500 400 300 200 100 0 AD (I I = 140) 800 AD (I I = 60) 480 160 80 Figure 9.13: Aggregate Demand with a Higher Level of Intended Investment = =

22. (1) Income (Y) (2) Aggregate Demand (AD) (3) Excess Inventory Accumulation (+) or Depletion (-) = column(1)- column(2) (4) Intended Investment (I I ) (5) Investment (I) = column(3) + column(4) (6) Check that the macroeconomic identity still holds: Y = C+I 300 320 -20 60 40 300 400 0 60 400 500 480 20 60 80 500 600 560 40 60 100 600 700 640 60 120 700 800 720 80 60 140 800 Table 9.5: The Possibility of Excess Inventory Accumulation or Depletion

23. 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 Figure 9.14: Unintended Investment in the Keynesian Model

24. 45 Income (Y ) Aggregate Demand and Output 400100 1000 800 700 600 500 400 300 200 100 0 AD 0 (I I = 140) 800 E0E0 Full Employment Y* 160 Figure 9.15: Full Employment Equilibrium with High Intended Investment

25. 45 Income (Y ) Aggregate Demand and Output 400100 1000 800 700 600 500 400 300 200 100 0 AD 0 (I I = 140) 800 E1E1 E0E0 Full Employment AD 1 (I I = 60) Persistent unemployment equilibrium Y* 80 160 Figure 9.16: A Keynesian Unemployment Equilibrium

26. 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 Output (Y* ) Figure 9.17: Movement to an Unemployment Equilibrium

27. (1) Change in Intended Investment (2) Change in Aggregate Demand (as C or I I 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 I I =  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   4 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 Table 9.6: The Multiplier at Work