1. Learning Objectives: Aggregate Expenditures LO1: Understand the marginal propensity to consume and how consumption, saving, and investment relate to national income LO2: Understand the concept of expenditures equilibrium LO3: Describe how small changes in spending have a large effect on national income CHAPTER 6 6-1© 2012 McGraw-Hill Ryerson Limited

2. The Multiplier The effect on income of a change in autonomous spending The value of the multiplier depends on the MPE In general, a one dollar increase in autonomous spending will lead to more than a one dollar increase in income 6-2© 2012 McGraw-Hill Ryerson Limited LO3

3. The Multiplier 6-3© 2012 McGraw-Hill Ryerson Limited LO3

4. The Multiplier 6-4© 2012 McGraw-Hill Ryerson Limited LO3

5. Determinants of Consumption 1.Wealth effect: The effect of a change in wealth on consumption spending 2.Real-balances effect: The effect that a change in the value of real balances has on consumption spending. Financial assets may need to be replenished, through increased savings, when price levels rise 3.Changes in the age of consumer durables 4.Changes in consumer expectations 6-5© 2012 McGraw-Hill Ryerson Limited LO3

6. Determinants of Investment 1.Interest rates 2.Purchase price, installation, maintenance and operating costs of capital goods 3.The age of capital goods 4.Business expectations 5.Government regulations 6-6© 2012 McGraw-Hill Ryerson Limited LO3

7. The Multiplier Process A $50 billion increase in investment: Creates a $50 billion shortage Producers increase production of capital goods, raising incomes Increased incomes lead to increased consumption spending Producers increase production of consumer goods, again raising incomes Continues until no shortage exists 6-7© 2012 McGraw-Hill Ryerson Limited LO3

8. Table 6.4 The Multiplier Process 6-8© 2012 McGraw-Hill Ryerson Limited LO3 Period National Income (Y) Consumption (C) Investment (I) Aggregate Expenditures (AE) (C + I) Surplus(+)/ Shortage (−) (Unplanned Investment) 1500425755000... 2500425125550–50 3550462.5125587.5–37.5 4587.5490.625125615.625–28.125 5615.625511.72125636.72–21.10... Final7005751257000

9. Calculating the Multiplier OR The higher the MPE, the bigger the multiplier Multiplier also works in reverse – a decrease in spending results in a greater decrease in national income 6-9© 2012 McGraw-Hill Ryerson Limited LO3 Multiplier = 1 / MLR Multiplier = 1 / (1-MPE)

10. Self Test 3 Given the following values for the MPE, calculate the values of the MLR and multipliers: a)MPE = 0.9 b)MPE = 0.75. 6-10© 2012 McGraw-Hill Ryerson Limited LO3

11. Adding the Government Sector Government spending is treated as autonomous Total taxes are made up of autonomous taxes and induced taxes Marginal tax rate: the ratio of the change in taxation as a result of a change in income 6-11© 2012 McGraw-Hill Ryerson Limited LO3