1. PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University 1 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Aggregate Demand and the Powerful Consumer Men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income. JOHN MAYNARD KEYNES

2. Aggregate Demand Aggregate demand –Total amount that all Consumers Business firms Government agencies Foreigners –Spend on final goods and services –Is a schedule, not a fixed number The numerical value depends on the price level 2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3. Aggregate Demand Components of aggregate demand –Consumer expenditure (C, consumption) –Investment spending (I) –Government purchases (G) –Net exports (X-IM) 3 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

4. Aggregate Demand C - Consumer expenditure / consumption –Total amount spent by consumers –On newly produced goods and services Excluding purchases of new homes –2/3 of total spending 4 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5. Aggregate Demand I - Investment spending –Sum of expenditures of business firms On new plant, equipment, and software –And households on new homes –Not included Financial “investments” Re-sales of existing physical assets 5 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6. Aggregate Demand G - Government purchases –All the goods and services purchased by all levels of government X-IM - Net exports –Difference between exports (X) and imports (IM) Aggregate demand C + I + G + (X-IM) 6 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. National Income National income –Sum of the incomes –That all individuals in the economy earn In the forms of wages, interest, rents, and profits –Excludes government transfer payments –Is calculated before any deductions are taken for income taxes 7 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

8. National Income Disposable income (DI) –Sum of the incomes of all individuals in the economy –After all taxes have been deducted and all transfer payments have been added –How much consumers have available to spend and save 8 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

9. National Income Transfer payments –Sums of money –That the government gives certain individuals as outright grants Rather than as payments for services rendered to employers –Examples Social Security and unemployment benefits 9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

10. Circular Flow Disposable income, DI = C+S –Consumption (C) –Savings (S) “Leakages” –S, IM, Taxes “Injections” –I, G, X, Transfers 10 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

11. Figure 1 The Circular Flow of Expenditures and Income 11 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

12. Circular Flow Aggregate demand = C+I+G+(X-IM) = Gross national income National income = Domestic product DI =GDP - Taxes + Transfer Payments =GDP - (Taxes – Transfers) =Y - T 12 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

13. Consumer Spending and Income Consumer spending - responds –Change in income taxes If DI increases –C – increases If DI decreases –C – falls 13 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

14. Figure 2 Consumer Spending and Disposable Income 14 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

15. Consumer Spending and Income Scatter diagram – graph –Graph showing the relationship between two variables –Each year: a point in the diagram Coordinates of each year’s point: values of the two variables in that year 15 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

16. Figure 3 Scatter Diagram of Consumer Spending and Disposable Income 16 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

17. Figure 4 Scatter Diagram of Consumer Spending and Disposable Income, 1947–1963 17 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

18. The C Function and the MPC Consumption function, C –Relationship between Total consumer expenditures Total disposable income in the economy –Holding all other determinants of consumer spending constant 18 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

19. The C Function and the MPC Marginal propensity to consume (MPC) –Ratio of changes in consumption to changes in disposable income –Slope of consumption function –How much more consumers will spend if DI rises by $1 19 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

20. The C Function and the MPC To estimate the initial effect of a tax cut on consumer spending –Estimate the MPC –Multiply the amount of the tax cut by the estimated MPC –Prediction – subject to some margin of error 20 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

21. Table 1 Consumption and Income in a Hypothetical Economy 21 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

22. Figure 5 A Consumption Function 22 C 2,700 3,000 3,300 3,600 3,900 Real Consumer Spending, C $4,200 3,2003,6004,00004,4004,800 Real Disposable Income, DI 5,200 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

23. Factors that Shift the C Function Movement along a given C function –Change in disposable income Shift of the C function –Change in other determinants of C Wealth Price level Real interest rate Future income expectations 23 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

24. Figure 6 Shifts of the Consumption Function 24 C0C0 Real Consumer Spending Real Disposable Income A C2C2 C1C1 Movements along consumption function Shifts of consumption function © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

25. Factors that Shift the C Function Wealth –Stock market wealth Higher stock prices – increase in C function –Houses Lower price of houses – fall in C function Price level –Higher price level – lower purchasing power of money-fixed assets 25 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

26. Factors that Shift the C Function Real interest rate –Interest rates have negligible effects on consumption decisions Future income expectations –Permanent cuts in income taxes cause greater increases in consumer spending Than do temporary cuts of equal magnitude 26 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

27. Table 2 Incomes of Three Consumers 27 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

28. The Extreme Variability of I Investment spending (I) –The most volatile component of aggregate demand Business investment – influenced by –Interest rates –Tax provisions –Technical change –Strength of economy –State of business confidence 28 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

29. The Extreme Variability of I Investment in housing – influenced by –Consumer incomes –Interest rates –Interest rates on home mortgages –Expected rate of price appreciation (or depreciation) 29 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

30. Determinants of Net Exports Exports, X –Foreign purchases of U.S. goods Imports, IM –Portion of domestic demand that is satisfied by foreign producers Net exports –Exports minus Imports 30 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

31. Determinants of Net Exports Changes in national income –Our GDP rises Our imports rise –Our GDP falls Our imports fall –Our exports Relatively insensitive to our GDP Sensitive to the GDPs of other countries 31 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

32. Determinants of Net Exports Relative prices and exchange rates –Prices increase Net exports decrease –Prices decline Net exports increase –Foreign prices increase Net exports increase –Foreign prices decrease Net exports decrease 32 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

33. How Predictable is AD? Aggregate demand – difficult to predict –Consumption Wealth, stock market Future prices, income tax law –Investment Business confidence, expectations –Government purchases Politics, military and national security events –Net exports Development abroad 33 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

34. Appendix National income accounting –System of measurement devised for collecting and expressing macroeconomic data Gross domestic product (GDP) –Sum of money values –All final goods and services –Produced over a specified period of time Usually one year 34 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

35. Appendix GDP – exceptions to the rule Government output –Valued at cost of inputs Inventories –Counted in GDP Investment goods –Intermediate goods –Included in GDP 35 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

36. Appendix GDP: sum of final goods and services Y = C + I + G + (X – IM) I = Gross private domestic investment –Business investment –Residential construction –Inventory investment –Includes only newly produced capital goods –Doesn’t include exchanges of existing assets 36 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

37. Appendix GDP: sum of final goods and services Y = C + I + G + (X – IM) G = Government purchases –Current goods and services –Purchased by all levels of government –Don’t include transfer payments 37 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

38. Appendix GDP: sum of final goods and services Nation’s total output Y=C+I+G+(X-IM) –Shares of GDP used up by Consumers (C) Investors (I) Government (G) Foreigners (X-IM) 38 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

39. Table 3 Gross Domestic Product in 2009 as the Sum of Final Demands 39 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

40. Appendix GDP: sum of all factor payments GDP = National income –Add up all income in the economy –GDP = Wages + Interest + Rents + Profits –Includes indirect business taxes –Excludes transfer payments –No deduction for income taxes 40 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

41. Table 4 Gross Domestic Product in 2009 as the Sum of Incomes 41 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

42. Appendix GDP: sum of all factor payments Net national product (NNP) –A measure of production –Is conceptually identical to national income Gross national product (GNP) –NNP plus depreciation Depreciation –Portion of capital equipment used up 42 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

43. Appendix GDP: sum of value added Value added by a firm –Revenue from selling a product –Minus amount paid for goods and services purchased from other firms GDP = sum of values added by all firms Value added = Wages + Interest + Rents + Profits 43 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

44. Table 5 An Illustration of Final and Intermediate Goods 44 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

45. Table 6 An Illustration of Value Added 45 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.