1. Unit 3—Aggregate Models Krugman Section 4 Module 16 Graphs: 5 Time: 2 weeks

2. Building the Aggregate Expenditures Model Aggregate means TOTAL (aggregate expenditure means total spending)

3. Consumption & Saving What can a person do with disposable income (money earned after taxes)? What can a person do with disposable income (money earned after taxes)? What is not spent is called savings What is not spent is called savings DI – C = Savings DI – C = Savings

4. Graphs Consumption in notes Consumption in notes Savings in notes Savings in notes Consumption Savings Link Consumption Savings Link Big graph number 4 Big graph number 4

5. Average Propensities to C & S Measures the average C (APC) or S (APS) at any level of disposable income Measures the average C (APC) or S (APS) at any level of disposable income APC = C / DI APC = C / DI APS = S / DI APS = S / DI C%  and S%  as DI  C%  and S%  as DI  APC + APS = 1 APC + APS = 1

6. Marginal Propensities to C & S (marginal means extra) (marginal means extra) Proportion of any change in income C is called MPC or income Saved is called MPS Proportion of any change in income C is called MPC or income Saved is called MPS MPC = ∆ C / ∆ DI MPC = ∆ C / ∆ DI MPS = ∆ S / ∆ DI MPS = ∆ S / ∆ DI MPC + MPS = 1 MPC + MPS = 1 The only choice people have is to C or to Save. An additional dollar in income must result in a change in C and/or a change in Savings. The only choice people have is to C or to Save. An additional dollar in income must result in a change in C and/or a change in Savings.

7. Practice Worksheet APC/APS APC/APS MPC/MPS MPC/MPS

8. Investment Demand Curve BIG GRAPH #5 BIG GRAPH #5

9. Investment Spending on new plants, capital equipment, machinery, construction, etc. Spending on new plants, capital equipment, machinery, construction, etc. Investment decision weighs mb & mc Investment decision weighs mb & mc The expected rate of return = mb The expected rate of return = mb The interest rate = mc The interest rate = mc

10. Expected Rate of Return Found by comparing the expected economic profit (total revenue minus total cost) to cost of investment to get expected rate of return Found by comparing the expected economic profit (total revenue minus total cost) to cost of investment to get expected rate of return Woodworker wants to buy equipment for $1,000. He expects a $100 profit. The expected rate of return in 10%. In order to make a profit, the woodworker would not want to pay more than 10% interest on the investment. Woodworker wants to buy equipment for $1,000. He expects a $100 profit. The expected rate of return in 10%. In order to make a profit, the woodworker would not want to pay more than 10% interest on the investment.

11. The Real Interest Rate The real interest rate, i, is the cost of the investment The real interest rate, i, is the cost of the investment Real interest rate = nominal rate - inflation Real interest rate = nominal rate - inflation If i > expected rate of return, r, the investment should not be made If i > expected rate of return, r, the investment should not be made

12. Shifts in the Investment Demand Curve—IDC or DIgC Movement occurs with a change in the interest rate Movement occurs with a change in the interest rate Shifts occur due to these determinants: Shifts occur due to these determinants: 1. acquisition, maintenance and operating costs 1. acquisition, maintenance and operating costs When cost falls, the r from prospective investment project rises, shifts the IDC to the right When cost falls, the r from prospective investment project rises, shifts the IDC to the right Higher electricity costs = shift to the left Higher electricity costs = shift to the left 2. business taxes 2. business taxes  in taxes = shift to the left  in taxes = shift to the left

13. Shifts Continued 3. technological change 3. technological change Development stimulates investment Development stimulates investment (shifts to the right) (shifts to the right) 4. stock of capital goods on hand 4. stock of capital goods on hand When firms are overstocked, the r declines (shifts to the left) When firms are overstocked, the r declines (shifts to the left) There is little incentive to invest in new capital when there is excess production There is little incentive to invest in new capital when there is excess production When firms are under stocked, the r increases (shifts to the right) When firms are under stocked, the r increases (shifts to the right)

14. Shifts continued again... 5. Expectations 5. Expectations Optimistic about future sales, the curve will shift to the right Optimistic about future sales, the curve will shift to the right Pessimistic outlook = shift to the left Pessimistic outlook = shift to the left

15. Instability of Investment 1. capital goods are durable so spending can be postponed 1. capital goods are durable so spending can be postponed 2. innovation occurs irregularly 2. innovation occurs irregularly 3. profits vary considerably 3. profits vary considerably 4. expectations can be easily changed 4. expectations can be easily changed