Lec.1. Aggregate Demand and the Powerful Consumer

8/4/2019 Lec.1. Aggregate Demand and the Powerful Consumer

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Chapter 4Aggregate 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


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Aggregate Demand

Aggregate demand

Total amount

All consumers, business firms, &government agencies

Spend: final goods and services

Components of aggregate demand

Consumer expenditure (C, consumption) Investment spending (I)

Government purchases (G)

Net exports (X-IM) 2


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Aggregate Demand

C - Consumer expenditure / consumption

Total amount

Spent by consumers

Newly produced goods & services Exclude: purchases of new homes

Investment goods

2/3 of total spending

3


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Aggregate Demand

I - Investment spending

Sum of expenditures

Business firms - new plant & equipment

Households - new homes

Not included

Financial investments

Re-sales of existing physical assets

4


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Aggregate Demand

G - Government purchases

Goods & services

Purchased by all levels of government

X-IM - Net exports X exports

Sell to foreigners

IM imports Buy from foreigners

Aggregate demand = C + I + G + (X-IM)

5


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National Income

National income

Total income - all individuals in economy

Wages, interest, rents, profits

Excludes

Government transfer payments

Before taxes / deductions

6


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National Income

Disposable income (DI)

Total income - all individuals in economy

After taxes deducted

After transfer payments - added Spend and save

Transfer payments

Sums of money Form government to certain individuals

Outright grants7


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Circular Flow: Spending, Production, Income

Disposable income, DI = C+S

Consumption (C)

Savings (S)

Leakages S, IM, Taxes

Injections

I, G, X, Transfers

8


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The circular flow of expenditures and income

Figure 1

9


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Circular Flow: Spending, Production, Income

Aggregate demand = C+I+G+(X-IM)

= Gross national income

National income = Domestic product

DI=GDP - Taxes + Transfer Payments=GDP - (Taxes - Transfers)

=Y - T

10


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Consumer Spending and Income

Consumer spending - responds

Change in income taxes

If DI increases

C increases If DI decreases

C falls

11

changeHorizontal

changeVerticalSlope


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Consumer spending and disposable income

Figure 2

12


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Consumer Spending and Income

Scatter diagram graph

Relationship between two variables

Each year a point in diagram

Coordinates of each years point Values of two variables - year

13


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Scatter diagram: consumer spending &disposable income

Figure 3

14


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Scatter diagram of consumer spending anddisposable income, 19471963

Figure 4

15


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Consumption Function & MPC

Consumption function

Relationship

Total consumer expenditures

Total disposable income

All other determinants constant

Marginal propensity to consume (MPC)

Ratio of changes in consumption To changes in disposable income

Slope of consumption function

16


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Consumption Function & MPC

Estimate initial effect of tax cut - on C Estimate MPC

= Amount of tax cut MPC

17

CinchangetheproducesthatDIinChange

CinChangeMPC


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Consumption and income in a hypothetical economy

Table 1

18

Year

(1)

Consumption, C

(2)

Disposable

Income, DI

(3)

Marginal Propensity

to Consume, MPC

2002

2003

2004

2005

2006

2007

$2,700

3,000

3,300

3,600

3,900

4,200

$3,200

3,600

4,000

4,400

4,800

5,200

0.75

0.75

0.75

0.75

0.75

Fi


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A consumption function

Figure 5

19

C

2,700

3,000

3,300

3,600

3,900

Re

alConsumerSp

ending,

C$4,200

3,200 3,600 4,0000 4,400 4,800

Real Disposable Income, DI

5,200


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Factors that Shift the Consumption Function

Change: disposable income

Movement along - consumption function

Change: other determinants of C

Shift - consumption function

20

Fi 6


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Shifts of the consumption function

Figure 6

21

C0

RealConsumerSpending

Real Disposable Income

A

C2

C1Movements alongconsumption function

Shifts of consumption

function


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Factors that Shift the Consumption Function

Other determinants of C

Wealth

Stock market boom: upward shift

Price level

Money-fixed assets

Real interest rate

Future income expectations

Permanent cuts in income taxes

Greater increase in C

Than temporary cuts

22

T bl 2


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Incomes of three consumers

Table 2

23

Incomes each year

Consumer 1974 1975 1976 1977 Total Income

Constant

Temporary

Permanent

$100

100

100

$100

120

120

$100

100

120

$100

100

120

$400

420

460


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Extreme Variability Of Investment

Investment spending (I)

Volatility

Interest rates

Tax provisions

Technical change

Strength of economy

State of business confidence

Expectations about future

24


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Determinants of Net Exports

Income levels

GDP rises

Imports rise

GDP falls

Imports fall

Exports - relatively insensitive to GDP

25


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Determinants of Net Exports

Relative prices & Exchange rates

Prices increase

Net exports decrease

Prices decline

Net exports increase

Foreign prices increase

Net exports increase

Foreign prices decrease

Net exports decrease

26


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How Predictable is Aggregate Demand?

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 abroad27

APPENDIX


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APPENDIX

National income accounting National income accounting

System of measurement

Collect & express macroeconomic data

Gross domestic product (GDP) Sum of money values

All final goods & services

Produced - specified period of time Usually one year

28

APPENDIX


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APPENDIX

GDP exceptions to the rule Government output

Valued at cost of inputs

Inventories

Counted in GDP Investment goods

Intermediate goods

Included in GDP

29

APPENDIX


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APPENDIX

GDP: sum of final goods and services Y = C + I + G + (X IM)

I = Gross private domestic investment

Business investment

Plant, Equipment, Software Residential construction

Inventory investment

Includes only Newly produced capital goods

Doesnt include

Exchanges of existing assets 30

APPENDIX


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APPENDIX

GDP: sum of final goods and services Y = C + I + G + (X IM)

G = Government purchases

Current goods & services

Purchased: all levels of government Dont include transfer payments

31

APPENDIX


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APPENDIX

GDP: sum of final goods and services Nations total output

Y=C+I+G+(X-IM)

Shares of GDP - used up by

Consumers (C) Investors (I)

Government (G)

Foreigners (X-IM)

32

Table 3


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Gross Domestic Product, 2007: sum of final demands

Table 3

33

Item Nominal Amount* Real Amount

Personal consumption expenditures (C)

Gross private domestic investment (I)

Government purchases of goods and

services (G)

Net exports (X - IM)Exports (X)

Imports (IM)

Gross domestic product (Y)

$9,732

2,1332

2,691

-7131,640

2,353

13,843

$8,276

1,831

2,022

-5601,408

1,968

11,567

*In billions of current dollars

In billions of 2000 dollars

APPENDIX


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APPENDIX

GDP: sum of all factor payments GDP = National income

Add up - All income in economy

GDP = Wages + Interest + Rents + Profits

Includes: indirect business taxes Excludes: transfer payments

No deduction for income taxes

34

Table 4


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Gross Domestic Product in 2007: sum of incomes

Table 4

35

Item Amount

Compensation of employees (wages)plus

Net interestplus

Rental incomeplus

ProfitsCorporate profits

Proprietors incomeplus

Indirect business taxes and

misc. items

equalsNational income

plus

Statistical discrepancyequals

Net national product

$7,878

603

65

2,6381,595

1,043v

1,042

v12,221

v

29v

12,250

Item Amount

Net national productplus

Depreciationequals

Gross national productminus

Income received fromother countriesplus

Income paid to

other countriesequals

Gross domestic product

12,250v

1,687v

13,937v

818

722v

13,841

APPENDIX


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APPENDIX

GDP: sum of all factor payments Net national product (NNP)

Gross national product (GNP)

Depreciation

Portion of capital equipment - Used up

36

APPENDIX


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APPENDIX

GDP: sum of value added Value added firm

Revenue from selling a product

Minus amount paid

Goods & services purchased from other firms GDP = sum of values added by all firms

Value added = Wages + Interest

+ Rents + Profits

37

Table 5


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An illustration of final and intermediate goods

Table 5

38

Item Seller Buyer Price

Bushel of soybeans

Bag of soy meal

Gallon of soy sauce

Gallon of soy sauce used as seasoning

Farmer

Miller

Factory

Restaurant

Miller

Factory

Restaurant

Consumers

$3

4

8

10

Total: $25

Addendum: Contribution to GDP $10

Table 6


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An illustration of value added

Table 6

39

Item Seller Buyer Price Value

Added

Bushel of soybeans

Bag of soy meal

Gallon of soy sauce

Gallon of soy sauce used as seasoning

Farmer

Miller

Factory

Restaurant

Miller

Factory

Restaurant

Consumers

$3

4

8

10

$3

1

4

2

Total: $25 $10 n

Addendum: Contribution to GDP

Final Product

Sum of value added

$10

$10

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Lec.1. Aggregate Demand and the Powerful Consumer