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Chapter 25 aggregate demand and the powerful consumer
1. PowerPoint Slides prepared by:
Andreea CHIRITESCU
Eastern Illinois University
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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
âTotal amount that all
⢠Consumers
⢠Business firms
⢠Government agencies
⢠Foreigners
âSpend on final goods and services
âIs a schedule, not a fixed number
⢠The numerical value depends on the price
level
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3. Aggregate Demand
⢠Components of aggregate demand
âConsumer expenditure (C, consumption)
âInvestment spending (I)
âGovernment purchases (G)
âNet exports (X-IM)
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4. Aggregate Demand
⢠C - Consumer expenditure / consumption
âTotal amount spent by consumers
âOn newly produced goods and services
⢠Excluding purchases of new homes
â2/3 of total spending
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5. Aggregate Demand
⢠I - Investment spending
âSum of expenditures of business firms
⢠On new plant, equipment, and software
âAnd households on new homes
âNot included
⢠Financial âinvestmentsâ
⢠Re-sales of existing physical assets
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6. Aggregate Demand
⢠G - Government purchases
âAll the goods and services purchased by
all levels of government
⢠X-IM - Net exports
âDifference between exports (X) and
imports (IM)
⢠Aggregate demand
C + I + G + (X-IM)
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7. National Income
⢠National income
âSum of the incomes
âThat all individuals in the economy earn
⢠In the forms of wages, interest, rents, and
profits
âExcludes government transfer payments
âIs calculated before any deductions are
taken for income taxes
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8. National Income
⢠Disposable income (DI)
âSum of the incomes of all individuals in
the economy
âAfter all taxes have been deducted and all
transfer payments have been added
âHow much consumers have available to
spend and save
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9. National Income
⢠Transfer payments
âSums of money
âThat the government gives certain
individuals as outright grants
⢠Rather than as payments for services
rendered to employers
âExamples
⢠Social Security and unemployment benefits
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10. Circular Flow
⢠Disposable income, DI = C+S
âConsumption (C)
âSavings (S)
⢠âLeakagesâ
âS, IM, Taxes
⢠âInjectionsâ
âI, G, X, Transfers
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11. Figure 1
The Circular Flow of Expenditures and Income
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12. Circular Flow
⢠Aggregate demand
= C+I+G+(X-IM)
= Gross national income
⢠National income
= Domestic product
⢠DI
=GDP - Taxes + Transfer Payments
=GDP - (Taxes â Transfers)
=Y - T
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13. Consumer Spending and Income
⢠Consumer spending - responds
âChange in income taxes
⢠If DI increases
âC â increases
⢠If DI decreases
âC â falls
13
changeHorizontal
changeVertical
Slope =
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14. Figure 2
Consumer Spending and Disposable Income
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15. Consumer Spending and Income
⢠Scatter diagram â graph
âGraph showing the relationship between
two variables
âEach year: a point in the diagram
⢠Coordinates of each yearâs point: values of
the two variables in that year
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16. Figure 3
Scatter Diagram of Consumer Spending and Disposable
Income
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17. Figure 4
Scatter Diagram of Consumer Spending and Disposable
Income, 1947â1963
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18. The C Function and the MPC
⢠Consumption function, C
âRelationship between
⢠Total consumer expenditures
⢠Total disposable income in the economy
âHolding all other determinants of
consumer spending constant
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19. The C Function and the MPC
⢠Marginal propensity to consume (MPC)
âRatio of changes in consumption to
changes in disposable income
âSlope of consumption function
âHow much more consumers will spend if
DI rises by $1
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CinchangetheproducesthatDIinChange
CinChange
=MPC
20. The C Function and the MPC
⢠To estimate the initial effect of a tax cut
on consumer spending
âEstimate the MPC
âMultiply the amount of the tax cut by the
estimated MPC
âPrediction â subject to some margin of
error
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21. Table 1
Consumption and Income in a Hypothetical Economy
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22. Figure 5
A Consumption Function
22
C
2,700
3,000
3,300
3,600
3,900
RealConsumerSpending,C
$4,200
3,200 3,600 4,0000 4,400 4,800
Real Disposable Income, DI
5,200
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23. Factors that Shift the C Function
⢠Movement along a given C function
âChange in disposable income
⢠Shift of the C function
âChange in other determinants of C
⢠Wealth
⢠Price level
⢠Real interest rate
⢠Future income expectations
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24. Figure 6
Shifts of the Consumption Function
24
C0
RealConsumerSpending
Real Disposable Income
A
C2
C1
Movements along
consumption function
Shifts of consumption
function
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25. Factors that Shift the C Function
⢠Wealth
âStock market wealth
⢠Higher stock prices â increase in C function
âHouses
⢠Lower price of houses â fall in C function
⢠Price level
âHigher price level â lower purchasing
power of money-fixed assets
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26. Factors that Shift the C Function
⢠Real interest rate
âInterest rates have negligible effects on
consumption decisions
⢠Future income expectations
âPermanent cuts in income taxes cause
greater increases in consumer spending
⢠Than do temporary cuts of equal magnitude
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27. Table 2
Incomes of Three Consumers
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28. The Extreme Variability of I
⢠Investment spending (I)
âThe most volatile component of
aggregate demand
⢠Business investment â influenced by
âInterest rates
âTax provisions
âTechnical change
âStrength of economy
âState of business confidence
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29. The Extreme Variability of I
⢠Investment in housing â influenced by
âConsumer incomes
âInterest rates
âInterest rates on home mortgages
âExpected rate of price appreciation (or
depreciation)
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30. Determinants of Net Exports
⢠Exports, X
âForeign purchases of U.S. goods
⢠Imports, IM
âPortion of domestic demand that is
satisfied by foreign producers
⢠Net exports
âExports minus Imports
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31. Determinants of Net Exports
⢠Changes in national income
âOur GDP rises
⢠Our imports rise
âOur GDP falls
⢠Our imports fall
âOur exports
⢠Relatively insensitive to our GDP
⢠Sensitive to the GDPs of other countries
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32. Determinants of Net Exports
⢠Relative prices and exchange rates
âPrices increase
⢠Net exports decrease
âPrices decline
⢠Net exports increase
âForeign prices increase
⢠Net exports increase
âForeign prices decrease
⢠Net exports decrease
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33. How Predictable is AD?
⢠Aggregate demand â difficult to predict
âConsumption
⢠Wealth, stock market
⢠Future prices, income tax law
âInvestment
⢠Business confidence, expectations
âGovernment purchases
⢠Politics, military and national security events
âNet exports
⢠Development abroad
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34. Appendix
National income accounting
⢠National income accounting
âSystem of measurement devised for
collecting and expressing macroeconomic
data
⢠Gross domestic product (GDP)
âSum of money values
âAll final goods and services
âProduced over a specified period of time
⢠Usually one year
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35. Appendix
GDP â exceptions to the rule
⢠Government output
âValued at cost of inputs
⢠Inventories
âCounted in GDP
⢠Investment goods
âIntermediate goods
âIncluded in GDP
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36. Appendix
GDP: sum of final goods and services
⢠Y = C + I + G + (X â IM)
⢠I = Gross private domestic investment
âBusiness investment
âResidential construction
âInventory investment
âIncludes only newly produced capital
goods
âDoesnât include exchanges of existing
assets
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37. Appendix
GDP: sum of final goods and services
⢠Y = C + I + G + (X â IM)
⢠G = Government purchases
âCurrent goods and services
âPurchased by all levels of government
âDonât include transfer payments
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38. Appendix
GDP: sum of final goods and services
⢠Nationâs total output
Y=C+I+G+(X-IM)
âShares of GDP used up by
⢠Consumers (C)
⢠Investors (I)
⢠Government (G)
⢠Foreigners (X-IM)
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39. Table 3
Gross Domestic Product in 2009 as the Sum of Final
Demands
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40. Appendix
GDP: sum of all factor payments
⢠GDP = National income
âAdd up all income in the economy
âGDP = Wages + Interest + Rents + Profits
âIncludes indirect business taxes
âExcludes transfer payments
âNo deduction for income taxes
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41. Table 4
Gross Domestic Product in 2009 as the Sum of Incomes
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42. Appendix
GDP: sum of all factor payments
⢠Net national product (NNP)
âA measure of production
âIs conceptually identical to national
income
⢠Gross national product (GNP)
âNNP plus depreciation
⢠Depreciation
âPortion of capital equipment used up
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43. Appendix
GDP: sum of value added
⢠Value added by a firm
âRevenue from selling a product
âMinus amount paid for goods and services
purchased from other firms
⢠GDP = sum of values added by all firms
⢠Value added
= Wages + Interest + Rents + Profits
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44. Table 5
An Illustration of Final and Intermediate Goods
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45. Table 6
An Illustration of Value Added
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