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Chapter 12 Powerpoint
1.
Chapter 12 Consumption, Real GDP,
and the Multiplier
2.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-2 Introduction Since the early 2000s, planned real investment spending has increased in most of the worldās nations. As a percentage of global real GDP, however, planned real investment spending in the worldās developed countries has declined. Yet, it has been rising in emerging-economy nations. These are countries transitioning to a developed status. How do changes in planned real investment spending affect a countryās real GDP? Reading Chapter 12 will help you answer this question.
3.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-3 Learning Objectives ā¢ Distinguish between saving and savings and explain how consumption and saving are related ā¢ Explain the key determinants of consumption and saving in the Keynesian model ā¢ Identify the primary determinants of planned investment
4.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-4 Learning Objectives (cont'd) ā¢ Describe how equilibrium real GDP is established in the Keynesian model ā¢ Evaluate why autonomous changes in total planned expenditures have a multiplier effect on equilibrium real GDP ā¢ Understand the relationship between total planned expenditures and the aggregate demand curve
5.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-5 Chapter Outline ā¢ Some Simplifying Assumptions in a Keynesian Model ā¢ Determinants of Planned Consumption and Planned Saving ā¢ Determinants of Investment ā¢ Determining Equilibrium Real GDP
6.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-6 Chapter Outline (cont'd) ā¢ Keynesian Equilibrium with Government and the Foreign Sector Added ā¢ The Multiplier ā¢ How a Change in Real Autonomous Spending Affects Real GDP When the Price Level Can Change ā¢ The Relationship Between Aggregate Demand and the C + I + G + X Curve
7.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-7 Did You Know That ... ā¢ The share of real GDP allocated to real consumption spending is: ā 66 percent in Germany ā 60 percent in the United Kingdom ā 70 percent in the United States ā Less than 41 percent in China? ā¢ In this chapter, you will learn how an understanding of householdsā real saving and real consumption spending can help you evaluate fluctuations in a nationalās real GDP.
8.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-8 Some Simplifying Assumptions in a Keynesian Model ā¢ To simplify the income determination model, letās assume: 1. Businesses pay no indirect taxes (sales tax) 2. Businesses distribute all profits to shareholders 3. There is no depreciation 4. The economy is closed; no foreign trade
9.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-9 Some Simplifying Assumptions in a Keynesian Model (cont'd) ā¢ Real Disposable Income ā Real GDP minus net taxes, or after-tax real income ā¢ Consumption ā Spending on new goods and services out of a householdās current income ā Whatever is not consumed is saved ā Consumption includes such things as buying food and going to a concert
10.
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Education, Inc. All rights reserved. 12-10 Some Simplifying Assumptions in a Keynesian Model (cont'd) ā¢ Saving ā The act of not consuming all of oneās current income ā Whatever is not consumed out of spendable income is, by definition, saved ā Saving is an action measured over time (a flow) ā Savings are a stock, an accumulation resulting from the act of saving in the past
11.
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Education, Inc. All rights reserved. 12-11 Some Simplifying Assumptions in a Keynesian Model (cont'd) ā¢ Consumption Goods ā Goods bought by households to use up, such as food and movies
12.
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Education, Inc. All rights reserved. 12-12 Some Simplifying Assumptions in a Keynesian Model (cont'd) ā¢ Accounting identity: Consumption + saving ā” disposable income Saving ā” disposable income ā consumption
13.
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Education, Inc. All rights reserved. 12-13 Some Simplifying Assumptions in a Keynesian Model (cont'd) ā¢ Investment ā Spending by businesses on things such as machines and buildings, which can be used to produce goods and services in the future ā The investment part of real GDP is the portion that will be used in the process of producing goods in the future
14.
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Education, Inc. All rights reserved. 12-14 Some Simplifying Assumptions in a Keynesian Model (cont'd) ā¢ Capital Goods ā Producer durables; nonconsumable goods that firms use to make other goods
15.
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Education, Inc. All rights reserved. 12-15 Determinants of Planned Consumption and Planned Saving ā¢ In the classical model, the supply of saving was determined by the rate of interest ā The higher the rate, the more people wanted to save, and the less they wanted to consume
16.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-16 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Keynes argued that: ā The interest rate is not the most important factor in saving and consumption decisions ā Rather, real saving and consumption decisions depend primarily on a householdās real disposable income. ā Furthermore, a personās anticipation about future flows of income influences how much of current income is allocated to consumption and how much is allocated to saving.
17.
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Education, Inc. All rights reserved. 12-17 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ The Life-Cycle Theory of Consumption ā The most realistic and detailed theory of consumption, often called the life-cycle theory of consumption, considers how a person varies saving and consumption as income ebbs and flows throughout an entire life span. ā¢ This theory predicts that when an individual anticipates a higher income in the future, he or she will tend to consume more and save less in the current period than would have been the case otherwise.
18.
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Education, Inc. All rights reserved. 12-18 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ The Permanent Income Hypothesis ā A related theory, called the permanent income hypothesis, suggests that the income level that matters for a personās decisions about current consumption and saving is permanent income, or expected average lifetime income. ā¢ Thus, if a personās flow of income temporarily rises without an increase in average lifetime income, the person responds by saving more and leaving consumption unchanged.
19.
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Education, Inc. All rights reserved. 12-19 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ The Keynesian Theory of Consumption and Saving ā Keynes argued that real consumption and saving decisions depend primarily on a householdās current real disposable income.
20.
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Education, Inc. All rights reserved. 12-20 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Consumption Function ā The relationship between amount consumed and disposable income ā A consumption function tells us how much people plan to consume at various levels of disposable income
21.
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Education, Inc. All rights reserved. 12-21 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Dissaving ā Negative saving; a situation in which spending exceeds income ā Dissaving can occur when a household is able to borrow or use up existing assets
22.
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Education, Inc. All rights reserved. 12-22 Table 12-1 Real Consumption and Saving Schedules: A Hypothetical Case
23.
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Education, Inc. All rights reserved. 12-23 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ 45-Degree Reference Line ā The line along which planned real expenditures equal real GDP per year
24.
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Education, Inc. All rights reserved. 12-24 Figure 12-1 The Consumption and Saving Functions
25.
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Education, Inc. All rights reserved. 12-25 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Autonomous Consumption ā The part of consumption that is independent of the level of disposable income ā Changes in autonomous consumption shift the consumption function
26.
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Education, Inc. All rights reserved. 12-26 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Average Propensity to Consume (APC) ā Real consumption divided by real disposable income ā The proportion of total disposable income that is consumed APC = Real consumption Real disposable income
27.
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Education, Inc. All rights reserved. 12-27 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Average Propensity to Save (APS) ā Real saving divided by real disposable income (DI) ā Saved proportion of real DI APS = Real saving Real disposable income
28.
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Education, Inc. All rights reserved. 12-28 MPC = Change in real consumption Change in real disposable income Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Marginal Propensity to Consume (MPC) ā The ratio of the change in real consumption to the change in real disposable income
29.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-29 MPS = Change in real saving Change in real disposable income Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Marginal Propensity to Save (MPS) ā The ratio of the change in saving to the change in disposable income
30.
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Education, Inc. All rights reserved. 12-30 APC = $49,200 $54,000 = .911 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Example ā Income = $54,000 ā C= $49,200 ā S = $4,800 ā¢ What is the APC?
31.
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Education, Inc. All rights reserved. 12-31 APC = $54,000 $60,000 = .90 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Example ā Income increases by $6,000 to $60,000 ā C = $54,000 ā S = $6,000 ā¢ What is the APC?
32.
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Education, Inc. All rights reserved. 12-32 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Some relationships APC + APS ā” 1 MPC + MPS ā” 1
33.
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Education, Inc. All rights reserved. 12-33 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Causes of shifts in the consumption function ā A change besides real disposable income will cause the consumption function to shift ā Non-income determinants of consumption ā¢ Population ā¢ Wealth
34.
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Education, Inc. All rights reserved. 12-34 Determinants of Planned Consumption and Planned Saving (cont'd) ā¢ Net wealth ā The stock of assets owned by a person, household, firm or nation (net of any debts owed) ā For a household, wealth can consist of a house, cars, personal belongings, stocks, bonds, bank accounts, and cash (minus any debts owed)
35.
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Education, Inc. All rights reserved. 12-35 Example: Lower Household Wealth and Subdued Growth in Consumption ā¢ Between 2007 and 2009, there was a substantial decline in two key components of real household wealth. ā Inflation-adjusted wealth in housing fell by 25 percent ā Inflation-adjusted wealth in corporate stocks fell by 50 percent ā¢ These wealth reductions shifted the U.S. consumption function downward. ā¢ Real disposable income also fell, causing a leftward movement along the consumption function and a further drop in consumption.
36.
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Education, Inc. All rights reserved. 12-36 Determinants of Investment ā¢ Investment, you will remember, consists of expenditures on new buildings and equipment ā Gross private domestic investment has been volatile ā Consider the planned investment function, and shifts in the function
37.
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Education, Inc. All rights reserved. 12-37 Figure 12-2 Planned Real Investment, Panel (a)
38.
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Education, Inc. All rights reserved. 12-38 Figure 12-2 Planned Real Investment, Panel (b)
39.
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Education, Inc. All rights reserved. 12-39 Example: Adding a Third Dimension Requires New Investment Spending ā¢ Of the approximately 40,000 movie screens in the United States, fewer than 8,000 are equipped with digital technology required for projection of three- dimensional (3D) movies. ā¢ Conversion to the 3D technology costs about $70,000. ā¢ Major movie-theater chains are currently undertaking this investment for more than 1,000 theaters. ā¢ This adds up to an aggregate investment expenditure of about $700 million.
40.
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Education, Inc. All rights reserved. 12-40 Determining Equilibrium Real GDP ā¢ We are interested in determining the equilibrium level of real GDP per year ā Consumption as a function of real GDP ā The 45-degree reference line
41.
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Education, Inc. All rights reserved. 12-41 Figure 12-3 Consumption as a Function of Real GDP
42.
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Education, Inc. All rights reserved. 12-42 Determining Equilibrium Real GDP (cont'd) ā¢ Adding the investment function AD = C + I + G + X
43.
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Education, Inc. All rights reserved. 12-43 Figure 12-4 Combining Consumption and Investment
44.
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Education, Inc. All rights reserved. 12-44 Determining Equilibrium Real GDP (cont'd) ā¢ Saving and investment: Planned versus Actual ā Only at equilibrium real GDP will planned saving equal actual saving ā Planned investment equals actual investment ā Hence planned saving is equal to planned investment
45.
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Education, Inc. All rights reserved. 12-45 Figure 12-5 Planned and Actual Rates of Saving and Investment
46.
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Education, Inc. All rights reserved. 12-46 Determining Equilibrium Real GDP (cont'd) ā¢ Unplanned increases in business inventories ā Consumers purchase fewer goods and services than anticipated ā This leaves firms with unsold products and inventories will rise ā Businesses respond by cutting back production and reducing employment
47.
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Education, Inc. All rights reserved. 12-47 Determining Equilibrium Real GDP (cont'd) ā¢ Unplanned decreases in business inventories ā Business will increase production of goods and services and increase employment ā Ultimately there will be an increase in real GDP
48.
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Education, Inc. All rights reserved. 12-48 Keynesian Equilibrium with Government and the Foreign Sector Added ā¢ To this point we have ignored the role of government in our model ā¢ We also left out the foreign sector of the economy in our model ā¢ Letās think about what happens when we add these elements
49.
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Education, Inc. All rights reserved. 12-49 Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd) ā¢ Government (G): C + I + G ā Federal, state, and local ā¢ Does not include transfer payments ā¢ Is autonomous ā¢ Lump-sum taxes = G ā¢ Lump-Sum Tax ā A tax that does not depend on income or the circumstances of the taxpayer
50.
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Education, Inc. All rights reserved. 12-50 Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd) ā¢ The Foreign Sector: C + I + G + X ā Net exports (X) equals exports minus imports ā Depends on international economic conditions ā Autonomousāindependent of real national income
51.
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Education, Inc. All rights reserved. 12-51 Table 12-2 The Determination of Equilibrium Real GDP with Government and Net Exports Added
52.
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Education, Inc. All rights reserved. 12-52 Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd) ā¢ Determining the equilibrium level of GDP per year ā We are now in a position to determine the equilibrium level of real GDP per year ā Remember that equilibrium always occurs when total planned real expenditures equal real GDP
53.
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Education, Inc. All rights reserved. 12-53 Figure 12-6 The Equilibrium Level of Real GDP
54.
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Education, Inc. All rights reserved. 12-54 Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd) The Equilibrium Level of Real GDP ā¢ Observations ā If C + I + G + X = Y ā¢ Equilibrium GDP ā If C + I + G + X > Y ā¢ Unplanned decrease in inventories ā¢ Businesses raise output ā¢ Y returns to equilibrium ā If C + I + G + X < Y ā¢ Unplanned increase in inventories ā¢ Businesses reduce output ā¢ Y returns to equilibrium
55.
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Education, Inc. All rights reserved. 12-55 The Multiplier ā¢ Multiplier ā The ratio of the change in the equilibrium level of real national income to the change in autonomous expenditures ā The number by which a change in autonomous real investment or autonomous real consumption is multiplied to get the change in equilibrium real GDP
56.
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Education, Inc. All rights reserved. 12-56 The Multiplier (cont'd) ā¢ Question ā How can a $100 billion increase in investment generate a $500 billion increase in equilibrium real GDP? ā¢ Answer ā The multiplier process
57.
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Education, Inc. All rights reserved. 12-57 Table 12-3 The Multiplier Process
58.
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Education, Inc. All rights reserved. 12-58 The Multiplier (cont'd) ā¢ The multiplier formula Multiplier = 1 1 - MPC = 1 MPS
59.
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Education, Inc. All rights reserved. 12-59 The Multiplier (cont'd) ā¢ By taking a few numerical examples, you can demonstrate to yourself an important property of the multiplier ā The smaller the MPS, the larger the multiplier ā The larger the MPC, the larger the multiplier
60.
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Education, Inc. All rights reserved. 12-60 The Multiplier (cont'd) ā¢ Examples MPC = 4 5 MPS = 1 5 Multiplier = 1 1/5 = 5 MPC = 3 5 MPS = 2 5 Multiplier = 1 2/5 = 2.5
61.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-61 Change in equilibrium real GDP = Multiplier x Change in autonomous spending The Multiplier (cont'd) ā¢ Measuring the change in equilibrium income from a change in autonomous spending
62.
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Education, Inc. All rights reserved. 12-62 The Multiplier (cont'd) ā¢ Significance of the multiplier ā It is possible that a relatively small change in consumption or investment can trigger a much larger change in real GDP
63.
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Education, Inc. All rights reserved. 12-63 What If . . . The government seeks a larger multiplier effect by funding private spending on certain items rather than buying them directly? ā¢ Whether the government gives funds to households and firms for purchasing goods or whether the government makes the purchases directly, the resulting increase in total autonomous expenditure is the same. ā Thus, the overall multiplier effect on equilibrium real GDP would also be the same. ā So, providing grants of public funds to be spent by households and firms rather than having government purchase the same items will not enlarge the overall theoretical multiplier effect.
64.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-64 How a Change in Real Autonomous Spending Affects Real GDP When the Price Level Can Change ā¢ So far our examination of how changes in real autonomous spending affects equilibrium real GDP has considered a situation in which the price level remains unchanged ā¢ Our equilibrium analysis has only considered how AD shifts in response to investment, government spending, net exports
65.
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Education, Inc. All rights reserved. 12-65 How a Change in Real Autonomous Spending Affects Real GDP When the Price Level Can Change (cont'd) ā¢ When we take into account the aggregate supply curve, we must also consider responses of the equilibrium price level to a multiplier-induced change in AD
66.
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Education, Inc. All rights reserved. 12-66 Figure 12-7 Effect of a Rise in Autonomous Spending on Equilibrium Real GDP
67.
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Education, Inc. All rights reserved. 12-67 International Example: The Effect of Higher Autonomous Spending on Chinaās Real GDP ā¢ Most estimates indicate that the marginal propensity to consume in China is about 0.50. ā¢ So, assuming no change in the price level, the multiplier would be about 2. ā¢ However, economists have estimated that the short-run effect of an initial increase in real autonomous spending on Chinaās real GDP is only about 1.1. ā¢ Therefore, once the higher price level is taken into account, an additional one-unit increase in real autonomous expenditure causes a 1.1 unit increase in Chinaās annual real GDP.
68.
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Education, Inc. All rights reserved. 12-68 The Relationship Between Aggregate Demand and the C + I + G + X Curve ā¢ Aggregate demand consists of: ā Consumption ā Investment ā Government ā Foreign sector
69.
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Education, Inc. All rights reserved. 12-69 The Relationship Between Aggregate Demand and the C + I + G + X Curve (cont'd) ā¢ There is a major difference between the two: ā C + I + G + X curve drawn with price level constant ā AD curve drawn with the price level changing ā¢ To derive the aggregate demand curve from the C + I + G + X curve, we must now allow the price level to change
70.
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Education, Inc. All rights reserved. 12-70 The Relationship Between Aggregate Demand and the C + I + G + X Curve (cont'd) ā¢ What are some of the effects of a price level increase? ā Real balance effect ā Interest rate effect ā The open economy effect
71.
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Education, Inc. All rights reserved. 12-71 Figure 12-8 The Relationship Between AD and the C + I + G + X Curve
72.
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Education, Inc. All rights reserved. 12-72 You Are There: Evaluating the Effects of Declining Real Disposable Income ā¢ Mark Vitner, an economist with Wells Fargo bank, examines the latest monthly economic data. ā¢ Real disposable income fell by 0.3 percent during the month. ā¢ Real consumption spending and real saving dipped as well, consistent with the theory. ā¢ Vitner summarizes the situation by saying that household budgets are getting tighter and consumers are having difficulty maintaining their standard of living.
73.
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Education, Inc. All rights reserved. 12-73 Issues & Applications: A Global Reversal in Planned Investment Spending ā¢ In the past, developed countries have displayed the largest upward shifts in their planned investment functions. ā¢ Recently, however, larger upward shifts have occurred among the emerging-economy nations, such as China, India, South Korea, and Singapore. ā¢ Figure 12-9 on the next slide displays real investment spending as a percentage of global real GDP for developed and emerging nations.
74.
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Education, Inc. All rights reserved. 12-74 Figure 12-9 Real Investment Spending as a Percentage of Global Real GDP in Two Groups of Nations since 1995 Sources: International Monetary Fund; authorās estimates.
75.
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Education, Inc. All rights reserved. 12-75 Issues & Applications: A Global Reversal in Planned Investment Spending (contād) ā¢ Variations in planned real investment spending operate through the multiplier to bring about changes in equilibrium real GDP. ā¢ Therefore, a country that experiences a larger upward shift in its planned investment function will observe a greater increase in its equilibrium real GDP. ā¢ This explains why countries such as China, India, South Korea, and Singapore are emerging to take a place alongside developed nations.
76.
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Education, Inc. All rights reserved. 12-76 Summary Discussion of Learning Objectives ā¢ The difference between saving and savings and the relationship between saving and consumption ā Saving is a flow over time while savings is a stock ā Consumption plus saving equals disposable income
77.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-77 Summary Discussion of Learning Objectives (cont'd) ā¢ Key determinants of consumption and saving in the Keynesian model ā In the classical model, the interest rate is the fundamental determinant of saving ā In the Keynesian model, the primary determinant is disposable income ā DI increases, so does C
78.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-78 Summary Discussion of Learning Objectives (cont'd) ā¢ The key determinants of planned investment ā The interest rate, business expectations, productive technology, and business taxes
79.
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Education, Inc. All rights reserved. 12-79 Summary Discussion of Learning Objectives (cont'd) ā¢ How equilibrium real GDP is established in the Keynesian model ā Equilibrium national income occurs where the C + I + G + X schedule crosses the 45-degree line
80.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-80 Summary Discussion of Learning Objectives (cont'd) ā¢ Why autonomous changes in total planned expenditures have a multiplier effect on equilibrium real GDP ā As consumption increases, so does real GDP, which induces further consumption spending ā The ultimate expansion of real GDP is equal to the multiplier times the increase in autonomous expenditures
81.
Copyright Ā©2014 Pearson
Education, Inc. All rights reserved. 12-81 Summary Discussion of Learning Objectives (cont'd) ā¢ The relationship between total planned expenditures and the aggregate demand curve ā AD consists of consumption, investment, and government purchases, plus the foreign sector ā Difference ā¢ C + I + G + X curve drawn with price level constant ā¢ AD with the price level changing
82.
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Education, Inc. All rights reserved. 12-82 Figure C-1 Graphing the Multiplier
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