Embed Size (px)
Citation preview
©The McGraw-Hill Companies, 2008
Chapter 20Output and aggregate demand
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9th Edition, McGraw-Hill, 2008
PowerPoint presentation by Alex Tackie and Damian Ward
©The McGraw-Hill Companies, 2008
Aggregate output in the short run
• Potential output– the output the economy would produce
if all factors of production were fully employed
• Actual output– what is actually produced in a period– which may diverge from the potential
level
©The McGraw-Hill Companies, 2008
Some simplifying assumptions
• Prices and wages are fixed• Actual output is less than potential output• Excess capacity so the actual quantity of
total output is demand-determined– this will be a Keynesian model– An increase in demand will increase the
production.• For now, also assume:
– no government– no foreign trade
• Later chapters relax these assumptions
©The McGraw-Hill Companies, 2008
Aggregate demand
• Given no government and no international trade, aggregate demand has two components:– Investment
• firms’ desired or planned additions to physical capital & inventories
• for now, assume this is autonomous
– Consumption• households’ demand for goods and services
• so, AD = C + I
©The McGraw-Hill Companies, 2008
Consumption demand
• Households allocate their income between CONSUMPTION and SAVING
• Personal Disposable Income– income that households have for
spending or saving
– income from their supply of factor services (plus transfers less taxes)
©The McGraw-Hill Companies, 2008
Consumption and income in the UKat constant 1995 prices, 1989-2004
350
450
550
650
750
400 500 600 700Real disposable income (£bn.)
Ho
us
eh
old
co
ns
um
tpio
n
ex
pe
nd
itu
re (
£b
n.)
Income is a strong influence on consumptionIncome is a strong influence on consumptionexpenditure – but not the only one.expenditure – but not the only one.
©The McGraw-Hill Companies, 2008
Consumption and income in Turkey, 1996-2005
5
55
105
155
205
255
305
355
5 55 105 155 205 255 305 355 Reel Harcanabilir Gelir (milyar YTL)
Source: TCMB, DPT, TU?K
Han
ehal
k? T
üke
tim
Har
cam
alar
?
(mil
yar
YT
L)
7
©The McGraw-Hill Companies, 2008
The consumption function
IncomeIncome
Co
nsu
mp
tion
Co
nsu
mp
tion
C = 8 + 0.7 YC = 8 + 0.7 Y
The consumption function shows desired aggregateThe consumption function shows desired aggregateconsumption at each level of aggregate incomeconsumption at each level of aggregate income
00
The The marginal propensitymarginal propensityto consumeto consume (the slope of (the slope ofthe function) is 0.7 – i.e.the function) is 0.7 – i.e.for each additional £1 of for each additional £1 of income, 70p is consumed.income, 70p is consumed.
With zero income,With zero income,desired consumptiondesired consumptionis 8 (“autonomousis 8 (“autonomousconsumption”).consumption”).
88
©The McGraw-Hill Companies, 2008
The saving function
S = -8 + 0.3 YS = -8 + 0.3 Y
IncomeIncome
Sa
vin
gS
avi
ng
00
The saving function showsThe saving function showsdesired saving at eachdesired saving at eachincome level.income level.
Since all income is either Since all income is either saved or spent on saved or spent on consumption, the savingconsumption, the savingfunction can be derivedfunction can be derivedfrom the consumption from the consumption function or function or vice versa.vice versa.
©The McGraw-Hill Companies, 2008
The aggregate demand schedule
IncomeIncome
Ag
gre
gat
e d
em
an
dA
ggr
eg
ate
de
ma
nd
CC
Aggregate demand isAggregate demand iswhat households planwhat households planto spend on consumptionto spend on consumptionand what firms plan toand what firms plan tospend on investment.spend on investment.
AD = C + IAD = C + I
IIThe AD function is The AD function is the vertical additionthe vertical additionof C and I.of C and I.(For now I is assumed (For now I is assumed autonomous.)autonomous.)
©The McGraw-Hill Companies, 2008
Equilibrium output
Output, IncomeOutput, Income
Des
ired
spen
d ing
Des
ired
s pen
ding 4545oo line line The 45The 45o o line shows the line shows the
points at which desiredpoints at which desiredspending equals output spending equals output or income.or income.
ADAD
Given the AD schedule,Given the AD schedule,
This the point at whichThis the point at whichplanned spending equalsplanned spending equalsactual output and income.actual output and income.
equilibriumequilibrium is thus at E.is thus at E.
EE
©The McGraw-Hill Companies, 2008
II
planned investment (planned investment (II))
An alternative approachS
, IS
, I
Output, IncomeOutput, Income
An equivalent view ofAn equivalent view ofequilibrium is seen byequilibrium is seen byequatingequating
SS
to planned saving (to planned saving (SS))
The two approaches are equivalent.The two approaches are equivalent.
EEagain giving usagain giving usequilibrium at Eequilibrium at E
©The McGraw-Hill Companies, 2008
Effects of a fall in aggregate demand
Output, IncomeOutput, Income
Des
ired
sp
end
ing
Des
ired
sp
end
ing 4545oo line line
ADAD00
YY00
Suppose the economySuppose the economystarts in equilibrium starts in equilibrium at Yat Y0.0.
a fall in aggregate a fall in aggregate demand to ADdemand to AD11
ADAD11
leads the economyleads the economyto a new equilibrium to a new equilibrium at Yat Y11..
YY11
Notice that the change in equilibrium output isNotice that the change in equilibrium output islarger than the original change in AD.larger than the original change in AD.
©The McGraw-Hill Companies, 2008
The multiplier
• The multiplier is the ratio of the change in equilibrium output to the change in autonomous spending that causes the change in output.
• The larger the marginal propensity to consume, the larger is the multiplier.– The higher is the marginal propensity to save,
the more of each extra unit of income ‘leaks’ out of the circular flow.
– Multiplier= 1/1-mpc
©The McGraw-Hill Companies, 2008
The multiplier
– Suppose that the mpc=0.9. – The change in investment by one unit
increases the national output by one unit, so the income will increase by one unit. The consumption will increase by 0.9. That would increase the output and income by 0.9, so additionally the consumption will increase by 0.81, etc.
– At the end the total effect is 1/1-0.9=10
