# Aggregate Supply and Demand

Pages: 9 (1717 words) Published: October 26, 2014
Chapter 27
Expenditure Multipliers
Fixed Prices and Expenditure Plans

Several factors influence consumption expenditure and saving. The most direct influence is disposable income, which is real GDP or aggregate income minus net taxes (taxes minus transfer payments).

Planned consumption expenditure plus planned saving equals disposable income. The greater the disposable income, the greater is consumption expenditure and the greater is saving.
The relationship between consumption expenditure and disposable income, other things remaining the same, is called the consumption function.
The relationship between saving and disposable income, other things remaining the same, is called the saving function.
The extent to which a change in disposable income changes consumption expenditure depends on the marginal propensity to consume.
The marginal propensity to consume (MPC) is the fraction of a change in disposable income that is consumed.
The marginal propensity to consume is calculated as the change in consumption expenditure ΔC, divided by the change in disposable income, ΔYD.
That is:
MPC = ΔC ÷ ΔYD
The extent to which a change in disposable income changes saving depends on the marginal propensity to save.
The marginal propensity to save (MPS) is the fraction of a change in disposable income that is saved.
The marginal propensity to save is calculated as the change in saving ΔS, divided by the change in disposable income, ΔYD.
That is:
MPS = ΔS ÷ ΔYD
The marginal propensity to consume plus the marginal propensity to save sum to 1. You can see this from the following:
C + S = YD
ΔC + ΔS = ΔYD
(ΔC ÷ ΔYD) + (ΔS ÷ ΔYD) = (ΔYD ÷ ΔYD)
MPC + MPS = 1

The figure below shows the MPC as the slope of the consumption function. MPC is \$150 billion ÷ \$200 billion = 0.75.

The figure below shows the MPS as the slope of the saving function. MPS is \$50 billion ÷ \$200 billion = 0.25.

The relationship between imports and real GDP is determined by the marginal propensity to import. • The marginal propensity to import is the fraction of an increase in real GDP that is spent on imports.

• It is calculated as the change in imports divided by the change in real GDP that brought it about, other things remaining the same.

Real GDP with a Fixed Price Level

Aggregate planned expenditure equals planned consumption expenditure plus planned investment plus planned government expenditures plus planned exports minus planned imports. The table sets out an aggregate expenditure schedule, together with the components of aggregate planned expenditure.

The figure shows the AE curve.
It is made up from the consumption function minus the import function plus I, G, and X. •

The AE curve can be thought of as
two parts:
o Autonomous expenditure
o Induced expenditure
Autonomous expenditure is the
sum of investment, government
expenditures, and exports, which
does not vary with real GDP.
Induced expenditure is
consumption expenditure minus
imports, which varies with real GDP.

Actual aggregate expenditure is always equal to real GDP.
Aggregate planned expenditure is not necessarily equal to real GDP. Planned expenditure can depart from real GDP because of unplanned changes in inventories. Equilibrium expenditure is in the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP.

The figure shows equilibrium expenditure.
The AE curve shows aggregate planned
expenditure at each level of real GDP.
The 45-degree line shows actual aggregate
expenditure at each level of real GDP.
Only at point D is actual aggregate expenditure
equal to aggregate planned expenditure.
So, \$1,200 billion is equilibrium real GDP.
Below \$1,200 billion, aggregate planned
expenditure exceeds real GDP.
Above \$1,200 billion, aggregate planned...