Basic Macroeconomic Relationships

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Basic Macroeconomic Relationships

• Chapter 9

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Chapter 9 Figure 9.1
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Average and Marginal Propensities to Consume and
Save

• Average Propensities
• APC C/DI
• APS S/DI
• since DI S C
• APC APS 1

• Marginal Propensities
• MPC ?C/?DI
• MPS ?S/?DI
• Since DI S C
• ?DI ?S ?C
• MPC MPS 1

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Chapter 9 Table 9.1
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The Consumption and Saving Functions
Chapter 9 Figure 9.2
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Consumption and Saving Functions I

• Consumption function
• C CA MPC(Y)
• Where
• CA (intercept) Autonomous Consumption
• MPC (slope) Marginal Propensity to Consume
  (also 1 MPS)
• Y GDP or Disposable Income

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Consumption and Saving Functions II

• Saving function
• S S0 MPS(Y)
• Where
• S0 (intercept) Maximum Dissaving - CA
• MPS (slope) Marginal Propensity to Save (also
  1 MPC)
• Y GDP or Disposable Income

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Consumption and Saving Functions III

• Since CA - S0 and MPS MPC 1
• If the consumption function is
• C 100 .85Y
• The saving function must be
• S -100 .15Y
• If the saving function is
• S -125 .3Y
• The consumption function must be
• C 125 .7Y

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Chapter 9 Figure 9.3
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Shifting the Consumption Schedule
Chapter 9 Figure 9.4(a)
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Shifting the Saving Schedule
Chapter 9 Figure 9.4(b)
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The Investment Demand Schedule
Chapter 9 Table 9.2
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The Investment Demand Function
Chapter 9 Figure 9.5
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Chapter 9 Figure 9.6
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What Shifts the Investment Demand Function?

• Changes in the cost of acquiring capital
  equipment, maintaining capital equipment, or
  operating capital equipment
• e.g., changes in the price of gasoline
• Changes in taxes on business
• e.g., accelerated depreciation
• Technological Improvements
• How much capital equipment is already installed
• Producer Expectations
• Overoptimistic during the expansionary phase of
  the business cycle
• Frustrating efforts to slow down the economy
• Overpessimistic during the contractionary phase
  of the business cycle
• Delaying recovery

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Investment is highly volatile!
Chapter 9 Figure 9.7
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The AE multiplier M 1/(1- MPC) 1/MPS
Chapter 9 Table 9.3
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The Multiplier Formula

• First round, increase in Aggregate Expenditure
  ?AE0
• This induces an increase in C, ?C1 (MPC)?AE0
• Which becomes the second round increase in income
• Inducing a further increase in C, ?C2 (MPC)?C1
  (MPC)2?AE0
• ?C3 (MPC)?C2 (MPC)3?AE0, etc.

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Derivation of the Multiplier

• ?Y ?AE0 ?AE1 ?AE2 ?AE3 ?AEn
• ?Y ?AE0 (MPC)?AE0 (MPC)?AE1 (MPC)?AE2
  ?AEn
• ?Y ?AE0 (MPC)?AE0 (MPC)2?AE0 (MPC)3?AE0
  (MPC)n?AE0
• ?Y (MPC)0?AE0 (MPC)1?AE0 (MPC)2?AE0
  (MPC)3?AE0 (MPC)n?AE0

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Derivation of the Multiplier

• ?Y (MPC)0?AE0 (MPC)1?AE0 (MPC)2?AE0
  (MPC)3?AE0 (MPC)n?AE0
• ?Y ?i0,8(MPC)n?AE0 ?AE0?i0,8(MPC)n
• for infinite convergent sums,
• m ?Y/?AE 1/(1 MPC) 1/MPS
• MPC lt 1 necessary for infinite sum to converge

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Chapter 9 Figure 9.8
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How M varies with the MPC
Chapter 9 Figure 9.9
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The AE multiplier

• M 1/(1- MPC) 1/MPS
• M change in real GDP/change in spending
• M ?GDP/?AE ?Y/?AE
• Change in AE can come from any component of
  aggregate expenditure
• AE C Ig G Xn