Spending and

Output in the
Short Run: Part 1

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Lecture 4
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Contents

 1. Planned Aggregate Expenditure

 2. The Components of Planned Aggregate Expenditure
 3. Planned Spending Versus Actual Spending
 4. Consumption Function
 5. Planned Aggregate Expenditure and Output

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Planned Aggregate Expenditure

 Planned Aggregate Expenditure

 Total planned spending on final goods and
services
 Output at each point in time is determined
by the amount that the people throughout
the economy want (plan) to spend.

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Planned Aggregate Expenditure

 The Components of Planned Aggregate

Expenditure
1. Consumer expenditure or
Consumption (C)
Household spending on durables,
nondurables, and services

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Planned Aggregate Expenditure

 The Components of Planned Aggregate

Expenditure
2. Investment expenditure (I),
 New capital goods spending
New residential spending

Increases in inventories

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Planned Aggregate Expenditure

 The Components of Planned Aggregate

Expenditure
3. Government purchases (G)
Federal,state, and local governments’
spending on goods and services

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Planned Aggregate Expenditure

 The Components of Planned Aggregate

Expenditure
4. Net exports (NX)
Exports - imports
Therefore,

PAE = C + I + G + NX

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Planned Aggregate Expenditure

 Planned Spending Versus Actual

Spending
 Inthe Keynesian model, output is
determined by PAE.
 Actual expenditures may not equal PAE.
If inventories are larger than expected:

o I > planned Investment (IP)

If inventories are smaller than expected:

o I < IP

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Planned Aggregate Expenditure

 Planned Aggregate Expenditure
 PAE = C + Ip + G + NX
 Because firms meet demand at preset prices
and cannot control how much they sell, their
actual investment (including inventory) may differ
form planned investment. That’s why we write Ip
for planned investment to distinguish from I
(actual investment).

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Planned Aggregate Expenditure

 Planned Aggregate Expenditure

 PAE = C + Ip + G + NX
 For consumption, govt. spending and
net export we assume planned and
actual spending are the same. So we
need not write Cp Gp, etc.

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Planned Aggregate Expenditure

 Consumer Spending and the Economy

 Consumption (C) accounts for two thirds of

total spending
 The primary determinant of C is
disposable income or Y - T ( or Yd)

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Planned Aggregate Expenditure

 Consumption Function

It shows the relationship between

consumption spending and its
determinants, in particular,
disposable (after-tax) income

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Planned Aggregate Expenditure

 Relating Consumption to Income and Other

Determinants
 The consumption function:
 C = č + c(Y - T)
 č = a constant; represents the non income determinant
of C (also called autonomous consumption).
Consumer optimism

Wealth

Real interest rates

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Planned Aggregate Expenditure

 Consumption Function
C = č + c(Y - T)
 C = č + cYd

 c = marginal propensity to consume

 c = the amount by which consumption
rises when disposable income rises by
$1; 0 < c < 1

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A Consumption Function

Consumption
function
Consumption spending C

C =C + c(Y - T)

Slope = c = MPC
C

Disposable income Y-T

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The U.S. Consumption Function,
1960-2001

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Planned Aggregate Expenditure

 Planned Aggregate Expenditure and

Output
 The relationship between changes in
production and income and PAE
C is a large part of PAE

C depends on Y

PAE depends on Y

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Planned Aggregate Expenditure

 Example
 PAE = C + IP + G + NX
 C = č + c(Y – T)
 PAE = č + c(Y – T) + IP + G + NX
 Suppose

č = 620; c = 0.8; T = 250; IP = 220; G =

300; NX = 20

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Planned Aggregate Expenditure

 Example:
Then: Substituting
PAE = 620 + 0.8(Y - 250) + 220 + 300 + 20
PAE = 620 + 0.8Y - 0.8(250) + 220 + 330 +
20
 PAE = 620 + 0.8Y - 200 + 220 + 300 + 20
 PAE = (620 - 200 + 220 + 300 + 20) + 0.8Y
 PAE = 960 + 0.8Y

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Planned Aggregate Expenditure

 Example
 PAE = 960 + 0.8Y
 0.8 = Marginal propensity to consume
(MPC)
 If Y increases by $1, C will increase by 80
cents (c = 0.80)
 C is part of PAE
 PAE increases by 80 cents ($1 X 0.80)

Macro Lecture 4 Slide 20