Fluent Essays

Instructions: Post one significant sentence from any chapter 10-12 and one from any chapter 13-14. And please explain why it is a powerful sentence. Both paragraphs should have a total of 5-7 sentences for each significant sentence.Please find the chapters 10-14 attached as a pdf. ch_10_14.pdf Unformatted Attachment Preview CHA PT E R 1 0 Income and Expenditures Equilibrium FUNDAMENTAL QUESTIONS 1. What does equilibrium mean in macroeconomics? 2. How do aggregate expenditures affect income, or real GDP? ª Antb/Shutterstock.com 3. What are the leakages from and injections into spending? 4. Why does equilibrium real GDP change by a multiple of a change in autonomous expenditures? Preview top: ª Carsten Reisinger/Shutterstock What determines the level of income and expenditures, or real GDP? In the chapter titled “Macroeconomic Equilibrium: Aggregate Demand and Supply,” we used aggregate demand and aggregate supply to answer this question. Then, in the chapter titled “Aggregate Expenditures,” we developed the components of aggregate expenditures in more detail to provide the foundation for an additional approach to answering the question, “What determines the level of real GDP?” If you know the answer to this question, you are well on your way to understanding business cycles. Sometimes real GDP is growing and jobs are relatively easy to find; at other times real GDP is falling and large numbers of people are out of work. Macroeconomists use several models to analyze the causes of busi- 5. What is the spending multiplier? 6. What is the relationship between the GDP gap and the recessionary gap? 7. How does international trade affect the size of the spending multiplier? 8. Why does the aggregate expenditures curve shift with changes in the price level? ness cycles. Underlying all of these models is the concept of macroeconomic equilibrium. 203 Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 204 Chapter 10 Income and Expenditures Equilibrium Equilibrium here means what it did when we talked about supply and demand: a point of balance, a point from which there is no tendency to move. In macroeconomics, equilibrium is the level of income and expenditures that the economy tends to move toward and remain at until autonomous spending changes. Economists have not always agreed on how an economy reaches equilibrium or on the forces that move an economy from one equilibrium to another. This last issue formed the basis of economic debate during the Great Depression of the 1930s. Before the 1930s, economists generally believed that the economy was always at or moving toward an equilibrium consistent with a high level of employed resources. The British economist John Maynard Keynes did not agree. He believed that an economy can come to rest at a level of real GDP that is too low to provide employment for all those who desire it. He also believed that certain actions are necessary to ensure that the economy rises to a level of real GDP consistent with a high level of employment. In particular, Keynes argued that government must intervene in the economy in a big way (see the Economic Insight “John Maynard Keynes”). To understand the debate that began during the 1930s and continues on various fronts today, it is necessary to understand the Keynesian view of how equilibrium real GDP is determined. This is our focus here. We have seen in the chapter titled “Macroeconomic Equilibrium: Aggregate Demand and Supply” that the aggregate demand and supply model of macroeconomic equilibrium allows the price level to fluctuate as the equilibrium level of real GDP changes. The Keynesian income-expenditures model assumes that the price level is fixed. It emphasizes aggregate expenditures without explicitly considering the supply side of the economy. This is why we considered the components of spending in detail in the chapter titled “Aggregate Expenditures”—to provide a foundation for the analysis in this chapter. The Keynesian model may be viewed as a special fixed-price case of the aggregate demand and aggregate supply model. In later chapters, we examine the relationship between equilibrium and the level of employed resources and the effect of government policy on both of these elements. 10-1 Equilibrium Income and Expenditures 1. What does equilibrium mean in macroeconomics? Equilibrium is a point from which there is no tendency to move. People do not change their behavior when everything is consistent with what they expect. However, when plans and reality do not match, people adjust their behavior to make them match. Determining a nation’s equilibrium level of income and expenditures is the process of defining the level of income and expenditures at which plans and reality are the same. 10-1a Expenditures and Income 2. How do aggregate expenditures affect income, or real GDP? We use the aggregate expenditures function described at the end of the chapter titled “Aggregate Expenditures” to demonstrate how equilibrium is determined. Keep in mind that the aggregate expenditures function represents planned expenditures at different levels of income, or real GDP. We focus on planned expenditures because they represent the amount that households, firms, government, and the foreign sector expect to spend. Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 10 Income and Expenditures Equilibrium 205 ECONOMIC INSIGHT John Maynard Keynes John Maynard Keynes (pronounced “canes”) is considered by many to be the greatest economist of the twentieth century. His major work, The General Theory of Employment, Interest, and Money, had a profound impact on macroeconomics, both in thought and policy. Keynes was born in Cambridge, England, on June 5, 1883. He studied economics at Cambridge University, where he became a lecturer in economics in 1908. During World War I, Keynes worked for the British treasury. At the end of the war, he was the treasury’s representative at the Versailles Peace Conference. He resigned from the British delegation at the conference to protest the harsh terms being imposed on the defeated countries. His resignation and the publication of Economic Consequences of the Peace (1919) made him an international celebrity. In 1936, Keynes published The General Theory. It was a time of world recession (it has been estimated that around one-quarter of the U.S. labor force was unemployed at the height of the Depression), and policymakers were searching for ways to explain the persistent unemployment. In the book, Keynes suggested that an economy could be at equilibrium at less than potential GDP. More important, he argued that government policy could be altered to end recession. His analysis emphasized aggregate expenditures. If private expenditures were not sufficient to create equilibrium at potential GDP, government expenditures could be increased to stimulate income and output. This was a startling concept. Most economists of the time believed that government should not take an active role in the economy. With his General Theory, Keynes started a “revolution” in macroeconomics. Andre Seale/Alamy Actual expenditures always equal income and output because they reflect changes in inventories. That is, inventories automatically raise or lower investment expenditures so that actual spending equals income, which equals output, which equals real GDP. However, aggregate expenditures (which are planned spending) may not equal real GDP. What happens when planned spending and real GDP are not equal? When planned spending on goods and services exceeds the current value of output, the production of goods and services increases. Because output equals income, the level of real GDP also increases. This is the situation for all income levels below $500 in Figure 1. At Net exports equal exports minus imports. Agricultural products are important exports for many these levels, total spending is greater countries, like these papayas being shipped from the port of Manaus Amazonas Brazil. If sold to than real GDP, which means that a U.S. importer, the papayas will represent Brazilian exports and contribute to increased GDP in Brazil by means of higher net exports. more goods and services are being purchased than are being produced. The only way this can happen is for goods produced in the past to be sold. When planned spending is greater than real GDP, business inventories fall. Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 206 Chapter 10 Income and Expenditures Equilibrium FIGURE 1 The Equilibrium Level of Real GDP (1) Real GDP (Y ) $0 (2) Consumption (C ) (3) Investment (I ) (4) Government Spending (G) $30 $50 $70 (5) Net Exports (X ) (6) Aggregate Expenditures (AE ) (7) Unplanned Change in Inventories $200 $200 $50 (8) Change in Real GDP Increase $100 $100 $50 $70 $40 $260 $160 Increase $200 $170 $50 $70 $30 $320 $120 Increase $300 $240 $50 $70 $20 $380 $80 Increase $400 $310 $50 $70 $10 $440 $40 $500 $380 $50 $70 $0 $500 $0 $600 $450 $50 $70 $10 $560 $40 Decrease $700 $520 $50 $70 $20 $620 $80 Decrease Increase No change AE < Y Income Falls 700 Expenditures (AE ) (dollars) 600 Equilibrium 500 AE > Y Income Rises 400 AE 300 200 100 45 0 100 200 300 400 500 600 700 Real GDP (Y ) (dollars) Macroeconomic equilibrium occurs where aggregate expenditures (AE) equal real GDP (Y). In the graph it is the point where the AE line crosses the 45-degree line, where expenditures and real GDP both equal $500. When aggregate expenditures exceed real GDP (as they do at a real GDP level of $400, for example), real GDP rises to the equilibrium level. When aggregate expenditures are less than real GDP (as they are at a real GDP level of $600, for example), real GDP falls back to the equilibrium level. When aggregate expenditures exceed real GDP, real GDP rises. This change in inventories offsets the excess of planned expenditures over real GDP, so actual expenditures (including the unplanned change in inventories) equal real GDP. You can see this in column 7 of the table in Figure 1, where the change in inventories offsets the excess of aggregate expenditures over real GDP (the difference between columns 6 and 1). What happens when inventories fall? As inventories fall, manufacturers increase production to meet the demand for products. The increased production raises the level of real GDP. When aggregate expenditures exceed real GDP, real GDP rises. At real GDP levels above $500 in the table, aggregate expenditures are less than income. As a result, inventories are accumulating above planned levels—more goods and services are being produced than are being purchased. As inventories rise, businesses begin to reduce the quantity of output they produce. The unplanned increase in inventories is counted as a form Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 207 Chapter 10 Income and Expenditures Equilibrium of investment spending so that actual expenditures equal real GDP. For example, when real GDP is $600, aggregate expenditures are only $560. The $40 of goods that are produced but not sold are measured as inventory investment. The $560 of aggregate expenditures plus the $40 of unplanned inventories equal $600, the level of real GDP. As inventories increase, firms cut production; this causes real GDP to fall. When aggregate expenditures are less than real GDP, real GDP falls. There is only one level of real GDP in the table in Figure 1 at which real GDP does not change. When real GDP is $500, aggregate expenditures equal $500. The equilibrium level of real GDP (or output) is that point at which aggregate expenditures equal real GDP (or output). When aggregate expenditures equal real GDP, planned spending equals the output produced and the income generated from producing that output. As long as planned spending is consistent with real GDP, real GDP does not change. But if planned spending is higher or lower than real GDP, real GDP does change. Equilibrium is that point at which planned spending and real GDP are equal. The graph in Figure 1 illustrates equilibrium. The 45-degree line shows all possible points where aggregate expenditures (measured on the vertical axis) equal real GDP (measured on the horizontal axis). The equilibrium level of real GDP, then, is simply the point where the aggregate expenditures line (AE) crosses the 45-degree line. In the figure, equilibrium occurs where real GDP and expenditures are $500. When the AE curve lies above the 45-degree line—for example, at a real GDP level of $400—aggregate expenditures are greater than real GDP. What happens? Real GDP rises to the equilibrium level, where it tends to stay. When the AE curve lies below the 45-degree line—at a real GDP level of $600, for example—aggregate expenditures are less than real GDP; this pushes real GDP down. Once real GDP falls to the equilibrium level ($500 in our example), it tends to stay there. When aggregate expenditures are less than real GDP, real GDP falls. The equilibrium level of real GDP is where aggregate expenditures equal real GDP. 10-1b Leakages and Injections Equilibrium can be determined by using aggregate expenditures and real GDP, which represents income. Another way to determine equilibrium involves leakages from and injections into the income stream, the circular flow of income and expenditures. Leakages reduce autonomous aggregate expenditures. There are three leakages in j the stream from domestic income to spending: saving, taxes, and imports. • • • The more households save, the less they spend. An increase in autonomous saving means a decrease in autonomous consumption, which could cause the equilibrium level of real GDP to fall (see the Economic Insight “The Paradox of Thrift”). Taxes are an involuntary reduction in consumption. The government transfers income away from households. Higher taxes lower autonomous consumption, in the process lowering autonomous aggregate expenditures and the equilibrium level of real GDP. Imports are expenditures for foreign goods and services. They reduce expenditures on domestic goods and services. An autonomous increase in imports reduces net exports, causing autonomous aggregate expenditures and the equilibrium level of real GDP to fall. For equilibrium to occur, these leakages must be offset by corresponding injections of spending into the domestic economy through investment, government spending, and exports. • • • 3. What are the leakages from and injections into spending? Saving, taxes, and imports are leakages that reduce autonomous aggregate expenditures. Investment, government spending, and exports are injections that increase autonomous aggregate expenditures. Household saving generates funds that businesses can borrow and spend for investment purposes. The taxes collected by government are used to finance government purchases of goods and services. Exports bring foreign expenditures into the domestic economy. Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 208 Chapter 10 Income and Expenditures Equilibrium ECONOMIC INSIGHT The Paradox of Thrift People generally believe that saving is good and more saving is better. However, if every family increased its saving, the result could be less income for the economy as a whole. In fact, increased saving could actually lower savings for all households. An increase in saving may provide an example of the paradox of thrift. A paradox is a true proposition that seems to contradict common beliefs. We believe that we will be better off if we increase our saving, but in the aggregate, increased saving could cause the economy to be worse off. The paradox of thrift is a fallacy of composition: the assumption that what is true of a part is true of the whole. It often is unsafe to generalize from what is true at the micro level to what is true at the macro level. The graph illustrates the effect of higher saving. Initial equilibrium occurs where the S1 þ T þ IM curve intersects the I þ G þ EX curve, at an income of $500. Suppose saving Saving Increases 100 Leakages (S + T + I M ), Injections (I + G + EX) (dollars) increases by $20 at every level of income. The S1 þ T þ IM curve shifts up to the S2 þ T þ IM curve. A new equilibrium is established at an income level of $400. The higher rate of saving causes equilibrium income to fall by $100. Notice that the graph is drawn with a constant I þ G þ EX line, since these are autonomous spending items that do not depend upon income. If investment increases along with saving, equilibrium income will not necessarily fall. In fact, because saving is necessary before there can be any investment, we would expect a greater demand for investment funds to induce higher saving. If increased saving is used to fund investment expenditures, the economy should grow over time to higher and higher levels of income. Only if the increased saving is not injected back into the economy is there a paradox of thrift. The fact that governments do not discourage saving suggests that the paradox of thrift generally is not a real-world problem, 80 S2 S1 e2 e1 60 20 –20 T G IM IM EX Income Falls 40 0 I T 100 200 300 400 500 600 Real GDP (Y ) (dollars) –40 –60 The equilibrium level of real GDP occurs where leakages equal injections. There is no reason to expect that each injection will match its corresponding leakage— that investment will equal saving, that government spending will equal taxes, or that exports will equal imports. But for equilibrium to occur, total injections must equal total leakages. Figure 2 shows how leakages and injections determine the equilibrium level of real GDP. Column 5 of the table lists the total leakages from aggregate expenditures: saving (S) plus taxes (T) plus imports (IM). Saving and imports both increase when real GDP increases. We assume that there are no taxes, so the total amount of leakages (S þ T þ IM) increases as real GDP increases. Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some th ... Purchase answer to see full attachment