Fig.

1a Potential and Actual Real

GDP and Employment, 1960-2003
Actual and Potential Real GDP

9,000 The orange line shows full-

(Billions of 1996 Dollars)

8,000 employment or potential output.

7,000
6,000 The green line shows
actual output. During recessions,
output declines.
5,000
4,000 During expansions, output
rises—sometimes rapidly.
3,000
2,000
60

65

70

75

85

90

95

00
03
80
19

19

19

19

19

19

19

20
20
19
 Fig. 1b Potential and Actual Real
GDP and Employment, 1960-2003
140
Employment
(Millions) Employment falls in recessions . . .
120

100

80 and rises in expansions.

60
60

65

70

75

80

90

95

00
85

03
19

19

19

19

19

19

19

20
19

20
 A ctual and
Figure 1 Potential R eal 9,000
G D P (B illions of

Potential and 1996 D ollars) 8,000

Actual 7,000

Real GDP and 6,000

Employment,
5,000

4,000
1960–2001(p574) 3,000

2,000

Red line- 1960 1965 1970 1975 1980 1985 1990 1995 2001
Year

full-employment
or potential real GDP Em ploym ent
140

(M illions)

Blue-line- 120

actual real GDP 100

Shaded-contraction 80

output declines;
during expansions, 60

it rises quickly(not last 1960 1965 1970 1975 1980 1985 1990 1995 2001
for long???) Year
 Chapter 11

The Short-run
Keynesian Model
Prepared by
Harry Huang
The Short-Run Macro
Model
Table 1 Expansions, Recessions, and Shocks That
Caused Them
Period Event Spending Shock

E arly 1950s E xpansion K orean W ar D efense S pending 

1953 R ecession E nd of K orean W ar D efense S pending 
Late 1960s E xpansion Vietnam W ar D efense S pending 
1970 R ecession C hange in Federal R eserve P olicy S pending on N ew H om es 
1974 R ecession D ram atic Increase in O il P rices S pending on C ars and O ther
E nergy-using P roducts 
1980 R ecession D ram atic Increase in O il P rices S pending on C ars and O ther
E nergy-using P roducts 
1981–82 R ecession C hange in Federal R eserve P olicy S pending on N ew H om es, C ars
and B usiness Investm ent  
E arly 1980s E xpansion M ilitary B uildup D efense S pending 
Late 1980s E xpansion H uge D ecline in O il P rices S pending on E nergy-using
P roducts 
1990 R ecession Large Increase in O il P rices; S pending on C ars and O ther
C ollapse of the S oviet U nion E nergy-using P roducts  ;
D efense S pending 
1991–2000 E xpansion Technological A dvances in C om - S pending on
puters; D evelopm ent of the C apital E quipm ent  ;
Internet; H igh W ealth C reation C onsum ption 
 The Short-Run Macro
Model
Short-Run Macro Model
A macroeconomic model that
explains how changes in spending
can affect real GDP in the short
run
 The Short-Run Macro
Model
Short-Run Macro Model
On assumption that other factors
remain unchanged- as labor market,
production functions, loanable funds
market we discussed in long run
model
Here, we assume spending is the only
determinant of output
 The circular flow of income

INJECTIONS
Export
expenditure (X)
Investment (I)
Government
Consumption of expenditure (G)
Factor
Payments domestically
BANKS, etc GOV. ABROAD
(through factor produced goods
market) and services (Cd)
(through product market) Import
Net expenditure (M)
Net taxes (T)
saving (S)

fig
leakages
 The Short-Run Macro Model
• Spending is very important in short-run
– The more income households have, the
more they will spend
• Spending depends on income
– But the more households spend, the more
output firms will produce
• More income they will pay to their workers
– Thus, income depends on spending
 The Short-Run Macro
Model
In the short run,
spending depends on
income, and income
depends on spending.
 The Short-Run Macro Model
• Many ideas behind the model were originally
developed by British economist John
Maynard Keynes in 1930s
– Short-run macro model focuses on spending in
explaining economic fluctuations
– Explains how shocks that affect one sector
influence other sectors
• Causing changes in total output and employment
 The Short-Run Macro
Model
In the short-run macro model, we
focus on spending in markets for
currently produced a nation’s
goods and services—that is,
spending on things that are
included in the nation’s GDP.
 Real Spending
Four categories of buyers:
•Households: consumption spending
(C)
•Businesses: investment spending (IP)
•Government Agencies: government
purchases (G)
•Foreigners: net exports (NX)
 Real Spending
•In this Chapter, we will discuss on all
sectors respectively to analyze their
impacts on the economy as a whole
and how to use them as tools to
interfere the economy. Concepts such
as :
•Consumption Function & MPC
•Consumption-income line
•The Aggregate Expenditure
•The Expenditure Multiplier
•…
 Consumption Spending

•Consumption and Disposable Income

•Consumption and Income
•Consumption Function & MPC
•Shifts in the Consumption-Income Line
 Consumption Spending

Disposable Income( 可支配收入）

The part of household income that
remains after paying taxes
Disposable income = Income – Taxes
 Consumption Spending
•Consumption Function
A positively sloped relationship
between real consumption
spending and real disposable
income
Determinants of Consumption
Spending(p595)
Real
Disposable
Income +
Interest
Rate –
Real
Consumption
Spending
+
Real
+
Wealth
Expectations
of Future Income
 Fig. 1 U.S. Consumption and
Disposable Income, 1985-2002
2000
7,000
Real Consumption Spending

6,000 1995
($ Billions)

1990
5,000
1985

4,000

3,000

3,000 4,000 5,000 6,000 7,000

Real Disposable Income ($ Billions)
 Consumption and Disposable
Income
• Of all the factors that influence
consumption spending, most
important and stable
determinant is disposable
income
 Consumption and Disposable
Income
• Relationship between consumption and
disposable income is almost perfectly linear—
points lie remarkably close to a straight line
– This almost-linear relationship between
consumption and disposable income has been
observed in a wide variety of historical periods
and a wide variety of nations

They are of statistical not causal relationship

 Fig. 2 The Consumption Function
The consumption function shows the (linear)
8,000
relationship between real consumption
Real Consumption Spending

7,000 spending and real disposable income

6,000 Consumption
Function
($ Billions)

5,000
4,000 600
3,000 1,000
and the slope of the line
2,000 The vertical intercept ($2,000 (0.6) is the marginal
billion) is autonomous propensity to consume.
1,000 consumption spending . . .

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

Real Disposable Income ($ Billions)
 Consumption Spending
•Autonomous Consumption Spending （自主
性消费支出）
The part of consumption spending
that is independent of income; also,
the vertical intercept of the
consumption function
 Marginal Propensity to
Consume
•Marginal Propensity to Consume (
MPC) 边际消费倾向
The amount by which consumption
spending rises when disposable
income rises by one dollar
 Marginal Propensity to
Consume
Marginal Propensity to Consume
(MPC) is also:
•the slope of the consumption function
•the change in consumption divided by
the change in disposable income
(C/YD)
 Consumption Equation

C = a + bYD
where
a = vertical intercept of the consumption function
(representing theoretical level of consumption
spending at YD = 0)
b = the slope of the consumption function (or the
MPC)
 Consumption and Income

Consumption-Income Line
A line showing aggregate
consumption spending at each level
of income or GDP
 From The Consumption Function….
8,000
Real Consumption Spending

7,000
6,000 Consumption
Function
($ Billions)

5,000
4,000 600
3,000 1,000

2,000
1,000

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

Real Disposable Income ($ Billions)
 Fig. 3 The Consumption-Income Line
Real Consumption
Consumption-
Spending ($ Billions)
Income Line
5,600 B
2. The line has the same 5,000 A
slope as the consumption
function in Figure 2 . . . 4,000

3,000 600
1,000
1. To draw the consumption- 2,000
income line, we measure 3. but a different
real income (instead of real 1,000 vertical intercept.
disposable income) on the
horizontal axis. 2,000 4,000 6,000 8,000
Real Income ($ Billions)
 Shifts in the Consumption
Income Line
When government collects fixed amount of
taxes from households: line representing the
relationship between consumption and
income is shifted downward by amount of
tax times MPC
The slope of this line is unaffected by taxes,
and is equal to the MPC.
 Fig. 4 A Shift in the Consumption-
Income Line
Real 8,000
Consumption Consumption-Income Line
Spending ($ 7,000 When Net Taxes = 500
Billions) 6,000

5,000
4,000
3,000
Consumption-Income Line
2,000 When Net Taxes = 2,000
1,000

2,000 4,000 6,000 8,000

Real Income ($ Billions)
 Consumption Spending
When a change in income causes
consumption spending to change, we
move along the consumption-income line.
When a change in anything else besides
income causes consumption spending to
change, the line will shift.
 Getting to Total Spending

•Investment Spending
•Government Purchases
•Net Exports
•Summing Up: Aggregate Expenditure
•Income and Aggregate Expenditure
 Investment Spending
Investment spending: plant and
equipment purchases by business firms,
and new home construction

Inventory investment: unintentional and

undesired, therefore excluded from the
definition of investment spending
 Government Purchases

In the short-run macro model,

government purchases are
treated as a given value,
determined by forces outside
of the model.
 Net Exports

Net Exports =
Total Exports – Total Imports
 Aggregate Expenditure (AE)
Aggregate Expenditure (AE)
The sum of spending by
households, business firms, the
government, and foreigners on
final goods and services produced
in the nation
 Aggregate Expenditure

Aggregate expenditure =
p
C + I + G + NX
 Aggregate Expenditure

When income increases,

aggregate expenditure (AE )
will rise by the MPC times the
change in income.
 Fig. 5 Deriving the Aggregate
Real 8,000
Expenditure Line
Aggregate
Expenditure 7,000 5. to get the aggregate expenditure line.
($ Billions) C + IP + G + NX
6,000 C + IP + G
4. and net exports (NX) . . .
5,000 C + IP
C
4,000

3,000
3. government purchases (G) . . .
2,000
2. then add planned investment (IP) . . .
1,000

1. Start with the

consumption- 2,000 4,000 6,000 8,000
income line, Real GDP ($ Billions)
 Fig. 6 Using a 45° Line to Translate
Distances
1. Using a 45-degree line . . .

2. we can translate 3. into an equal

any horizontal vertical distance
distance (such (BA).
as 0B) . . . 45°

0 B
 Finding Equilibrium GDP

•Inventories and Equilibrium GDP

•Finding Equilibrium GDP with
a Graph
•Equilibrium GDP and Employment
 Finding Equilibrium GDP

When aggregate expenditure is less than

GDP, output will decline in the future.
Thus, any level of output at which
aggregate expenditure is less than GDP
cannot be the equilibrium GDP.
 Finding Equilibrium GDP
When aggregate expenditure is
greater than GDP, output will rise in
the future.
Thus, any level of output at which
aggregate expenditure exceeds GDP
cannot be the equilibrium GDP.
 Finding Equilibrium GDP
Equilibrium GDP
In the short run, the level of
output at which output and
aggregate expenditure are
equal.
 Finding Equilibrium GDP
The AE line is found by adding fixed
amounts of investment, government
purchases, and net exports to
consumption, as determined by the
consumption-income line.

The slope of the AE line is the MPC.

 Fig. 5 Deriving the Aggregate
Real 8,000
Expenditure Line
Aggregate
Expenditure 7,000 5. to get the aggregate expenditure line.
($ Billions) C + IP + G + NX
6,000 C + IP + G
4. and net exports (NX) . . .
5,000 C + IP
C
4,000

3,000
3. government purchases (G) . . .
2,000
2. then add planned investment (IP) . . .
1,000

1. Start with the

consumption- 2,000 4,000 6,000 8,000
income line, Real GDP ($ Billions)
 Fig. 6 Using a 45° Line to Translate
Distances
1. Using a 45-degree line . . .

2. we can translate 3. into an equal

any horizontal vertical distance
distance (such (BA).
as 0B) . . . 45°

0 B
 Finding Equilibrium GDP

A 45 degree line is a translator line:

It allows us to measure any
horizontal distance as a vertical
distance instead.
 Fig. 7 Determining Equilibrium Real
GDP Increase in Inventories
Real Aggregate
A
Expenditure 9,000 C + IP + G + NX
($ Billions) 8,000
H
7,000
E
6,000 Decrease in
Inventories
5,000
K Total Output
4,000 Aggregate Expenditure
3,000 J
Aggregate
2,000 Expenditure
Total
1,000 Output
45°
2,000 4,000 6,000 8,000 Real GDP ($ Billions)
 Finding Equilibrium GDP
At any output level at which the
aggregate expenditure line lies below the
45 degree line, aggregate expenditure is
less than GDP.
If firms produce any of these output
levels, their inventories will grow, and
they will reduce output in the future.
 Finding Equilibrium GDP
At any output level at which the
aggregate expenditure line lies above the
45 degree line, aggregate expenditure
exceeds GDP.
If firms produce any of these output
levels, their inventories will decline, and
they will increase output in the future.
 Finding Equilibrium GDP
Equilibrium GDP is the output level at
which the AE line intersects the 45 line.
If firms produce this output level, their
inventories will not change, and they will
be content to continue producing the
same level of output in the future.
 Equilibrium GDP and Employment
• When economy operates at equilibrium, will
it also be operating at full employment?
– Not necessarily
• It would be quite a coincidence if our
equilibrium GDP happened to be output level
at which entire labor force were employed
• In short-run macro model, cyclical
unemployment is caused by insufficient
spending
– As long as spending remains low, production will
remain low, and unemployment will remain high
 Equilibrium GDP and Employment
• In short-run macro model, economy can
overheat because spending is too high
– As long as spending remains high,
production will exceed potential output, and
unemployment will be unusually low
• Aggregate expenditure line may be low,
meaning that in short-run, equilibrium
GDP is below full employment
– Or aggregate expenditure may be high,
meaning that in short-run, equilibrium GDP
is above full-employment level
 Fig. 8 Equilibrium GDP Can Be
Less than Full-Employment GDP
Aggregate When the aggregate Real GDP
Expenditure expenditure line is ($ Billions)
($ Billions) low . . .
AELOW Aggregate
Production
F B Function
$7,000 $7,000
E $6,000 cyclical
A unemployment
equilibrium
output ($6,000) = 25 million
is less than
potential output,
45°
$7,000 Real GDP 100 Number of
($ Billions) Million Workers
$6,000 75
Potential GDP Million Full Employment
and equilibrium employment is less than full employment.
 Fig. 9 Equilibrium GDP Can Be Greater
than Full-Employment GDP
When the aggregate
Aggregate expenditure line is high . . . Real GDP
Expenditure ($ Billions)
($ Billions) AEHIGH
Aggregate
E' H Production
$8,000 B
$7,000 $7,000 Function
F $7,000
and equilibrium employ-
ment is greater than full
equilibrium output ($8,000) is
employment.
greater than potential output,

$7,000 Real GDP 100 Number of

($ Billions) Million Workers
$8,000 135
Potential GDP Full Employment Million
 Equilibrium GDP and
Employment
In the short-run macro model, the
economy can overheat because spending
is too high.
As long as spending remains high,
production will exceed potential output,
and unemployment will be unusually
low.
网络文章：许小年：经济已过热 行政调控等同于计划经济
 What Happens
When Things Change?
•A Change in Investment Spending
•The Expenditure Multiplier
•The Multiplier in Reverse
•Other Spending Shocks
•A Graphical View of the Multiplier
•An Important Proviso About the Multiplier
 A Change in Investment Spending

• Increase in investment spending will

set off a chain reaction
– Leading to successive rounds of
increased spending and income
• At end of process, when economy has
reached its new equilibrium
– Total spending and total output are
considerably higher
 Fig. 10 The Effect of a Change in
Investment Spending
Increase in 2,500
Annual GDP 2,306
2,176
1,960

1,600

1,000

Initial After After After After After

Rise in Round Round Round Round All
IP 2 3 4 5 Rounds
 The Expenditure Multiplier
支出乘数（效应）
Expenditure Multiplier
The amount by which equilibrium real
GDP changes as a result of a one-dollar
change in autonomous consumption,
investment, or government purchases.
 The Expenditure Multiplier

For any value of the MPC, the

formula for the expenditure
multiplier is
1/( 1 - MPC ).
 The Expenditure Multiplier
Due to saving leakages, we have MPC
Assuming that MPC=80%, an increase in spending is 100,
then
1st round 100.0 = 100x1
2nd round 80.0 = 100x80%
3rd round 64.0 = 100x80%x80%
4th round 51.2 = 100x80%x80%x80%

Total change 500 = 100x( 1/1-80%)

 The Expenditure Multiplier
Because Total change
Y= 100x1 + 100x80% + 100x80%2 +100x80%3+…
= 100[1+80% + (80%)2 +(80%)3 +…]
since 1 + r + r2 +r3 +… = 1/1-r, let r=80% (MPC)
then we have (geometric progression)
Y = 100 ( 1/1-MPC),
If Multiplier = Kc then
Kc= 1/1-MPC
An example:
If MPC is ¾, what is the
value of the multiplier?

1/¼=4
If government increases its spending
by $10 billion with an MPC of 3/4
what affect on GDP?

GDP increases by $40 billion

 The Expenditure Multiplier
Just as increases in investment spending
cause equilibrium GDP to rise by a
multiple of the change in spending,
decreases in investment spending cause
equilibrium GDP to fall by a multiple of
the change in spending.
 Other Spending Shocks

Changes in planned investment, government

purchases, net exports, or autonomous
consumption lead to a multiplier effect on
GDP.
The expenditure multiplier is what we
multiply the initial change in spending by in
order to get the change in equilibrium GDP.
 Other Spending Shocks

 1 
GDP     I P

 (1  MPC) 
 Other Spending Shocks

 1 
GDP     G
 (1  MPC) 
 Other Spending Shocks

 1 
GDP     NX
 (1  MPC) 
 Other Spending Shocks

 1 
GDP     a
 (1  MPC) 
 A Graphical View of the
Multiplier

 1 
GDP     Spending
 (1  MPC) 
 A Graphical View of the
Multiplier
Real
Aggregate AE2
Expenditure 9,000
($ Billions) F
AE1
8,000

7,000

6,000
E

5,000 $1,000

4,000
Increase in
Equilibrium
3,000
GDP

2,000 $2,500
Billion
1,000
45°

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 Real GDP
($ Billions)
 Other Spending Shocks

An increase in autonomous consumption

spending, investment spending,
government purchases, or net exports
will shift the aggregate expenditure line
upward by the increase in spending,
causing GDP to rise.
 The Effect of Fiscal Policy

In the short run, an

increase in government purchases causes a
multiplied increase in equilibrium GDP,
so can change equilibrium GDP.

In the long run, fiscal policy is ineffective.