C.  Spending by Individuals, Firms, and Governments

• Focus on the short run

• Little change in the short run in potential GDP - the maximum amount of GDP that can be produced at any point in time

1.  Components of aggregate expenditures

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a.  Personal consumption expenditures

(1)  Income and consumption

• Consumption depends primarily on disposable income

• Marginal propensity to consume

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• Saving

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• Marginal propensity to save

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(2)  Consumption function

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(3)  Other factors affecting consumption

(a)  Personal taxes

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(b)  Real interest rate

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(c)  Consumer confidence

• Consumer sentiment - measures attitudes about expected business conditions, personal finances, and major purchases

- Calculated by the University of Michigan

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• Consumer confidence - measures attitudes about general business conditions, available jobs, and personal family income

- Calculated by The Conference Board

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(d)  Wealth

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(e)  Consumer credit

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(f)  Level of debt

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b.  Gross private domestic investment

(1)  Factors affecting investment

(a)  Income

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(b)  Real interest rate

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(c)  Business taxes

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(d)  Expected profits and business confidence

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(e)  Capacity utilization

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(f)  Residential investment

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(g)  Inventory investment

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(2)  Investment spending function

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c.  Government expenditure

• Fiscal policy - use of government spending and taxation policies to achieve macroeconomic goals

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d.  Net export expenditure

• Impact of exchange rates:

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(1)  Export expenditures

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(2)  Import expenditures

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(3)  Net exports

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2.  Equilibrium income and output

a.  Aggregate expenditures

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b.  Equilibrium

• Level of income where total spending equals aggregate output

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(1)  Adjustment toward equilibrium

• Unplanned inventory changes - unexpected increases or decreases in inventories that occur when aggregate expenditure differs from the level of output that is produced

- Unplanned inventory decrease - occurs when aggregate expenditures exceeds output level

- Unplanned inventory increase - occurs when aggregate expenditures is less than output level

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• Gives signal to either increase production (inventory decrease) or decrease production (inventory increase)

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(2)  Multiplier

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3.  Interest rates and equilibrium

• Interest-related expenditure (IRE) function - shows relationship between planned consumption and investment spending and the interest rate

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