580 PA R T V I I Monetary Theory I is $2 [ * 1/(1 + 0.5)]; if mpc * 0.8, the change in output for a $1 change in I is $5 The larger the marginal propensity to consume, the higher the expenditure multiplier RESPONSE TO CHANGES IN AUTONOMOUS SPENDING Because a is also multiplied by the term 1/(1 + mpc) in Equation 4, a $1 change in autonomous consumer expenditure a also changes aggregate output by 1/(1 + mpc), the amount of the expenditure multiplier Therefore, we see that the expenditure multiplier applies equally well to changes in autonomous consumer expenditure In fact, Equation can be rewritten as Y = * A - mpc (5) in which A * autonomous spending * a I This rewritten equation tells us that any change in autonomous spending, whether from a change in a, in I, or in both, will lead to a multiplied change in Y If both a and I decrease by $100 billion each, so that A decreases by $200 billion, and mpc * 0.5, the expenditure multiplier is [* 1/(1 + 0.5)], and aggregate output Y will fall by - $200 billion * $400 billion Conversely, a rise in I by $100 billion that is offset by a $100 billion decline in a will leave autonomous spending A, and hence Y, unchanged The expenditure multiplier 1/(1 + mpc) can therefore be defined more generally as the ratio of the change in aggregate output to a change in autonomous spending (,Y/,A) Another way to reach this conclusion that any change in autonomous spending will lead to a multiplied change in aggregate output is to recognize that the shift in the aggregate demand function in Figure 22-3 did not have to come from an increase in I; it could also have come from an increase in a, which directly raises consumer expenditure and therefore aggregate demand Alternatively, it could have come from an increase in both a and I Changes in the attitudes of consumers and firms about the future, which cause changes in their spending, will result in multiple changes in aggregate output APP LI CAT IO N The Collapse of Autonomous Consumer Expenditure and the Great Depression in the United States From 1929 to 1933, the U.S economy experienced the largest percentage decline in investment spending ever recorded One explanation for the investment collapse was the ongoing set of financial crises during this period, described in Chapter In 2000 dollars, investment spending fell from US$232 billion to US$38 billion a decline of over 80% What does the Keynesian analysis developed so far suggest should have happened to aggregate output in this period? Figure 22-4 demonstrates how the US$194 billion drop in planned investment spending would shift the aggregate demand function downward from Y 1ad to Y 2ad, moving the economy from point to point Aggregate output would then fall sharply; real GDP actually fell by US$352 billion (a multiple of the US$194 billion drop in investment spending), from US$1184 billion to US$832 billion (in 2000 U.S dollars) Because the economy was at full employment in 1929, the fall in output resulted in massive unemployment, with over 25% of the labour force unemployed in 1933