This MIT OpenCourseWare lecture introduces a model for determining equilibrium output in the short run. The lecture focuses on the role of aggregate demand, its components (consumption, investment, government spending), and the concept of the multiplier effect. The professor explains how changes in demand, particularly consumption, impact output and income, creating a cyclical effect.
Short-Run Output Determination: In the very short run, equilibrium output is primarily determined by aggregate demand (AD). Changes in AD directly influence production, income, and subsequently, further changes in demand.
Components of Aggregate Demand: AD comprises consumption (C), investment (I), government spending (G), exports (X), and imports (IM). For simplification, the lecture initially ignores X, IM, and inventory investment.
Consumption Function: Consumption is modeled as an increasing function of disposable income (income minus taxes). The marginal propensity to consume (MPC) represents the fraction of additional income spent on consumption.
The Multiplier Effect: Changes in autonomous spending (C0, I, G) are multiplied through the economy due to the MPC. A higher MPC leads to a larger multiplier effect, amplifying the impact of initial changes in spending on overall output.
Paradox of Saving: In the short run, increased saving (reduced consumption) can paradoxically lead to a decrease in overall output, due to the reduced aggregate demand.
