CH 05

Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Chapter Five:
Foundations of the Macroeconomy
Chapter Objectives
5-2
To define and explain business cycles.

To understand how total spending drives the economys levels of employment and production, and
influences prices.

To examine the spending behavior of households, businesses, government units, and the foreign sector.

To identify the macroeconomys leakages and injections and show how they affect economic activity.

To introduce the multiplier effect.

To discuss how expectations affect the economys output and price levels.

To identify the role of total spending in macroeconomic policies.
th
Chapter Five Overview
Chapter Five
5-3
Macroeconomic Activity Changes
Total Spending & Activity
Household Sector
Business Sector
Government Sector
Foreign Sector
Summary of Aggregate Spending, Leakages, and Injections
Multiplier Effect
Macroeconomic Policies
th
5-4
Business Cycles:
Recurring periods of growth and decline in an economys real
output, or real GDP.
Composed of four phases:
Recovery
Expansionary phase during which real GDP increases.
Peak
Where maximum output occurs.
Recession
Phase during which GDP falls.
Trough
Where GDP reaches its minimum.
th
5-5
Cyclical Business Cycles
th
5-7
Total Spending:
Also called aggregate spending.
Total combined spending of all units in the economy for new goods and services.
Includes households, businesses, government, and foreign.
th
Personal Consumption Expenditures:
Household spending on new goods and services.

Household Sector & the Circular Flow:
Income-Determined Spending:
Household spending on new goods and services that comes from income earned
from providing resources to producers.
Household Sector
5-8
th
5-9
Household Sector & the Circular Flow (cont.):
Transfer Payments:
Money from the government for which no direct work is
performed in return.
Non-income-Determined Spending:
Spending that is generated from sources other than household
earned income.
Injections into the Spending Stream:
Spending that comes from a source other than household
earned income; non-income determined spending.
Leakages from the Spending Stream:
Uses for earned income other than spending, such as paying
taxes and saving.
Household Sector
th
5-10
Household Sector
th
5-11
Business Sector
Investment Spending:
Also considered non-income-determined spending.
Business spending on new goods, such as machinery,
equipment, buildings, and inventories.
th
5-12
Business Sector
Business Sector & the Circular Flow:
Retained Earnings:
The portion of a businesss accumulated profits that
has been retained for investment or other purposes.
th
5-13
Business Sector
Business Sector & the Circular Flow:
Saving-Borrowing Relationship:
The relationship between the amount saved by households and
businesses and the amount returned to the spending stream
through business and household borrowing.
th
5-14
Government Sector
Government Purchases of Goods & Services:
Also considered non-income-determined spending.
Government spending on new goods and services.
th
5-15
Government Sector
th
5-16
Foreign Sector
Exports:
Goods and services that are sold abroad.

Imports:
Goods and services purchased from abroad.

Net Exports:
Exports minus imports is positive when
exports exceed imports and negative when
imports exceed exports.
th
5-17
Foreign Sector
th
5-18
Summary of Aggregate Spending, Leakages, and Injections
Total Spending:
Drives the economys production, employment, and income levels.
th
5-19
Multiplier Effect
Multiplier Effect:
Change in total output and income generated by a change
in non-income-determined spending is larger than, or a
multiple of, the spending change itself.
th
5-20
Multiplier Effect
Calculating the Multiplier Effect:
Initial change in non-income-determined spending
divided by the percentage of additional income not spent
will yield the total change in output and income.
$2,000,000 (what was not spent) / $10,000,000 = 0.20
$10,000,000 / 0.20 = $50,000,000
th
5-21
Macroeconomic Policies
Expectations:
Anticipations of future events; can affect current actions by
households and businesses and the likelihood that the future events
will occur.

Fiscal Policy:
Influencing the levels of aggregate output and employment or
prices through changes in federal government purchases, transfer
payments, and/or taxes.

Monetary Policy:
Influencing levels of aggregate output and employment or prices
through changes in interest rates and the money supply.

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Economics: Theory & Practice 9

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