Income and Expenditure

11

 

  • The nature of the multiplier, which shows how initial changes in spending lead to further changes

  • The meaning of the aggregate consumption function, which shows how current disposable income affects consumer spending

  • How expected future income and aggregate wealth affect consumer spending

  • The determinants of investment spending and the distinction between planned investment spending and unplanned inventory investment

  • How the inventory adjustment process moves the economy to a new equilibrium after a change in demand

  • Why investment spending is considered a leading indicator of the future state of the economy

IN COD WE TRUSTED—THE COD FISHERY IN NEWFOUNDLAND AND LABRADOR

Even during the boom years of cod fishing, few outport communities were wealthy. But just about every fisher had a boat, and fish plant work (shown on left) sustained over half the population. After the moratorium, that way of life disappeared for many. On the right is the fish processing plant in Burgeo, in decay. Once a thriving operation with hundreds of workers, it is now operational for only about 14 weeks of the year.

IN 1497, THERE WERE SO MANY cod off the coast of Newfoundland and Labrador that explorer John Cabot allegedly reported that a person “could walk across their backs.” For centuries in Newfoundland and Labrador, “cod was king,” providing tens of thousands of jobs and feeding the world. In the early 1980s, annual catches were averaging over 200 000 tonnes, generating huge revenues. And the industry was expanding, with people investing heavily in larger fishing vessels, as well as more powerful machines and equipment. Then, suddenly, the cod industry collapsed. What happened?

By the late 1980s and early 1990s, cod had been overfished to the brink of extinction. Consequently, the federal government declared a moratorium (a temporary suspension) on all commercial cod fishing in Atlantic Canada in 1992. This was the largest industry closure in Canadian history, and it remains in effect to this day.

The impact was devastating. More than 35 000 people lost their jobs, and businesses that had invested in the industry suffered huge financial losses. Local economies began to collapse: as the jobs created by cod fishing disappeared, local spending began to fall, leading to losses of other jobs in the region, leading in turn to further declines in spending, and so on. Realizing cod fishing was unlikely to start up again soon, people had to sell their vessels and equipment at bargain prices. Many folks went to other provinces, territories, or countries to look for work. From 1992 to 2011, Newfoundland and Labrador’s population declined by over 72 000 people, or about 12%.

The boom and bust of the cod industry shows how booms and busts can happen in the economy as a whole. The business cycle is often driven by ups or downs in investment spending. Changes in investment spending, in turn, indirectly lead to changes in consumer spending, which magnify—or, as economists usually say, multiply—the effect of the investment spending changes on the economy as a whole.

In this chapter we’ll study how this process works, showing how a change in expenditure would have a multiplier effect on GDP. As a first step, we introduce the concept of the multiplier informally.