6 Chap028 AE Model

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The Aggregate Expenditures

Model

28

McGraw-Hill/IrwinCopyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


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Assumptions and Simplifications

Use the Keynesian aggregateexpenditures model

Prices and interest rates are fixed

GDP = DI

Begin with private, closed economy

Consumption spending

Investment spending

LO1 28-2


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328-3

Investment demand vs. schedule

rand

i(percent)

Investment (billions of dollars)

ID

20

8

Real GDP (billions of dollars)

20

Investment(billionsofdollars)

Ig

Investment Demand Curve Investment Schedule

2020

InvestmentDemand

Curve

InvestmentSchedule

Model Simplifications


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428-4

Real GDP = C + Ig Aggregate expenditures

Equal to C + Ig

Aggregate expenditures schedule Quantity goods produced =

quantity goods purchased

Disequilibrium Only 1 equilibrium level of GDP

Equilibrium GDP

b


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528-5

(1) 40

(2) 45(3) 50

(4) 55

(5) 60

(6) 65

(7) 70

(8) 75

(9) 80

(10) 85

$375

390405

420

435

450

465

480

495

510

$-5

05

10

15

20

25

30

35

40

20

2020

20

20

20

20

20

20

20

$395

410425

440

455

470

485

500

515

530

$-25

-20-15

-10

-5

0

+5

+10

+15

+20

Increase

IncreaseIncrease

Increase

Increase

Equilibrium

Decrease

Decrease

Decrease

Decrease

$370

390

410

430

450

470

490

510

530

550

(2)Real

DomesticOutput

(andIncome)

(GDP=DI)

(3)Con-

sump-tion(C)

(4)Saving (S)(1) (2)

(5)Investment

(Ig)

(6)Aggregate

Expenditures(C+Ig)

(7)UnplannedChanges inInventories

(+ or -)

(8)Tendency ofEmployment,Output, and

Income

(1)Employ-

ment

in Billions of DollarsIn millions

qu br um

b


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628-6

53

0

51

0

49

0

47

0

45

0

43

0

41

0

39

45

370 390 410 430 450 470 490 510530 550

Disposable Income (billions of

dollars)

C

onsumption(billionsof

d

ollars)

C

Ig = $20Billion

AggregateExpenditures

C = $450 Billion

C +Ig

(C + Ig = GDP)

EquilibriumPoint

q

u br um

b


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51

0

49

0

47

0

45

0

43

0

45

430 450 470 490510

Real GDP (billions ofdollars)

AggregateExpenditure

s(billionsof

dolla

rs)

Increase in

Investment by 5

(C +Ig)0

Decrease inInvestment by 5

(C +Ig)2

(C +Ig)1

The

MultiplierEffect

anges n qu br um


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Other Features of Equil ibrium GDP

Saving equals planned investment Saving is a leakage of spending Investment is an injection of

spending No unplanned changes in inventories

Firms do not change production

LO2 28-8

t t


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Multiplier = Change in Real GDPInitial Change in Spending

More spending results in higherGDP

Initial change in spending changesGDP by a multiple amount

u t p er ect

t t


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1027-10

Causes of the initial change inspending Changes in investment Other changes

Rationale Dollars spent are received as

income

Income received is spent (MPC) Initial changes in spending cause

a spending chain

e u t p er ect

t t


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1127-11

(1)Changein

Income

(2)

Change inConsumption

(MPC = .75)

(3)

ChangeinSaving

(MPC = .25)

Increase in Investmentof $5Second RoundThird Round

Fourth RoundFifth RoundAll other rounds

Total

$ 5.003.752.812.11

1.584.75

$ 20.00

$ 3.752.812.111.58

1.193.56

$ 15.00

$1.25

.94

.70

.53

.391.19

$ 5.00

Rounds of Spending

1 2 3 4 5 All

$20.00

15.25

13.67

11.56

8.75

5.00$5.00

$3.75

$2.81

$2.11

$1.5

8

$4.75

I=$5 billion

e u t p er ect

t t


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1227-12

Multiplier =1

1 - MPC

Multiplier =1

MPS

-or-

e u t p er ect


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Adding International Trade Include net exports spending in

aggregate expenditures

Private, open economy

Exports create production,employment, and income

Subtract spending on imports

Xn can be positive or negative

LO4 28-


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Net Exports and Equilibrium GDP

RealGDP

+

5

0

-5

Netexports,

Xn

(billionsof

dollars)

Real domestic product GDP (billions ofdollars)

A

ggregate

ex

penditures

(billionsofdollars)

51

0

49

0

47

0

45

0

43

0

45

430 450 470 490 510

Aggregate expenditureswith positivenet exports

C +

Ig

Aggregateexpenditureswith negative netexports

C +Ig+Xn2

C +Ig+Xn1

Xn1

Xn2

Positive net exports

Negative net exports

450 470 490

LO4 28-


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International Economic Linkages Prosperity abroad

Can increase U.S. exports Exchange rates

Depreciate the dollar to increaseexportsA caution on tariffs and devaluations

Other countries may retaliate Lower GDP for all

LO4 28-


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Adding the Public Sector Government purchases and

equilibrium GDP

Government spending is subject tothe multiplier

Taxation and equilibrium GDP

Lump sum tax

Taxes are subject to the multiplier DI = GDP

LO4 28-


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Government Purchases and Eq. GDP

45

470550

Real domestic product, GDP (billions ofdollars)

Aggregateexpenditures(billionsof

dolla

rs)

C

Government spendingof $20 billion

C + Ig +Xn

C + Ig + Xn +G

LO4 28-


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Taxation and Equilibrium GDP

45

490550

Real domestic product, GDP (billions ofdollars)

Ag

gregateexpenditures(billionsof

dollars)

$15 billiondecrease inconsumptionfrom a$20 billionincreasein taxes

Ca + Ig + Xn +G

C + Ig + Xn +

G

LO4 28-


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Equilibrium versus Full-Employment Recessionary expenditure gap

Insufficient aggregate spending Spending below full-employment GDP

Increase G and/or decrease T

Inflationary expenditure gap

Too much aggregate spending

Spending exceeds full-employmentGDP Decrease G and/or increase T

LO5 28-


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Equilibrium versus Full-Employment

Real GDP(a)

Recessionary expenditure

gap

Aggrega

te

expenditu

res

(billionsofd

ollars)

53

0

51

0

49

0

45 490 510 530

AE0AE1

Fullemployment

Recessionaryexpendituregap = $5 billion

LO5 28-


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Equilibrium versus Full-Employment

Real GDP(b)

(billions ofdollars)

Aggregate

expenditures

(billionsofd

ollars)

53

0

51

0

49

0

45 490 510 530

AE0

AE2

Full

employment

Inflationaryexpendituregap = $5 billion

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