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Understanding the Aggregate Expenditures Model: Equilibrium and Economic Impact

This chapter provides a comprehensive overview of the Aggregate Expenditures Model in a private closed economy, emphasizing the relationship between consumption and investment. It discusses the equilibrium level of real GDP, the principle that saving equals investment, and how unplanned inventory changes affect overall economic stability. Furthermore, the text explores equilibrium changes, the impact of multipliers, and introduces government and foreign sectors into the model. Key concepts like recessionary and expansionary expenditure gaps are examined, shedding light on their significance in economic analysis.

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Understanding the Aggregate Expenditures Model: Equilibrium and Economic Impact

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  1. O 9.1 9 The Aggregate Expenditures Model

  2. Chapter Objectives • Economists Combine Consumption and Investment to Depict an Aggregate Expenditures Schedule for a Private Closed Economy • Three Characteristics of the Equilibrium Level of Real GDP in a Private Closed Economy • AE = Output • Saving = Investment • No Unplanned Changes in Inventories • How Changes in Equilibrium Real GDP Occur and Relate to Multiplier • Integrate Government and Foreign Sectors into AE • Recessionary and Expansionary Expenditure Gaps

  3. Consumption and Investment • Simplifications • Private Closed Economy • Planned Investment • Investment Schedule Investment Demand Curve Investment Schedule Investment Demand Curve Investment Schedule Ig 20 Investment (billions of dollars) r and i (percent) 8 20 20 ID 20 Investment (billions of dollars) Real GDP (billions of dollars)

  4. W 9.1 Consumption and Investment • Equilibrium GDP: C + Ig = GDP • Real Domestic Output • Aggregate Expenditures • Aggregate Expenditures Schedule • Equilibrium GDP • Disequilibrium

  5. (2) Real Domestic Output (and Income) (GDP=DI) (3) Con- sump- tion (C) (7) Unplanned Changes in Inventories (+ or -) (8) Tendency of Employment Output and Income (5) Investment (Ig) (6) Aggregate Expenditures (C+Ig) (1) Employ- ment (4) Saving (S) (1-2) Consumption and Investment …in Billions of Dollars • 40 • 45 • 50 • 55 • 60 • 65 • 70 • 75 • 80 • 85 $370 390 410 430 450 470 490 510 530 550 $375 390 405 420 435 450 465 480 495 510 $-5 0 5 10 15 20 25 30 35 40 20 20 20 20 20 20 20 20 20 20 $395 410 425 440 455 470 485 500 515 530 $-25 -20 -15 -10 -5 0 +5 +10 +15 +20 Increase Increase Increase Increase Increase Equilibrium Decrease Decrease Decrease Decrease Graphically…

  6. 530 510 490 470 450 430 410 390 370 Consumption (billions of dollars) 45° • 390 410 430 450 470 490 510 530 550 Disposable Income (billions of dollars) G 9.1 Consumption and Investment Equilibrium GDP C + Ig (C + Ig = GDP) C Equilibrium Point Aggregate Expenditures Ig = $20 Billion C = $450 Billion

  7. Equilibrium GDP • Other Features… • Saving Equals Planned Investment • Leakage • Injection • No Unplanned Changes in Inventories

  8. 510 490 470 450 430 Aggregate Expenditures (billions of dollars) 45° 430 450 470 490 510 Real GDP (billions of dollars) Changes in Equilibrium GDP …and the Multiplier (C + Ig)1 (C + Ig)0 (C + Ig)2 Increase in Investment Decrease in Investment

  9. International Trade • Net Exports and Aggregate Expenditures • Net Exports Schedule • Net Exports and Equilibrium GDP • Positive Net Exports • Negative Net Exports • International Economic Linkages • Prosperity Abroad • Tariffs • Exchange Rates

  10. 510 490 470 450 430 Aggregate Expenditures (billions of dollars) 45° 430 450 470 490 510 Real GDP (billions of dollars) +5 0 -5 Net Exports Xn (billions of Dollars) Real GDP International Trade Net Exports and Equilibrium GDP C + Ig+Xn1 C + Ig Aggregate Expenditures with Positive Net Exports C + Ig+Xn2 Aggregate Expenditures with Negative Net Exports Positive Net Exports Xn1 450 470 490 Xn2 Negative Net Exports

  11. GLOBAL PERSPECTIVE -700 200 150 100 50 0 50 100 150 200 250 International Trade Net Exports of Goods - Select Nations, 2004 Negative Net Exports Positive Net Exports +37 Canada -17 France Germany +195 Italy -2 Japan +111 -117 United Kingdom -707 United States Source: World Trade Organization

  12. (1) Level of Output and Income (GDP=DI) (5) Net Exports (Xn) (7) Aggregate Expenditures (C+Ig+Xn+G) (2)+(4)+(5)+(6) (2) Consump- tion (C) (4) Investment (Ig) (6) Government (G) Exports (X) Imports (M) (3) Saving (S) Adding the Public Sector Government Purchases and GDP …in Billions of Dollars • $370 • 390 • 410 • 430 • 450 • 470 • 490 • 510 • 530 • 550 $375 390 405 420 435 450 465 480 495 510 $-5 0 5 10 15 20 25 30 35 40 $20 20 20 20 20 20 20 20 20 20 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 10 20 20 20 20 20 20 20 20 20 20 $415 430 445 460 475 490 505 520 535 550

  13. Aggregate Expenditures (billions of dollars) 45° 470 550 Real GDP (billions of dollars) Adding the Public Sector Government Spending and GDP C + Ig + Xn + G C + Ig + Xn C Government Spending of $20 Billion $20 Billion Increase in Government Spending Yields an $80 Billion Increase In GDP

  14. Aggregate Expenditures (billions of dollars) 45° 490 550 Real GDP (billions of dollars) Adding the Public Sector Lump-Sum Tax Increase and GDP C + Ig + Xn + G Cd + Ig + Xn + G $15 Billion Decrease In Consumption From a $20 Billion (MPC=.75) Increase in Taxes $20 Billion Increase in Taxes Yields a $60 Billion Decrease In GDP

  15. G 9.2 W 9.2 Adding the Public Sector Cd + Ig + Xn + G = GDP • Leakages • Injections • No Planned Inventory Changes Sd + M + T = Ig + X + G

  16. 550 530 510 490 470 Aggregate Expenditures (billions of dollars) 45° 490 510 530 Real GDP (billions of dollars) Equilibrium Versus Full-Employment GDP Recessionary Expenditure Gap AE0 $5 Billion Gap Yields $20 Billion GDP Change AE1 Recessionary Expenditure Gap = $5 Billion Full Employment

  17. 550 530 510 490 470 Aggregate Expenditures (billions of dollars) 45° 490 510 530 Real GDP (billions of dollars) Equilibrium Versus Full-Employment GDP Inflationary Expenditure Gap AE2 AE0 Inflationary Expenditure Gap = $5 Billion $5 Billion Gap Yields $20 Billion GDP Change Full Employment

  18. W 9.3 Equilibrium Versus Full-Employment GDP • Application: • U.S. Recession of 2001 • Inflationary Expenditure Gap • U.S. Inflation in the Late 1980s • Full-Employment Output with Large Negative Net Exports • Negative Net Exports

  19. Equilibrium Versus Full-Employment GDP • Limitations of the Model • Does Not Show Price Level Changes • Ignores Premature Demand-Pull Inflation • Limits Real GDP to the Full-Employment Level of Output • Does Not Deal with Cost-Push Inflation • Does Not Allow for “Self-Correction”

  20. O 9.2 Say’s Law - The Great Depression and Keynes Last Word • Classical School – Automatic Self-Adjustment to Full Employment – Mill, Ricardo • Views Based Upon “Say’s Law” - J.B. Say (1767-1832) – Supply Creates its Own Demand • Great Depression Caused Questions • Keynes Answered in his General Theory of Employment, Interest, and Money • Income and Saving Discrepancies • Volatility in Investment Spending • Cyclical Unemployment Can Occur • Government Should Be Active in the Recovery Process

  21. planned investment investment schedule aggregate expenditures schedule equilibrium GDP leakage injection unplanned changes in inventories net exports lump-sum tax recessionary-expenditure gap inflationary-expenditure gap Key Terms

  22. Next Chapter Preview… Aggregate Demand and Aggregate Supply Chapter 10!

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