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The Aggregate Expenditures Model
11
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Assumptions and Simplifications
• Use the Keynesian aggregate expenditures model
• Prices are fixed• GDP = DI• Begin with private, closed economy
• Consumption spending
• Investment spending
LO1 11-2
Consumption and Investment r
an
d i
(p
erc
en
t)
Investment (billions of dollars)
(a)Investment demand curve
ID
20
8
Real domestic product, GDP(billions of dollars)
(b)Investment schedule
20
Inve
stm
ent
(bil
lio
ns
of
do
llar
s)
Ig
Investment Demand Curve Investment Schedule
20
Investmentdemandcurve
Investmentschedule
20
LO1 11-3
Equilibrium GDPDetermination of the Equilibrium Levels of Employment, Output, and Income: A Private Closed Economy
(1)Possible Levels of
Employment, Millions
(2)Real
Domestic Output
(and Income) (GDP =
DI),*Billions
(3)Consumption
(C),Billions
(4)Saving
(S),Billions
(5)Investment
(Ig),Billions
(6)Aggregate
Expenditure (C+Ig),
Billions
(7)Unplanned Changes in Inventories,
(+ or -)
(8)Tendency of Employment, Output, and
Income
(1) 40 $370 $375 $-5 $20 $395 $-25 Increase
(2) 45 390 390 0 20 410 -20 Increase
(3) 50 410 405 5 20 425 -15 Increase
(4) 55 430 420 10 20 440 -10 Increase
(5) 60 450 435 15 20 455 -5 Increase
(6) 65 470 450 20 20 470 0 Equilibrium
(7) 70 490 465 25 20 485 +5 Decrease
(8) 75 510 480 30 20 500 +10 Decrease
(9) 80 530 495 35 20 515 +15 Decrease
(10) 85 550 510 40 20 530 +20 Decrease
* If depreciation and net foreign factor income are zero, government is ignored and it is assumed that all saving occurs in the household sector of the economy, then GDP as a measure of domestic output is equal to NI,PI, and DI. Household income = GDP
LO1 11-4
Equilibrium GDP
530
510
490
470
450
430
410
390
370
45°
370 390 410 430 450 470 490 510 530 550
Real domestic product, GDP (billions of dollars)
Ag
gre
gat
e ex
pen
dit
ure
s, C
+ I g
(b
illio
ns
of
do
llars
)
C
Ig = $20 billion
Aggregateexpenditures
C = $450 billion
C + Ig
(C + Ig = GDP)
Equilibriumpoint
LO1 11-5
Planned and Unplanned Expenditures
Aggregate expenditure equals aggregate income and real GDP.
But aggregate planned expenditure might not equal real GDP because firms can end up with larger or smaller inventories
than they had intended.
• Production takes time• Production “for contract” and
“production “for market.”
Production Inventories Sales+ -
Aesop’s Bottles B.C. 400 Investment Plans
Planned spending on buildings, equipment, and tools
20,000 drachmas
Planned inventory investment 0 drachmasValue of inventories on Dec. 31, 401 B. C. 11,000 drachmas
Value of inventories on Dec. 31, 400 B.C. 13,500 drachmas
Unplanned inventory investment in 400 B.C. 2,500 drachmas
Actual investment in 400 B.C. 22,500 drachmas
Other Features of Equilibrium 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 11-9
Changes in Equilibrium GDP
510
490
470
450
430
45°
430 450 470 490 510
Real domestic product, GDP (billions of dollars)
Ag
gre
gat
e ex
pen
dit
ure
s (b
illio
ns
of
do
llars
)
Increase ininvestment
(C + Ig)0
Decrease ininvestment
(C + Ig)2
(C + Ig)1
LO3 11-10
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 11-11
The Net Export Schedule
Two Net Export Schedules (in Billions)
(1)Level of GDP
(2)Net Exports,Xn1 (X > M)
(3)Net Exports,Xn2 (X < M)
$370 $+5 $-5
390 +5 -5
410 +5 -5
430 +5 -5
450 +5 -5
470 +5 -5
490 +5 -5
510 +5 -5
530 +5 -5
550 +5 -5
LO4 11-12
Net Exports and Equilibrium GDP
RealGDP
+5
0
-5
Net
exp
ort
s, X
n(b
illio
ns
of
do
llars
)
Real domestic product GDP (billions of dollars)
Ag
gre
gat
e ex
pen
dit
ure
s(b
illio
ns
of
do
llars
)
510
490
470
450
43045°
430 450 470 490 510
Aggregate expenditureswith positivenet exports
C + Ig
Aggregate expenditureswith negative netexports
C + Ig+Xn2
C + Ig+Xn1
Xn1
Xn2
Positive net exports
Negative net exports450 470 490
LO4 11-13
International Economic Linkages
• Prosperity abroad
• Can increase U.S. exports• Exchange rates
• Depreciate the dollar to increase exports
• A caution on tariffs and devaluations
• Other countries may retaliate
• Lower GDP for all
LO4 11-14
Global Perspective
Source: World Trade Organization, http://www.wto.org.
LO4 11-15
Adding the Public Sector
• Government purchases and equilibrium GDP
• Government spending is subject to the multiplier
• Taxation and equilibrium GDP
• Lump sum tax
• Taxes are subject to the multiplier
• DI = GDP
LO4 11-16
Government Purchases and Eq. GDP
The Impact of Government Purchases on Equilibrium GDP
(1)Real
Domestic Output and
Income(GDP=DI), Billions
(2)Consumption
(C),Billions
(3)Saving (S),
Billions
(4)Investment
(Ig),Billions
(5)Net Exports(Xn), Billions
(6)Government Purchases(G), Billions
(7)Aggregate
Expenditures (C+Ig+Xn+G),
Billions(2)+(4)+(5)+(6)
Exports(X)
Imports(M)
(1) $370 $375 $-5 $20 $10 $10 $20 $415
(2) 390 390 0 20 10 10 20 430
(3) 410 405 5 20 10 10 20 445
(4) 430 420 10 20 10 10 20 460
(5) 450 435 15 20 10 10 20 475
(6) 470 450 20 20 10 10 20 490
(7) 490 465 25 20 10 10 20 505
(8) 510 480 30 20 10 10 20 520
(9) 530 495 35 20 10 10 20 535
(10) 550 510 40 20 10 10 20 550
LO4 11-17
Government Purchases and Eq. GDP
45°
470 550
Real domestic product, GDP (billions of dollars)
Ag
gre
gat
e ex
pen
dit
ure
s (b
illio
ns
of
do
llars
)
C
Government spendingof $20 billion
C + Ig + Xn
C + Ig + Xn + G
LO4 11-18
Taxation and Equilibrium GDPDetermination of the Equilibrium Levels of Employment, Output, and Income: Private and Public Sectors
(1)Real
Domestic Output
and Income
(GDP=DI), Billions
(2)Taxes
(T),Billions
(3)Disposable
Income (DI),
Billions, (1)-(2)
(4)Consump-
tion (C),Billions
(5)Saving
(S),Billions
(6)Invest-
ment (Ig),Billions
(7)Net Exports(Xn), Billions (8)
Govern-ment Pur-
chases(G),
Billions
(9)Aggregate Expendi-
tures (C+Ig+Xn
+G),Billions
(4)+(6)+(7)+(8)
Exports
(X)
Imports
(M)
(1) $370 $20 $350 $360 $-10 $20 $10 $10 $20 $400
(2) 390 20 370 375 -5 20 10 10 20 415
(3) 410 20 390 390 0 20 10 10 20 430
(4) 430 20 410 405 5 20 10 10 20 445
(5) 450 20 430 420 10 20 10 10 20 460
(6) 470 20 450 435 15 20 10 10 20 475
(7) 490 20 470 450 20 20 10 10 20 490
(8) 510 20 490 465 25 20 10 10 20 505
(9) 530 20 510 480 30 20 10 10 20 520
(10) 550 20 530 495 35 20 10 10 20 535
LO4 11-19
Taxation and Equilibrium GDP
45°
490 550
Real domestic product, GDP (billions of dollars)
Ag
gre
gat
e ex
pen
dit
ure
s (b
illio
ns
of
do
llars
)
$15 billiondecrease inconsumptionfrom a$20 billion increasein taxes
Ca + Ig + Xn + G
C + Ig + Xn + G
LO4 11-20
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-employment GDP
• Decrease G and/or increase TLO5 11-21
Equilibrium versus Full-Employment
Real GDP(a)
Recessionary expenditure gap
Ag
gre
gat
e ex
pen
dit
ure
s(b
illio
ns
of
do
llars
)
530
510
490
45° 490 510 530
AE0
AE1
Fullemployment
Recessionaryexpendituregap = $5 billion
LO5 11-22
Equilibrium versus Full-Employment
Real GDP(b)
(billions of dollars)
Ag
gre
gat
e ex
pen
dit
ure
s(b
illio
ns
of
do
llars
)
530
510
490
45° 490 510 530
AE0
AE2
Fullemployment
Inflationaryexpendituregap = $5 billion
LO5 11-23
Application: The Recession of 2007-09
• December 2007 recession began• Aggregate expenditures declined
• Consumption spending declined
• Investment spending declined
• Recessionary expenditure gap
LO5 11-24
Application: The Recession of 2007-09
• Federal government undertook Keynesian policies
• Tax rebate checks
• $787 billion stimulus package
LO5 11-25
Say’s Law, Great Depression, Keynes
• Classical economics
• Say’s Law
• Economy will automatically adjust
• Laissez-faire• Keynesian economics
• Cyclical unemployment can occur
• Economy will not correct itself
• Government should actively manage macroeconomic instability
11-26
•“Supply creates its own demand.”
•By producing goods and services, firms create a total demand for goods and services equal to what they have produced.
Say’s Law1
1 J.B. Say. Treatise on Political Economy, 1803.
Say’s law apparently rules out the
possibility of a widespread glut of
goods.
Resource Markets
Product Markets
Households
Firms
Factor Paym
ents
Inco
me
S
C
Simplified Circular Flow
Keynes: No guarantee that S will be offset by Planned I
The Classical view
• Market industrialized economies are inherently stable and tend automatically to full employment.
• Government policies that aim to improve the performance of the economy do more harm than good.
• “Laissez-faire.”
The Keynesian View
John Maynard Keynes (1936). The General Theory of Employment, Interest, and Money
• Market, industrialized economies are inherently unstable and do not automatically tend to full employment.
• Private spending (and most importantly, investment spending) is volatile—causing business cycle fluctuations.
• “The economy needs to be stabilized, the economy can be stabilized, the economy should be stabilized” (Franco Modigliani).
• Keynesian economics is an attack on the Classical theory.
J.M. Keynes
