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Chapter 29
The Aggregate Expenditures Model
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
29-2
Learning outcomesLO1. Explain how sticky prices relate to the AE model.
LO2. Explain how an economy’s investment schedule is derived from the investment demand curve & an interest rate.
LO3a. Illustrate how u can combine C & I to depict an AE scheduleLO3b. How AE schedule can be used to determine the equilibrium level of
output.LO4. Discuss 2 other ways to characterize the equilibrium level.LO5. Analyze how changes in equilibrium real GDP can occur in AE model &
describe how those changes relate to multiplier. LO6. Explain how economists integrate the international sector (exports &
imports) into AE modelLO7. Explain how economists integrate the public sector (government &
taxes) into the AE model.
29-3
Madam, what is aggregate? a whole formed by combining several
(typically disparate) elements.
ooo..hehe..nak tanya lagi, so what
is aggregate expenditures
model?
Aggregate expenditure (AE) is the sum of consumption, investment, government
purchases, and net export.
Understand ?
Hello ? …..understand or not ?Haiihh ! Tido la tu!
BUDAK MAKRO ATW108Last seen online 12.31am
29-4
Learning outcomesLO1. Explain how sticky prices relate to the AE model. (DIY)
LO2. Explain how an economy’s investment schedule is derived from the investment demand curve & an interest rate.
LO3a. Illustrate how u can combine C & I to depict an AE scheduleLO3b. How AE schedule can be used to determine the equilibrium level of output.LO4. Discuss 2 other ways to characterize the equilibrium level.LO5. Analyze how changes in equilibrium real GDP can occur in AE model & describe how those
changes relate to multiplier.
29-5
Assumptions and Simplifications
• Keynes developed this model in 1930s• Help explain how modern economies adjust to
economic shocks/sudden crisis. • To simplify, ignore the government role first.• Assuming economy only has private sector;
• Household & business• Also assume economy has no international interaction =
closed economy (no intl trade)• Also, assume saving is personal. • So, this economy has its GDP = DI
LO1
29-6
Consumption and Investment r
and
i (pe
rcen
t)
Investment (billions of dollars)
ID20
8
Real domestic product, GDP(billions of dollars)
20
Inve
stm
ent (
billi
ons
of d
olla
rs)
Ig
(a) Investment Demand Curve (b) Investment Schedule
20
Investmentdemandcurve
Investmentschedule
20
LO2
Investment is determined by real ir
29-7
29-8
Learning outcomesLO1. Explain how sticky prices relate to the AE model. (DIY)LO2. Explain how an economy’s investment schedule is derived from the investment demand
curve & an interest rate.
LO3a. Illustrate how u can combine C & I to depict an AE schedule
LO3b. How AE schedule can be used to determine the equilibrium level of output.LO4. Discuss 2 other ways to characterize the equilibrium level.LO5. Analyze how changes in equilibrium real GDP can occur in AE model & describe how those
changes relate to multiplier.
29-9
This table shows equilibrium GDP using the expenditures-output approach for a private, closed economy
Determination 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
LO3
shows 10 possible levels that producers are willing to offer, assuming their sales would meet the
output planned“ we will produce $370 bill o.p if we can
receive at least $370bil revenue”
shows the amount of consumption and planned gross investment spending (C + Ig)
at each output level Equilibrium GDP is the level of output whose production will create total spending just
sufficient to purchase that output
29-10
This table shows equilibrium GDP using the expenditures-output approach for a private, closed economy
Determination 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 Expenditur
e (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
LO3
29-11
Learning outcomesLO1. Explain how sticky prices relate to the AE model. (DIY)LO2. Explain how an economy’s investment schedule is derived from the investment demand curve & an
interest rate.LO3a. Illustrate how u can combine C & I to depict an AE schedule
LO3b. How AE schedule can be used to determine the equilibrium level of output.
LO4. Discuss 2 other ways to characterize the equilibrium level.LO5. Analyze how changes in equilibrium real GDP can occur in AE model & describe how those changes relate
to multiplier.
29-12
figure graphically illustrates equilibrium GDP in a private closed economy
(want to find where is i. Aggregate expenditure, ii) equilibrium GDP )
C
Ig = $20 billion
AE
C = $450 billion
C + Ig
(C + Ig = GDP)Equilibriumpoint
LO3
Default 45
degree
29-13
Learning outcomesLO1. Explain how sticky prices relate to the AE model. (DIY)LO2. Explain how an economy’s investment schedule is derived from the investment demand
curve & an interest rate.LO3a. Illustrate how u can combine C & I to depict an AE scheduleLO3b. How AE schedule can be used to determine the equilibrium level of output.
LO4. Discuss 2 other ways to characterize the equilibrium level.
LO5. Analyze how changes in equilibrium real GDP can occur in AE model & describe how those changes relate to multiplier.
29-14
Other Features of Equilibrium GDP
• Saving = planned investment, at equilibrium GDP• Saving is a ‘leakage’ of spending, causing C to be lesser than
GDP.
LO4
C < GDP
S
C C C
How to replace outflows caused by spending leakage?
Find/inject investment
29-15
Other Features of Equilibrium GDP
If AE < GDPe (think it as when ur spending is lesser than income)-business will have unplanned inventory (think it as terlebih inventory in store)
If AE > GDPe (think it as when ur spending is lesser than income)-Business will have no inventory & need to invest to have more inventory-Business will have –ve unplanned inventory.
LO4
29-16
Learning outcomesLO1. Explain how sticky prices relate to the AE model. (DIY)LO2. Explain how an economy’s investment schedule is derived from the investment demand
curve & an interest rate.LO3a. Illustrate how u can combine C & I to depict an AE scheduleLO3b. How AE schedule can be used to determine the equilibrium level of output.LO4. Discuss 2 other ways to characterize the equilibrium level.
LO5. Analyze how changes in equilibrium real GDP can occur in AE model & describe how those changes relate to multiplier.
29-17
Changes in Equilibrium GDP
Increase ininvestment
(C + Ig)0
Decrease ininvestment
(C + Ig)2
(C + Ig)1
LO5
Increase the GDPeDecrease the GDPe
29-18
The extent of the changes in equilibrium GDP will depend on the size of the multiplier, which, in this case, is 4.
The multiplier = 1 / MPS
29-19
Learning outcomesLO1. Explain how sticky prices relate to the AE model. LO2. Explain how an economy’s investment schedule is derived from the investment demand
curve & an interest rate.LO3a. Illustrate how u can combine C & I to depict an AE scheduleLO3b. How AE schedule can be used to determine the equilibrium level of output.LO4. Discuss 2 other ways to characterize the equilibrium level.LO5. Analyze how changes in equilibrium real GDP can occur in AE model & describe how those
changes relate to multiplier.
LO6. Explain how economists integrate the international sector (exports & imports) into AE model
LO7. Explain how economists integrate the public sector (government & taxes) into the AE model.
29-20
Adding International Trade
LO6
+GDP-
GDP+ +
GDP
EXPANSIONARY
- - CONTRACTIONARY
29-21
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 -5LO6
29-22
Net Exports and Equilibrium GDP
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
LO6
29-23
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
LO6
29-24
Global Perspective
LO6
29-25
Learning outcomesLO1. Explain how sticky prices relate to the AE model. LO2. Explain how an economy’s investment schedule is derived from the investment demand
curve & an interest rate.LO3a. Illustrate how u can combine C & I to depict an AE scheduleLO3b. How AE schedule can be used to determine the equilibrium level of output.LO4. Discuss 2 other ways to characterize the equilibrium level.LO5. Analyze how changes in equilibrium real GDP can occur in AE model & describe how those
changes relate to multiplier. LO6. Explain how economists integrate the international sector (exports & imports) into AE model
LO7. Explain how economists integrate the public sector (government & taxes) into the AE model. DIY
29-26
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
LO7
29-27
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
LO7
29-28
Government Purchases and Eq. GDP
C
Government spendingof $20 billion
C + Ig + Xn
C + Ig + Xn + G
LO7
29-29
Taxation and Equilibrium GDP
Determination 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
LO7
29-30
Taxation and Equilibrium GDP
45° 490 550
Real domestic product, GDP (billions of dollars)
Agg
rega
te e
xpen
ditu
res
(bill
ions
of d
olla
rs)
$15 billiondecrease inconsumptionfrom a$20 billion increasein taxes
Ca + Ig + Xn + GC + Ig + Xn + G
LO7
29-31
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 T
LO8
29-32
Equilibrium versus Full-Employment
Real GDP(a)
Recessionary expenditure gap
Agg
rega
te e
xpen
ditu
res
(bill
ions
of d
olla
rs)
530
510
490
45° 490 510 530
AE0AE1
Fullemployment
Recessionaryexpendituregap = $5 billion
LO8
29-33
Equilibrium versus Full-Employment
AE0
AE2
Fullemployment
Inflationaryexpendituregap = $5 billion
LO8
29-34
Application: The Recession of 2007-09
• December 2007 recession began• Aggregate expenditures declined
• Consumption spending declined• Investment spending declined• Recessionary expenditure gap
LO8
29-35
Application: The Recession of 2007-09
• Federal government undertook Keynesian policies• Tax rebate checks• $787 billion stimulus package
LO8
29-36
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