ema atw108_ch29

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