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Chapter 11
The Aggregate
Expenditures
Model
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• Aggregate expenditures for a private
closed economy
• Characteristics of equilibrium real
GDP in a private closed economy
• Changes in equilibrium real GDP
and the multiplier
• Adding the government and
international sectors
• Recessionary and inflationary
expenditure gaps
11-2
Model Simplifications
• Private closed economy
• Consumption and investment
only
• Prices are fixed
• Excess capacity exists
• Unemployed labor exists
• Disposable income = real GDP
–No taxes
11-3
Model Simplifications
• Investment demand vs. schedule
Investment
Demand
Curve
8
20
ID
20
Investment (billions of dollars)
Investment Schedule
Investment (billions of dollars)
r and i (percent)
Investment Demand Curve
Investment
Schedule
20
Ig
Real GDP (billions of dollars)
11-4
Equilibrium GDP
• 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
11-5
Equilibrium GDP
(2)
Real
(7)
(8)
Domestic (3)
(5)
(6)
Unplanned Tendency of
Output Con(1)
(4)
Investment Aggregate Changes inEmployment,
(and sumpEmploy- Income) tion Saving (S)
(Ig)
Expenditures Inventories Output, and
ment (GDP=DI) (C)
(1) – (2)
(C+Ig)
(+ or -)
Income
…in Billions of Dollars
In millions
(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
11-6
Equilibrium GDP
530
(C + Ig = GDP)
Consumption (billions of dollars)
510
Equilibrium
Point
490
470
450
C + Ig
C
Aggregate
Expenditures
Ig = $20 Billion
430
410
390
C = $450 Billion
370
45°
370 390 410 430 450 470 490 510 530 550
Disposable Income (billions of dollars)
11-7
Equilibrium GDP
• Saving equals planned
investment
–Leakage
–Injection
• No unplanned inventory
changes
11-8
Aggregate Expenditures (billions of dollars)
Changes in Equilibrium GDP
(C + Ig)1
(C + Ig)0
(C + Ig)2
510
490
Increase in
Investment by 5
Decrease in
Investment by 5
470
450
The
Multiplier
Effect
430
45°
430
450
470
490
510
Real GDP (billions of dollars)
11-9
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
11-10
Net Exports and
Equilibrium GDP
C + Ig+Xn1
C + Ig
C + Ig+Xn2
Aggregate Expenditures
(billions of dollars)
510
Aggregate
Expenditures
490 with Positive
Net Exports
Aggregate
Expenditures
with Negative
Net Exports
470
450
430
45°
Net Exports Xn
(billions of
Dollars)
430
450
470
490
510
Real GDP (billions of dollars)
+5
0
-5
Positive Net Exports
450
470
Negative Net Exports
490
Xn1
Xn2
Real
GDP
11-11
Net Exports of Goods
Select Nations, 2006
Negative Net Exports
Positive Net Exports
+31
Canada
France
-45
Japan
+70
Italy
-27
+203
Germany
United Kingdom
-171
-881
-700
United States
200
150
100
50
0
50
Source: World Trade Organization
100
150
200
250
11-12
Adding the Public Sector
• GDP = Cd + Ig + Xn + G
• Lump sum taxes
–Taxes affect disposable income
–Consumption and the MPC
• Leakages = Sd + M + T
• Injections = Ig + X + G
• Sd + M + T = Ig + X + G
11-13
Adding the Public Sector
(1)
(5)
Level of
(7)
Net Exports
(2)
Output
(Xn)
Aggregate
(4)
(6)
Consumpand
(3)
Investment Exports Imports Government Expenditures
tion
Income
(C+Ig+Xn+G)
Saving (S)
(Ig)
(G)
(C)
(GDP=DI)
(X)
(M)
(2)+(4)+(5)+(6)
…in Billions of Dollars
(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
11-14
Aggregate Expenditures (billions of dollars)
Government Spending Effect
C + Ig + X n + G
C + Ig + X n
C
Government
Spending of
$20 Billion
$20 Billion Increase
in Government
Spending Yields an
$80 Billion Increase
In GDP
45°
470
550
Real GDP (billions of dollars)
11-15
Aggregate Expenditures (billions of dollars)
Lump Sum Tax Effect
C + Ig + X n + 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
45°
490
550
Real GDP (billions of dollars)
11-16
Recessionary Expenditure Gap
GDP is below full employment
Aggregate Expenditures
(billions of dollars)
550
530
510
AE0
AE1
$5 Billion
Gap Yields
$20 Billion
GDP
Change
Recessionary
Expenditure
Gap = $5 Billion
490
Full
Employment
470
45°
490
510
530
Real GDP (billions of dollars)
11-17
Inflationary Expenditure Gap
GDP is above full employment
AE2
Aggregate Expenditures
(billions of dollars)
550
530
AE0
Inflationary
Expenditure
Gap = $5 Billion
$5 Billion
Gap Yields
$20 Billion
GDP
Change
510
490
Full
Employment
470
45°
490
510
530
Real GDP (billions of dollars)
11-18
The Complete Model
• GDP and full employment
• Multiplier effects
–Government spending
–Lump sum taxes
• Recessionary gap
–Policy options
• Inflationary gap
–Demand pull inflation
11-19
Application
• U.S. economy late 1990’s
–Too much investment
–Stock market bubble
–Consumer debt
–Fraudulent business practice
• Aggregate expenditure falls
• U.S. recession of 2001
• Terror attacks prolonged
recession
11-20
The Great Depression
• Classical economics
– Mills and Ricardo
– Prices adjust to maintain full
employment
• Say’s Law
– Supply creates its own demand
• Depression challenged the theory
• New theory developed
– Keynes
– Aggregate expenditure model
11-21
Key Terms
•
•
•
•
•
•
•
•
•
•
•
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
11-22
Next Chapter Preview…
Aggregate Demand
and Aggregate Supply
11-23