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28 The Aggregate Expenditures Model McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Assumptions and Simplifications • Use the Keynesian aggregate • • • LO1 expenditures model Prices are fixed GDP = DI Begin with private, closed economy • Consumption spending • Investment spending 28-2 Aggregate expenditures, C + Ig (billions of dollars) Equilibrium GDP 530 C + Ig (C + Ig = GDP) 510 490 470 450 Equilibrium point Aggregate expenditures C Ig = $20 billion 430 410 390 C = $450 billion 370 45° 370 390 410 430 450 470 490 510 530 550 Real domestic product, GDP (billions of dollars) LO1 28-3 Other Features of Equilibrium GDP • Saving equals planned investment • Saving is a leakage of spending • Investment is an injection of • LO2 spending No unplanned changes in inventories • Firms do not change production 28-4 Aggregate expenditures (billions of dollars) Changes in Equilibrium GDP (C + Ig)1 (C + Ig)0 (C + Ig)2 510 490 Increase in investment 470 Decrease in investment 450 430 45° 430 450 470 490 510 Real domestic product, GDP (billions of dollars) LO3 28-5 Adding International Trade • Include net exports spending in • • • LO4 aggregate expenditures • Private, open economy Exports create production, employment, and income Subtract spending on imports Xn can be positive or negative 28-6 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 LO4 450 470 490 510 Real domestic product GDP (billions of dollars) +5 0 -5 Positive net exports 450 470 Negative net exports Xn1 490 Xn2 Real GDP 28-7 International Economic Linkages • Prosperity abroad • Can increase U.S. exports • Exchange rates • Depreciate the dollar to increase • LO4 exports A caution on tariffs and devaluations • Other countries may retaliate • Lower GDP for all 28-8 Adding the Public Sector • Government purchases and • LO4 equilibrium GDP • Government spending is subject to the multiplier Taxation and equilibrium GDP • Lump sum tax • Taxes are subject to the multiplier • DI = GDP 28-9 Aggregate expenditures (billions of dollars) Government Purchases and Eq. GDP C + Ig + Xn + G C + Ig + X n C Government spending of $20 billion 45° 470 550 Real domestic product, GDP (billions of dollars) LO4 28-10 Aggregate expenditures (billions of dollars) Taxation and Equilibrium GDP C + Ig + Xn + G Ca + Ig + Xn + G $15 billion decrease in consumption from a $20 billion increase in taxes 45° 490 550 Real domestic product, GDP (billions of dollars) LO4 28-11 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 LO5 28-12 Aggregate expenditures (billions of dollars) Equilibrium versus Full-Employment AE0 AE1 530 510 Recessionary expenditure gap = $5 billion 490 Full employment 45° 490 510 530 Real GDP (a) Recessionary expenditure gap LO5 28-13 Aggregate expenditures (billions of dollars) Equilibrium versus Full-Employment AE2 530 Inflationary expenditure gap = $5 billion AE0 510 490 Full employment 45° 490 510 530 Real GDP (b) (billions of dollars) LO5 28-14
