Chapter 28 - The aggregate expenditures model. In this chapter, you will learn to: 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.
Chapter 28 The Aggregate Expenditures Model McGrawHill/Irwin Copyright © 2009 by The McGrawHill 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 28-2 Model Simplifications • Private closed economy • Consumption and investment only • Prices are fixed • Excess capacity exists • Unemployed labor exists • Disposable income = real GDP – No taxes 28-3 Model Simplifications • Investment demand vs schedule Investment Demand Curve 20 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) 28-4 Equilibrium GDP • Real GDP = C + Ig • Aggregate expenditures – Equal to C + Ig – Aggregate expenditures schedule • Quantity goods produced = quantity goods purchased • Disequilibrium – Only equilibrium level of GDP 28-5 Equilibrium GDP (2) Real (7) (8) Domestic (3) (5) (6) Unplanned Tendency of Output Con(1) (4) Investment Aggregate Changes inEmployment, (and sump(Ig) Employ- Income) tion Saving (S) Expenditures Inventories Output, and (C+Ig) ment (GDP=DI) (C) (1) – (2) (+ or -) Income …in Billions of Dollars In millions (1) 40$370 $375 $-5 20 $395 $-25 Increase (2) 45 390 390 20 410 -20 Increase (3) 50 410 405 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 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 28-6 Equilibrium GDP 530 Consumption (billions of dollars) 510 (C + Ig = GDP) 490 Equilibrium Point 470 Aggregate Expenditures 450 430 C + Ig C Ig = $20 Billion 410 390 370 C = $450 Billion 45° 370 390 410 430 450 470 490 510 530 550 Disposable Income (billions of dollars) 28-7 Equilibrium GDP • Saving equals planned investment – Leakage – Injection • No unplanned inventory changes 28-8 Aggregate Expenditures (billions of dollars) Changes in Equilibrium GDP (C + Ig)1 (C + Ig)0 (C + Ig)2 510 490 Increase in Investment by 470 Decrease in Investment by 450 The Multiplier Effect 430 45° 430 450 470 490 510 Real GDP (billions of dollars) 28-9 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 28-10 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 470 Aggregate Expenditures with Negative Net Exports 450 430 45° Net Exports Xn (billions of Dollars) 430 +5 -5 450 470 490 510 Real GDP (billions of dollars) Positive Net Exports 450 470 Negative Net Exports 490 Xn1 Xn2 Real GDP 28-11 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 50 100 150 200 250 Source: World Trade Organization 28-12 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 = I g + X + G 28-13 Adding the Public Sector (1) (5) Level of (7) Net Exports (2) Output (Xn) Aggregate (4) and Consump(6) (3) Investment Exports Imports Government Expenditures Income tion (C+Ig+Xn+G) (Ig) Saving (S) (GDP=DI) (C) (G) (X) (M) (2)+(4)+(5)+(6) …in Billions of Dollars (1) $370 $375 $-5 $20 10 10 20 $415 (2) 390 390 20 10 10 20 430 (3) 410 405 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 28-14 Aggregate Expenditures (billions of dollars) Government Spending Effect C + I g + Xn + 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) 28-15 Aggregate Expenditures (billions of dollars) Lump Sum Tax Effect C + I g + Xn + 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) 28-16 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 490 470 Full Employment 45° 490 510 530 Real GDP (billions of dollars) 28-17 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 510 490 470 Full Employment 45° 490 510 530 Real GDP (billions of dollars) 28-18 The Complete Model • GDP and full employment • Multiplier effects – Government spending – Lump sum taxes • Recessionary gap – Policy options • Inflationary gap – Demand pull inflation 28-19 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 28-20 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 28-21 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 28-22 Next Chapter Preview… Aggregate Demand and Aggregate Supply 28-23 ... Exports +31 Canada France -4 5 Japan +70 Italy -2 7 +203 Germany United Kingdom -1 71 -8 81 -7 00 United States 200 150 100 50 50 100 150 200 250 Source: World Trade Organization 2 8- 12 Adding the Public... (+ or -) Income …in Billions of Dollars In millions (1) 40$370 $375 $-5 20 $395 $-2 5 Increase (2) 45 390 390 20 410 -2 0 Increase (3) 50 410 405 20 425 -1 5 Increase (4) 55 430 420 10 20 440 -1 0... inventories net exports lump-sum tax recessionary expenditure gap inflationary expenditure gap 2 8- 22 Next Chapter Preview… Aggregate Demand and Aggregate Supply 2 8- 23