Aggregate Expenditures 10 C H A P T E R Aggregate Expenditures The Multiplier, Net Exports, and Government

CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Equilibrium GDP at Ig1 level of investment Equilibrium GDP at Ig0 level of investment 510 490 470 450 430 (C + Ig ) 1 (C + Ig ) 0 Increases in the level of C + Ig Private spending (billions of dollars) 45 o o 430 450 470 490 510 Real domestic product, GDP (billions of dollars)

CHANGES IN EQUILIBRIUM GDP at Ig2 level of investment AND THE MULTIPLIER Equilibrium GDP at Ig2 level of investment 510 490 470 450 430 (C + Ig ) 0 (C + Ig ) 2 Private spending (billions of dollars) Decreases in the level of C + Ig 45 o o 430 450 470 490 510 Real domestic product, GDP (billions of dollars)

Inverse relationship between THE MULTIPLIER EFFECT Multiplier = Change in Real GDP Initial Change in Spending Change in GDP = Multiplier x initial change in spending The Multiplier Effect and the Marginal Propensities Inverse relationship between Multiplier & MPS

= = x MPC and the Multiplier THE MULTIPLIER EFFECT or 1 Multiplier MPS Change in GDP = Multiplier x initial change in spending MPC and the Multiplier MPC Multiplier .9 .8 .75 .67 .5 10 5 4 3 2

INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT Net Exports Positive if exports > imports Negative if imports > exports Net Exports and Aggregate Expenditures C + Ig + ( X – M ) Xn = ( X – M ) C + Ig + Xn

INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT Net Export Schedule Net Exports and Equilibrium GDP Positive Net Exports Negative Net Exports Graphically…

INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT 510 490 470 450 430 Aggregate Expenditures with Positive Net Exports C + Ig + Xn1 C + Ig Private spending (billions of dollars) 45 o o 430 450 470 490 510 Real domestic product, GDP (billions of dollars) +5 -5 (billions of dollars) Net Exports, Xn Real GDP 430 450 470 490 510

INTERNATIONAL TRADE AND EQUILIBRIUM OUTPUT 510 490 470 450 430 Aggregate Expenditures with Negative Net Exports C + Ig C + Ig + Xn2 Private spending (billions of dollars) 45 o o 430 450 470 490 510 Real domestic product, GDP (billions of dollars) +5 -5 (billions of dollars) Net Exports, Xn Real GDP 430 450 470 490 510

INTERNATIONAL ECONOMIC LINKAGES Prosperity Abroad Tariffs Exchange Rates

GLOBAL PERSPECTIVE NET EXPORTS OF GOODS, 1999 Negative Net Exports Positive Net Exports Canada France Germany Italy Japan United Kingdom United States -400 -140 -100 -60 -20 20 60 100 Billions of Dollars Source: World Trade Organization

ADDING THE PUBLIC SECTOR Simplifying Assumptions Investment and Net Exports are Independent of the Level of GDP Government Purchases Do Not Affect Private Spending All Taxes are Personal Tax Collections are Fixed Unless Stated Otherwise, Price Level is Constant

ADDING THE PUBLIC SECTOR Government Purchases and Equilibrium GDP Government Spending of $20 Billion C + Ig + Xn + G C + Ig + Xn C Aggregate Expenditures (billions of dollars) 45 o o 470 550 Real domestic product, GDP (billions of dollars)

ADDING THE PUBLIC SECTOR Lump-Sum Tax and Equilibrium GDP $15 Billion Decrease in Consumption from a $20 Billion Increase in Taxes C + Ig + Xn + G Ca + Ig + Xn + G Aggregate Expenditures (billions of dollars) 45 o o 490 550 Real domestic product, GDP (billions of dollars)

ADDING THE PUBLIC SECTOR Injections Leakages Unplanned Changes in Inventories Balanced Budget Multiplier Recessionary Gap Inflationary Gap

FULL-EMPLOYMENT GDP Recessionary Gap Recessionary Gap = $5 Billion AE0 530 510 490 AE1 Recessionary Gap = $5 Billion Aggregate Expenditures (billions of dollars) Full Employment 45 o o 490 510 530 Real domestic product, GDP (billions of dollars)

FULL-EMPLOYMENT GDP Inflationary Gap Inflationary Gap = $5 Billion AE2 Inflationary Gap = $5 Billion AE0 530 510 490 Aggregate Expenditures (billions of dollars) Full Employment 45 o o 490 510 530 Real domestic product, GDP (billions of dollars)

The End of the Japanese Growth “Miracle” APPLICATIONS OF THE MODEL Great Depression Vietnam War Inflation The End of the Japanese Growth “Miracle”

Does Not Show Price-Level Changes LIMITATIONS OF THE MODEL Does Not Show Price-Level Changes Ignores Premature Demand-Pull Inflation Bars Real GDP Beyond Full-Employment Does Not Deal With Cost-Push Inflation

CHAPTER CONCLUSIONS

balanced-budget multiplier recessionary gap inflationary gap KEY TERMS multiplier net exports lump-sum tax balanced-budget multiplier recessionary gap inflationary gap BACK END Copyright McGraw-Hill/Irwin, 2002

AGGREGATE DEMAND AND AGGREGATE SUPPLY Coming Next: AGGREGATE DEMAND AND AGGREGATE SUPPLY CHAPTER 11