The Aggregate Expenditures Model 10 C H A P T E R The Aggregate Expenditures Model

Aggregate Expenditures Model Simplifications... A Private Closed Economy Defer Government & Taxes Defer Exports and Imports Real GDP = DI Excess Production Capacity Unemployed Labor Exists More Aggregate Expenditures Doesn’t Affect Price Level

INVESTMENT DEMAND & SCHEDULE Real Domestic Product, GDP Curve Investment Schedule Ig 20 (billions of dollars) Investment Expected rate of return, r, and real interest rate, i (percents) 8 20 20 I D 20 Investment (billions of dollars) Real Domestic Product, GDP (billions of dollars)

GDP = C + Ig EQUILIBRIUM GDP Real Domestic Output Aggregate Expenditures Schedule Equilibrium GDP GDP = C + Ig Disequilibrium Graphical Analysis…

EQUILIBRIUM GDP Ig = $20 Billion C =$450 Billion (C + I g = GDP) $530 510 490 470 450 430 410 390 370 Equilibrium C Ig = $20 Billion Private spending, C + I g (billions of dollars) C =$450 Billion 45 o o 370 390 410 430 450 470 490 510 530 550 Real domestic product, GDP (billions of dollars)

EQUILIBRIUM GDP Saving and Planned Investment are Equal Leakage Injection No Unplanned Changes in Inventories Above Equilibrium Below Equilibrium Actual Investment

CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Equilibrium GDP at Ig0 leveEquilibrium GDP at Ig1 level of investmentl 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)

INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES 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 AGGREGATE EXPENDITURES Net Export Schedule Net Exports and Equilibrium GDP Positive Net Exports Negative Net Exports Graphically…

INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES 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 AGGREGATE EXPENDITURES 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, 2001 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 Government Purchases do not Affect Consumption and Investment Spending All Taxes are Personal Tax Collections are Fixed Graphically…

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)

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)

Unplanned Changes in Inventories Recessionary Gap Inflationary Gap FULL-EMPLOYMENT GDP Injections Leakages Unplanned Changes in Inventories Recessionary Gap Inflationary Gap

U.S. Inflation in the Late 1980s APPLICATIONS OF THE MODEL U.S. Recession of 2001 U.S. Inflation in the Late 1980s

Does Not Show Price-Level Changes LIMITATIONS OF THE MODEL Does Not Show Price-Level Changes Ignores Premature Demand-Pull Inflation Limited Real GDP to the Full-Employment Level Does not Deal with Cost-Push Inflation Does not Allow for “Self-correction”

aggregate expenditures schedule equilibrium GDP leakage injection KEY TERMS planned investment investment schedule aggregate expenditures schedule equilibrium GDP leakage injection unplanned changes in inventories net exports lump-sum tax recessionary gap inflationary gap BACK END Copyright McGraw-Hill/Irwin, 2005

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