Ch 9.The Aggregate Expenditures Model

(a) The investment demand curve and (b) the investment schedule a)The level of investment spending ($20 bill) is determined by the interest rate (8%) together with the investment demand curve (ID). b)The investment schedule (Ig) relates the amount of investment ($20 bill) determined in (a) to the various levels of GDP (set amount/constant).

A.Equilibrium GDP: (GDP = C + Ig). Savings equals planned investment (S=Ig). B.Planned investment – amount firms plan to invest. C.Investment schedule – shows amount firms plan to invest at possible values of real GDP. D.Aggregate expenditures schedule – shows total amount spent on final goods/ services at diff. levels of real GDP.

Aggregate Expenditure is a measure of national income. It is a way to measure the total GDP or Gross Domestic Product (A measure of the level of economic activity). It is defined as the value of planned goods and services produced in an economy. GDP is calculated by the formula C + I + G + N X C = Consumption Expenditure (Also written as CE) I = Investment (Ip + Iu planned + unplanned) G = Government spending N X = Net exports (Exports-Imports) Aggregate Expenditures is defined as C + Ig. -- John Maynard Keynes (pronounced Caines) developed the Aggregate Expenditures Model, aka the ‘Keynesian Model’ or ‘Keynes Cross.’ -- The amount of goods & services produced and therefore the level of employ- ment depend directly on the level of aggregate expenditures (total spending).

 John Maynard Keynes – British economist favored the heavy gov’t spending during a recession, even running a deficit, to jumpstart the economy (Keynesian economics). Keynes appeared on Dec 31, 1965 edition of TIME magazine. Keynes ideas, called Keynesian economics, had a major impact on the Great Depresison and modern economic / political theory as well as on many gov’ts' fiscal policies. He advocated Interventionist gov’t policy, by which the gov’t would use fiscal and monetary measures to mitigate the adverse effects of economic recessions, depressions and booms. He is one of the fathers of modern theoretical macroeconomics. Keynes argued that the solution to depression was to stimulate the economy ("inducement to invest") through some combination of two approaches :  A reduction in interest rates.  Government investment in infrastructure.

Consumption and Investment (1)40 (2)45 (3)50 (4)55 (5)60 (6)65 (7)70 (8)75 (9)80 (10)85 $ $ $ $ Increase Equilibrium Decrease $ (2) Real Domestic Output (and Income) (GDP=DI) (3) Con- sump- tion (C) (4) Saving (S) (1-2) (5) Investment (I g ) (6) Aggregate Expenditures (C+I g ) (7) Unplanned Changes in Inventories (+ or -) (8) Tendency of Employment Output and Income (1) Employ- ment Graphically… …in Billions of Dollars The table shows 10 possible levels of production.

° Disposable Income (billions of dollars) Consumption (billions of dollars) Consumption and Investment Equilibrium GDP C I g = $20 Billion Aggregate Expenditures C = $450 Billion C + I g (C + I g = GDP) Equilibrium Point The Keynesian Model (Keynes Cross) showing the Aggregate Expenditure Model

Equilibrium GDP: C + Ig = GDP Aggregate expenditures – in a closed economy, AE consists of C (col 3) + I (col 5) = sum in col 6. Col 2 makes the AE schedule (GDP=DI). Aggregate expenditures – in a closed economy, AE consists of C (col 3) + I (col 5) = sum in col 6. Col 2 makes the AE schedule (GDP=DI). The schedule shows the amount (C+Ig) that will be spent at each possible output or income level. The schedule shows the amount (C+Ig) that will be spent at each possible output or income level. Equilibrium GDP where GDP (DI) & AE columns are equal (col. 2 and 6, are each $470 bill). Equilibrium GDP where GDP (DI) & AE columns are equal (col. 2 and 6, are each $470 bill).

Changes in the equilibrium GDP caused by shifts in the aggregate expenditures schedule and the investment schedule Aggregate expenditures Real domestic product, GDP Increase in investment Decrease in investment Equilibrium Graph Equilibrium point C+Ig C ● 470 The Keynes Cross showing the Aggregate Expenditure Model

If the amount invested increased by $5 billion, that increase will shift the graph upward. If the amount invested increased by $5 billion, that increase will shift the graph upward. $5 billion Δ in investment spending leads to $20 billion Δ in output & income (income is Y). $5 billion Δ in investment spending leads to $20 billion Δ in output & income (income is Y). Multiplier is 4 (= $20/$5). Multiplier is 4 (= $20/$5). MPS is.25 MPS is.25 Δ in output & income E.Multiplier: Δ in output & income Δ in investment spending

In an open-mixed economy, equilibrium GDP occurs where: C a +I g +X n +G=GDP In an open-mixed economy, equilibrium GDP occurs where: C a +I g +X n +G=GDP

Net exports and equilibrium GDP Net exports are exports minus imports.

Gov’t spending and equilibrium GDP Aggregate expenditures Real GDP Gov’t spending increase a b c ● d ● e -- In a private closed economy, the APC is equal to 1 at what income level? -- If AE are Ca+Ig+Xn+G, the amount of savings at $225 are what points? Point ‘a’ Points ‘c and d”

Equilibrium Versus Full-Employment GDP Recessionary Expenditure Gap Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) ° AE 0 AE 1 Full Employment Recessionary Expenditure Gap = $5 Billion $5 Billion Gap Yields $20 Billion GDP Change

Equilibrium Versus Full-Employment GDP Inflationary Expenditure Gap Real GDP (billions of dollars) Aggregate Expenditures (billions of dollars) ° AE 0 AE 2 Full Employment Inflationary Expenditure Gap = $5 Billion $5 Billion Gap Yields $20 Billion GDP Change

F.Lump-sum tax – tax that’s a constant amount at all levels of GDP. G.Recessionary gap – amount the agg expenditures schedule must shift upward to increase real GDP to full-employment. H.Inflationary gap – amount the agg expenditures schedule must shift downward to decrease real GDP to full- employment. Opposites