2. Aggregate expenditures & aggregate demand Chapters 10 and 11

3. Aggregate Expenditures approach Simplifications –Closed private economy –GDP=DI –No exports, Gov’t –Aggregate expenditures doesn’t impact price

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

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

6. CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Private spending (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 510 490 470 450 430 430 450 470 490 510 (C + I g ) 0 (C + I g ) 1 Equilibrium GDP at I g0 level of investment Equilibrium GDP at I g1 level of investment Increases in the level of C + I g

7. CHANGES IN EQUILIBRIUM GDP AND THE MULTIPLIER Private spending (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 510 490 470 450 430 430 450 470 490 510 Equilibrium GDP at I g2 level of investment (C + I g ) 0 (C + I g ) 2 Decreases in the level of C + I g

8. INTERNATIONAL TRADE AND AGGREGATE EXPENDITURES Private spending (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 510 490 470 450 430 430 450 470 490 510 Aggregate Expenditures with Negative Net Exports C + I g C + I g + X n2 Net Exports, X n (billions of dollars) +5 0 -5 430 450 470 490 510 Real GDP

9. ADDING THE PUBLIC SECTOR Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 470 550 C C + I g + X n C + I g + X n + G Government Spending of $20 Billion Government Purchases and Equilibrium GDP

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

11. FULL-EMPLOYMENT GDP Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 490 510 530 AE 0 Recessionary Gap AE 1 530 510 490 Recessionary Gap = $5 Billion Full Employment

12. FULL-EMPLOYMENT GDP Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 490 510 530 AE 0 Inflationary Gap AE 2 530 510 490 Inflationary Gap = $5 Billion Full Employment

13. PROBLEMS WITH AGGREGATE EXPENDITURES APPROACH 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”

14. Defined: Amounts of Real Output Buyers Collectively Desire At Each Possible Price Level AGGREGATE DEMAND Aggregate Demand Curve Down Sloping Due To: Real-Balances Effect Interest-Rate Effect Foreign Purchases Effect Graphically…

15. AGGREGATE DEMAND CURVE Price level Real domestic output, GDP AD

16. Shifts in Aggregate Demand Caused by Non-Price Level Factors Factors that Shift the Curve

17. Change in Consumer Spending Consumer Wealth Consumer Expectations Household Indebtedness Taxes

18. Change in Investment Spending Interest Rates Profit Expectations Business Taxes Technology Degree of Excess Capacity

19. Change in Government Spending Desire to add or deduct from government supported programs.

20. Net Export Spending Increased exports----Increased AD Based on 1- national income abroad 2-exchange rates

21. AGGREGATE SUPPLY Defined: Levels of Real Domestic Output At Each Possible Price Level Long-run Supply Curve Wages and Resource Prices Match Price Level Short-run Supply Curve Wages and Resource Prices Do Not Match Price Level

22. AGGREGATE SUPPLY Price level Real domestic output, GDP Q P Long Run AS LR Long-run Aggregate Supply QfQf Full-Employment

23. AGGREGATE SUPPLY Price level Real domestic output, GDP Q P Short Run AS Aggregate Supply Short-run QfQf Full- Employment

24. Shifts in Aggregate Supply Caused by Non-Price Level Factors Factors that Shift the Curve

25. Change in Input Prices Domestic Resource Availability Prices of Imported Goods Market Power

26. Change in Productivity Effect of Training Programs Technology Gains

27. Change in Legal-Institutional Environments Business Taxes Business Subsidies Government Regulation

28. Price Level Real Domestic Output, GDP Q P AS AD 510502514 EQUILIBRIUM AND CHANGES IN EQUILIBRIUM 92 100 ab Equilibrium Real Output

29. Price Level Real Domestic Output, GDP Q P AS AD 1 INCREASES IN AD: DEMAND-PULL INFLATION P2P2 P1P1 AD 2 QfQf Q1Q1 Q2Q2

30. Price Level Real Domestic Output, GDP Q P AS AD 1 DECREASES IN AD: RECESSION & CYCLICAL UNEMPLOYMENT P1P1 AD 2 QfQf Q1Q1 a c b

31. Ratchet Effect At full employment AD declines –GDP declines but price does not –“sticky” prices Wage contracts Efficiency wages Min. wage Menu cost Fear price wars

32. Price Level Real Domestic Output, GDP Q P AS 1 AD 1 DECREASES IN AS: COST-PUSH INFLATION P2P2 QfQf Q1Q1 a b AS 2 P1P1

33. Price Level Real Domestic Output, GDP Q P AS 1 AD 1 INCREASES IN AS: FULL EMPLOYMENT P1P1 Q2Q2 Q1Q1 a b AS 2 P2P2 …With Price-Level Stability AD 2 P3P3 Q3Q3