1. The Aggregate Expenditures Model 28 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Assumptions and Simplifications Use the Keynesian aggregate expenditures model Prices are fixed GDP = DI Begin with private, closed economy Consumption spending Investment spending LO1 28-2

3. Equilibrium GDP 530 510 490 470 450 430 410 390 370 45° 370 390 410 430 450 470 490 510 530 550 Real domestic product, GDP (billions of dollars) Aggregate expenditures, C + I g (billions of dollars) C I g = $20 billion Aggregate expenditures C = $450 billion C + I g (C + I g = GDP) Equilibrium point LO1 28-3

4. Other Features of Equilibrium GDP Saving equals planned investment Saving is a leakage of spending Investment is an injection of spending No unplanned changes in inventories Firms do not change production LO2 28-4

5. Changes in Equilibrium GDP 510 490 470 450 430 45° 430 450 470 490 510 Real domestic product, GDP (billions of dollars) Aggregate expenditures (billions of dollars) Increase in investment (C + I g ) 0 Decrease in investment (C + I g ) 2 (C + I g ) 1 LO3 28-5

6. Adding International Trade Include net exports spending in aggregate expenditures Private, open economy Exports create production, employment, and income Subtract spending on imports X n can be positive or negative LO4 28-6

7. Net Exports and Equilibrium GDP Real GDP +5 0 -5 Net exports, X n (billions of dollars) Real domestic product GDP (billions of dollars) Aggregate expenditures (billions of dollars) 510 490 470 450 430 45° 430 450 470 490 510 Aggregate expenditures with positive net exports C + I g Aggregate expenditures with negative net exports C + I g +X n2 C + I g +X n1 X n1 X n2 Positive net exports Negative net exports 450470490 LO4 28-7

8. International Economic Linkages Prosperity abroad Can increase U.S. exports Exchange rates Depreciate the dollar to increase exports A caution on tariffs and devaluations Other countries may retaliate Lower GDP for all LO4 28-8

9. Adding the Public Sector Government purchases and equilibrium GDP Government spending is subject to the multiplier Taxation and equilibrium GDP Lump sum tax Taxes are subject to the multiplier DI = GDP LO4 28-9

10. Government Purchases and Eq. GDP 45° 470 550 Real domestic product, GDP (billions of dollars) Aggregate expenditures (billions of dollars) C Government spending of $20 billion C + I g + X n C + I g + X n + G LO4 28-10

11. Taxation and Equilibrium GDP 45° 490 550 Real domestic product, GDP (billions of dollars) Aggregate expenditures (billions of dollars) $15 billion decrease in consumption from a $20 billion increase in taxes C a + I g + X n + G C + I g + X n + G LO4 28-11

12. Equilibrium versus Full-Employment Recessionary expenditure gap Insufficient aggregate spending Spending below full-employment GDP Increase G and/or decrease T Inflationary expenditure gap Too much aggregate spending Spending exceeds full-employment GDP Decrease G and/or increase T LO5 28-12

13. Equilibrium versus Full-Employment Real GDP (a) Recessionary expenditure gap Aggregate expenditures (billions of dollars) 530 510 490 45° 490 510 530 AE 0 AE 1 Full employment Recessionary expenditure gap = $5 billion LO5 28-13

14. Equilibrium versus Full-Employment Real GDP (b) (billions of dollars) Aggregate expenditures (billions of dollars) 530 510 490 45° 490 510 530 AE 0 AE 2 Full employment Inflationary expenditure gap = $5 billion LO5 28-14